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Are video gaming stocks still investable?

26022019_Video games

Are video gaming stocks still investable?

One industry that the Montgomery Global team has followed with some interest, and previously invested in, is the video game publishing industry.

Over the last several years, the once uneventful and decidedly unglamorous group of video game publisher stocks have gone on an absolute tear as the industry transformed from selling boxed games to hardcore gamers at $60 a pop to selling subscriptions, microtransactions, virtual loot and advertising to anyone with a smartphone or other computing device. But what goes up exponentially must come down, and these video gaming stocks provide investors with yet another warning against succumbing to greed and the fear of missing out.

The extreme volatility of video gaming stocks

Since 2015, stocks such as Activision Blizzard (ATVI), Electronic Arts (EA), Take-Two Interactive (TTWO) and Ubisoft Entertainment (UBI) have tripled, quadrupled and even sextupled before crashing by up to 50 per cent from their peaks in mid-2018. As far as the cycle of greed and fear goes, this basket of video game publishers has been far more extreme than the often talked-about FAANG stocks.

The structural tailwinds to the bull thesis were benign enough – the shift to AAA mega-franchises that could be capitalised (similar to the tentpole franchises in Hollywood), the proliferation of smartphones and rise of casual gaming, the increasing willingness to pay for quality content, and the phenomenon of watching other people play games on streaming platforms such as YouTube and Twitch.tv – which underpins a vast e-sports opportunity. But somewhere along the line, investors lost sight of two fundamental facts: i) the nature of growth is incremental, which is to say that next year requires a repeat of this year, plus more; and ii) as with all forms of digital entertainment, the consumer has a short attention span.

ATVI  the poster boy of the extreme rise and subsequent collapse of the video game publishing stocks

ATVI had a tremendous year in 2016 with the success of its team-based shooter Overwatch, the acquisition of Candy Crush developer King, plus better than expected monetisation of previous Call of Duty titles through microtransactions and virtual loot. ATVI established the Overwatch League, the world’s first professional e-sports league, and King’s 300 million-plus monthly active players offered a lucrative mobile advertising opportunity. Investors seemingly extrapolated this strong performance into perpetuity, forgetting that growth is incremental (even more players need to spend even more time playing and more money on virtual items every year hereafter) and ascribing ludicrous valuations to these adjacent opportunities. By our estimates, the market was valuing the nascent e-sports and advertising opportunities in excess of $20 billion at the peak.

The stock price inevitably collapsed once it became evident that strong, sustained growth was not forthcoming, and players were losing interest in the Overwatch, Call of Duty and Destiny titles (consumers have short attention spans). Our current valuation of ATVI is largely unchanged from our initial valuation in late 2016, yet the stock price has doubled and halved in the interim. This raises the question in the title – is ATVI, and video game publishers more broadly, still investable after their recent price declines?

Are video game publishers still investable? 

The answer is not so straightforward. As value investors, we get excited when stocks we want to buy get cheaper, and we have been waiting patiently for a while for ATVI to get cheaper. However, the environment has changed, and old structural tailwinds are no longer. The relentless rise of Fortnite, and more recently the sudden emergence of Apex Legends (an EA-published game that attracted 25 million registered players in one week), has changed the equation for gamers, developers/publishers and investors. The younger generation of gamers don’t view Fortnite as a game, but rather a virtual social platform and thus other games must compete (and mostly fail) against Fortnite on this basis. Publishers must develop and release the “best of the best” AAA titles in order to build growing communities around their franchises and it is not apparent to us that ATVI, or any publisher for that matter, can consistently release top-rated AAA games. And investors must be extremely cautious when capitalising any game franchise in their valuation models, even AAA franchises that generate substantial recurring revenue from in-game transactions and loot.

For ATVI specifically, the e-sports opportunity may also not be fully realised. As the Overwatch League enters its second year, interest in the game is waning. Such a league structure has never been tested before, and unlike sports such as basketball or football, video games have historically not had the greatest longevity. As casual players move on to other games, viewership of the league, and thus advertising dollars and team revenues, may decline.

Ultimately, whether video game publishers are now cheap or un-investable is up for each individual investor to decide. What is important is to not let greed or the fear of missing out influence the decision – investors who let their thesis and valuations drift upwards with the share price have been burnt once before.

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Daniel Wu is a Research Analyst at MGIM. Prior to joining MGIM in June 2016, Daniel was an analyst in the investment banking divisions of UBS and Goldman Sachs, where he covered the Infrastructure, Utilities, Technology and Media sectors.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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3 Comments

  1. With respect, have you played the games they sell ?

    You really should read some of the comments on the gaming platforms about some of these companies, and understand the sub-culture behind the games.

    How the hardcore, Gen-X and older gamers HATE the inclusion of microtransactions, because it essentially means that anyone relatively new (disparagingly called “kiddies” and “noobs”) can unlock everything (for a price) which used to take hours of “grinding” to get and unlock, there were no shortcuts, and this just annoys people. UbiSoft got absolutely canned for the same in Assassin’s Creed.

    Also, the way that games “jump the shark” (Happy Days reference) by adding in ridiculous things. GTA Online is a great example of this. Call of Duty used to be great until MW4 and Black Ops (CoDBlops), but it got silly when it became 3 and 4…it’s like “Rocky 5″…how long can it go on ?

    They also dropped the ball with later titles in the series, especially the way they remastered CoD MW and still charged players…”Yeah lets pay £11 for 4 maps that came FREE and INCLUDED with the original” said one reviewer on Steam.

  2. Gaming companies are only as good as their last game (ha), and to speak with reference to ATVI they are a long way between quality titles. Overwatch is an outstanding player versus player experience but as a gamer myself it doesn’t have the longevity that other Blizzard titles have had. The experience of watching the Overwatch esport, even as a player, is lackluster, and I am not convinced it will prove successful for the company moving forward.

    Destiny has evidently been a complete flop commercially and was a very ordinarily game, and it is unsurprising that ATVI are choosing to move away from the IP. World of Warcraft continues to bleed subscriptions and is ever reliant on milking cash from its users through in-game cash shops, rather than its original focus of providing a great experience. My view is these strategies will only last so long before players wise-up and become more sophisticated consumers.

    The release of World of Warcraft: Classic wasn’t even mentioned on the recent earnings call but I think it will provide a useful insight into what Blizzard fans think of the current philosophy of the Blizzard development/management team. A highly successful launch of WoW: Classic will represent a repudiation of Blizzard’s current games and will send a signal that people would rather play a 15 year old game over the current (mediocre) offerings.

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