The video games industry’s revenue model has evolved markedly in recent times, but investors’ pricing of the sector has failed to keep pace.
The scale of the opportunity is well documented. There are now more than 2.4 billion gamers worldwide, according to market researcher Newzoo, which suggests that in 2019 the total global games market will generate revenue of $148 billion (£115 billion), with mobile contributing nearly half this.
But much less understood is the scale of the impact of companies’ pivoting
away from one-off purchases to subscription and freemium models on their revenue streams.
Jeremy Gleeson, manager of the Axa Framlington Global Technology fund, likens the shift to a Netflix-like model and believes that it will generate far greater revenues for gaming firms
‘Valuations have not moved to reflect online subscriptions, and are still based on retail sales,’ he said.
‘Publishers can now take more of the profits, as they don’t have to share them with a retailer. They can also gain much more data on gamers in the process.’
Tech giants Apple and Google have recently branched into the gaming subscription model with their Arcade and Stadia services, and this may provide even greater revenues for publishers if their games appear on these platforms.
Fortnite’s franchise challenge
The huge success of the Fortnite franchise, which was launched in 2017 and passed 250 million players in March, has been a watershed moment for the gaming industry.
The game, which is owned by Epic Games in which Tencent has a 40% stake, generates revenue via microtransactions, rather than a one-off sale.
Chris Ford, who runs Smith & Williamson’s Artificial Intelligence fund, says that Fortnite ‘changed everything’ in terms of the business model for games developers, saying the industry responded accordingly, with large gaming franchises launching their own freemium titles.
Activision Blizzard, which Gleeson backs, owns the Call of Duty and World of Warcraft franchises and launched a mobile version of Call of Duty in October that is free to play. Another of his holdings, EA, also launched a freemium console game, Apex Legends, that is a direct competitor to Fortnite.
Ford, who has a 2% allocation to Activision Blizzard, believes the firm is ‘reasonably well diversified’ across several large franchises which include the Overwatch and Diablo series.
He adds that he felt the company’s purchase of Candy Crush in 2015 was a ‘smart acquisition’, as the game is highly cash generative and brought on board a development team that had the ‘best possible understanding of mobile gaming’.
Since the start of the year, Activision Blizzard’s shares are up 14.9%, while EA’s have risen by 22.1%.
Despite some forays into mobile, the traditional games developers are still mainly focused on consoles.
A new console cycle is set to kick off next year with new generations of Playstation and Xbox incarnations due to be launched.
‘The new console cycle will be good for developers, but there may be a time lag due to consumers spending a lot of cash on new hardware rather than new games,’ Gleeson said.
‘This is where the large evergreen franchises like Call of Duty and Fifa are really powerful, as gamers are still likely to buy them over taking a chance on a new franchise.’
Gotta catch ‘em all
Despite mobile now accounting for nearly half of the global market, traditional firms such as Nintendo have continued to thrive. The Japanese firm has been boosted by the success of its Switch console, which shipped nearly five million units in the second quarter, up 50% from a year ago.
Nintendo is the second largest holding in Lindsell Train’s Japanese Equity fund, with a 9% allocation. The fund has held the company since 2008 and since the start of the year it has risen by 43%.
Lindsell Train’s Citywire AA-rated Michael Lindsell notes that Nintendo’s release of its budget Switch Lite console in September achieved ‘somewhat underwhelming’ sales, causing its share price to weaken of late, however.
‘The Lite’s ultimate success will be measured by future software sales. The release of Pokémon titles in November will be an important catalyst, as will year-end sales generally,’ he said.
‘Beyond the oncoming year-end sales season, Nintendo hopes to release the Switch in China in partnership with Tencent, but no date is fixed.’
Pokemon Go and Mario Kart Tour have pushed Nintendo into mobile
Nintendo itself has recently entered into the mobile gaming market in a bid to diversify its revenue streams. Mario Kart Tour was released in September, giving players the option to subscribe to premium features for £4.99 a month.
Lindsell also invests in developer Square Enix, holding a 5.3% allocation. He notes that the company was one of the top performers in the fund in September, rising in value by 24%. Much of its success was due to the launch of mobile game Dragon Quest Walk, which hit the top of the iOS games charts.
The firm is also relaunching its Final Fantasy VII game next year for modern consoles and Lindell believes that with a strong pipeline of games, Square Enix is undervalued compared with its US peers.