Revenge of the Nerds
Video Games are Replacing Hollywood
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What if I told you that out of the top FOUR most-viewed US Sporting events of 2018, THREE of them were not “Sports” events at all.
They were esports events.
And only the Super Bowl was bigger…
Gaming is now the fastest-growing form of entertainment globally.
It has graduated from the basement to the stadium.
Nerds have become heroes and hobbies have become billion dollar businesses.
Kids don’t know who Larry Bird, Wilt Chamberlain, or Bobby Orr are. But mention the names Ninja, Shroud, or Dr. Disrespect and their eyes light up.
They don’t want to go to baseball camp, they want to go to Minecraft camp.
And while esports is a great buzzword, it’s only a sliver of the vast empire of Video Games. Albeit one of the fastest growing.
To add fuel to the fire, last week Epic (creator of Fortnite) announced a $1B investment at a US$27.8B valuation.
Also last week, a Chinese video game company created a 1,500 drone QR code to celebrate the first anniversary of its release. Clever!
In my last newsletter, I covered why I like sports betting because it adds a layer of interactivity (two-way) in an otherwise linear (one-way) entertainment medium.
Think of video games as that concept on steroids with significantly more monetizable moments!
Also, a couple months back, I did a deep dive on gaming platform Roblox and how its virtual economy is exploding. They IPO’d and the stock is up +50% from its reference price. Check it out here!
This week let’s break down VIDEO GAMES in <5 mins:
Why Video Games? 👉 Shifting Consumption Patterns
Market 👉 Size, Players, Catalysts
Profitability 👉 Free-to-play, Platforms?
Esports 👉 Cool piece of the puzzle (but not the whole picture)
How Grit’s Playing it 👉 Long-time “Enthusiastic” holder of this one + Picks and Shovel Business.
1. Why Video Games? 👉 Shifting Consumption Patterns
Video games have been around since the 1950s and have advanced from Pong on the Atari to the modern-day, cross-device cultural phenomenon of Fortnite (if you have kids, or generally… the internet, you know what this is).
With this evolution, video games have progressed from a leisurely pastime into a vibrant, inclusive and lucrative ecosystem.
While hardcore gamers are a subset of the ecosystem, there are a lot of casual gamers out there as well. People “log on” and “drop in” to hang and chat with their friends and they just HAPPEN to be playing a video game.
In community building, the “third place” is a social surrounding other than home and work. In the physical world, Howard Shultz set out for Starbucks to be this place. But I believe it now exists online in the social and gaming environment, particularly today when our office and home worlds have converged. We are desperate for an escape!
Die-hard entertainment industry veterans like to call this a Metaverse. They also like to get very upset if you call something a Metaverse that is not indeed a Metaverse…
Without enraging the people of Twitter, I’ll just give you Wikipedia’s definition so you can’t yell at me.
“The Metaverse is a collective virtual shared space, created by the convergence of virtually enhanced physical reality and physically persistent virtual space, including the sum of all virtual worlds, augmented reality, and the Internet.”
Pretty Cool. Sounds like a lot of things tie in here…Gaming, NFTs, crypto, AR/VR, etc…
If you’ve ever seen the movie “Ready Player One”, that’s kind of it. Where you create a virtual character, and you do really cool things in that virtual world through that character.
This virtual world can also have its own economy (Robux on Roblox) that has incentive and consequence structures built into it.
It also has experiences that span across genres - like music or movies within the universe. For example when musicians Travis Scott and Marshmellow held concerts within a Fortnite game, the Marshmello concert had 10.7MM LIVE views and Travis Scott brought in 12.3MM.
That’s right. A DJ with a marshmallow instead of a head played a concert within a video game and over ten million people watched this live… What a time to be alive.
Even Burning Man has been digitized. You can now prance around the sandy desert visiting art installations, enjoying concerts and tripping out with your avatar friends – all from the comfort of your own home.
It seems like a lot of the entertainment lines are blurring, and there is more and more IP that is crowding around gaming.
“Experts are calling this convergence between gaming and cinema, music, learning and social constructs.”
This is all due to the trend of entertainment consumption becoming more interactive, and at the same video games are becoming more casual and inclusive, starting to more closely resemble a platform.
But do the same platform powers of old (Facebook, Uber, TikTok, etc…) apply?
I don’t know. I don’t think anyone does. And that is what makes it so exciting to try to figure out.
Let’s check in with our Outrageous Chartered FinMEME Analyst Dr. Patel and see what he thinks of the video game industry?
2. Market 👉 Size, Players, Catalysts
I think the most important part to understand is the sheer amount of dollars spent on video games.
According to IDC, video game revenue ($180B in 2020), is now larger than the global film industry ($100B in 2019) and North American Sports ($73B in 2019) combined!
COVID sent the growth into hyperdrive in 2020, but I think this should be sustainable as NextGen consoles — Xbox and Playstation — keep the momentum going.
If you further break down the global games market, mobile eats a big piece of the growing pie.
If you look at the overall ecosystem, you can break it down into these categories:
Publishers: Make/acquire the games. Tencent, Activision, EA, TakeTwo, Roblox, Microsoft, and Ubisoft.
Channels: Facilitate the consumption and distribution of games: YouTube Gaming, Facebook Gaming, Twitch, Steam, and Discord.
Engines: The pipes of the system: Unity and Unreal Engine
Let’s follow the money and see how it flows through the categories of the ecosystem…
3. Profitability 👉 $60/ea —> Free-to-play
Back in the day, big rich publisher like Activision would go out and spend $300MM developing and marketing a game, then sell $60 copies and hope to sell enough to turn a sexy profit!
(Number of Copies sold x $60) - (Developing & marketing costs) = Profit of that title.
Execs would huddle around as the data trickled in over the first couple of weeks because this would be that one shot of seeing if you got it right. For hit titles, over 90% of sales would take place in the first month or so (similar to theatrical releases)
BUT the game has changed.
Gaming companies such as Fortnite today operate on what is called Free-to-play or F2P. AKA they hook you with freebies. F2P titles were popularized early on in mobile and have now started gaining momentum on PC and Console.
The concept is that you can play and start off for free, but then you spend money on microtransactions to either speed up your progression or just to look cool.
Think of the F2P part as the “top of funnel” I talked about last week. You then have to convert these players to pay just a little bit to improve their experience.
Fortnite executed this to a tee because it was a shooter game in third-person, meaning you don’t look down the barrel of a gun, you look at your character hopping around. This triggers a certain vanity emotion in the gamer by always seeing what they look like to other players.
Above is what is referred to as a “No Skin,” meaning you have the basic character design that you were given from the start.
This also means you were ridiculed and likely have no friends because your character looks…uninspired.
This also meant you would run to your mom’s room, steal her credit card and buy a skin that looked like this:
Now you’re a cool new character - Venom from the Marvel universe (remember the blurring of lines and convergence I talked about? video games x movies!) but you paid something like $3-5 to look like this. A lot more affordable than $60, but when you do this over and over, it adds up.
If you’re a video game publisher, this changes your revenue from one-time to repear almost/recurring revenue.
“And as we know, recurring revenue = higher stock multiple!.” -Genevieve Roch-Decter
From a production side, your cost is now constantly adding refreshes (Downloadable Content) to the game to keep up with relevant and timely pop culture. This then creates individual incentives for more and more microtransactions!
Starting to sound a bit like the same lifetime value: customer acquisition cost model we know and love…Which also starts to sound like a platform company.
4. Esports 👉 Piece of the Puzzle
Everyone and their nephew is talking about esports. This is people watching other people play video games.
“Why don’t you just play it instead of watching it?”
Ok bud, why don’t you go play hockey instead of watching the Toronto Maple Leafs? Same reason. The admiration and showmanship of superior skill brought on by professionals that are way better than you competing at the highest level.
Professional Starcraft (Real-Time-Strategy PC game) players walk around South Korea and are just as famous as footballers in Europe, basketball players in America, or hockey players in Canada. Gamers are starting to get more cred around the world. They have models on their arms and Lambos in their driveways.
And the reason this is so interesting is that esports already has the viewership to match traditional sports. And this is where the BIG MONEY comes in. If you’re a media exec, you’re licking your chops because the younger demographic has never seen a commercial and is very tough to reach. Now they’re being served up on a silver platter through esports.
This all comes down to one thing: EYEBALLS. The more people watch, the more ads you can sell, so the higher the sponsorships and media rights.
The problem is how convoluted the system is.
For example, no one owns the “sport of baseball,” but Activision owns Call of Duty. Call of Duty has a professional league with franchised teams that circuit and play each other, but Activision owns the IP. The league would not exist without Activision.
This allows Activision to extract most of the value from the ecosystem through upfront franchise fees in the tens of millions. The teams have to ALSO split the media rights revenue that they do generate going forward. Talk about unbalanced.
However, if the sponsorship and media rights move towards the same monetization path as traditional sports, this could be a very lucrative opportunity - but for who?
The teams? The Players? Activision? Time will tell.
The other component is that Lebron James cannot be Lebron James outside of the NBA. This is the exact opposite in esports.
Frequently, pro-gamers will ditch professional leagues and focus on building themselves out as a brand and build up their following on Twitch.
The highest-paid gamers are not the best players on the best franchised teams. The highest paid gamers are the most entertaining and the ones that have the most views, which exist outside of the league.
For example - one of the highest paid streamers is TimtheTatman. He is objectively bad at video games. People don’t watch him for his skill, they watch him because when he streams live, it is like a mix between Joe Rogan and Seth Rogen. It is entertaining as hell.
In traditional sports, higher skill = higher entertainment value. Sure, the off-court antics are fun to follow, but people watch more based on skill than anything else. Lets call it 95 parts skill and 5 parts personality as to why you are drawn to a player.
In video games, people allocate much more weight to the character and charisma of the streamer. Call it 30 parts skill and 70 parts personality.
That is why entertainment value, eyeballs, and content are the most important, which leads me to the first company that I like and how I’m playing this.
5. How Grit is Playing it 👉 Long-time “Enthusiastic” holder of this one + Bonus
Before I get into the company I have been enthusiastic about for 3 years – a warning on companies I am not very enthusiastic about.
There are a lot of promoters in this space that throw up some buzzwords but in fact have no assets of value or sustainable value. Look out for companies that do not have a clear sight of revenue or companies that rely solely on sponsorship because this revenue is NOT likely recurring. They may be in a league or have a star that is hot in the moment, but can fade out in popularity.
Some companies also just slap a celeb’s name on the front and call them investors. Don’t get me wrong - it’s great to leverage star power, but a lot of it is empty promises.
PRO GRIT TIP: Make sure they company has recurring revenue and is diversified.
Which brings me to one of my best performing small cap investments to date… Enthusiast Gaming!
They have hit the nail on the head. It IS a gaming company, but its a media company first - they get it. They understand that in the end, this is about aggregating and monetizing eyeballs, and they do this through a string of new-age media channels, primarily websites.
They do have an esports team, but more important was their acquisition of Omnia in August of 2020. On top of adding significant revenue, Omnia added a distribution network that has over 90MM unique viewers, 1000 channels, over 500MM subscribers and over 3.2B monthly total video views.
I first invested in their go-public financing back in Oct. 2018 — when they were a client of my previous company, one of the co-founders is my advisor now.
They had a $40MM market cap when they went public, and are now +$1.2B market cap mark and listed on the NASDAQ last week. They’ve grown their revenues ~7x while their operating expenses have only grown ~2x. There is some M&A in there, but talk about operating leverage…
Another name that is particularly exciting is Unity Technologies. This is a picks and shovel type of software business that is on my radar and has pulled back (-40%) from recent highs. Unity provides the tools to help build games easier and better.
Creating games is a hits business. You can be hot or cold. 50%+ of all mobile/ PC/ console games are made with Unity, making it one of the best subscription software ways to play a diversified revenue stream across the entire ecosystem.
Here’s a comp table to check out as you can see the multiples are rich but most of the stocks have performed well over the last 3 and 5 years.
I find that in investing, you mostly have to get the big things right, then take shots on net in that category. Video Games is one of those big things.
Gaming is becoming more about community. We need togetherness now more than ever and this is proving to be a massive competitive advantage!
Until next time. Always Yours. Incessantly Chasing ROI,
-Genevieve Roch-Decter, CFA
P.S Bitcoin crashes to lows not seen since last month. Remember, most bitcoiners love dips. If you sold, I don’t know how you even hold a pen with such weak hands 🙃
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Coca-Cola. CEO says company will raise prices to offset higher commodity costs. Inflation alert!
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