The heat is rising in the video game industry and it is an exciting time both for players (of all ages!) and developers alike. The industry has fundamentally changed in recent years due to greater digitalisation and online gaming. But the breakneck pace of change is showing no signs of abating and recent developments could represent the biggest revolution to the gaming industry since smartphones were released over a decade ago.
Here is your dummy’s guide to the structural drivers underpinning the growth for the video game industry and why we think Ubisoft, a standout industry player, is well-placed to capitalise on them.
- China is home to over 580m of the world’s 2.2bn gamers. The rise of the middle class, improved economic conditions (allowing more people to be able to pay for the equipment needed to play), combined with the related dramatic increase in internet penetration is a formidable tailwind for video gaming in China. In Dec 2017, internet penetration reached more than half of the population – 55.8% exactly, a number which sits above the worldwide average and the Asia-Pacific countries average. This huge long-term opportunity for the industry needs to be balanced with short-term political noise at times – for instance when China’s press and publication regulator suspended the approval process for video games for several months last year, before releasing new rules.
- Mobile gaming is now the industry’s largest segment, contributing more than half of all game revenues, with 80% of those generated through smartphones and the rest from tablets. Mobile games are lucrative, mostly because they’ve mastered the free-to-play model which in turn leverages massively the use of micro-transactions (in-app purchases). In 2018 alone, Apple App Store and Google Play together generated around $50bn of gross revenue from mobile games. Upcoming 5G and unlimited data will further underpin mobile gaming trends.
- Around 400m people watch eSports globally and this staggering number is expected to grow to around 850m by 2025. ESports are electronic sports. They are competitive computer gaming events attended online and in massive arenas where, similar to traditional sports, professional winning teams or individual players can now expect to receive endorsements and potentially millions in prize money. How do eSports generate revenues? Well much like traditional sports, with media rights deals, sponsorship deals, and ticket and merchandise sales. It is still relatively under-monetised, with revenues estimated at $0.7bn today but industry experts see it grow into a $20bn market by 2025.
- Cloud gaming / subscription services announcements from new entrants such as Google Stadia, Microsoft Project xCloud or Apple Arcade (subscription) are coming fast and furious. These are new digital gaming platforms, that will work on existing desktops, laptops, TVs and Under the cloud gaming model (Stadia/xCloud), the game content is not stored on the player’s device or disc. Instead, the game is executed on powerful servers and then streamed to the gamer’s device. The heavy computing lifting is done at server level, easing the burden on the gamer’s device. It removes the need for up-front hardware spend, hence lowering the barriers to adoption. These are positive changes for the video game publishers as they significantly expand the total addressable market. For instance, the installed base of consoles is currently just 100-150m, compared with over 300m smart TVs already. Anyone up for a battle royale game in a driverless car?
We believe these structural changes fundamentally benefit the business model of Ubisoft, one of the world’s largest developers, publishers and distributors of video computer games for consoles, PCs and mobile.
The company has produced many phenomenally successful games franchises, which are now household names. Tom Clancy’s the Division and Watch Dogs are two of the top three best-selling new franchises of all time and the product suite is augmented by other titles such as Assassin’s Creed, Rainbow Six Siege, Ghost Recon and Far Cry. The recently launched Division 2 has received critical acclaim for its combat, mission designs and a beautiful open world brimming with reasons to explore. It was the most downloaded title for the PlayStation Store in the US and EU, respectively, for March.
Thanks to greater digitalisation and in-game monetisation with associated increased longevity for games franchises, companies like Ubisoft are deriving ever-higher amounts of revenue from their back catalogue. The result of this trend is less cyclicality for developers, who previously had to rely on constantly turning out the next blockbuster release. New content failing to meet expectations still presents a risk, but with recurring revenues now making up 20% of total for Ubisoft and forecasted to grow to 25% over 2019, this risk is lessened. On digital platforms, Ubisoft is also well positioned as the war heats up between the leader Steam and contenders such as Epic store. For instance, the Division 2 is an exclusive on the Epic Store.
In 2018 Chinese internet giant Tencent took a 5% stake in Ubisoft and the two companies signed a strategic partnership to grow Ubisoft’s franchises in China. Tencent’s position in the market makes this opportunity hugely exciting and they can provide their local expertise to help with the approval process for games with the Chinese regulator and to ensure the games appeal to the taste of the Chinese consumer.
On the Cloud gaming front, Assassin’s Creed Odyssey is one of only three titles confirmed for Google Stadia. In the near term such cloud gaming initiatives are positive for Ubisoft as the likes of Google or Apple need premium, AAA content from leading studios to entice gamers. Both Google and Apple have already spent hundreds of millions of dollars to secure content and are providing incentives (lower platform fees, paying for exclusivity, or minimum guarantees) for more. On the flip side, the entry of such well-funded players could pose some risks to incumbent publishers in the long run. Indeed, the cost of attracting/retaining talent could rise as they develop their in-house studios.
To top it off on Ubisoft, financials for the company are solid, with hardly any debt on the balance sheet (net debt/equity at 5.5%), strong margin and continued strong growth – estimated CAGR sales for 2019-2021 at 12% and CAGR EPS at 86% over the same period.
All-in-all, we believe the video game industry is entering a new exciting phase of structural changes with significant growth opportunities for leading publishers, including Ubisoft. Ready player one?
At the time of writing, we held Ubisoft in portfolios.
Opinions and views from the Equities team at Kames Capital are not an investment recommendation, research or advice and should not be considered as such. Content discussing investment strategies and stocks is derived from and solely relates to the investment management activities of Kames Capital.
About the author
Mark Peden is the architect of our global equity income strategy and has been the lead manager of the Kames Global Equity Income Strategy since its inception in 2011. European equities are his main area of research expertise where he has been analysing companies since joining the firm in 1992. Over his tenure Mark has held a number of positions and managed a range of both International and European equity funds. He graduated from the University of York and the University of California (Santa Barbara) with a BSc honours degree in Economics with Politics. He a CFA charterholder and is also an Associate member of the UK Society of Investment Professionals (ASIP). He has 26 years ’industry experience.* *As at 30 November 2018
About the author
Luc Simoncini is a senior investment specialist in the equities team, with responsibility for providing client support and representing the firm’s equity capabilities to clients, consultants and prospects. He joined us in 2014 from Mediolanum where he led the marketing and client servicing team in Europe. Prior to that, Luc was a Client Portfolio Manager with Schroders in Australia covering global equities and was a senior investment specialist for Pioneer Investments, specialising in emerging markets. Luc studied Business Studies at Institut Supérieur de Gestion, Paris and holds an MBA from Macquarie Graduate School of Management, Sydney. He has 24 years’ industry experience*. *As at 30 November 2018.