While it has been around for nearly half a century, fast-growing video gaming industry is entering a new and potentially disruptive stage.
Over the past decade, the consumer video game market underwent a significant transformation. Smartphones made everyone a potential gamer, and the emergence of more powerful consoles with increased storage capabilities paired with faster Internet connectivity further supported the move from packaged to digital games. The net result has been a durable and consumer-friendly business model with impressive global consumption growth.
Perhaps the most exciting aspect of gaming from an investment standpoint is the ways in which it resembles the software industry. Mobile gaming companies can also eschew consoles and opt to efficiently load games and updates for customers using digital platforms.
A shift in gamers’ demographics represents another significant tailwind. Many gamers are young adults with disposable incomes. These gamers also demonstrate a strong willingness to spend incrementally on gaming, suggesting they equate spending on video games with entertainment. Indeed, the cost per hour of gaming remains low relative to other forms of entertainment. Not only are they willing to spend more money on gaming, but gamers overall are now devoting more leisure time to gaming.
Paradigm shift in technology
Technological advances have prompted a paradigm shift, with gaming consoles increasingly viewed as mainstream home entertainment systems. Smartphones also continue to play a major role in expanding the addressable market outside the home, and consumers are increasingly willing to pay for mobile games. The video game industry has expanded every year since 2000, and smartphones are a key accelerator.
Technological changes and consumption patterns are helping digital games generate recurring revenues. Add-on digital content purchased after initial game sales enables consumers to increase engagement with their favourite titles and publishers as well as expands the monetisation of intellectual property. Doing so generates new and ongoing revenue streams at higher profitability. In-game content on console and PC games yields gross margins of more than 90 per cent.
Leading video game publishers are continuously getting better at delivering this extra content, and the more content they create, the more time gamers have been willing to pay to play.
We believe this represents a significant growth opportunity for the industry. Additionally, most mobile games are free to play and then monetised through similar high-margin digital content that is continuously added to the game. As mobile devices increase the addressable market, mobile gaming will continue to play an important role in spurring growth for the industry.
Appealing factors for investors
When conducting our bottom-up analysis of companies in the gaming industry, we consider a company’s ability to grow by expanding its addressable market. We first examine a company’s track record and portfolio of intellectual property as well as its ability to monetise beyond initial game sales. These elements form the foundation of increasing market share, in our view.
We also consider the degree to which a company’s revenues come from digital downloads. Companies with more room for growth and the ability to achieve it present intriguing investment opportunities that warrant additional attention. Because the move to digital is still a relatively new phenomenon, we value companies that are finding ways to innovate.
Electronic Arts, a video game content provider, is a good example of both. The company possesses a strong portfolio of sports franchises, including FIFA and Madden Football, and non-sports franchises, such as Star Wars Battlefront. The company also offers a consumer-friendly subscription business that helps introduce gamers to other names within the Electronic Arts universe.
Electronic Arts share price over 5yrs
Source: Google Finance
We believe franchises like this, coupled with a company’s strategy for increasing in-game monetisation, can result in higher revenues from digital.
Josh Spencer is portfolio manager of the T. Rowe Price Global Technology Equity fund. All views are his own and should not be taken as investment advice.