1994 was a seminal year for the gaming industry as we know it today: Sony launched its “next generation” console the PlayStation, and China went online permanently for the first time.
25 Years of Progress
The PlayStation business model, where gamers bought a new, expensive console every year or so and also bought expensive games to play on them, has served the industry well over the past 25 years and is still hugely profitable for companies such as Sony and Nintendo, as well as US-listed software firms including Electronic Arts.
But gaming has changed in recent years. No longer something done at home alone, gamers can play each other over the internet, at birthday parties or even at international e-sports competitions, followed by thousands of fans.
Chinese gamers have opened up a new frontier in the industry and raised the potential audience for games exponentially: the majority of China’s 800 million-plus internet users use mobiles, for which many of these games are developed. These days you don’t need a pricey console, you can play online with anyone in the world using just a smartphone. This presents opportunities for established companies – the audience for games is growing sharply – but also threats, in that there is less outlay required from gamers. Indeed, games firms are having to take the threat of the “free to play” model seriously and adapting their business models to the new ways people are playing games.
For investors looking to access the trend, choosing funds with exposure to the industry is the least risky route. Indeed, if you own a technology or Asia fund - especially one with Chinese giant Tencent in the portfolio - you are already indirectly exposed to the industry. Many of the companies in the industry are small or unquoted, and the chances of them hitting on success with the next Fortnite are slim.
Sony and Nintendo Have Survived
Japan is birthplace of the computer games industry and while Sony and Nintendo have been through tough times, they are widely held by fund managers focusing on the country. Buying a tech-focused Japan fund is one option for investors wishing to ride the games boom.
Nintendo is the top holding in the Silver-rated Lindsell Train Japanese Equity fund. The firm has revived its fortunes through the Nintendo Switch console after struggling in the years following the financial crisis. Lindsell Train manager Michael Lindsell says Nintendo’s recent venture with Tencent gives access to “a massive consumer market whose affinity for games is already proven”.
Tencent also bought a 40% stake in Epic Games in 2012 - it's the US private company that developed Fortnite, which has gripped gamers worldwide. According to Pitchbook, Epic’s latest funding round in October 2018 puts a value on the company of around $14 billion.
Lindsell Train Japan Equity also holds a software company called Square Enix, which developed the successful Final Fantasy franchise- Lindsell says the company has a great business model because, unlike Nintendo, it is not tied into the costs and risks of developing games consoles.
This seems to be a growing trend for developers, which make a range of games for different companies. Jack Neele, manager of the Silver-rated Robeco Global Consumer Trends fund, says that digital downloads are much more profitable for games companies - with no shops to pay or distribution costs, the profit margin on downloads of famous “franchise” games like Fifa are very high.
According to Morningstar data, 1.48% of the Robeco fund is invested in Electronic Arts - one of the biggest US-listed games companies - 1.81% in Tencent and 1.76% in Take-Two Interactive (TTWO), which owns Rockstar games, the maker of Grand Theft Auto and Red Dead Redemption.
Neele notes that established companies like Electronic Arts and fellow US tech firm Activision Blizzard (ATVI) are using the “free to play” or subscription model to build followings for new games but they wouldn’t risk this approach for more established games “franchises”.
Morningstar analyst Neil Macker believes EA will benefit from the growth in mobile gaming; it also owns rights to publish Star Wars games and has had success with free-to-play game Apex Legends. EA is also successful at what Macker describes as “engaging users beyond the initial game sale” by adding users to its network through new content; the number of people using its services makes it similar to a social network, Macker notes.
The UK and Europe
Japan and the United States are clearly hotbeds of gaming creativity, but what about Europe? Macker thinks French firm Ubisoft - which makes Assasin's Creed - stands to benefit from the changes in the industry. The stock is held by the BlackRock Throgmorton Trust (THRG), which has a Bronze rating from Morningstar.
Rathbone Global Opportunities, the Silver-rated fund run by James Thomson, holds companies that are exposed to the computer games industry, such as Tencent and US-listed Nvidia (NVDA), which makes computer chips for PCs to make games run faster. The five-star rated fund is up nearly 25% year to date.
The UK is also home to a number of small-cap games companies, such as Aim-listed Codemasters (CDM), which was founded in 1986 and makes the official Formula 1 computer game for Playstation, Xbox and PCs. The company is held by four-star rated Axa Framlington UK Smaller Companies.
Another Aim-listed firm, Gfinity (GFIN) taps into the burgeoning e-sports industry, which sees gamers around the world compete against each other for multi-million dollar prizes. It's a small but rapidly growing part of the wider global games industry that Microsoft estimates is worth more than $100 billion
Gfininty, which is held by tech-focused Herald Investment Trust (HRI), organises events for the big games development firms such as Electronic Arts. Herald’s Ian Russell says that Aim remains a happy hunting ground for fund managers, and that is where the next UK games company is likely to be found.
Gfinity has recently launched a £5 million share placing to fund further growth and landed a new contract from the UK Premier League to host the first football gaming tournament, as well as existing contracts with EA, Activision and Formula to host events.
No Spotify for Games - Yet
The gaming industry has changed beyond all recognition since Sony’s PlayStation launched in December 1994 - the number of distribution channels has grown in step with the rise in user numbers, plus the internet has allowed people to play anyone else in the world. Robeco’s Neele thinks that the rollout of 5G will help boost gaming speeds, which are currently holding the industry back.
But the industry is still lacking a Netflix or Spotify model. Neele says content-sharing platform "Steam" is building momentum and Electronic Arts has had some success with its subscription service, which charges roughly £3.99 a month.
Games firms are reluctant to share content across a neutral platform while the current ways of doing business are lucrative. At the moment games companies still sell significant units of popular games and are benefiting from the rise downloads and in e-sports events. This may not last as technological trends keep shifting. After all, the average console costs around £250 and the games are £50 each.
Morningstar’s Macker says that, unlike in other areas of technology, gaming is not a “winner takes all” industry, but he thinks that competition is stiffening and that favours the existing big names such as Electronic Arts.
