This article originally appeared in The Sunday Times, February 26, 2023.
The video games industry has been on an incredible run, having benefited greatly from the Covid-19 pandemic.
The global gaming market is worth at least $180 billion and is the fatest-growing form of entertainment. The film industry, for reference, is worth circa $100 billion.
The business model for video games has changed significantly over the years. Gamers used to buy their favourite titles at a retailers at a one-time cost for unlimited play. Today, the dominant model is freemium, which lets users play at no cost but incites them to make in-game purchases to unlock further content, speed up their progress, dress up their avatars, and so on. This is a much more profitable model for developers.
Yet there is more than one way to get exposure to this growth story, not least through some of the biggest names in technology, many of them trading at a compelling valuation.
Amazon’s approach to the sector is among the more intriguing. In August 2014, it surprised the market by buying Twitch, a video-game streaming service, for $970 million. Twitch had launched just three years earlier but, by the time Amazon came calling, it had 55 million users a month.
Amazon has been subject to the same selling pressure experienced by all in the tech sector, with its stock falling by about half through 2022.
On 2023 numbers, its shares are trading on 34 times forward price-to-earnings (PE) ratio. While this might look expensive, the stock has traditionally traded at extended multiples and this is a discount of over 50 per cent on its long- term average.
In its earnings report for the second quarter of 2022, Microsoft announced a 10 per cent annual increase in Xbox content and services revenue. In January 2022 it announced its intention to acquire Activision Blizzard for $68.7 billion, a deal that would give it ownership of franchises such as Call of Duty and Candy Crush Saga.
The US Federal Trade Commission has moved to block the acquisition, ruling it to be anti-competitive. The European Commission is conducting an additional review, due to end in April.
The market has all but factored in that the deal will not close, so any turnaround would be a boost. With no deal, Microsoft will have an extra $70 billion on the balance sheet to channel into growth or return to shareholders. We still believe that paying 18 times earnings for a company growing those earnings by 10 per cent annually over the next three years represents good value.
Alphabet, the umbrella company of Google and YouTube, is cashing in on the sector with nearly half a million unique streaming channels on YouTube Gaming Live. Despite recovering about 10 per cent on their 52-week low, Alphabet shares are down about a third from their 52-week high in spring 2022, reflecting weakness in the broader tech sector. The shares trade on a forward PE ratio of 16 times, a significant discount to peers and its own five-year average of over 20 times. We have a buy rating on Alphabet, and a price target of $125.
Though he worked at Atari before co-founding Apple, Steve Jobs reportedly hated video games. And for a long time, it showed. For decades Apple seemed to discourage, or just grudgingly tolerate, game development on its desktop computers, almost entirely ceding the PC game market to DOS and Windows.
Yet video games are now one of Apple’s most important financial drivers, generating about 70 per cent of total revenue on the company’s mobile app store. More than a billion people play games on iPhones and iPads, according to Apple executives, making IOS by far the world’s most popular gaming platform.
Apple does not even make games, yet the sector generates more revenue for the business – an estimated $10 billion annually – than for any company besides Tencent, Sony and Microsoft.
Apple, having briefly breached the $3 trillion valuation level at the beginning of 2022, has dropped just over 20 per cent from this peak. We expect continued robust operational performance from Apple as it develops new products and enhances its existing ones. Our price target of $186 offers a roughly 25 per cent upside from current levels.
Pure-play gaming stocks may carry more risk, which can be diversified through exchange-traded funds (ETFs). This avoids the challenge associated with trying to pick individual winners. The Vaneck Video Gaming and eSports UCITS ETF offers exposure to companies with at least half their revenues from video gaming or esports. Note that it still carries a risk rating of six, indicating high risk.