Last week we looked at the impact of cloud gaming on gaming developers, publishers and hardware providers. (Click here to read more about that). This week, I’d like to explore a different area of gaming that is very much overlooked by investors – the ‘value-adding’ segment of the value chain, which consists of gamers broadcasting themselves playing games to an audience – whether that be professionally (esports) or for amusement (gaming YouTubers/streamers). As a quick reminder, this is what the gaming value chain looks like:
Game Developer:
They create the game’s code.
Game publisher:
They facilitate devs, from funding development to marketing/distributing the final product.
Platform supplier (Consoles, PC, mobile):
They create the device through which the consumer engages with the game.
Value-adders (content creators, esports):
They create content that consumers can engage with; games with active value-adding communities often have longer lives, higher monetisation rates and see more success.
We’ll explore the history of this value-adding segment, the rather odd situation it finds itself in now, the likely future of the segment, and finally how we as investors can profit from it.
A quick history lesson
Playing video games professionally has been around for as long as gaming itself. However, for much for its’ history it was limited to the realm of ‘neckbeards living in their mum’s basement who never shower’, with limited prize money and even more limited viewership. This has all changed in the past decade, with prize pools now reaching millions of dollars and audience reach of tens of millions for the major esport tournaments. At the same time, a completely novel career – that of a gaming YouTuber, where you play and react to video games in a specific way that attracts viewers, has also sprung up. The paradigm shift in both of these career paths can be traced to one thing: the surge in video sharing platforms like YouTube, and later Twitch. Before these platforms appeared, viewership of video gaming as entertainment was extremely limited. Experiments with TV channels showing people gaming flopped.
In my opinion, learning why it took these internet video streaming sites to launch value-adders to the stratosphere is extremely important, because it’ll help cast light on possible future paths of monetising the segment. From viewership data of major content creators, the average demographic of people who consume this content skews heavily male and <25. While the gender is not much use (expect possibly as a demonstration of a potential gap in the market), the age is incredibly important. 95% of the target demographic does not buy their own TV subscription, but has their own internet-enabled devices. Traditional media distribution channels through cable or satellite television cannot monetise this audience, but the internet business model of using consumers’ data and attention as revenue sources can monetise them successfully. This is why it took until this decade for these value-adding gaming content creators to take off.
The current situation:
Esports is incredibly ‘hot’ right now. It has a CAGR (annual growth rate) of over 16%, and is expected to eclipse ‘traditional’ sports such as hockey, golf etc. in the coming years. Meanwhile, gaming youtubers CAGR (measured by ad revenue) is growing at 36%, also an incredibly high rate. However, despite this, there is a distinct lack of profit in the space. Although neither have directly reported numbers, experts suggest that YouTube and Twitch both have never been profitable. They earn huge revenue, but pay out just as much, or even more in expenses to their content creators, operating expenses of hosting video, etc. Meanwhile, the largest esports competitions, such as ‘the International’ tournament in Dota2, with a $35,000,000 prize pool and 1.9M peak viewership, are all heavily subsidised by their respective developers. It is clear that currently, the ‘value-adding’ vertical of the gaming industry is viewed by the dominant players as a loss-leading area, with the expectation that they will bring in greater longevity (and ultimately revenue) for their ‘main’ business.
It is also worth noting the rise of the ‘org’ in recent years. These esports organisations are similar to traditional sports teams in that they hedge risk for individual players by offering them a certain wage, but take most of any winnings. At the same time, these orgs often have incredibly strong brands, with teams stretching across multiple games, and fans that are even more dedicated than those who support traditional sports teams. These orgs can raise revenue from sponsorships, licensing, merchandise etc. The strongest brands, such as the likes of Faze, Team Liquid, Cloud9 etc. could arguably command billion-dollar valuations like Manchester United if their growth continues. Although there are currently no esports organisations that are traded publicly, this is an area worth keeping an eye on.
Future of the segment:
Most people expect that gaming will continue to grow in the mold of traditional sports, before capping out in potential when it rivals the size of football, cricket or Formula 1. It’ll see dramatic growth in the next few years as penetration (especially in the West) increases, before decelerating and maturing in its monetisation potential. If you think in this mold, you likely expect the more ‘casual’ content creators, who play games to humour you, to grow less than professional esports competitors. After all, as a sport matures, it gets increasingly professional and casual players get forced out the market.
However, my opinion is that this view is incredibly simplistic and tends to view ‘video games’ as a direct alternative to any one of the traditional sports. The structure of the video game market is unique in having a constant battle between various games for popularity and dominance. Instead of consolidation in the market leading to a preference for more professional esports gamers, and casual content creators being left behind, it is the very non-professionalism of the casuals that will mean they ultimately see greater growth. We have already seen consolidation in this specific space, with many casual content creators getting signed by esports organisations (instead of just professional competitors); getting signed by streaming platforms (e.g. the epic failure of Mixer signing Ninja and Shroud for multi-million dollar deals), etc. It doesn’t take the most imaginative person to see that they could in the future be signed by game developers, with exclusivity deals to play only that developers’ games. The aforementioned Mixer was owned by Microsoft, which also owns various game studios. With exclusivity deals, these content creators with their enormous audiences could be the difference between your next game being a flop and being the biggest hit of the year – while at the same time damaging your competitors. When you compare the probable cost of a ‘AAA’ content creator such as Ninja - $30 million, to the marketing budget that publishers spend when they try to make a viable esports title - $300 million (estimated cost to ATVI of marketing Destiny), it seems like an absolute bargain.
When considering the direction that games seem to be going in, having these value-adders on board and promoting a narrative aligned with yours seems more important than ever before. Fortnite, with its incredible success, has managed to transition from being just a video game, to somewhere where you can simply socialise with friends. Real-time experiences, from map-changing events to concerts held by huge stars like Travis Scott, regularly draw significantly higher viewers to content creators than their ordinary content.
If games can transition from being video games to a platform where friends can enjoy themselves, they could break out of the current paradigm of being ‘a rapidly growing sport that’s hugely popular with the younger generation’ into a way of life. Content creators will be essential if this is to happen. They are viewed as role models, and every word they say has immense sway – for instance, FaZe Tfue, a popular Fortnite streamer, commenting that he used a particular model of mouse, led to that mouse being immediately sold out and the resale value of those mice tripling overnight. If companies can properly leverage these content creators into promoting their games, they will find it much easier to reach a critical mass in playerbase, where everyone and their mother plays a game. Few games have ever reached that status – League of Legends, Fortnite and Call of Duty are a few that come to mind; and once you reach that status your monetary wealth is guaranteed. Compared to traditional games, it is likely that any game which reaches ‘platform’ status will be much stickier- more successful at retaining players, and thus generate recurring revenue.
Who to invest in?
As we saw last week, Microsoft seems to be the most clued in about the future of the industry, and has made attempts to be the first mover in the coming wave of consolidation. Although Mixer as a service was a huge failure, considering the potential size of the market, it seems possible that they could have a second go at a platform for these value-adding content creators – especially if they acquire a game studio that produces a game with more ambition than their current stable, which typically produce more casual exclusive games for the Xbox, rather than competitive, highly-monetised games that appear on PC. Amazon is in a similar position to Microsoft, although its’ failure has been in producing games of its’ own, and it has been hugely successful in being a platform with Twitch. Finally, Google has YouTube, the dominant platform in the industry, and has tried its’ hand at entering the hardware side of the value chain, as opposed to the development side with Amazon. All 3 of these companies are, of course, hugely diversified, and so it is difficult to gain significant exposure to their gaming segment specifically.
If you’d like more concentrated plays on players that could capitalise on this trend, apart from the possible IPOs of esports organisation, you could invest in game developers. ATVI currently has the most esports-ready stable of titles, with Overwatch and Call of Duty. However, I do recommend you read part 1 of this series on gaming to get a more holistic view of their entire business, and how game developers might be affected by cloud gaming.