Nicholas Hyett, Equity Analyst 11 June 2019
Computer gaming isn’t just about fun anymore. With a global annual spend of $134.9bn, it’s big business too.
The rush to get a slice of the action has seen tech giants step into the sector, with Amazon, Google and Microsoft all dipping a toe in. However, with companies of this size, gaming is just a small piece of a much larger pie, and growth trends in the sector are unlikely to significantly move the share price.
Fortunately there are lots of options for those looking for more direct exposure to gaming and its prospective growth.
This article isn’t personal advice, if you’re not sure an investment is right for you please seek advice. Investments rise and fall in value, so you could get back less than you invest.
A big name game
The most straightforward way to invest in gaming is through one of the big name publishers. Activision Blizzard, Electronic Arts and Ubisoft are the best known, owning and selling blockbuster games, including Call of Duty, FIFA and Assassin’s Creed respectively.
These franchises are very powerful brands, keeping fans coming back again and again. Fan favourites can generate hundreds of millions of dollars in sales every year, with console, PC and mobile variants.
The sector’s been attracting increased attention from investors recently, largely thanks to the rise of in-game micro-transactions. Allowing players to buy extra in-game perks has provided publishers with opportunities to squeeze more cash from each player. Even for traditional console games, sales after a game’s initial purchase can account for up to 40% of total revenues.
The transition to in-game spending hasn’t been entirely smooth though. Accusations that developers were selling ‘incomplete’ games, where further spending is required rather than optional, has led to a backlash from gamers. Meanwhile regulators have raised concerns that ‘loot-box’ type models, where gamers pay for uncertain prizes, are encouraging gambling among children.
Putting these headwinds to one side though, we still think the quality of intellectual property (IP) the big gaming groups own makes them long term winners.
Ubisoft is probably the stand out name when it comes to internally generated IP – with Assassin’s Creed a particular gem. However, we think Activision offers a great range of content and has been better at monetising its user base.
Looking beyond the obvious
The risk with investing in a games developer is that the next blockbuster instalment fails to live up to history. We’ve also seen disruptive new arrivals Alternatively you can invest in the gaming trend more broadly.
Grab for graphics
Nvidia was founded in 1993 to make graphics chips for PCs, producing the first graphics processing unit (GPU) in 1999. The invention of the GPU, and similar chips from rivals, simplified 3D graphics and sparked a massive revolution in gaming.
The group's been at the forefront of gaming and graphics technology ever since. While demand for Nvdia’s chips now comes from industries as diverse as self-driving cars and graphic design, gaming still accounts for 56.9% of sales.
The group’s GeForce products serve 200m gamers worldwide, and its most recent Turing card is able to simulate the behaviour of light in real time – creating photorealistic games. Current projects under development include powerful cloud-based gaming computers, and an increased focus on gaming laptops.
Of course, operating in these kinds of rapidly changing markets comes with challenges. The group’s enjoyed and endured a cryptocurrency boom and bust in the last couple of years, and the recent slowdown in data centres has tripped the group up.
We think Nvidia’s got an impressive business model. Its cutting edge technology commands a high price, and the group outsources all of its manufacturing. Without the costs, capital and risk associated with owning manufacturing facilities, Nvidia's been able to deliver some very impressive gross margins. A significant chunk of the proceeds is reinvested through the research & development budget, which at $2.4bn accounted for 70.6% of operating expenses last year.
While the big players may be listed in the US, Europe or Asia, the London Stock Exchange isn’t devoid of gaming talent.
Keywords Studios is a market leader in outsourced design, audio and translation services for game developers. Services range from artwork to voice actors and making sure games are ready for the different markets in which they need to be released.
Keywords usually has an overall contract with its customers, and charges a monthly fee based on the time and materials used. If Keywords were a small business that would make for an uncomfortably volatile earnings stream, with bumper months in the lead up to a big game release and droughts at other times.
Fortunately Keywords is far from small. The group works with many of the world’s largest gaming groups, in offices all over the world. It’s also a serial acquirer as it looks to build scale and expertise around it to serve more of its clients’ needs, becoming the ‘go to’ provider of video game services.
The results have, so far, been impressive. Since listing in 2013, earnings per share have risen by an average of 56.5% a year, and analysts are forecasting double digit percentage growth in organic revenues out to 2021 at least.
The group’s quality hasn’t gone unnoticed though. The shares trade on a PE ratio of 30.4 times, which is 18% above their longer term average, and offer a yield of just 0.1%.
Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.
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