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US Equities Everything You Wanted to Know About Video Games but Were Afraid to Ask

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US Equities Everything You Wanted to Know About Video Games but Were Afraid to Ask US equities Everything you wanted to know about video games but were afraid to ask Chief Investment Office GWM | 23 April 2019 7:24 pm BST Robert Samuels, Consumer Discretionary and Media Analyst Americas, [email protected]; Reid Gilligan, Equity Associate Analyst Americas, [email protected] • Although growth is slowing, the video game market continues to expand driven by macro tailwinds, new titles and in-game expenditures. • Mobile devices eclipse consoles and PCs as the primary tool for gaming. • Revenue model is in flux with the rise in popularity of free- to-play games like Fortnite. • Subscription gaming services and cloud gaming are likely to Fig. 1: 2018 video game revenue by region disrupt the industry over the next several years. Latin America Europe, 4% Middle East & Africa The video game industry has seen explosive growth over the past 22% few years driven by favorable demographics, a growing addressable market, improving product quality, and faster internet speeds. Asia-Pacific We expect these trends to continue although competition within 49% the space, and for share of the consumer's wallet and time, is likely to make share gains for individual game publishers more challenging. Furthermore, the popularity of free-to-play games such as Fortnite has altered the industry's revenue model, which creates North America both opportunity and risk for game makers. 25% Before jumping into some of the most frequently asked questions Source: Newzoo, UBS around gaming, there are several macro trends to understand that help expand the landscape. The success of current video games relies on fast and dependable network speeds as more consumers are playing online. Today, the majority of video game players live in China, the US, Japan, and Europe—areas of the world where access to high broadband speeds is prevalent. As access to reliable broadband becomes more widespread, the number of potential gamers increases correspondingly. This also applies to the global smartphone market, which is expanding the potential number of consumers given the growth of mobile gaming. This report has been prepared by UBS Financial Services Inc. (UBS FS). Analyst certification and required disclosures begin on page 8. UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. US equities 1. How big is the video game market? Fig. 2: Global video games market Consumer spending on entertainment is rising and the gaming sub- (USD billions) $174.0 segment is expected to experience the fastest growth. According $160.5 $148.1 to market intelligence firm Newzoo, global video game revenues $134.9 $121.7 reached roughly USD 135 billion in 2018, an 11% increase over the prior year. While the gaming market is likely to grow at a slower pace than it has over the past several years, revenues are forecast to grow 8.4% annually from 2019 to 2021. We see a number of secular tailwinds that will help support growth over the next several 2017 2018 2019E 2020E 2021E years, including a growing installed base, increased engagement, Source: Newzoo and in-game expenditures. In terms of users, Newzoo estimates that there were almost 2.5 billion gamers worldwide in 2018, mainly located in China and the United States. 2. I've seen my kids playing games on their phones and Fig. 3: 2018 Global gaming market device tablets. How big is the market for mobile gaming? breakdown The installed base mentioned above consists of consoles (Xbox, Console 28% PC Playstation, etc.), PCs, and mobile. While the console installed 25% base has certainly increased, the mobile gaming audience has Boxed/Downladed PC grown exponentially thanks to the prevalence of smartphones, Browser PC USD 134.9 bn Tablet increased quality, and free or very inexpensive games. In fact, Tablet mobile gaming revenue surpassed USD 60 billion last year. Looking 10% Smartphone Console Smartphone forward, Newzoo estimates that mobile sales will grow at a 12.6% 37% annually compounded growth rate from 2019 to 2021 to USD 91.2 Mobile billion and be over 50% of global video-game revenues. 47% Source: Newzoo The growth of mobile gaming is vital to the overall health of the industry given the global installed base of smartphones compared to consoles and PCs. With already fast internet speeds and the coming of 5G, mobile users have access to games with astounding Fig. 4: Percentage of revenue by device over graphics, almost on par with Xbox or PC. In fact, Activision Blizzard time announced that the newest version of its popular Diablo game will 23% 22% 21% 20% 19% 2% 2% 1% be released on mobile and not PC. Apple is also diving deeper into 4% 3% 27% the mobile gaming market with the launch of Apple Arcade later 28% 27% 27% 28% Boxed/Downloaded PC this year. Thousands of games are available on both the iOS and 9% Browser PC 10% 10% 10% 10% Android app stores, with a majority of them being free. Free games Console Tablet 43% make money by selling advertisements within the game or incorpo- 36% 37% 39% 41% Smartphone rating in-game purchases. The vast number of free games is a sign of the low barriers to entry in the mobile space. 2017 2018 2019E 2020E 2021E Source: Newzoo 3. I've owned a Playstation 4 and Xbox One for several years already. When can I expect to see a new console? We are currently in the eighth generation of video game con- soles, which encompasses all consoles released since 2012. This includes Microsoft's xBox One, Sony's PlayStation 4, and Nintendo's Switch. While the original consoles were released in 2012 and 2013, upgraded consoles such as the PlayStation 4 Pro and the Xbox One X have been developed and released in recent years, which is still considered part of the 8th generation. Console cycles have histor- ically lasted five to eight years but with continued additions and upgrades we expect this cycle to last slightly longer than those in years past. The 8th generation console installed base ended 2018 at roughly 125 million units, up from 89 million in 2016, which lends credence that there are a growing number of consumers to spend money on games. 2 US equities The market generally believes this generation of consoles will be Fig. 5: Facebook's Occulus coming to an end in the next year or two, with expected announce- ments of the 9th generation to occur in 2019 and a release date in 2020. We expect the 9th generation to hold more competitors than simply the popular Xbox, Playstation, and Switch. Virtual reality and cloud streaming will also play a role. As the hardware continues to improve and the price points come down, we expect to see a rise in VR headset popularity. PlayStation VR and Gear VR have so far been a success for Sony and Samsung, respectively. Facebook's Oculus is also gaining traction especially with the Oculus One, which does not need to be hooked up to a computer as in previous iterations. Source: Facebook website 4. Who are the biggest players in the video game industry? Given economies of scale and M&A over the past decade, the video game market is dominated by a small number of companies. In fact, the ten largest companies comprise greater than 50% of the overall Fig. 6: Top public companies by gaming revenue global market. There are currently three publicly traded video game 25 publishers in the US: Activision Blizzard, Electronic Arts and Take- 20 ) Two Interactive. s n o 15 i l l i b 5. How do video game companies make money? ( D S 10 Historically, companies sold games for an upfront price in the USD U 30-60 range. However, over the past few years, the industry has 5 trended towards a more recurring and diversified revenue stream. 0 This transition occurred as (1) games became much more social and (2) the focus shifted towards digital downloads (rather than purchasing a physical disc), in-game purchases of downloadable 2017 2018 content (DLC), and microtransactions (see Fig. 7). According to Source: Newzoo SuperData, global in-game purchases totaled USD 87 billion last year, up more than 11% from 2017. Finally, digital revenue made up 73% of total revenue for the major US video game makers com- Fig. 7: Revenue tree pared to 37% in 2009. The ability to offer new maps, characters, achievements, and more Video helps extend the lifespan of a game because it offers new and Game Publisher exciting opportunities for the fan base over a longer period. Digital Revenue purchases and transactions also enhance game profitability. The margin on a digital download and DLC is approximately in the mid-60% range while microtransactions are even higher at approx- imately mid-80%. While mobile is 100% digital downloads and PC is greater than 90%, console digital downloads are still in the 50% range, meaning there is still room for growth in the digital download Digital Physical space. A large reason for the lower console percentage is due to · Digital download · Disc the fact that physical discs are a popular gift giving item and the memory limitations. 6. Why do I hear my kids talking to other people while they play video games? I thought they were playing by them- selves? DLC (downloadable content) Microtransactions Looking back at popular games of the past, including Super · Season pass · Characters / costumes · Expansion pack · Loot Boxes Mario Brothers, Legend of Zelda, and Doom, gamers predomi- · Maps · Emotes / Dance moves nantly played by themselves.
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