Long or Short Video Games?

A lot of folks around here have been in all-out Diablo III mode, the latest hit from Activision Blizzard (NASDAQ: ATVI). But does Diablo’s success translate into a long equity position in its creator?

Activision Blizzard’s stock has struggled for years, trading at $10-12 range since January 2009. With a market cap of over $13 billion and trading at 14.5 times earnings, it seems that even with hit after hit that stock just doesn’t seem to budge.

Some would argue that the fundamentals of the gaming industry are changing.

Detractors of the video game industry in general would argue that although hits like Diablo, World of Warcraft, and Call of Duty do make money for the company, their success is uneven and comes in fits and bursts throughout the year. And they cost a lot more capital to produce than a lot of investors realize.

Casual gamers are also flocking to free games and apps for mobile devices, and the gaming bears say that there’s too much emphasis on wooing the hardcore gamers rather than the casual fans (exemplified by Angry Birds). In the below Breakout video, there is mention of a truly ridiculous valuation of $9 billion for that franchise alone.

Believe it or not, the leader in mobile gaming is actually Electronic Arts (the company made more than 4 times what Angry Birds made last year).

Nevertheless, as always we have some gaming bulls in the house. As Blizzard never fails to remind us, there are over 11 million people playing the industry-shifting World of Warcraft online (half the population of Australia by comparison). Monetizing all of those players is a huge source of revenue, and the avid fans will snap up whatever upgrades Blizzard churns out, knowing that it will be terrific. If they can find a way to effectively breach the mobile and tablet space with their titles, that would also be a game-changer for the industry.

Are you guys convinced? Would you long stocks like EA and ATVI? Or are you content to enjoy the games?

 

Looking at ATVI you need to remember that Vivendi owns 57%, not sure if I remember correctly but think that they also get involved if it dips below a certain level

 

When I used to play video games frequently and read the gaming magazines, it seemed like there was a new video game company/maker going out of business almost every month. Doesn't seem too stable... this was ~3-5 years ago now though.

If your dreams don't scare you, then they are not big enough. "There are two types of people in this world: People who say they pee in the shower, and dirty fucking liars."-Louis C.K.
 
Best Response

I want to see a PE firm buy a game studio (actually, I think a few have...) I say that because it is an industry with a terrible development structure and cost management system.

Games cost a ton; triple A titles can rocket past 40 million. They target a relatively narrow market. The consumer must invest quite a bit of time and capital. Quality rules here...the market does not support mediocre games, unlike movies. Thankfully, focus groups are usable.

Game designers often operate like artists, making the game in their vision, as opposed to according to market demands. Anyone remember DaiKatana from the 90s?

I see a few models going forward: OnLive pay to play streaming, Free to Play with microtransactions, and episodic content.

At 40 million a pop, a failed game can wreck a studio. There is no "learn then iterate"...the above models work because they can preserve a studios reputation and allow developers to fix problems going forward.

I also think we will see a resurgence of PC gaming. Buying a game "console" seems almost archaic. With a mid range PC (high end laptop) able to play triple A titles, buying a machine to play games seems ridiculous.

 
West Coast rainmaker:
I want to see a PE firm buy a game studio (actually, I think a few have...) I say that because it is an industry with a terrible development structure and cost management system.

Games cost a ton; triple A titles can rocket past 40 million. They target a relatively narrow market. The consumer must invest quite a bit of time and capital. Quality rules here...the market does not support mediocre games, unlike movies. Thankfully, focus groups are usable.

Game designers often operate like artists, making the game in their vision, as opposed to according to market demands. Anyone remember DaiKatana from the 90s?

I see a few models going forward: OnLive pay to play streaming, Free to Play with microtransactions, and episodic content.

At 40 million a pop, a failed game can wreck a studio. There is no "learn then iterate"...the above models work because they can preserve a studios reputation and allow developers to fix problems going forward.

I also think we will see a resurgence of PC gaming. Buying a game "console" seems almost archaic. With a mid range PC (high end laptop) able to play triple A titles, buying a machine to play games seems ridiculous.

I'm actually surprised that the average MSRP for a game hasn't gone up. The super franchises with huge followings can easily support higher prices. Video games cost the same/more in the 80's and 90's. $60 for Diablo III? I paid more for Mortal Kombat for Genesis.

 
RagnarDanneskjold:
I'm actually surprised that the average MSRP for a game hasn't gone up. The super franchises with huge followings can easily support higher prices. Video games cost the same/more in the 80's and 90's. $60 for Diablo III? I paid more for Mortal Kombat for Genesis.

You can thank Nintendo there. Those little cartridges cost a ton and killed their margins. Other companies could kill them on price while still making a killing per unit. The cartridges were meant to deter piracy.

 

I think the 2002-2006 period was the golden age of console video games. All games produced today work on the same systems that were available in 2005/6. The genres are the same: sports, fps, fantasy. There is only so much more that game creators can to do make the graphics better, gameplay better, and overall experience better. You will even see some game developers getting lazy on their sequel editions because they know that the costs of implementing or improving game features will not dramatically increase revenues. Game developers also seek exclusive licensees or claims to game personas ala NFL for Madden, Tom Clancy for strategic FPS. Once a company acquires exclusivity, this drives out competitors and creates fewer incentives for a company to put money into R+D.

The future of gaming is a pay-per-play setup that charges players for the amount of time that they spend playing a game. Many foreign game makers are currently implementing this strategy with varying levels of success. I believe that companies will find a suitable pay-per-play model that will generate substantial profits beyond what the pay-per-game model can currently deliver. Otherwise we will see $120 dollar console games.

I imagine in a few years there will only be 2 or three major video game distributors, who also own their development labs.

 

The fact of the matter is that the gaming sector has bifurcated between value and volume. The value players (ID, Blizzard, EA, etc) are struggling to innovate with regard to monetization schemes, while the volume players are often flashes in the pan (see: OMGPop and DrawSomething). Most acquisitions in the gaming sector are talent-acquisitions anyway. The true innovators are those offering cross-platform game networks, horizontally scalable virtulization platforms, and analytics engines that drive engagement (see: iQu). Subscription-based MMOs are making a comeback as well (see: CCPGames and EVE Online). Regardless, there is far more activity in the private sector.

Just my 2 cents.

 

Long - The first company that figures out a netflix type format where games can be played via an online accessible hub. I also agree that gaming consoles will start to become outdated. The one drawback to online gaming is that you cant play with other friends in the room. (no 4 player mario kart, halo, etc) Cable services will begin to offer a gaming platform you can access straight from your TV at home, mark my words.

Short - the brick and mortar gaming stores like gamestop. Its the second coming of borders, barnes and noble, etc.

Here's the thing. If you can't spot the sucker in the first half hour at the table, you are the sucker.
 
bullbythehorns:
Long - The first company that figures out a netflix type format where games can be played via an online accessible hub. I also agree that gaming consoles will start to become outdated. The one drawback to online gaming is that you cant play with other friends in the room. (no 4 player mario kart, halo, etc) Cable services will begin to offer a gaming platform you can access straight from your TV at home, mark my words.

Short - the brick and mortar gaming stores like gamestop. Its the second coming of borders, barnes and noble, etc.

I wouldn't be so quick to dismiss Gamestop for 2 reasons:

1) For some psychological reason, most gamers actually prefer hard copies of games (studies have been done on this)

2) Most importantly, the resell value of games. I'd say a large majority of games are purchased with the intent to resell for half the price a couple of months later. With the online option, that can't happen, meaning that a large segment of consumers will no longer be willing to pay $60 a pop for a game when they can't recoup some of that cost later that on. That's a competitive moat that gives Gamestop some value that the market isn't recognizing.

 
chill101:

2) Most importantly, the resell value of games. I'd say a large majority of games are purchased with the intent to resell for half the price a couple of months later. With the online option, that can't happen, meaning that a large segment of consumers will no longer be willing to pay $60 a pop for a game when they can't recoup some of that cost later that on. That's a competitive moat that gives Gamestop some value that the market isn't recognizing.

Perhaps, but what do they re-coup on that? maybe like $15 from the original $60? (I have no idea im just asking). Wouldn't you rather pay $30 and have unlimited access to a wide variety of titles month to month? Questions to ponder.

Here's the thing. If you can't spot the sucker in the first half hour at the table, you are the sucker.
 

I'm currently long ATVI, and have been since last August. It will be interesting to see if there will be any changes at Vivendi that could will affect ATVI, since they own such a large portion of the stock. It yields a 1.5% dividend as well.

I think quality games will always have a market. The volume players I'm not so sure about, but if ATVI started making lots of money with games like Angry Birds, I say all the more power to them as long as they continue to focus on the quality triple A titles as well.

 

If they get a fat contract for their content maybe. They obviously wouldn't do this with new releases like Diablo 3, rather sell the online content for older titles that have fallen out of favor.

Here's the thing. If you can't spot the sucker in the first half hour at the table, you are the sucker.
 
bullbythehorns:
If they get a fat contract for their content maybe. They obviously wouldn't do this with new releases like Diablo 3, rather sell the online content for older titles that have fallen out of favor.

Fair point. But do you think that this is imminent/a big enough threat to warrant shorting Gamestop?

 
chill101:
bullbythehorns:
If they get a fat contract for their content maybe. They obviously wouldn't do this with new releases like Diablo 3, rather sell the online content for older titles that have fallen out of favor.

Fair point. But do you think that this is imminent/a big enough threat to warrant shorting Gamestop?

at the right entry point yes ... there are plenty other reasons to short the stock IMO. Deteriorating margins, limited innovation in the gaming product cycle, competition from discount and internet retailers, increased social gaming IE angry birds, plus if you look at their FY12 street guidance they still have a looooooooooong way to go to hit 9.39 B in rev and $3.17.

Here's the thing. If you can't spot the sucker in the first half hour at the table, you are the sucker.
 
chill101:
bullbythehorns:
If they get a fat contract for their content maybe. They obviously wouldn't do this with new releases like Diablo 3, rather sell the online content for older titles that have fallen out of favor.

Fair point. But do you think that this is imminent/a big enough threat to warrant shorting Gamestop?

Gamestop already has a game downloading service. If bricks and mortar stores fall completely out of favor, which is unlikely to happen anytime soon, why wouldn't they further develop the online service? Their brand still has worth in the eyes of many a gamer, and services like Gamefly stink.

The industry will resist services where you can download full games at a set subscription price, so a huge shakeup in the industry won't happen overnight. In the meantime I could see Gamestop struggling with any potential transitions but I doubt they will completely fail to respond to the changes and end up bankrupt.

 

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