Few industries invited more interest from investors amidst the lockdowns of 2020 than gaming.
According to gaming market research firm Newzoo, the global gaming industry grew by over $30 billion from 2019 as much of the developed world stayed indoors. Meanwhile, Deloitte reported that a third of consumers surveyed in its 2020 Digital Media Survey have newly subscribed to a video gaming service, whether it be cloud or console based.
As such, console kings Sony and Microsoft (MSFT) - Get Microsoft Corporation Report as well as cloud-gaming providers like Nvidia (NVDA) - Get NVIDIA Corporation Report, Amazon (AMZN) - Get Amazon.com, Inc. Report and Alphabet (GOOGL) - Get Alphabet Inc. Class A Report were boosted by an exogenous event that, while overwhelmingly negative for the world, was positive for gaming.
Similarly, many game developers like Activision Blizzard (ATVI) - Get Activision Blizzard, Inc. Report, Take-Two Interactive (TTWO) - Get Take-Two Interactive Software, Inc. Report, and Zynga (ZNGA) - Get Zynga Inc. Class A Report all saw their stocks soar over the course of the year as well.
Yet, 2021 has not been a tale of such success, with many of the gaming-specific stocks cited in the latter group now serving as market laggards. In fact, both Take-Two and Activision Blizzard have declined over the course of 2021, with the former falling most significantly.
Further, Newzoo has recently forecast the gaming market to contract for the first time in the history of its market reports. This reversal of fortune has many wondering whether the best is behind the sector or if its key players remain unfairly underappreciated given long-term prospects.
It's Not Time to Give Up on Gaming
In the bull camp, many analysts are advising that investors stand their ground in gaming as a slight step back was to be expected after an anomalous 2020.
“Similar to the traditional entertainment industry, the video game business is hit-driven with limited visibility into the performance of many new releases,” Baird analyst Colin Sebastian told investors in a recent note. “As such, there is inconsistency in the performance of video game publishers and a degree of lumpiness in quarterly results.”
He added that he believes the market is overestimating the regression of the industry, instead positing that 2020 represented a pull-forward of secular trends in gaming that will show in the long term. Under this presumption, some added “lumpiness” is not a reason for alarm as the underlying macro trends remain positive.
Backing up Sebastian’s view, Morgan Stanley analyst Brian Nowak voiced his bullishness on the industry overall while highlighting Activision Blizzard, Zynga, and Take-Two as undervalued stocks with strong enough pipelines to generate a solid pop in the near future.
He cited a remastered GTA as a likely boost in Take-Two’s pipeline ahead as other titles like Red Dead Redemption 2 and its slate of NBA games continue strong performance. However, Nowak saved his highest praise for Activision.
“The pipelines of some leading publishers are also about to flow,” he wrote in a note to investors. “We remain most positive ATVI with Diablo Immortal launching globally by year end, Diablo2 remaster expected in the fall and 2022/2023 set to have DiabloIV and Overwatch 2.”
Essentially, Nowak advised investors not to depart from positions in the top game developers amid some delays as their pipelines still point to a big payoff just over the horizon.
However, that horizon may be obscured by some high-profile scandals in the case of Activision Blizzard. While not having quite the downturn touted by Take-Two in 2021, serious allegations levied against many of its key game developers could provoke a sustained slide.
Firstly, one must consider the allegations and legal issues confronting the company.
The workplace issues for Activision Blizzard appeared on investors’ radar in late July as the California Department of Fair Employment and Housing filed a lawsuit over what they termed systemic workplace harassment and discrimination. Further, the suit accuses the workplace of appearing more akin to a “frat house” than a place of business.
Named directly in the lawsuit was former Senior Creative Director of Blizzard flagship World of Warcraft Alex Afrasiabi, who departed the company in June 2020 ahead of the latest allegations. However, he was not the only staffer to be implicated. Per video game news outlet Kotaku, three more senior designers were forced from the company, each playing pivotal roles in the company’s Diablo and World of Warcraft franchises.
For investors, this begs the question of the development talent pool if so many key figures in the company’s most popular titles were also key figures in its workplace harassment scandal. At the least, heavy turnover would hamper the company’s ability to keep its pipeline on track within its flagship titles.
Yet, and perhaps more importantly, this also begs over increasingly important ESG considerations. Clearly, the work environment comes as a result of poor corporate culture that corporate governors allowed to fester.
Such consideration will need to be noted by not only retail investors seeking to allocate capital in a responsible fashion, but large institutions that can significantly influence the stock’s trajectory should they become fed up with failures in the G of ESG.
Game Over in China?
Still, the largest risk remaining for investors is likely linked to China and its ability to effectively eliminate billions in revenue by simple decree. In this case, the risk is not merely tied to one company.
Earlier this month, the state-sponsored Economic Information Daily published a piece railing against the problem of video game addiction in China. The piece put a spotlight on serious physical, emotional, and psychological damage from gaming. The report even went as far as to liken video games to "spiritual opium", an extremely harsh criticism in the Chinese context given its allusion to the Opium Wars that began what the ruling Chinese Communist Party calls the “hundred years of national humiliation.”
While the China Game Publishers Association Publications Committee pushed back on this excoriating language, there remains a broad fear of a crackdown akin to what occurred in the education industry. Thus far, Tencent and other Chinese firms have felt the brunt of market apprehension over impending action by Beijing.
However, it should not stop there given the reliance of essentially all game developers on the $55 billion Chinese market. "It's a great market for us," Take-Two CEO Strauss Zelnick said in an earnings call earlier this month. "NBA 2K Online continues to grow in China.”
According to the company’s latest Securities and Exchange Commission 10-Q filing, the NBA 2K alone has more than 53 million registered users in China, making up the largest national concentration of users. He added that his relationship with Tencent is a linchpin in the company’s penetration into the Chinese market. Obviously, any major regulatory shifts could kill this key growth engine.
Zynga, likewise, has heavy concentration in China given its mobile gaming focus. In fact, 35% of global mobile gaming revenue was generated in China over the course of 2020, according to GlobalData, meaning the market is integral to all mobile developers.
Seeking to seize on this opportunity, Zynga added China exposure with its recent $525 million acquisition of China-based developer StarLark earlier this month. With the industry now under review, the takeover could prove costly should crackdowns come.
Finally, for Activision Blizzard, the company’s pivot to increased production of mobile gaming titles is a clear indication of focus on China’s mobile-first gaming community. Yet, it’s 10-Q filing does not make mention of China at all.
“China was less than 5% of our net bookings for us last year,” CFO Armin Zerza told analysts on an earnings call earlier this month, downplaying the regulatory drama. “As you know, we have a long history of adapting and responding to changes in the regulatory environment there.”
While less of an impact directly than its peer in TakeTwo, the tremors from major regulatory action in China certainly takes away a major growth factor, especially for the company’s push toward mobile gaming. Therefore, if there is an overreaction to such autocratic action in China, Activision’s less acute exposure could offer investors an opportunity.
Still, China’s unpredictability is but another indicator of an increasingly uncertain gaming sector.
Kevin Curran is long ATVI.