The Alpha Of All Megatrends: ESports
eSports is quickly becoming a dominant force across the world entertainment industry.
With growth set to continue, monetization will follow to around an easy $10 billion.
The industry is young, and so is the target audience. Decades of profits are ahead.
I don't use the word 'megatrend' lightly. It is a precarious word, full of hype and unrealistic expectations. People often think that they can invest in any one of the companies exposed to one of these trends and make bank. Such strategies have lost many people a lot of money over the decades. Think of railroads, airlines, and solar, all boasted as megatrends. Sweeping cemeteries could be filled with the remains of companies that had remarkably short lifespans, their megatrend status notwithstanding. That's not to say that some companies haven't ridden those waves to tremendous profitability. There are some. But it takes time, the maturing of the industry, one or more shake-outs to scrub the losers, and finally stability. Good luck picking the winners.
Most recently, the aging of America and the swelling senior population has been often cited as a megatrend. Yet, the situation is stuffed with nuance, which I wrote in detail about here, here, and here.
I mention all this to underscore the fact when I use the word megatrend, it is not some loose label or click-bait. When it comes to eSports, or the competitive video gaming industry, there is plenty of data indicating how huge the rise has been and will yet be. That isn't to say that there is no nuance here and you can just grab an eSports ETF and have your retirement secured. No, granularity and wisdom are always mandatory for true investing. Nonetheless, of all the megatrend waves to try and catch, I think this one is the easiest.
A Little History
Esports goes farther back than you might think. Ever heard of Spacewar!? It was developed in 1962 and features two spaceships dog-fighting around a gravity pulling star. This was the game featured in the first documented instance of an eSports tournament, hosted by Stanford University in 1972. Competitors played for a year-long subscription to Rolling Stone magazine.
Fast-forward to 1980 and we find the first large scale tournament, with 10,000 competitors showing up to clash in Atari's Space Invaders. Then in 1983, the U.S. National Video Game Team was formed and took a bus tour around the country challenging arcade gamers to bouts and even tried organizing contests with other countries.
As the sport grew, so did the number of tournaments. From the Evolution Championship Series ("EVO") to the Nintendo World Championships (OTCPK:NTDOY), both players and spectators started flocking. EVO is of particular mention. Since its inception in 1996, it has occurred every year since 2000, with each year showing considerable growth in a variety of metrics. Featuring only fighting games such as Street Fighter, Smash Brothers, and the like, EVO has garnered a tremendous popular following. EVO 2019, held at the Mandalay Bay for three days in Las Vegas, had 9,000 participants and was streamed to millions of others via various streaming sites. Viewed hours totaled 5.73 million.
The internet has revolutionized the gaming industry. Consoles gave way to personal computers. The prevalence of computers naturally rose to a prevalence of computer gaming, with players able to compete, alone or on teams, against opponents thousands of miles away.
Esports has become so popular that an arena was constructed at The Luxor in Las Vegas to host gaming events:
The 30,000-square-foot, multilevel HyperX Esports Arena is designed to host every form of competitive gaming, from daily play to high-stakes esports tournaments, and features a competition stage, 50-foot LED video wall, telescopic seating, PC and console gaming stations, and a network TV-quality production studio.
A new $50 million dollar facility is under construction in Philadelphia. This is in addition to dedicated eSports facilities in Honolulu HI, Arlington TX, and Burbank CA. Other facilities are outfitting themselves to host eSports events occasionally like Boardwalk Hall in Atlantic City. The worldwide architectural firm HOK, with 24 offices on three continents, is dedicating ever more personnel and resources to the field, imagining high tech and interactive eSports stadiums. HOK was in fact involved in the renovations to Boardwalk Hall mentioned above, as explained in a New York Times article:
HOK, a sports-focused architecture firm with a growing e-sports practice, which helped reconfigure the stage, change the lighting and set up a broadcast studio for live streaming, said Rashed Singaby, a firm senior associate whose previous work includes the Mercedes-Benz Stadium, home of the Atlanta Falcons.
HOK, based in Kansas City, is funneling more resources into the growing field. Two years ago, it had no designers working on e-sports; today, it has 15, said Mr. Singaby, who added he has had commissions for five e-sports projects in the past year.
Developers are now knocking on HOK's door, including owners of empty big-box stores hoping to repurpose them, Mr. Singaby said.
"The numbers don't lie," he added. "The commitment to this ecosystem has been gigantic in the last 10 years. We don't think this is going away."
The parallels to professional physical sports are apparent. Interestingly, eSports has attracted the attention of professional athletes. Back in 2016 previous NBA star Shaquille O'Neal and MLB players Alex Rodriquez and Jimmy Rollins invested in NRG eSports, a professional group that plays League of Legends and Counter-Strike:
I am not suggesting that we use professional athletes as a gauge for whether or not an investment should be made. Rather, my point is that eSports is getting noticed. It is huge and growing. What was once a corner for people to point and laugh it is becoming mainstream, credible, competitive, and scalable.
Massive institutions are in on the action. eSports sponsors include Intel, Toyota, Coca-Cola, Comcast, Red Bull, Mountain Dew, T-Mobile, Audi, and Airbus. eSports events have occurred in London, Madrid, Hong Kong, Paris, and many others.
A Word On League of Legends
This particular game has become so important it deserves a section all its own. League of Legends, currently the most popular game in the world, is one I have personally had considerable experience with as a player and as a spectator. As most who have played will attest, it is addicting. Launched in 2009 by Riot Games [acquired in 2015 by Tencent (OTCPK:TCTZF) (OTCPK:TCEHY)], League of Legends has 80 million monthly users and 27 million daily users across 145 countries. From 2011, that is a CAGR of 36% and 33% between monthly and daily users, respectively. The 2018 League of Legends world championship had more viewers than the NFL Superbowl from that same year. The LoL Esports page on YouTube has 3.2 million subscribers. The video of the 2019 World Championships on that same page has had 5.1 million views. While it is free to play, the game relies on micro-transactions to earn revenue. For example, people can pay to get different "skins", outfits if you will, for the characters they play. Riot brought in $1.4 billion of revenue in 2018. As they and other platforms continue working on monetizing their products, hefty profits will follow. A dedicated eSports facility, complete with dining area and gift shops, sits adjacent to Riot's headquarters in Los Angeles.
So it's popular. But is it profitable?
This is the question that investors want answers. While there is plenty of money involved in eSports, where and when it flows is tricky. An April 2018 article from gameanalytics explains it well:
eSports has come far in 20 years, but while it might be rivaling professional sports leagues in terms of viewership, the financials are a different story. The NFL was expected to generate $14 billion in revenue in 2017, with the NBA hitting $7.4 billion. At its most optimistic level, Newzoo forecasts that global eSports revenue could reach $2.4 billion in 2020.
Video games can be hard to monetize, especially those offered online. The list is long of free to play titles: League of Legends, Fortnite, World of Tanks, Apex Legends, and Hearthstone among many others. These games require people to spend money on extras, which is not necessarily a given or consistent.
That being said, higher education is catching on to the trend, indicating that the space has moved from hobby to profession, as told by a Forbes article:
Ohio State will debut an 80-seat facility in the fall (of 2019) around the time it debuts what it calls "a first-of-its-kind comprehensive esports program" that will include "undergraduate and graduate degrees; an elective course in esports content production; online certification programs for specialized credentials; and a gaming speaker series."
Smaller schools such as the University of North Texas have been engaged in esports for even longer. UNT opened a $200,000 esports facility in 2017, open to any student or faculty member but designed specifically for competition training.
And the 40-year-old private Full Sail University is building a significant portion of its campus life and work opportunities around a new esports arena, team and club, said the school's esports strategist Bennett Newsome.
What the Future Holds
We have established that eSports is ridiculously popular and will very likely continue to grow. We have also established that the monetization of video games has been elusive, and currently sits at a pretty low level. But if the popularity can be coupled with profitable monetization, you have a true megatrend. That was the topic of a fascinating article from venturebeat that is worth reading in entirety, but I will quote and summarize. The article was based on a webinar wherein industry experts held a panel discussion to address the issue of monetization. Some main points:
- Like professional sports, eSports can earn money from media distribution rights, live events, advertising, sponsorship, merchandising, and prize winnings. Unlike professional sports, however, the games themselves are owned, which introduces another avenue of monetization. No one owns football. No one owns basketball. They are without copyright. This is in stark contrast to video games, which are intellectual property and which are owned. Robb Chiarini, director of eSports at Ubisoft, spoke to this in some detail:
If you've ever heard me talk about these things, I talk about how traditional sports have to sell media rights. They have to have sponsors. They have to have advertisers. They have to have all this influx of money, because they don't have anything, at the end of the day. They don't own the ball. You and I could start up a new football league tomorrow if we wanted to and no one can stop us from using that sport as a vehicle for a program. We'd get our own sponsors, do our own things, and we could do anything we wanted. Nobody owns the IP of the football.
With video games, we're in a very different place, in that we can look at things differently if we choose to. As many esports start up, they look at it going, hey, this is a marketing a vehicle, a messaging vehicle, an engagement vehicle, a community retention and engagement vehicle, rather than a P&L against a thing to provide an entertainment that creates profit. For us, owning the game gives us the opportunity that every activity we do, every dollar we spend on an esport, is actually a way for us to engage with our existing communities, create viewership, create playership, create opportunities for monetization within the game and on the game itself.
All of that is super interesting. I believe esports has the biggest leg up against traditional sports in that way. Adding to that-I agree with your list, merch and media rights and things. There are some other things that are interesting. Gambling is out there in the space, not that I'm a proponent or otherwise, but that's a revenue stream that's out there in the world. Fantasy leagues, gambling sites, things like that. Another thing we do in esports, or in gaming in general, is interactive money. When you look at things like Twitch Bits and things of that nature that allow people to purchase around the game, that's different from the traditional sports. That's another revenue opportunity within the ecosystem, and for all of gaming.
Revenue for eSports was $906 million in 2018, broken down as follows:
Jonathan Singer, industry strategist at the content delivery network, cybersecurity, and cloud service provider Akamai mentioned the following to elaborate on that above graph:
I have a little bit of a bomb to throw, which I feel is a good way to start off a panel. That is, we talk about where the revenue is growing to. I think it's supposed to be $904 million this year and then a billion soon enough, with 380 million global viewers. That's a nice size of audience. But when you do the division there, you're talking about $2.60 a user... Is that enough money to go around? It's not a lot of money yet. I know we're growing as an industry, but when we're talking about revenue models, you have to talk about how we're getting there and how we get-everyone's fighting for a slice of that pie.
While today that sounds bad, it also underscores the opportunity, as Kent Wakeford, chief operating officer at eSports organization Gen.G pointed out:
I think what you just framed up is one of the most exciting opportunities in esports. Goldman Sachs had a report recently where they showed that the average esports consumer monetized to about $3.94. Whereas the average consumer in traditional sports is monetizing to about $54. That means there's a 10X opportunity within the esports market to grow and build those connections with fans, to bring them things they're willing to pay for, for their excitement and their fandom and their engagement with teams and players. I view that as an opportunity.
When I look at the revenue growth drivers in esports, I think they're all way under what the reality is going to be. We see it in the viewership. We see what's happening on a global basis with stadiums being built all around the world - in the U.S., in China, in Korea. We see brand sponsors coming in. We see bigger media rights deals happening. We see merchandise. We just saw the announcement with the Overwatch League and Fnatic doing merchandise. It's moving at a much faster speed than a lot of the industry reports have been putting out. That's the opportunity. That's why you see so much capital coming into esports.
The Silver Screen
Another avenue for profitability is turning video games into full-length movies. This has already been happening to some success with the titles "Pokemon: Detective Pikacho", "Rampage", and "Angry Birds 2", "Tomb Raider", and "Prince of Persia". I imagine the trajectory here being similar to how sports have become inexorably tied to cinema. What with hugely popular movies like "Field of Dreams", "Hoosiers", "Miracle", "Rocky", "Rudy", "Remember the Titans", "Radio" and others, don't be surprised to see movies based on video games taking their place among the most popular movies. The difference with video games is that, as was mentioned before, no one owns the rights to football or basketball. I could make a sports movie today and not have to pay a dime of royalties. However, if I tried to make a movie about one of the champions from League of Legends without getting the rights and paying a handsome fee, I could be sued. This could be a vast source of revenue and growth.
See, League of Legends has considerable lore surrounding each of the 146 characters you can play as. Their stories are distinct, yet many are tied to one another. The structure is already in place to make full length features films derived from this lore. In fact, the folks at Riot have already put some stories to cinematics. Feel free to conduct a YouTube search of your own, but this clip tells the story of one Lucian seeking to free the soul of his deepest friend, Senna, who was killed by Thresh, a soul collector:
As the popularity of League of Legends continues to grow, expect big-name studios to start launching themselves into these gamer worlds.
Even the mighty Amazon (AMZN) is getting heavily involved. They purchased the video gamer streaming service Twitch in 2014. Twitch has 15 million daily active users.
In all my talk of megatrends, I have to mention Asia here. Everyone has talked about Asia, and China in particular, as the next big growth markets. Successful investing in these regions has been challenging as the situation is filled with complications. As it relates to video games, it is valuable to understand the cultural role technology and video games have there. Traditional sports, as we would term them, don't have a huge place in Asian culture. Children are encouraged to study rather than exercise. In contrast, video games are massive in the region. eSports professionals are celebrities. Regarded as the best League of Legends player in history, "Faker" of South Korea is paid $2.5 million dollars a year to play for the eSports squad SK Telecom T1. He dropped out of high school to get on the team.
China alone makes up 57% of the global eSports audience. Ann Hand, CEO of Super League (SLGG), an eSports community and content platform said, "The first place you should go if you care about gamers is Asia, and specifically Greater China, as fast as possible."
If Asia is the next big growth market, video gaming is the industry that will be among those to lead the way there.
Where Traditional Sports and eSports collide
Never ones to look down their nose at potential profits, the world of traditional sports is hitching their wagon to eSports. Nike recently disclosed a four-year sponsorship of the League of Legends Pro League ("LPL") in China. They are to provide shoes and apparel to 16 teams in the region. Of the deal Nike said:
Since its inception, Nike has always believed that in all sports, a strong body and will make athletes better. As China becomes a new e-sports cultural center, Nike is pleased to support the next generation of athletes and establish a long-term cooperative relationship with e-sports to contribute to the future development of sports ecology."
This isn't all. Adidas has signed agreements with the French team Vitality. Puma has linked up with North American team Cloud9 to create signature apparel for gamers. While not necessarily inevitable or to happen soon, eSports may even become part of the Olympic games. A forum was held by the International Olympic Committee and the International Sports Federation last July to discuss the matter. They are steering clear of involvement for now, but the fact that the discussion was had at all is revealing. The proverbial ball is rolling.
Brief Exploration and Conclusion
The final point to make is that the audience for eSports is young. The average video gamer is between 20 and 25 years of age. There are many decades of monetization ahead as these fans age and bring up their own children in the video gaming culture. This is in contrast to traditional sports, where recent data has shown considerable waning interest. The average NFL viewer is 50 years old. MLB is 57 years old. MBA and NHL is 49. This is amid a backdrop of plummeting viewership and emptier stadiums. eSports is young. It is growing. Money is flowing into it. But the best part is that the ship has not set sail yet, as it were. Remember the stats from above where the average eSports consumer monetized to about $3.94 vs. the $54 for traditional sports? Recall also that people are watching eSports more than they are watching the Superbowl. As eSports monetization closes the gap on traditional sports, lucrative might be an understatement. As firms figure out how to monetize eSports, and they are, it is going to be fantastically profitable.
The opportunity exists because profitability has lagged popularity, for now. A quick look at some of the top names in the space shows that market participants are concerned about growth. Tencent currently trades at $43, well off the all-time high of $60 back in the first part of 2018. Activision Blizzard (ATVI) is trading around $55, while back in mid-2018 they were above $80. The breather is an opportunity to buy while monetization takes shape.
As it relates to valuations, value investing purists might shy away from the high P/E ratios of Tencent at 32 or Activision at 25. I prefer to consider these ratios in context, and for both companies, their respective P/E ratios are well off their five year average P/Es of 43 and 51. In that respect, they are cheap. In fact, all the other traditional valuation measures (P/S, P/FCF, etc.) for Tencent are below 5-year averages. Activision is more of a mixed bag. If value is your thing, Tencent may be the better choice. Activision Blizzard owns Call of Duty, Overwatch, and Candy Crush. Tencent owns League of Legends and has a 40% interest in Fortnite. It terms of the most popular games and in demand content, these two are the winners. That should be a good starting point for individuals to conduct their own due diligence.
For exposure to a more pure eSports model, Super League Gaming is interesting in that it doesn't own any games but rather operations in the content delivery and interactive platform space. It connects players through its cloud. They specifically market themselves to the sub-pro audience. The CEO is aiming to create a "Little-League" for eSports. This niche player might be interesting to explore. They had their IPO earlier this year at $8.50 but currently trade at $2.74.
In light of that brief overview, in my upcoming articles, I am going to start jumping into this sector head first. I will begin by exploring several eSports and video-gaming ETFs (NERD) (ESPO) (VIDG) and then move on to individual companies such as Activision Blizzard, Tencent, and Super League Gaming. I hope you join me. For now, the best way to play the trend is to either A) buy one of the above mentioned ETFs or B) buy the stock of the companies who own the more popular titles in the eSports and gaming world.