STOCK MARKET ANALYSIS

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In a world where the boundaries between reality and the virtual are becoming increasingly blurred, the video games sector is transforming itself into an economic colossus. Despite tougher regulation in China, the number of gamers worldwide continues to rise (see Fig. 2). What's more, the profile of gamers is increasingly diverse, and improved mobile connectivity is making video games more accessible (see Fig. 3). Today, the industry is booming, at the heart of a battle where innovation and creativity dictate the valuation of companies.

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Fig. 2 & 3 - Revenues in the global video games market, by segment and by country

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Nevertheless, the sector's performance continues to disappoint. Since the financial bubble of February 2021, artificially inflated by the lockdown periods during the Covid-19 pandemic, the ETFs that include the main companies in the sector (HERO US, GAMR US, NERD US) have underperformed the MSCI World index by between -45% and -60% (see Fig. 4). Up until October 2022, the underperformance may have seemed justified, but over the last eight months the trend has been exaggerated (see Chart of the Week).

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Fig. 4 - Performance of the main video game ETFs

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For the record, video games took off in the 1970s and 1980s, with the advent of arcade terminals and the first home consoles. Atari and Nintendo had a simple business model: selling consoles and physical games. The stock market value reflected the popularity of the games and sales. Since then, the sector has continued to evolve. In the 1990s and 2000s, Sony's PlayStation and Microsoft's Xbox introduced 3D graphics and online gaming. These innovations paved the way for business models based on subscriptions and downloadable content (DLC). Companies' stock market valuations began to incorporate not only the sales of hardware and physical games, but also the recurring revenue potential of online services. More recently, the arrival of smartphones has revolutionised the sector with the emergence of mobile games and the free-to-play model (F2P). Companies such as Supercell (Clash of Clans) and King (Candy Crush) have succeeded in broadening their target audience and generating considerable revenues through microtransactions in free-to-play games. As a result, companies' stock market valuations are increasingly based on their ability to engage and monetise mobile user bases.

Cloud gaming is now revolutionising the industry. This technology gives gamers access to high-quality games without having to invest in expensive hardware, while companies in the sector can develop subscription models similar to Netflix (see Fig. 5). Google (Stadia), Microsoft (Xbox Cloud Gaming) and Sony (PlayStation Now) are all investing heavily in this area, anticipating a market transformation like that seen in the music and film industries with streaming. The transition to cloud gaming and the associated business models has significant implications for the valuation of listed companies. More than sales of hardware and physical games, it is the ability of companies to attract gamers and monetise digital services that matters. Recurring revenues, by definition more predictable and stable, are more highly valued by investors.

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Fig. 5 - Cloud gaming ecosystem

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Technological advances such as virtual reality, artificial intelligence (AI) and blockchain are also having a crucial impact on the video games industry. Companies that effectively adopt and integrate these technologies are well positioned to take advantage of them :

▪ Virtual reality and augmented reality are transforming the gaming experience by offering unprecedented immersion. They enable the creation of more engaging gaming experiences, expanding the possibilities for storytelling and interaction, opening the door to new game genres such as virtual tourism or theme parks.

▪ Artificial intelligence is used to improve real-time graphics and create more realistic and convincing character behaviour. AI is also used to tailor game elements to player expectations, such as world generation or enemy control, to increase satisfaction. The personalisation and adaptability of games encourages engagement and retention. It also optimises in-game product recommendations and increases monetisation opportunities.
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▪ Blockchain introduces digital ownership and monetisation of virtual assets within video games. Thanks to non-fungible tokens (NFTs), players can now own, buy, sell, or trade unique game elements on global markets. For example, with play-to-earn, players can earn rewards in the form of cryptocurrencies or NFTs. This approach tends to increase player engagement and opens up new revenue opportunities for companies in the sector.

Fig. 6 - eSports ecosystem

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eSports, streamers and online forums now exert a significant influence on the promotion and success of video games. Developers and publishers are increasingly turning to them.

▪ eSports provide a platform for video game competitions, such as League of Legends or Counter-Strike. Major tournaments pit professional players against each other and are broadcast online, increasing visibility and engaging a passionate community of spectators. These events are now positioning eSports as a legitimate competition, with dedicated fans and significant sponsorship (see Fig. 6).

▪ Streamers, via platforms such as Twitch and YouTube, play a crucial role in the popularity of games. Their ability to draw attention to new titles or revive older games can significantly influence trends and revenues. Fortnite, for example, has seen its popularity soar following the broadcasting of games by influential streamers such as Ninja, but also in collaboration with celebrities such as Drake and Travis Scott. This increased visibility is capable of transforming a niche game into a global cultural phenomenon.

▪ Online forums and social networks allow gamers to share tips, reviews, and gaming experiences. Platforms like Reddit are helping to forge a deep-rooted and diverse gaming culture.

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The video games sector is facing a number of regulatory and ethical challenges, particularly in terms of data protection, intellectual property, and social and environmental challenges (sustainability, inclusion, mental health). Many countries are taking a close look at these issues, which has already begun to lead to changes in regulation and therefore in business practices. In China, measures taken between 2021 and 2023 to combat addiction have restricted the amount of screen time children are allowed to play. Beijing has also limited the maximum monthly amount that minors are allowed to spend on microtransactions, whereas previously they tended to pay out colossal sums to progress more quickly in games. Measures of this kind are holding back the development of video games and help to explain the sharp correction in the share prices of companies in the sector, led by national giant Tencent.

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Video game companies can be divided into two main categories: game publishers and hardware manufacturers. Game publishers, such as Microsoft (Activision Blizzard), Tencent and Electronic Arts, have high profit margins because they continue to sell game updates after the initial release of a title. Hardware manufacturers, such as Microsoft, Sony and Nintendo, generally have lower margins, but are now managing to compensate for this by expanding their product portfolio to include online services and accessories.

▪ Microsoft (MSFT US) is diversifying and strengthening its revenues with the introduction of the Xbox Series X|S, which has boosted sales, but also with services, such as Xbox Game Pass, that provide a recurring revenue stream. The company is now focusing on cloud gaming, seeking to make games accessible on a variety of devices. After two years of twists and turns, Microsoft (MSFT US) has succeeded in acquiring Activision Blizzard. Boosted by successful franchises such as "Call of Duty", "World of Warcraft" and "Overwatch", the company generates significant revenues on PC, console, and mobile platforms.

▪ Tencent (700 HK) dominates the Chinese video game market, with revenues from popular mobile games, online advertising, and stakes in other video game companies. The company is also investing in cloud gaming technology and artificial intelligence.

▪ Electronic Arts (EA US) is known for its successful franchises such as FIFA, Madden NFL, and the Battlefield series of games. The company profits from the sale of games, downloadable content, and online services.

▪ Sony (6758 JT) enjoys a strong market position thanks to its PlayStation division, which makes a significant contribution to its sales and profitability. The PlayStation 5, despite production constraints, has been a commercial success. The company is constantly investing in research and development, as demonstrated by the launch of PlayStation VR.

▪ Nintendo (7974 JT) is renowned for the hybrid nature of its Switch, which can be used as both a home console and a portable device.

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Fig. 7 & 8 - Share price performance of the main video game companies

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Just behind these giants (see Fig. 7), several companies (see Fig. 8) are trying to gain market share :

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▪ Epic Games (unlisted) is known for its hit game Fortnite and its Unreal Engine. The company has managed to diversify its revenues through the sale of games and engine licences, as well as through its Epic Games Store. The strategic decision to offer developers a more favourable distribution of revenues than its competitors has made its platform a must for game distribution.

▪ NetEase (9999 HK) excels in the development and operation of online multiplayer and mobile games. The company is renowned for its collaboration with Blizzard Entertainment and the publication of famous titles such as World of Warcraft and Overwatch. It is actively exploring new technologies and business models to maintain a dominant position in the Chinese market.

▪ Roblox (RBLX US) is a gaming and creation platform that allows users to develop and share their own games, from simple adventure games to complex simulations. It stands out for its dynamic community and its business model based on in-game purchases. The company never ceases to surprise, both in terms of active users and revenues.

▪ Take-Two Interactive (TTWO US) has a large portfolio of successful franchises. The resounding success of GTA V generated more than $8 billion in revenues and enabled the company to demonstrate the financial potential of its strategy. With the release of GTA VI, already scheduled for 2025, it aspires to go even further, creating a space where gaming, social and commerce converge in unprecedented ways. The promise of an immersive metaverse experience and the integration of NFTs through Zynga, positions Take-Two at the forefront of digital entertainment.
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▪ Ubisoft (UBI FP) is renowned for its blockbuster franchises such as Assassin's Creed, Prince of Persia, Avatar, and Just Dance. The company is distinguished by its commitment to innovation and the diversity of its game offerings, which span multiple platforms. With a global network of studios, the company pursues its quest for immersive and narrative gaming experiences, notably by integrating virtual reality to enrich the worlds of its games.

The video games sector has seen major waves of redundancies: 10,000 jobs lost by 2023 and already 8,000 by 2024. These figures confirm the scale of the crisis affecting the industry, particularly in North America and Europe. Higher development costs, a return to normal post-pandemic levels, and ambitious acquisitions help to explain this trend. The other side of the coin is that companies have a much more efficient production base and are likely to post higher profits.

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Finally, and counter-intuitively, the contraction in household purchasing power is proving to be a positive factor for the sector. Despite the fact that video games are considered to be discretionary consumer goods, the economic crisis is forcing consumers to make trade-offs in their leisure spending. When budgets are tight, video games are seen as an affordable form of entertainment, to the detriment of restaurants, museums, or cinemas, and even more so of travel or holidays. Seeking to maximise the value of each leisure expenditure, households perceive video games as a cost-effective source of entertainment. For between €40 and €70, they can spend several hundred hours playing and finding a form of escape and socialisation. Furthermore, the economic crisis will encourage the roll-out of paid subscription offers such as Xbox Game Pass and PlayStation Plus.

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Conclusion :

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Video games represent a major and growing economic sector. Paradoxically, against a backdrop of economic crisis and loss of purchasing power, households are favouring video games over other forms of leisure. This phenomenon will enable hardware manufacturers and games publishers to continue to increase their profits. So, after two years of underperformance on the stock markets, linked to the tightening of regulatory constraints, companies could once again attract investors and start a significant recovery.

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RETURN ON FINANCIAL ASSETS

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