Enforced lockdowns across the globe have turbocharged the number of people playing video games.

In this article we will look at the main domestic and global players in this market and identify two ways to gain exposure to this emerging space.

DEMAND SHOWING UP IN PLATFORMS

The demand for gaming is showing up in online marketplaces like Steam which has seen a 40% increase in players to 25m since March.

US telecom carrier Verizon reported a 115% increase in data traffic and research firm Earnest Research reported that spending on games in the US was 75% higher in the week ending 1 April.

In the UK sales of gaming consoles spiked 127% in the week beginning 9 March and 250% the following week. In the week before lockdown, digital sales of games shot-up 67% week-on-week while Italy, Spain and France saw even bigger spikes.

While undoubtedly driven by the increased number of people working at home with extra time on their hands, video games have more of a social and interactive element relative to watching Netflix for example.

In fact the World Health Organisation (WHO) recently endorsed video gaming as part of the campaign ‘Play Apart Together’ to encourage adherence to social distancing measures. Mental health workers have highlighted the potential long-term damaging effects of extended periods of total isolation.

People like watching other individuals and playing games isn’t any different, as seen in the data gathered by Twitch, one of the largest streaming platforms, which showed an amazing 73% increase in viewers watching others play games since February 2020.

E-SPORTS KICKING REAL SPORTS INTO TOUCH

Another knock-on effect of social isolation has been the cancellation of many popular global sporting events, depriving people of one of their most prized social activities. This void is being increasingly filled by growth in e-sports, where around 400m people around the globe pay to watch other players compete against each other.

One recent example is the launch of the inaugural ePremier League Invitational tournament which featured fans and professional players alike competing against each other. 

The prize fund will be donated to the NHS under the #PlayersTogether initiative, advising viewers to stay at home and observe social distancing. The semi-finals and final were broadcast live on Sky Sports Premier League. 

Another example is Formula 1 where the first eight races have been postponed or more likely cancelled due to the global pandemic.

Racing game developer Codemasters (CDM:AIM) would normally benefit from the release of a new version of its F1 game during the season, so in its absence the PC version of the official F1 2019 PC video is being used in the new F1 Esports Virtual Grand Prix series, featuring several current F1 drivers.

FOCUS ON FORTNITE

While e-sports is a fledgling and growing business the biggest prize pots and audiences have traditionally been seen in the bestselling video games. 

Fortnite, which was released in 2017, is a survival game where the winner is the last man standing The game, which is 50% owned by Tim Sweeney, chief executive of Epic Games and 40% by Chinese online games company Tencent, pays out over $100m in annual prizes.

Reportedly one player who went by the name of Tyler ‘Ninja’ Blevins made $1m a month playing Fortnite and streaming it on Twitch.

Broker Peel Hunt believes the unexpected boost to the gaming industry is simply accelerating already established long-term trends and it will therefore maintain the momentum post lockdown.

While the lockdown has presented some logistical challenges for the gaming sector, all companies have transitioned to home working without too much disruption.

In its full-year results announcement on 21 April developer Sumo Digital (SUMO:AIM) said it had experienced some delays around larger projects of 150 people or more, but expected to see this normalise later in the year.

Chief executive Carl Cavers told Shares there were early signs that working from home may actually be increasing productivity. Sumo tends to attract creative people for whom working is more of a passion and lifestyle choice.

SECTOR OUTPERFORMANCE

Shares in most gaming companies have shown gains this year against a fall of 25% in the FTSE 350. We have included overseas shares to underscore the global nature of the outperformance. The UK’s exposure to gaming is relatively small in a global context, with much larger firms in the rest of the world.

UK gaming firms are specialist developers working within a specific niche. Codemasters specialises in racing games, Frontier Developments (FDEV:AIM) makes games which are based on simulated worlds, such as Jurassic Park, and Team 17 (TM17:AIM) develops tactical games such as its iconic Worms where players combat other teams of worms or the computer.

Sheffield-based Sumo Digital has collaborated on big franchises such as Hitman, F1 2009 and Mortal Kombat 11 as well as working with the world’s biggest publishers including Microsoft and Sony.

However, the firm is instrumental in the creation as well as the development of games and this is reflected in the fact that it owns the intellectual property attached to around a third of its revenue.

The company’s latest launch was a co-owned game with Apple called Spyder, which is available on the Apple Arcade platform.

On 21 April the company reported that revenue grew 27% to £49m and gross profit was 30% higher at £24m. However, the company has been one of the poorest stock market performers against peers this year.

SUCCESS STORIES

Frontier Developments was founded by industry veteran David Braben in 1984 and today publishes its own innovative games across different genres. Planet Zoo was released in November 2019 and sold the most units on PC of any of Frontier’s games during an equivalent time period, crossing 500,000 units in early December.

The game allows players to build their own individual zoo and populate them with animals that think and feel while exploring the world that players create for them.

At the interim stage the company stuck to its prior full-year revenue guidance of £65m to £73m.

Independent Wakefield-based developer and publisher Team17 has released over 90 premium games over 30 years and won many awards in collaboration with partners.

The shares have been by far the best performer in the gaming sector so far in 2020, up 52% and since floating on the AIM market almost two years ago are up an impressive 338%.

It reported another very strong performance in 2019 with revenues up 43% to £61.8m and operating profits up 52% to £19m. The company is debt-free and had cash equivalents of £41.9m at year-end with the board saying they expect the group to be ‘significantly’ cash generative in 2020.

The benefit of increased demand for games has more than offset any disruption impact from home working and the company is confident it has the technology and systems in place to allow working from anywhere.

While management has impressed since coming to the stock market, faultless execution is perhaps already reflected in the share rating with a forward price-to-earnings (PE) ratio of 40.

OVERSEAS PLAYERS

California-based Electronic Arts is one of the largest gaming companies in the world with annual revenue of $5.2bn, publisher of the largest sports video game, FIFA soccer, as well as NBA Live.

On 16 April the company said it had witnessed a dramatic increase in viewership for e-sports broadcasts while its Apex Legends game saw
two-to-three times more viewers in the first quarter of 2020.

Over two thirds of its revenue is generated through digital channels and via live streaming, providing more visibility compared with new game releases. The digital format also attracts higher margins as the distribution costs are negligible. The company is due to report full-year results to 31 March 2020 in early May.

With a world-renowned portfolio of brands such as Assassin’s Creed and Tom Clancy’s Ghost Recon, French company Ubisoft Entertainment is expected to generate revenue of $1.5bn in the year to 31 March 2020.

The company has one of the biggest in-house creative capabilities in the industry with more than 80 teams and 40 development studios. In October the company slashed profit targets after delaying the release of five major titles.

Following the lockdown the company announced a month-long series of offers, trials and discounts in an effort to encourage people to stay at home.

Activision Blizzard owns renowned franchises such as Call of Duty, Candy Crush and World of Warcraft. It reported better than expected revenue and profit in 2019 with sales of $6.4bn and operating profit of $1.6bn.

Growing popularity of Call of Duty mobile and e-sports initiatives are expected to provide good near-term revenue momentum.

TWO INVESTMENTS TO MAKE

Codemasters 273P  BUY

Codemasters is the biggest laggard in the peer group, down 3% year-to-date, and trades on the cheapest PE ratio of around 15.4 times. This doesn’t reflect the strong pipeline of game releases over the next two years.

The acquisition of Slightly Mad Studios in November 2019 will potentially provide a 30% uplift to earnings and is based on the release of two games for launch in 2021; a new mobile game Project CARS GO and a game based on an existing, successful franchise.

Beyond this two further game releases are expected in 2023. In addition, the Formula 1 franchise was extended to 2025, de-risking the business.

The delayed release of the Fast and Furious Crossroads game, based on the film franchise is expected to be launched sometime in the first quarter of 2021. The movie franchise has grossed $5.1bn across the eight movies in the series.

Meanwhile, the virus pandemic has given extra momentum to digital revenues as physical outlets have closed which provides margin uplift to the company. The strong growth profile seems to be at odds with the valuation of the shares.

VanEck Vectors Video Gaming and eSports ETF (ESGB) £20.90 BUY

For those investors with a lower risk appetite, it may be worth looking to get a broader sector exposure through an exchange traded fund (ETF). This will also provide exposure to adjacent businesses such as console makers and other technology businesses.

The aim of VanEck ETF is to replicate the performance of the MVIS Global Video Gaming and eSports Index as precisely as possible in terms of price and yield, before costs and fees.

The index tracks the performance of the global video game and e-sports industry and is designed to offer a ‘pure play’ concept, only including companies that generate more than 50% of their revenue from video games and/or e-sports.

The $133m ETF is invested in large cap gaming stocks across the world with 53% invested in Asia and 37% in the US. The largest holdings include computer graphics processors maker NVIDIA (8%), Chinese entertainment platform company Tencent (7.7%) and Japanese console maker Nintendo (7%).

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