Tim Merel sees lots of action coming in the video game industry as it expands to become one of the biggest entertainment industries in the world. Merel is corporate finance director for games and other sectors at IBIS Capital in London. He just released a 60-slide review of the global opportunities for investing in video games. He looks at everything from funding to merger opportunities throughout the industry, from console games to social games. Here are his thoughts on various sectors and trends in video games. Check out his complete slide deck at the bottom of the post.
On the game industry –
“The video games industry is big, getting bigger and changing, with console game costs, revenue and risks accelerating and online/mobile games growing and fragmenting the market. Investment dynamics are entering a new phase, and deal activity is being driven by subsector consolidation.”
On the pure console video games sector –
“The pure console sector will remain the largest, low-growth sector, where major video games companies have converged on “fewer, bigger, faster” video game franchise refreshes. This makes perfect sense in the short to medium term, as it maximizes earnings and minimizes risks. However, it is a high-risk strategy in the long term, as churning out the 25th incarnation of most franchises won’t cut it. If the games business is all about innovation and new unimagined games experiences driving growth, the majors risk becoming like old media companies. Cash generative, but declining and cost driven.”
On why the next video game console cycle may be the last –
“Downloadable content (as with Valve’s Steam) and actual delivery of PS3/Xbox360-quality games via broadband without a console (as with the anticipated OnLive launch) are challenging traditional game distribution and console hardware platforms. There are concerns about bandwidth requirements and usage restrictions, but increasing broadband speeds in developed markets should address these in the medium term. So while it appears that there should be an 8th console cycle starting in 2013-14, there are now question marks over whether there will be a 9th console cycle at all. If the next console cycle is the last, it would create potentially significant long term issues for Sony, Microsoft, Nintendo and GameStop amongst others.”
On casual online and mobile video game sectors, and what they mean for major publishers –
“Casual online and mobile games are both high growth investment opportunities, but the majors aren’t structured for these markets. Major publishers’ core competencies focus on management of $20m+ serial, high risk, complex developments, launches and commercialization. In contrast, casual online and mobile games require rapid, multiple, small scale parallel development platform investments.
Large scale casual online/mobile M&A is high risk, as these markets are early stage and fragmented, with low barriers to entry. Social game acquisitions are particularly high risk because of their primary dependence on Facebook distribution. EA bought Playfish for $400 million to leapfrog the market, yet despite strategic and operational synergies the risks remain significant. Then again, EA bought Jamdat in late 2005 for nearly $700 million and now has a third of the U.S. mobile games market.
To avoid the risks of large scale M&A, dedicated game funds (as opposed to the standard publisher model) offer a lower risk solution. These would focus on equity investment in casual online and mobile parallel development platforms, rather than individual games (effectively a VC A round). The strongest developments would then be backed with significant marketing and distribution support (as a B or C round). Corporate VCs Intel Capital and SAP Ventures have already done well with a VC style approach in their respective sectors, and Shanda Games’ Mochi Media has recently set up a small game fund of its own.
A fund like this should use a light structure and portfolio approach, with a high growth slate of parallel development platforms. The commercial winners would be backed to deliver a substantial return, with commercial losers closed with limited costs at risk. In practice, the initial focus should be on small scale (say $150M) game funds, investing $30m a year for 5 years. Fund sizes could then be increased if sufficient revenue and profit traction were delivered. Managed by small teams with experience across video games, direct investment, deal making, and software engineering/product development, what I really like about this approach is that it is lower cost and lower risk than big ticket M&A.”
On why the massively multiplayer online (MMO) sector is both a good and bad place to invest –
The MMO sector is interesting in that it’s both high growth and consolidated, while still being cash generative. It remains an early stage market with evolving dynamics, but there is a clear hierarchy of successful business models. High end retail MMO offers significant rewards, yet remains as hit driven and risky as the pure console sector. The businesses I like most are subscription and in-game item/micro-transaction supported (like Bigpoint), which have already delivered significant revenue and profit traction. The trick here is “game balancing” to ensure that the players who spend the most don’t spoil the game for free players.
The challenge for the MMO sector is that World of Warcraft (“WoW”) is so dominant that it skews the market, with fantasy almost the default genre. As there have been many copycat offerings, investing in yet another fantasy MMO looks like hard work. I think that the opportunity is investment in breakout MMOs in other game genres, with the prize being do to the MMO market what Nintendo’s Wii did to the console market. I met W. Chan Kim when he published his “Blue Ocean Strategy” book, and Nintendo’s Satoru Iwata has already shown that his approach can work extremely well in the video games market.
On the mobile video game sector and Apple’s iPad –
“Mobile games growth rates are even higher than online, and Apple promises to change everything as it focuses on becoming the mobile entertainment company. I believe that the iPad will have a far greater impact on video games, but [will] take far longer to do so than people expect, mainly due to the many copycat products already in development. To put this in stark relief, 58% of the 150,000 apps in the App Store are games, so there are already more iPhone/iPad games than all the different Android, Nokia, Blackberry, Palm and Windows mobile apps of any type combined.
Online and mobile business models are already converging, with some “free” games with in-game items sold for $0.99 grossing more than major publisher-supported mobile games selling for $6.99 a pop. So the “freemium” model has already successfully transferred from online to mobile games.”
On the independent console video game sector –
“Many independent console games companies are in a bad way because of the stage of sector consolidation and the impact of the majors’ strategies cutting both development advances and third party work. Some good AAA houses are either sadly going to the wall or more happily exiting, such as the Warner/Rocksteady deal. VC/Private Equity firms generally won’t (and shouldn’t) invest in this space because of the risk profile.”
On the online gambling and skill based video game sectors –
“Online gambling continues to cannibalize offline, with the skill based sector of most interest for most major video games, media, venture capital and private equity firms. However, skill based games still have only 4% of the market. If current efforts to legalize online poker in the US come to fruition, then skill based games would become a quarter of the legal online gambling market and a much more exciting prospect. The online gambling tech firms also remain interesting, because of their different risk profile and high growth.”
On the in-game advertising sector –
“Lastly, there is in-game advertising, which is still early stage. It is forecast to double in size but is still a small part of the market. High growth rates to be sure, but a relatively small opportunity.”
Global Video Games Investment Review 290310 Tim Merel Ibis Capital
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