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Winning the game

Peter Garnry
Filed on March 22, 2021

The gaming industry has grown by 37 per cent in 2020 as the pandemic boosted demand for in-home socialisation and entertainment

The gaming industry is not only a high growth industry it is also very profitable, but this, in turn, has lured big technology companies such as Apple, Google, Amazon, and Microsoft into the industry. The competition will likely increase and so will the overall global revenue from gaming. 

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Revenue growth in 2020

The gaming industry is a sprawling and fragmented industry with many companies deriving revenue and profits from other businesses than gaming. 

The revenue growth rate is very high with 37 per cent on average in 2020 as the pandemic impacted demand positively. Whereas other high growth industries such as e-commerce are running low margins and having difficulties generating large free cash flows, the gaming industry is very profitable. Capital expenditures required are low and revenue can easily scale due to the digital nature of the business. EBITDA growth was 59 per cent in 2020 and analysts are very positive about the industry with an average price target that is 16 per cent above the current price.

Saxo Bank's gaming basket is up 5.8 per cent year-to-date and up 101 per cent the past year and up 772 per cent over the past five years. Historic performance is no indication of future performance so investors should not put too much weight on these performance metrics. They reflect the high growth of gaming but what is relevant is whether the growth can continue for another decade.

Grabbing the leisure market

According to data on gaming consumption, the average American adult spends around an hour a day gaming socially online, and streaming of e-sports is gaining popularity. In 2019 the CEO of Netflix said that the company's biggest threat was not Disney or HBO, but that of Fortnite, one of the most popular games in the world.

In 2019, before the pandemic emerged, the industry generated $120 billion in revenue and by 2021 it is projected that 2.7 billion people will be playing games on some platform. The industry has benefitted a lot from smartphones, allowing them to steal time from people commuting or when they have a spare moment. Many games are also designed around the same reward feedback loops invented by social media platforms increasing engagement. The future of gaming will see fierce competition as the high profitable growth in gaming is luring in big technology firms mentioned before. The expectation is that VR/AI will become more dominant features of gaming in the future.

Key risks to consider

The pandemic has lifted revenue growth rates for all gaming companies and elevated their share prices and equity valuations. As society opens on the back of vaccines people are likely to prioritise physical socialising for some time instead of playing video games. This could reduce revenue growth in 2021. 

Other key risks are the difficulties as a gaming developer to constantly develop the next new game that will captivate users to keep growth high. There are several examples of gaming developers who were once successful, losing their ability to innovate. 

Many gaming stocks come with rich equity valuation, which means that the implied equity risk premium is low. This means that rising interest rates impact the equity valuations more and thus the risk of rising interest rates in the US should be a key consideration for investors who want exposure to the gaming industry.

Peter Garnry is the Head of Equity Strategy at Saxo Bank

 





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