Given that the E3 video game conference is this week and a number of analysts have recently come out expressing their highly positive views of the gaming industry, we wanted to provide members with a special video rundown of what we think is deserving of your attention in the space, how we stand to benefit from the trend and a few other, more direct ways in which members may be interested in gaining exposure to this rapidly expanding industry.
Additionally, for those members interested in digging even deeper, we've included links to some of the initiatives we mentioned following the transcript below.
Hi this is Zev Fima, Research Analyst for AAP.
As you know, last week, Morgan Stanley put out a note on Microsoft ( MSFT
) outlining what they believe to be the company's path to a $1 trillion market cap.
The focus of the note was something they believe, in line with our own view, to be an undervalued, underappreciated, and in general, not very well understood piece of the Microsoft story - GAMING- specifically, cloud-gaming and their quest to build the "Netflix of Gaming," via its Game Pass subscription service.
In fact, according to the analysts' upside scenario, they actually think gaming could add another $0.38 to earnings by FY2021. Multiply that by the current P/E ratio of about 28x and we're talking about another $10 added to the share price -- not accounting for any multiple expansion we could certainly see as the Azure cloud and recurring revenue streams grow. This was actually a part of a series being worked on by the analysts entitled "Plotting the Path to $1 Trillion," in which each note discusses a different aspect of how the company gets to the fabled $1 trillion market cap. The previous discussion had been on O365 -- which as is the goal with everything else software related -- has successfully transitioned from one-time license sales to a subscription service, providing a recurring revenue stream with enhanced margins. Members know how highly we value recurring revenue, especially given our Apple ( AAPL
But, before we dive into cloud-gaming and how MSFT and others are looking to take advantage of the trend -- as you know the cloud is an important part of our thesis on a few of our holdings, including the most recent addition, Salesforce ( CRM
) -- I just want to remind you that Jim's monthly members call is this Wednesday, June 13 at 11:30 a.m. We will be addressing your most pressing concerns regarding the market, our holdings and the macroeconomic environment overall. So be sure send us all your questions.
Ok, so let's get back to gaming and its impact on the cloud. Bernstein is out with their own note this morning discussing Microsoft's increased investments in the field, noting the addition of five new creative teams to Microsoft Studios -- four via acquisitions of high quality developers and another internally created one called The Initiative. Baird also released a note stating the video games are emerging as the largest segment of the global media and entertainment industry -- calling it a "must own." Clearly, the Street is finally starting to catch on to just how big this trend.
So, we believe strong growth in online gaming and ultimately true cloud-gaming, where games are streamed instantly, the same way movies are on Netflix ( NFLX
) today will provide a real earnings boost to not only Microsoft, but also Amazon ( AMZN
) , Apple, Google ( GOOGL
) , Nvidia ( NVDA
) and even names like Comcast ( CMCSA
) . And since we're on the subject, I'll also update you on some recent news regarding each of those companies and how they are taking advantage of the boom currently taking place in the game industry.
By the way, these notes from MS, Bernstein and Baird couldn't have come at a better time as this week is E3 -- which is basically the biggest video gaming event of the year. All of the game developers will be giving updates and announcing new games and strategies for their companies going forward. More on that later...
OK, so the best way to really see how cloud-gaming is evolving is MSFTs Game Pass, a subscription service in which members can access hundreds of games for one a monthly fee. And with this weekend's announcements of new Microsoft's own first-party games, including a new Halo game and new Gears of War game -- game pass subscriptions should definitely gain some more traction.
Now, in addition to the recurring revenue, by housing games in the cloud, MSFT is also providing a growth catalyst for Azure, the company's hybrid cloud answer to Amazon's AWS. And while, games currently need to be downloaded before being played, the service should ultimately transition into true cloud-gaming.
In addition to streaming, cloud-gaming could also eventually lead to hardware consoles such as the Xbox becoming obsolete, perhaps replaced by an app like Netflix on a smart TV or OTT device -- making MSFT's online gaming services more easily accessible with much less of an upfront cost. Don't worry it's not a big deal for earnings when you consider that these consoles are basically sold at cost, with the real profits coming from subsequent game sales. So that's two ways the move to cloud gaming stands to benefit the company -- an increase in recurring subscription revenue and a boost to the companies crucial Azure business, the main portion of our thesis.
Oh, and by the way, playing online also requires an Xbox Live subscription so there's another revenue stream gaming gets you. There is also another cloud-based service that MSFT has up its sleeve thanks to the recent acquisition of PlayFab, a platform that allows developers to more easily build, launch and maintain cloud-based games, so not only is MSFT attacking this on the user end, but on the developer end as well. And they aren't the only one going after developers, Amazon is taking steps on this front as well.
Amazon is positioning themselves in a few different ways. They of course have Amazon Web Services, the dominate player in the public cloud rivaled only by Microsoft. They also have Twitch, which is the leading platform for the online viewing of video games. By the way, if you want to know what the hottest online game is look no further than the Twitch rankings. But for our purposes here today, cloud-gaming, I want to highlight Amazon's Lumberyard, their game engine.
A game engine is responsible for graphics rendering, how the physics of the game work, the Artificial Intelligence in a game and so on. Lumberyard will be free to use but is capable of handling AAA games, meaning those of the highest quality. Where Amazon plans to make money with it is through Lumberyard's integration to both Twitch and Amazon Web Services. So, developers will be able to experiment and build games on Lumberyard for free and then as they scale the game and need cloud services, AWS, they'll pay Amazon. Now, we haven't seen much of what it can do, so we're actually pretty early on this front of the Amazon story but Amazon Game Studios is building three games for it -- Breakaway, Crucible and New World -- that should show off what the engine is really capable of.
Additionally, just to show that these guys mean business, Leslie Benzies, the former president of Rockstar North, a subsidiary of Take-Two's ( TTWO
) incredible Rockstar division and a lead developer for Grand Theft Auto 3-5, is among a team developing another game using Amazons Lumberyard called "Everywhere", and has said, "Amazon's vision for the future enables us to make a new type of game never before possible." That's a pretty big statement coming the from the guy that brought us GTA V. So that is something to be excited about.
It should also be noted that Lumberyard is equipped not only for games but to render high quality animations for film as well. And speaking to that, games these days are really evolving into experiences and with the adoption of VR that's something we can expect to see become more prevalent and immersive than ever before.
There are already a few examples of "games" that are actually just immersive digital stories, with no real "game" aspect to speak of. The Walking Dead was actually made into one of these interactive stories -- basically you're playing a graphic novel.
So these game engines will start to be used more and more for things other than games.
Now of course, this wouldn't be much of a cloud gaming piece if we didn't discuss Jim's dog, Nvidia... You all know how much we love what Nvidia has been doing with gaming and their GPUs, but I want to highlight the work Nvidia is doing in cloud gaming, specifically as it relates to their GeForce NOW and Nvidia Shield platforms. Like the others, they are really trying to get out ahead of the trend here, which may actually help to explain why they are holding off on announcing the next update to their gaming chip line, news that initially pressured the stock last week. The goal of GeForce NOW is to allow for less equipped computers, to play those games that would normally need the most cutting-edge hardware, by having all of the compute intensive functions take place in the GeForce NOW cloud and then streaming the end-result, the game, back to players. Basically, it allows gamers to bypass the need for high-end GPUs by allowing them to remotely tap into the GPUs back in Nvidia's data center. Playing to this service the Nvidia Shield is a set top box that allows players to stream games to their TV. It uses the same chip Nintendo uses in the Switch and they've actually partnered with them to stream older Nintendo games, including in China where the Switch isn't currently available. On top of games it also has a host of other services found on many of today's OTT devices such as Netflix, Hulu, YouTube and so on. And while MSFT, AMZN and NVDA are the three big names with real tangible evidence of a push into the space, there are hints that others are taking notice and trying to jump on the trend...
When it comes to Apple I want to update you about the recent change Apple made regarding their app store policy -- it now allows for what are known as mirror link apps. What this does is allow for a company like Valve to release their Steam Link app - which was previously forbidden under the old rules and allows for the digital distribution of countless games. The iOS app allows for users to link their steam account from their computer at home to their iPhone or apple TV in another room and run games on it. So, while this is more of an indirect move into the space by Apple, it does serve to illustrate the power of this trend as Apple doesn't open up its platform for just any old fad. Steam is the largest digital distributor for PC games. It has many top games including GTA V, PUBG, and Call of Duty. So, it's essentially turning your phone or your Apple TV into a gaming console. On the mobile front, this could give those people who were holding off on upgrading their phones the push they needed since you're going to want the best hardware available to stream these games in all their glory. And while it may not be ready to compete with today's dedicated gaming consoles, it could certainly make the Apple TV platform a lot more attractive, especially if you're already looking for an over-the-top streaming device.
As for Google, while details are still under wraps, they are working on what's known as Project Yeti. Not much is known but it is said to be a subscription streaming service that can stream games to Chromecast capable devices and in true cloud-gaming fashion, looks to eliminate the need for high end hardware on the user end. As I said, not much is known but what's clear is that all the big companies are looking to get in on the trend. In addition, the growth of the gaming industry obviously helps Google's android gaming. As is the case with Apple, the Steam link app is also in beta on the Google Play store.
OK, of course, I can't not talk quickly about Facebook ( FB
) . Facebook is obviously looking to jump on the VR trend and you have to believe Oculus sales will get a boost if they can get some strong games for the platform, especially since Oculus Go is so affordable compared to other VR platforms.
The last thing I'll say on this front is that while there is a lot to be excited about, we are still a few years away from true cloud-gaming, where downloads, and potentially hardware are unnecessary, and games are simply streamed at the touch of a button, a big barrier right now is internet speeds. This is a MASSIVE amount of data we're talking about streaming and when it comes to online gaming or eSports, a split-second delay is the difference between winning and losing.
So, while I am confident that this is where the industry is headed, we still need to see internet connections get up to a speed where they can support the infrastructure - a factor that should allow a provider like Comcast to raise its average revenue per user as more people begin to demand the higher speeds required for the type of content we are talking about.
Alright, so that pretty much sums up our thoughts on the cloud-gaming front, which we are clearly pretty bullish on and have strong exposure to through the names I mentioned. However, since E3 is this week, I also want to leave with some things to consider if you are interested in a more direct approach to the sector by taking a look at some of the game developers. Now since we are not in any of the names, I'm going to refrain from opining on the stocks and instead focus on what we believe to be crucial for any name you may want to invest in. That said, I want you to remember that part of the reason we moved out of Activision is the market saturation - which has made determining which video game publisher is a winner and which is a loser very much a stock pickers game.
We saw how Fortnite came out of nowhere and took players and maybe more importantly, Twitch viewers from games like Overwatch, putting pressure on names like ( EA
) , TTWO and ( ATVI
That said, Fortnite does an incredible job of showing off the social media aspect of games, maybe even better than any game before it - kids are going home and instead of Instant Messaging like they once did, they are jumping on a session of Fortnite with all their friends and playing and chatting for hours.
That's another thing to keep in mind with the growth of online game play, people want to play whatever their friends are playing.
Ok so when you are looking to invest in a video game publisher, there are seven key factors that we believe you should be looking for:
3. In-game purchases
4. International expansion with a focus on Asia
5. Strong IP with core franchises you can count
6. Plans to take advantage of AR/VR
7. And strategic acquisitions like the ones made by Microsoft - there are TONS of indie developers and these guys are going to get bought up as competition intensifies.
Now I'm not going to cover everyone of these but that is what you should be looking for in every company.
Starting with EA: Madden, Fifa, Battlefield and the new title Anthem -- a multiplayer online RPG -- in-app purchases across the board here. They're also coming out with their own streaming service which according to CTO Ken Moss will eventually will allow players to stream high end games on any device as long as its connected to the internet. - so there's your mobile play. As for strong IP and core franchises, Madden and Fifa are about as strong as it gets. By the way these guy are also Salesforce customers and credit the company for providing an ability to generate very strong customer relations, calling it a "game changer"
Next up is Activision, long-time members know we love these guys. For eSports, we have the Overwatch League and their streaming platfrom Major League Gaming. On the mobile front you've got King, which is looking to bring a lot of the Blizzard IP onto mobile as means to real gain share in Asian markets. They're also partnered with Tencent so that's going to help push into Asia as well For franchises, these guys have some real powerhouses, Call of Duty, Destiny, Overwatch, World of Warcraft and the list goes on. By the way, these guys are also Salesforce customers, so we can cleary see Salesforce benefiting as more gaming companies really make a push to increase user engagement
Moving on to Take-Two Interactive you've got the eSports NBA 2K League - also a very strong franchise. As for recurring revenue, there's no better example than what the company has done with GTA V online, which was released years ago, on the previous generation of consoles and still generates millions in revenues. The franchises are as strong as it gets with, GTA V, Red Dead Redemption 2 later this year, NBA 2K, WWE 2K and more.
OK almost done, but before we wrap up I want to quickly just update you on two foreign stocks that don't receive enough coverage: Ubisoft ( UBSFY
) and Nintendo ( NTDOY
Watch these guys, Ubisoft is a French company that also has ties to Tencent ( TCEHY
) and the rights to loads of Tom Clancy content, providing some very strong franchises including, Ghost Recon, Splinter Cell and Rainbow Six - R6 is also gaining a lot of attention on the eSports front so check that out. There's also Assassins Creed, Far Cry, The Division and more. As for online, they are all over it with CEO Yves Guillemot calling for consoles to essentially be obsolete by 2027, replaced entirely by cloud services and calling out the his big focus is "long-term engagement" and "recurring spending."
Ok, finally, Nintendo, they trade a little bit different than the other game publishers - due to their hardware exposure and because they tend to play to a younger demographic but their new CEO, Shuntaro Furukawa means business and has called for a big push into mobile. Now eSports has lagged here but with a new Super Smash Bros game on the way that could all change, so we'll be watching closely for any updates. Older versions of the game already do well on Twitch viewer metrics. As for franchises, where do I begin Mario, Zelda, Pokemon (3 new ones just announced), and the list goes on. Basically, the reason you buy a Nintendo is for the first party content.
A few other names just to be aware of if you want to dig deeper include, Sony ( SNE
) , Tencent - both with robust gaming segments - but with a lot of other non-gaming factors you have to account for. As for other public pure-play publishers to check out, there's Square Enix and Capcom -- smaller names but both of which have made some interesting announcements as of late.
Alright, so there you have it our view on cloud gaming and countless ways to play the video game trend. I hope this provides some clarity on the what is being called the hottest segment of media and entertainment today! Don't forget to stick to the alerts and join us for our monthly members only call this Wednesday at 11:30 a.m.
Links to some of the things mentioned in the video: