Recession: A Gaming Tailwind
The landmark Microsoft/Activision deal is likely to be approved on October 13. As this antitrust saga comes to a close, it’s a good time to think through what’s ahead for the industry.
After billions in legal fees on top of the $69bn price tag, Microsoft will need to show the market why it went through the trouble.
I predict three things will happen:
First, the deep roster of Microsoft’s engineering talent (plus AI Copilots expediting processes) will usher in the next wave of game engine and technology innovation, making games better than ever.
Cash-rich and motivated to stir up demand to meet high-quality supply of new releases and product features, Microsoft’s marketing machine will work to spur video game frenzy.
Third, with stringent antitrust regulators ensuring power does not remain concentrated in one gaming leader, the growth of Microsoft’s investment will spread beyond Activision, and through positive entropy, spur the gaming industry overall.
But what about the recession?
The recession’s effect on entertainment spending may not apply to video games. Unlike theme parks and travel, video games may prove countercyclical. Check out video game consumer spending during the last recession.
Will there be deal activity across the industry?
Strategic Buyers more likely than Financial Buyers given macroeconomic conditions and cost synergy prospects.
Market conditions look good for strategic buyers. Macro consensus suggests high interest rates will come down from peak, but will keep hurdle rates high and dampen PE activity. Thus, I would expect gaming activity to be more corporate strategic buyer led.
High interest rates and dried up runway may coax companies into selling. Depressed multiples for tech companies tempered the ravenous 2021 M&A appetite, as buyers and sellers disagreed on fair price in 2023. Smaller gaming studios have remained in bootstrap mode longer than they may have liked, and need capital to invest in new growth.
Synergies are compelling for strategic buyers and sellers. The largest two expenses in game platforms are advertising and employee costs (see this breakdown of 24x7, a card game platform, for example). Consolidation of gaming platforms can help cut down the overhead and cross-promote across games for more efficient advertising.
Several strategic buyer categories that may be seeking to grow inorganically through acquisition, each for slightly different rationale.
TV/Film Streamers: We’ll see traditional media players choosing to buy rather than build their gaming departments, like Netflix/NextGames ($72M) as they face pressures to quickly diversify revenue streams as quickly as possible. We see proof here in the form of gaming-experienced execs coming on to the board of Netflix leadership.
Casinos/ Parlors/Online Gambling: Pressured to draw new subscribers amidst rising churn rates and to monetize expensive IP more aggressively, we’re seeing experimentation with how to add gamified elements to IP to squeeze more juice from the lemon. We see this with Netflix licensing Squid Games to gambling slot machines.
Hardware companies: Sony, Nintendo and Microsoft are all hardware plays as well. We’ll see their acquisition appetite increase as supply chains stabilize over next 1–2 years and backlog of inventory finally starts converting to cash (for revenue impact scale example, Nintendo doing ~66m console sales per year at $300 price point…). Game releases are so tied in with the sales cycles of gaming hardware (i.e. Harry Potter/PS5), publishers and developers will likely be tapped for exciting releases to push console inventory, and hardware companies will need to assess whether to partner or buy outright.
Publishers: consolidation between gaming publishers, platforms and studios into vertical shops (though EA/Glu at $2.4B, and TakeTwo/Zynga at $12.7 have struggled to justify the premiums paid as mobile gaming faced headwinds with IDFA and Google Play ad-bidding regulation changes, making mobile IAA less profitable than predicted at time of purchase.)
The flywheel will benefit the whole gaming industry, from developers to publishers to hardware suppliers.
As supply chain correction simultaneously increases the TAM of people with the physical tools (consoles) to stream/ play the games in the US and worldwide (currently at 1.2 billion console gamers), just in time for the recession, where people will be seeking cheap entertainment, all of these effects will create a flywheel for the gaming industry. Expect more deals like Sony/Bungie for $3.6B.
You’re a big gaming company. How to play this hand?
Choose a good acquisition target. Many developer + publisher teams looking to sell will flaunt hitting benchmarks on retention and user growth at low CAC. In addition to these table stakes metrics, look for differentiated advantage in the fundamentals of the game fesign.
Software, especially superiority from a latency will win the favor of discerning users
Gameplay dynamics that inherently encourage retention and network effects; pleasurable repeatable actions and social integration, with evolving algorithms to dynamically adapt in real-time as not to burn out that endorphin nub. There’s many theories on achieving this.
Attention advantage more effective than than traditional passive media; can’t knit and play! Since games demand full attention, games that offer premium ad space with captive audiences will be attractive to advertiser revenue, product placement, and innovative brand experiences
Data accumulated, stored and analyzed effectively for insights will create edge. Every choice (left right, blue candy red candy, fight flight) exposes psyche of user, and in multiplayer games, group dynamics. Companies that can store, synthesize or extract insights from that data to optimize their products or package for resale will win
Multi-use Assets: Content re-use for video assets. Twitch for instance has benefitted from contemporaneous release of League of Legends, and League benefited from Twitch network effects, creating a 2-company network effect, players watched, watchers played; similar to Minecraft, which is as much a YouTube phenomenon as it is a video game phenom, as much as it is a commercial merch and toy business.
But there are risks.
Anti-trust, as we saw hold up Microsoft/Activision Blizzard
Regulations around gambling and addiction, and we see in China with government restrictions on teen gameplay
Lawsuits, as we’ve seen in COPA cases with kids safety and in-game purchase issues
Exclusivity pressure: IP limited to one distributor (ex. if Bungee games only played on Sony PlayStations) limiting potential network effects and user base of games
Semi-conductor shortages: caused a 20% YoY decline on per-unit Switch console sales for H12022, and decreased their hardware sales forecast overall by 10% (but Nintendo is known for conservative estimates)
Recession effect on advertising: while video games may be more resilient to recession, brands’ advertising budget may not be
Choose carefully where not to play, even if Makers Fund, a16z, GrIffin go in heavy.
- VR: still struggling to take off
- Cross-platform plays: inter-game avatar creation, inter-game economic ecosystems, protocolizing the transfer of goods and the monetary system translating experiences across games. This is all a crazy intellectual challenge, coding challenge, likely won’t be real for 5–10 years.
Sources
https://www.morganstanley.com/ideas/global-investment-strategy-outlook-2023
https://www.businesswire.com/news/home/20220517005874/en/Candle-Media-Acquires-ATTN
