Goldman Sachs predicts 'golden era' for gaming console and software makers

by Nicholas Megaw

When Microsoft launched the Xbox 360 gaming console in 2005, Nokia controlled almost a third of the mobile phone market and the latest innovation was a device with a front-facing camera.

By the time the next Xbox arrived eight years later, Apple had released seven generations of the iPhone and five iPads, and Nokia had just sold Microsoft its struggling mobile business.

In the fast-changing technology world, many assumed that consoles such as the Xbox and Sony’s PlayStation, and the companies that develop games for them, would soon face “game over”.

But as the industry goes into its earning season, some in the sector are bullish about its future. The head of Sony’s gaming division and analysts at Goldman Sachs have forecast a “golden era” for console makers and the publishers who develop games for them. One reason: top publishers have seen their shares more than double in the past three years and gain more than $US20 billion in market value since the start of 2015.

Shares in the big four western games publishers – Activision Blizzard, Electronic Arts, Ubisoft and Take-Two –​ have all increased by 18 to 70 per cent since the start of 2015. The tech-heavy Nasdaq and the wider SP500 both declined in the same period.

In Japan, shares in the four companies that focus on console games – Square Enix, Capcom, Konami and Koei Tecmo –​ increased by 13 to 55 per cent, while the Nikkei 225 declined by 4.5 per cent in the same period.

Nintendo develops games for its own consoles and its Wii U has struggled compared with the PS4 and Xbox One, but despite difficulties even its shares have increased 20 per cent since the start of 2015.

Big-budget blockbusters

The major games publishers are following the approach of the big Hollywood studios by focusing on a few big-budget blockbusters and exploiting them to build a similar scale of market dominance. According to NPD Group, the market research company, 10 companies account for almost 90 per cent of physical game sales in the US, with the big four western publishers accounting for more than half the total.

Doug Creutz, senior analyst at Cowen and Company, says “people who thought these companies were going to get replaced were probably people who never played video games”.

He adds: “It’s a content business, not a technology business … People were thinking about [games publishers] like software companies when they should look at them like television and movies.”

The positivity contrasts with years of warnings and fear that the industry had entered permanent decline set against rapid growth in the mobile games market. The number of publishers capable of developing so-called triple-A games –​ those with the highest production values and budgets –​ has fallen from a peak of about 80 to 10-15, according to Yoshio Osaki, president of IDG Consulting, a games consultancy.

Experienced publishers such as THQ and Midway, creator of Mortal Kombat and the fourth-biggest publisher by sales in 2000, collapsed as sales declined. Other groups moved to focus on smaller mobile titles.

Alain Martinez, chief financial officer of Ubisoft, a Paris-based gaming group being courted by media group Vivendi, said the long gap between new consoles led output to grow “stale”. He admits “people had serious doubts about the future of high-end games”.

Sales rebounded

Since the release of the PlayStation 4 and Xbox One in 2013, however, sales have rebounded, with combined PS4 and Xbox sales almost 50 per cent higher than the previous console cycle. This week, Sony announced the PS4′s success had helped the company to its first full-year net profit in three years.

In a presentation to analysts on Thursday, Sony said it expected the console’s strong momentum to continue, and its success had translated into higher revenues for games publishers.

Global revenues from console games are forecast to reach $28 billion for the first time since 2010 this year, according to PwC, the professional services firm.

Consolidation means the remaining companies are enjoying a bigger share of those revenues, while technology has helped them to improve margins. Selling games as direct downloads to customers’ consoles has allowed publishers to avoid paying a slice of revenue to retailers, and many have established new divisions to track customers.

Industry figures described their old business model as “fire and forget”: a game would be released and publishers would move on to the next one. Now, Mr Martinez says, “we have a precise knowledge of what and how and with whom customers play, we have a much better context for communicating with them”.

Publishers adapted such micropayment methods from the mobile and social games that some had thought would threaten their business model. They also expanded directly into new markets with their own mobile games. Activision Blizzard, the largest gaming company in the US, paid $5.9 billion for Candy Crush developer King Digital, while shares in Nintendo surged last month after the unexpected success of its first mobile app.

Reliable revenues

However, the discount price paid for King –​ Activision’s $18 per share takeover was 20 per cent lower than the price at King’s 2014 initial public offering –​ highlights one of the factors that have drawn investors back to consoles.

In contrast to the unpredictable mobile market, the reliable revenues of triple-A franchises such as Call of Duty and Assassin’s Creed, and the high barriers to entry for any would-be competitors, have made big developers more appealing to investors.

Mobile games are much cheaper to produce, making it easier for new competitors to emerge and mainly target “casual” gamers, who are less likely to be loyal to a particular series.

Neil Doshi, an analyst at Mizuho, says the console market “is starting to feel saturated”, and Activision, EA and Ubisoft have all disappointed investors with recent sales figures or targets. The PS4 and Xbox One’s success has relied on hardcore, committed gamers and Mr Osaki believes console makers and games developers will soon have to provide more mass-market offerings to achieve further growth.

Mr Martinez says there is still capacity for growth and new markets such as Latin America and eastern Europe are growing, even if sales in mature markets such as the US remain fairly flat.

If the remaining triple-A developers benefit from operating as Hollywood film studios, however, they also face the same challenges. In 2015, 54 per cent of EA’s revenues came from just three franchises, while Take-Two is even more reliant on its Grand Theft Auto series. Production delays or a few flops could cause serious damage.

“I don’t know any publisher that hasn’t postponed a game at one point,” Mr Martinez adds. “The fans are very experienced and demanding, so we need to ensure we deliver.”

Big difficulty

At its peak in 2012, social games company Zynga was valued at more than seven times higher than fellow US games company Take-Two. Today, the roles have switched: Take-Two’s market capitalisation is around 40 per cent higher than the FarmVille creator.

The focus on FarmVille highlights Zynga’s big difficulty: its most well-known game is seven years old, and the company has struggled to replicate a similar level of success. Zynga’s shares have fallen 83 per cent from their post-IPO peak in 2012, and it has not posted a full-year profit since 2010.

Casual gaming has not gone away in that time –​ it is forecast to be worth more than $22 billion in annual revenues by 2019, according to PwC. The problem is that few companies have been able to achieve repeat success, making investors increasingly wary.

IDG Consulting’s Yoshio Osaki says: “Just because mobile is growing faster doesn’t mean it’s easier to be successful.” The most popular mobile games rely on a “freemium” model, through which only a small percentage of users pay to speed up play or boost their abilities. So publishers need to reach huge numbers of users to make profits.

Helsinki-based Supercell has succeeded by focusing on a small number of titles –​ Clash Royale, released earlier this year, was only its fourth game –​ but the sheer volume of mobile games makes it difficult for many to capture gamers’ attention.

Five hundred new games enter app stores every day, and analysts at Goldman Sachs suggest console developers’ recognisable brands will help their expansions into mobile stand out, offering a chance for further growth rather than threatening their revenues.

“There used to be maybe 80 developers that could make a big triple-A console title, now there are 10 to 15,” says Mr Osaki. “On mobile you’re competing with tens of thousands.”

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