For the past six months, nothing has shown up on time. The pandemic has pushed back sports seasons, the Olympics, major film releases, and massive trade shows. Even the latest iPhone has been delayed. But there’s one major consumer event proceeding as scheduled next month: the long-awaited launch of new videogame consoles from Microsoft and Sony.
Pre-orders for the consoles—Microsoft’s Xbox Series X and Sony’s PlayStation 5—sold out in a matter of hours last month, despite their hefty $500 price tags.
The next-generation machines arrive with videogames atop the entertainment pecking order, especially with many movie theaters shuttered and Americans still stuck at home. U.S. videogame sales are forecast to rise 19% this year, according to research firm IDC, to $45.6 billion. The U.S. film box office, in comparison, peaked at $11.9 billion in 2018 and has grossed just $1.9 billion this year.
“It’s a pretty significant moment for our industry,” says Laura Miele, chief studios officer for game publisher Electronic Arts. “We’re interactive, not passive. There are new generations of players that prioritize gaming over other mediums.”
Shares of Activision Blizzard (ticker: ATVI),
(EA), and Take-Two Interactive
(TTWO) are each up at least 24% this year. But if history is any guide, there are more gains to come.
Few trends in technology have been as enduring as the videogame console cycle. Every six to seven years, powerful new machines are unveiled, ushering in a new wave of innovation, customers, and sales. It’s a pattern that’s been repeated for two decades, with publishers of videogames reaping much of the reward.
(MSFT) launched the modern videogame cycle with the first Xbox in 2001, an equal-weighted basket of Activision Blizzard, Electronic Arts, and Take-Two stocks have returned more than 1,700%, versus 330% for the S&P 500.
Each wave of consoles spurs another step up for the shares. In the 12 months after
(SNE) and Microsoft launched the PlayStation 4 and Xbox One in November 2013, the game-publisher stocks rose an average of 41%, compared with 15% for the broad market.
As the new consoles arrive, the publishers are also benefitting from a more fundamental shift: Videogames have never been more central to the living room.
“This has become an ongoing entertainment business. It is no longer a seasonal business, really,” Take-Two CEO Strauss Zelnick says. “You shouldn’t look at it any differently than you would look at television or motion-picture distribution, except that our economics are much better.”
Today, Microsoft and Sony are more committed than ever to gaming. Last month, Microsoft agreed to pay $7.5 billion for ZeniMax Media, which makes popular game franchises Doom and Fallout and has estimated annual sales of $700 million. Assuming the deal goes through, it would be the third-largest acquisition in Microsoft’s 45-year history, behind its deals for LinkedIn and Skype Technologies.
Similar to its business-software approach, Microsoft is hoping to expand the potential videogame market by offering its latest hardware on a subscription basis. Starting next month, the Xbox Series X will be available for monthly payments of $35, effectively lowering the cost of entry, versus the all-in $500 price. A lower-end console, the Xbox Series S, will be part of a $25 monthly package. Both bundles come with online services, including games from EA and Microsoft.
“Microsoft is very much a platform and services company, and gaming really reflects that same strategy,” Xbox CFO Tim Stuart says.
Both Sony and Microsoft continue to push the envelope with their videogame hardware. The PlayStation 5 and Xbox Series X have moved to flash storage to shorten load times. The consoles use chips from Advanced Micro Devices’ (AMD) custom semiconductor unit, which combine central processing and graphics. Both machines also offer ray tracing, a technology previously reserved for high-end PCs, which helps make graphics look more realistic.
For gamers, improved graphics have always been a reason to upgrade. They’ll have to choose between Sony’s much-heralded exclusive lineup of titles and Microsoft’s improved online game play. Investors, fortunately, don’t have to make the same choice. The game publishers are poised to benefit whichever console takes the lead. They’re the best way to play the new console cycle, since videogames remain a relatively small part of Microsoft’s and Sony’s businesses.
The publishers are also using the new consoles as a reason to boost the price of their games to $70, from a longtime industry standard of $60. Take-Two was the first to announce a price increase for the new console version of its NBA 2K21 basketball game. Other publishers have followed suit. Barclays analyst Mario Lu expects about 35% of new games in 2021 to get the price bump.
Take-Two’s Zelnick says that the increase in price matches the higher production costs—and higher consumer value—associated with new games. “Our production costs have gone up 200% to 300%,” he adds. “Undoubtedly, a price increase will translate to both gross and operating margins, as it should.”
Zelnick and Take-Two are responsible for what’s arguably the most lucrative entertainment title of all time. The company’s Grand Theft Auto V game, launched in 2013, has sold 135 million units, when 10 million is considered a success. Take-Two’s stock is up nearly 900% since the game’s debut.
You shouldn’t look at it any differently than you would look at television or motion picture distribution, except that our economics are much better.
Take-Two currently trades at 32 times earnings estimates for the next 12 months, making it the richest of the gaming stocks. Shares of EA and Activision look cheap in comparison, at 23 times and 24 times, respectively. All of the stocks trade at a premium to the broad market, but they’re not extravagant for the world of tech.
(AAPL), for instance, fetches 30 times forward earnings.
As sales of the new consoles kick in and popular games arrive, the videogame makers should outgrow Apple.
“Why can’t these companies trade at a comparable or higher multiple to Apple,” asks Dan Niles, founder and portfolio manager of the Satori Fund, a tech-focused hedge fund.
Niles owns EA, Take Two, and Activision, along with French game publisher
(UBI.France). He thinks all of the publishers will get more credit from investors, as they continue to bolster their revenue streams with online play and extra downloadable content.
“The reason I’m so interested is that there are a number of things that are completely changing the industry—and then people give it a much higher multiple,” Niles says. “I don’t see a reason why there can’t be a 30% to 50% multiple expansion and earnings growth on top of it.”
The Take-Two story is largely centered around the anticipated launch of Grand Theft Auto VI. The stock will likely get a boost when the release date is disclosed, with more gains to come if the game proves to be another hit. But it’s unlikely to launch before 2022. The last three titles in the franchise arrived in 2013, 2008, and 2004. Until then, Take-Two will continue to squeeze profits from the online edition of Grand Theft Auto V, which keeps gamers returning, night after night.
Take-Two sales are forecast to slip 1%, to $2.97 billion, in the company’s current fiscal year, which ends in March. But future growth will show the impact of the new consoles and Grand Theft Auto VI.
Wall Street forecasts a 10% drop in earnings this fiscal year, to $4.77 a share, followed by gains of 16% and 37% in the next two years.
Rival Electronic Arts, meanwhile, has been fairly vague about the timing for new games. Like Take-Two, the company is focused on so-called live services, emphasizing new content for existing games. Even as Covid-19 spread across the world, EA released 207 game updates, including a $40 add-on to its popular The Sims 4. The company has also released six new titles since March.
Miele, EA’s studio chief, says the updates increase engagement from gamers and bring more consistency to the company’s results. Despite Covid, EA’s sales are forecast to grow 14%, to $5.96 billion, in the fiscal year that ends in March, with earnings down 5%, to $4.81 a share. Analysts expect 15% profit growth next fiscal year.
Jefferies videogame analyst Alex Giaimo says that Activision Blizzard shares deserve more of a premium because the company has confirmed development of major games like Overwatch 2 and Diablo IV. The road map offers investors more predictability around future results. Activision executives declined an interview request from Barron’s.
Console games are an important part of Activision’s revenue, but the company gets more of its sales from mobile games than other publishers.
The company’s mobile DNA comes from King Digital, the maker of Candy Crush and other popular smartphone games, which Activision acquired in 2016 for $5.9 billion. King had sales of $2.03 billion last year, nearly a third of Activision’s total revenue.
Activision launched a mobile version of its Call of Duty series last year with positive results, and the company has a deep archive of other games it can repurpose for the mobile market.
Activision’s sales and earnings were down about 12% last year, but Wall Street expects a big rebound in the current calendar year, with profits up 44%, to $3.26 a share and sales up 23%, to $7.9 billion.
The most interesting stock among the non-U.S. publishers is
. The company has had a choppy year, in part due to the departure of high-profile executives following allegations that it had mishandled sexual misconduct claims.
Ubisoft declined to make executives available for this article. CEO and co-founder Yves Guillemot has previously said, “I am committed to implementing profound changes across the company to improve and strengthen our workplace culture.”
Those issues are serious, and they’ve led to a leadership vacuum, but Niles says the problems have created an attractive entry point for investors.
At about 25 times forward earnings, Ubisoft trades well below Take-Two, even though Ubisoft has the most ambitious game- launch schedule among the publishers.
The company, which makes popular franchises like Far Cry and Assassin’s Creed, is planning to release five big games within the next fiscal year. If even a couple of those products are hits, the stock should do well.
To be sure, videogames remain a hit-driven business, with winners needing to find the right combination of gameplay, timing, and economics.
In the U.S., Activision, Electronic Arts, and Take-Two essentially live and die on how well their games sell to console players. But subscriptions, along with the still-growing mobile opportunity, could continue to de-risk the business in the months and years to come.
“If you can play a game on 200 million consoles, that’s one thing, but if you can play a game on four to five billion smartphones, that’s a much bigger number,” Niles says. “That’s where things get interesting.”
Write to Max A. Cherney at [email protected]