MorningWord 08/30/14: Gaming The Future – $TTWO, $GME, $NTES, $EA

by Enis August 29, 2014 9:33 am • Commentary

One secular theme where I’m very bullish is video games.  The video gaming sector has actually not gotten much attention, even as the first generation to grow up with video games has grown up to become the key 30-45 age group.  The youngsters have more choice than ever when it comes to games, whether on a console, on a computer, on a tablet or on a phone.  And for those with toddlers, future gamers are being groomed from the age of 2 and 3 as parents reach for the tablet to distract the rowdy rugrats for a few moments of peace and quiet.

Amazon’s acquisition of Twitch for $1 billion was one more confirmation that the global community of video game enthusiasts is a potentially big market.  Our friend Eric Jackson, who wrote a guest post about YHOO on RiskReversal earlier this month, wrote a terrific article on Wednesday on discussing the similarities and differences between Amazon’s purchase of Twitch today and ABC’s purchase of ESPN in 1984.  Here’s Eric’s breakdown of Twitch at the moment as well as its potential:

In Twitch — as well as Maker Studios sold earlier this year to Disney — you have a new kind of “channel” where users get their content.  But it doesn’t fit into any box we’re used to.  It’s not a cable channel.  It’s a Web channel or something even more nebulous than that. It’s a YouTube channel, or an Apple TV channel or a mobile channel.  What is that and how should it be valued?

We know it has 55 million subscribers or unique visitors (as opposed to the 30 million ESPN had when ABC bought it).  That sounds like a lot.  But will they go up or go down?

We know Twitch is dedicated to gamers but isn’t a channel dedicated to gaming so hyper-niche that it doesn’t make sense — just as a 24 hour network dedicated to sports sounded crazy, too.

The mere fact that Twitch has gathered 55 million subscribers dedicated to watching video game highlights in just a few years is a stunning feat on its own.  But what about the idea that it might just be in the early innings?  Wow.

Who knows what the eventual outcome is with Twitch after Amazon’s purchase.  One takeaway, however, is that the future market for video game products and content could be multiples higher than what we already see today.  That of course includes gaming on various devices, and includes Candy Crush and Farmville as much as it includes Halo or Grand Theft Auto.  What matters is that the overall gaming pie is getting much bigger as consumers dedicate more of their leisure time to games rather than legacy entertainment models like TV, movies, or even socializing with friends.  Gamers are not just the stereotypical teenage boy demographic any longer.

What are the investment opportunities?  Well, we’ve seen the video game publishers outperform the market handily so far in 2014.  Here are the year-to-date returns of EA, ATVI, and TTWO:

EA (red), ATVI (orange), and TTWO (green) year-to-date performance, 100 base, courtesy of Bloomberg
EA (red), ATVI (orange), and TTWO (green) year-to-date performance, 100 base, courtesy of Bloomberg

TTWO and ATVI are both up around 30%, while EA is up over 60% year-to-date.

Of the three, we continue to prefer TTWO based on its valuation discount and its impressive new lineup for 2015, though we haven’t had a position in the name since we took off a position for a gain in February.  Another gaming stock where we took a position earlier this year is NTES.  I flubbed the management of that position, but would love a chance to get back in if the market offers that opportunity (which means it probably won’t).

I am currently long GME stock, which I bought ahead of earnings nearly 2 weeks ago.  While the shift to digital games has been a longstanding concern for GME investors (and the stock’s depressed valuation reflects that), the results so far indicate that GameStop remains the preferred intermediary for video game enthusiasts for console-based titles.  Management is doing a good job of diversifying its product lines to benefit from the long-term growth in the digital market as well.

This is an exciting time for video game fans and investors.  Of course, not all gaming stocks are going to win given the heated competition (see ZNGA), but the secular tailwind is certainly at the sector’s back.  We’ll continue to look for good risk/reward opportunities in what might still be a relatively nascent growth opportunity.