Damien Klassen

The digital games and interactive media sector have captured investor interest during the COVID-19 pandemic, says Damien Klassen, Head of Investments of the superannuation and wealth manager Nucleus Wealth.

“The current high valuations these stocks are being accorded globally reflect strong market interest, although it remains a sector that’s under-appreciated by many investors.

“What’s also often not appreciated is the fact this sector was booming before COVID-19 with $US120 billion in earnings in 2019. To give that figure added meaning, one of the highest rating movies ever, Avengers: Endgame, grossed $US858 million in its opening weekend. By contrast, Grand Theft Auto V’s release earned $US1 billion in just over three days.

“Originally just a PC/console experience, ubiquitous smartphones are now raking in the cash. And, it’s important to note, the phone market appears to complement the PC/console experience, not compete with it.”

Klassen identifies five trends driving this sector. They are:

• The emergence of eSports: The global eSports audience grew to $US450 million worldwide in 2019, up 15% year on year. And this was before Coronavirus forced half the world indoors. Those under 20 are more likely to watch eSports than live sports.
• The move to mobile. Historically, digital games were the preserve of PCs and then consoles. Today, mobile games generate almost twice the revenue of PCs and consoles combined.
• Broadening demographics: There’s a stereotype that video games are the sole preserve of adolescent boys. The move to Smartphone gaming has seen games such as Candy Crush and Words with Friends effectively raise the average user age to about 35. Additionally, women now make up almost 50% of overall gamers.
• Evolution of the business model: Initially, game designers pursued a traditional software purchase model with dollars paid upfront. Now games have no upfront costs but use in-game purchases to generate revenue. These so-called ‘Micro-transactions’ accounted for four out of every five dollars spent on digital games in 2019.
• Geographic trends: More than two-thirds of digital gaming revenue is generated in Asia. The increasing affluence in China and emerging markets is another key driver of growth.

For investors, Klassen says there are a dearth of investment options in this space in Australia, with the only real candidate being Aristocrat (ASX: ALL) if micro-caps below a market capitalisation of $50 million are excluded.

“Aristocrat provides entertainment from casino-themed games such as Vegas Penny Slots or adventure games such as RAID: Shadow Legends. These are free to play but make money through in-app purchases. This shift to digital games now generates around 40% of its revenue, with recent comment by Aristocrat indicating revenue is up 20% due to COVID restrictions.

“For the brave-hearted, there are four micro-cap options (see Appendix A). But remember, they are mostly early stage and capital hungry. They should be regarded as venture capital stage opportunities, not dissimilar to listed bio-techs, where the risk to capital is high because you are more exposed to the success or failure of an individual game than the industry’s growth.

“There’s also the option of investing offshore, with US-listed video game companies such as Activision Blizzard, Take-Two Interactive providing a pure play, or, for a more diversified exposure, via a Sony, Google, Apple and Microsoft, with all four having significant exposure to the growth of gaming.

“For a more targeted Asian focus investors could target some of the big Chinese stocks such as Tencent Holdings. But buyer beware. There is political risk in these stocks as the situation currently unfolding with TikTok highlights.”

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