VIDEO GAMES: CLOUD INVADERS - CitiFirst

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Citi GPS: Global Perspectives & Solutions

June 2019

VIDEO GAMES: CLOUD INVADERSBracing for the Netflix-ization of Gaming

© 2019 Citigroup

Authors

Jason B Bazinet

U.S. Entertainment, Cable & Satellite Analyst

+1-212-816-6395 | [email protected]

Thomas A Singlehurst, CFA

Head of European Media Research Team

+44-20-7986-4051 | [email protected]

Kota Ezawa

Co-Head of Global Technology Research


Mark May

U.S. Internet Analyst


Walter H Pritchard, CFA

U.S. Software Analyst


Alicia Yap, CFA

Head of Pan-Asia Internet Research

+852-2501-2773 | [email protected]

Expert Commentators

Luke Alvarez

Founding Managing

Partner, Hiro Capital

Ralf Reichart

Co-CEO of ESL

Wil Stephens

CEO, Founder of Fusebox

Games

Global Video Game Team

Hillman Chan, CFA

China Internet & Media Analyst


Arthur Lai

Greater China Technology Analyst


Carrie Liu `

Taiwan Technology Hardware Analyst

+886-2-8726-9086 | [email protected]

Atif Malik

U.S. Semiconductor and Semi Equip Analyst


Rafal Materka

Poland Investment Research Team


Asiya Merchant, CFA

U.S. IT Hardware & Tech Supply Chain Analyst


Minami Munakata

Japan Metals & Mining, Media Analyst


Catherine T O'Neill

European Media Analyst

+44-20-7986-8053 | [email protected] +

Ashwin Shirvaikar, CFA

U.S. Payments, Processors & IT Analyst


Jim Suva, CPA

IT Hardware & EMS, Telco & Network Equipment Analyst


Kyle Twomey

Europe Small Cap Analyst

+44-20-7986-7955 | [email protected]

John Yu

Korea Internet & Media Analyst


© 2019 Citigroup

3

VIDEO GAMES: CLOUD INVADERS Bracing for the Netflix-ization of Gaming What was your first memory of playing video games? Mine was playing Centipede

at the local pizzeria. Armed with quarters and enough money for one slice of pizza,

we would play until we were either broke or our fingers were sore from firing digital

missiles. Eventually my friend got an Atari game system and after months of

begging for the same, my Dad caved in and bought us a gaming system – an

Intellivision game system. He told us over and over that it was a better system to

Atari but it didn’t have all the cool games that my friends played. It was hard

sometimes being the daughter of an engineer who cared about technology

superiority, but at least the hockey game let you punch people.

Game choices moved quickly after that – Tetris on my Macintosh Plus, Donkey

Kong on my Nintendo DS, Brickbreaker on my Blackberry, and now Candy Crush

on my iPhone. The common constraint through the years was that the games I

played continued to be dependent on the device I owned.

When the Internet came about, new firms started disrupting traditional media

businesses such as newspapers, radio, and television by giving consumers what

they wanted, when they wanted, and on the device they wanted. But it didn’t disrupt

the video game industry. Game publishers were able to use the Internet to augment

their revenues. They used the Internet to increase in-game sales and sell software

directly to consumers, and tapped into the smartphone market and the growth of

mobile gaming.

Are video game publishers immune from disruptive threats? The authors of the

report that follows answer with a resounding no. There is a technology on the

horizon that has all the characteristics of a disruptive threat to the video game

ecosystems — the cloud.

The video game ecosystem has been evolving over the last few years — towards

group play vs. single play, to in-game monetization vs. software sales, to renting vs.

buying hardware, to video games being a spectator sport, and to software being

made for all devices vs. software made specifically for hardware. These new trends

in the video game industry could make it much easier for the big cloud players to

come in and start pulling away revenue.

The cloud-based providers will be able to offer low-cost access to cloud-based

gaming and a wide array of gaming content. They will also be able to monetize

gaming in non-traditional ways that play to their strengths — through in-game

monetization, in-game advertising, broadcasting, and digital. For consumers, cloud

will make it easier to play games on different platforms and allow players to be

device agnostic, hitting pause on a PC game and picking it up again on a mobile

device. Game developers will be able to support more devices as compatibility

issues decrease between software and hardware.

eSports, a $1billion business and growing, will have increased opportunities on the

cloud and we believe game publishers will still be able to thrive in the emerging

video game world but will have to adapt their business models to ensure they’re

positioned appropriately..

If the report is right, I may finally be able to play PacMan!

Kathleen Boyle, CFA

Citi GPS Managing Editor

HOW CLOUD CAN DISRUPT THE VIDEO GAME INDUSTRY Over the last 18 years, video games have experienced rapid growth, topping $100bn in global sales with much of the growth fueled by Internet connectivity

In the next wave of innovation, consumers will likely rent access to gaming hardware, using the cloud for processing. This will likely give the largest cloud infrastructure players an advantage. Amazon, Microsoft and Google make up 58% of the market.

Pre-internet Today120%

100%

80%

60%

40%

20%

0%

Arcade Console PC Handheld Mobile VR

‘00 ‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11 ‘12 ‘13 ‘14 ‘15 ‘16 ‘17 ‘18

© 2019 Citigroup

BENEFITS OF CLOUD GAMING PLATFORMS

For console manufacturers: revenues can migrate from

episodic to monthly recurring

For consumers: every screen will experience the

same level of play

For game developers: compatability issues are reduced and more devices

can be supported

Play alone Group play

Buy software

In-game monetization

Play at home

Play anywhere

Play on own

Spectator Sport

Hardware

Software

Arcade Console Cloud

Arcade Disc, Download Stream

Cheaper processing power

Mor

e pr

oces

sing

pow

er Ren

tB

uy

Software

Hardware

Delay

Legacy

In-game Ads

Software

Hardware

Most cloud providers don’t generate material in-game ad revenue

Incumbent software firms have material legacy software revenue to protect

Only Microsoft will be incented to protect legacy HW revenue (Xbox)

Incumbents have material in-game monetization revenue to protect

Amazon, Microsoft and Google are the large cloud providers

Due to Android and iOS, Google and Apple apt to benefit from mobile ad growth

Amazon (Twitch) and Google (YouTube) will be able to monetize gaming via broadcasting assets

Game monetization

Cloud hardware

AdTech (Mobile)

Broadcaster

Emerging

Amazon GoogleMicrosoft Apple Incumbent Comments

Emerging cloud providers have low exposure to legacy game revenue and high exposure to emerging game revenue. Traditional publishers can’t easily replicate assets owned by cloud providers (like mobile AdTech and eSports broadcasters).

Pricing for cloud services could be disruptive as cloud providers exploit the revenue disparity between hardware (small) and software (large). Cloud firms can also tap into fast growing revenues from eSports and AdTech.

Total Gaming Revenues:

Software

AdTech

eSports

Hardware

The shift from PC/Console processing to cloud processing will prompt new business models. Cloud gaming is apt to exploit the rise of free-to-play (FTP) and new revenues like eSports.

Distant past Past Present Future

Buy Rent Free

Hardware

Software

In-game spend

New monetization (eSports, Mobile, AdTech)

Hardware Hardware Cloud Gaming

FTPFTP

FTPFTP

FTP

FTP

FTP

FTP

2018

2008

© 2019 Citigroup

6

Contents Summary 7

The Console/PC Value Chain 11

Layer I: Intellectual Property 12 Layer II: Game Developers 14

The Genres 20 AAA Versus Independent Games 21

Layer III: Game Publishers 26 Layer IV: Hardware 29

Arcades: Where the Games Begin 29 Console and Handsets: Where the Market Expands 30 Handheld Market 32 PC Market 38

Layer V: Distribution 40 Cloud Gaming 45

Layer VI: Consumer 53 Layer VII: eSports 55

Mode of Distribution 55 Live Streamers 58 Sponsorships 63 Subscribers 64 Ads 64 Donations 65 Professional eSports 69 Turnover of eSports Titles a Key Consideration 79 Grassroots Competition 80 Live Streaming vs. eSports: The Broadcaster’s Perspective 81

The Mobile Value Chain 83 Layer I: Intellectual Property 86 Layer II: Developers and Publishers 87 Layer III: Installs 89 Layer IV: Mobile OS 92 Layer V: Generate Advertising 93 Layer VI: Advertiser 95 Layer VII: Consumer 96

Mobile Economics 97 Mobile Gaming Revenues 99

Industry Evolution 100 Internet-enhanced Gaming Profits 100 Foundation In Place for a New Model 102 What the New Model Might Look Like 107 Pricing of Cloud Gaming Services 114 Regulations 121

Prudent Strategic Responses 122 Potential M&A 122 How Publishers Should Respond 123

Expert Views 128

Expert Views from the Gaming Industry 129 A Conversation with Luke Alvarez 130 A Conversation with Ralf Reichart 138 A Conversation with Wil Stephens 146

© 2019 Citigroup

7

Summary Eight years ago, Marc Andreesen – of Netscape fame – penned an article in The

Wall Street Journal titled: ‘Why Software is Eating the World’. Mr. Andreesen’s idea,

like all good ideas, was simple: software — riding on top of the Internet — was

changing everything. For the software owners, it was a boon. But, for incumbents, it

represented unrelenting value destruction.

In the wake of this software-induced upheaval, non-software centric firms have

been dented, damaged, upended, or dethroned. The list of victims is long: book

stores (Amazon), brick-based retail (Amazon), travel agencies (Expedia), taxi cabs

(Uber), phone books (Google), photos (Apple), newspapers (Google), magazines

(Facebook), radio stations (Spotify), and cable networks (Netflix).

Indeed, over the last 20 years, five U.S. leviathans have proven particularly adept at

using software to create significant economic value. Wall Street’s shorthand for

these firms is FAANG: Facebook, Apple, Amazon, Netflix, and Google. In Asia, there

are three disruptive firms — Baidu, Alibaba and Tencent — or BAT. Each firm —

and a handful of smaller entities — has used software and the Internet to give

consumers what they want, when they want it, at far lower cost.

After the FAANG or BAT transformation is complete, these giants jockey for position

to ensure they capture the lion’s share of the sector’s remaining, albeit diminished,

profits. In the process, the largest Internet firms get bigger. Incumbent firms stall,

shrink, or sometimes, disappear.

Within the entertainment sector, however, there’s a small collection of rarefied

entities. To date, these few firms have been immune to the software-centric,

Internet-enabled FAANG assault: Sports teams, concert promoters, and video game

publishers. Indeed, each of these businesses has actually used the Internet to

improve results:

Sports teams sold digital content rights on top of traditional TV rights.

Concert promoters — like Live Nation —- benefitted as lucrative CD sales

collapsed. That’s because rock stars toured more often to preserve their

lifestyles.

Video game publishers have deftly used the Internet to: (1) sell copies of their

software directly to consumers, disintermediating retailers; (2) augment game

sales with in-game monetization (like loot boxes); and (3) tap into explosive

smartphone growth to monetize mobile games.

But, will video game publishers remain immune to the FAANG threat? We don’t

think so. A number of large firms — including Google, Amazon, and Microsoft — are

rapidly building cloud scale. And, we suspect a natural way to leverage this

infrastructure is to move into gaming. Moreover, there’s quite a bit of money up for

grabs: $100 billion per year for software and $35 billion a year for hardware.

But, to understand why we’re so focused on Google, Amazon, and Microsoft, we

need to understand five powerful trends that are — or will — rumble across the

video game ecosystem.

© 2019 Citigroup

8

First, video games are migrating from a solo to a group activity. Second, upfront

software purchases are slowly being replaced by in-game monetization causing

free-to-play games to explode in popularity. Third, consumers — especially young

consumers — will migrate from buying upfront hardware to renting access to cloud

infrastructure. Fourth, gaming will increasingly migrate from a non-spectator to a

spectator activity driving the growth in popularity of eSports. Fifth, software used to

be written for a specific piece of hardware. Today, software like Overtime will work

on all devices, including mobile.

Figure 1. Trends Across the Video Game Ecosystem

Source: Citi Research

If we’re right about these five trends, it has powerful implications for the gaming

ecosystem. It means cloud-based providers will offer consumers low-cost access to

a cloud-based gaming platform and a wide array of gaming content. And, it will

monetize this content in non-traditional ways. But, these non-traditional methods of

monetization will leverage existing assets already owned by the largest cloud

providers. In short: Software is eating the world, but, clouds may eat software.

Figure 2. Cloud-Based Gaming and Video Game Ecosystem


From To Loser Winner

Software made for

hardware

Software for all devices Casual mobile Strong game titles5

Non-spectator Spectator n/a eSports broadcasters4

Buy hardware Rent access Hardware firms Cloud firms3

Buy software In-game monetization Paid games Free-to-play2

Play alone Group play Single-player games Multi-player games1

Hardware

+

Software

Hardware

+

In-game

Spend

+

Hardware

FTP

+

+

Cloud

Gaming

+

Present FuturePast

FTP

Distant Past

Buy

New

Monetization

FTPFTP

eSports

Mobile

AdTech

Rent

Free

© 2019 Citigroup

9

What assets will a cloud-based firm leverage? There are quite a few:

First, Google, Amazon, and Microsoft are the largest providers of cloud-based

services (with ~60% share as of the fourth quarter of 2018). This will enable low-

cost cloud gaming services.

Second, the largest game broadcasters are Twitch (owned by Amazon) and

YouTube (owned by Google). This gives two cloud-based firms indirect methods

of monetization that cannot be matched by incumbent game publishers.

Third, a large portion of gaming revenues stem from in-game advertising,

particularly on mobile devices. And, the mobile AdTech ecosystem is controlled

by two firms: Apple and Google.

Fourth, digital distribution — particularly for Amazon — is a core competency. As

such, these cloud-based firms could open (or acquire) gaming distribution

platforms like Valve’s Steam.

Fifth, cloud gaming companies have ample means to cross-sell their offerings.

Cross-selling opportunities span both hardware (FireTV, AppleTV, Alexa) and

software (YouTube Premium, Amazon Prime).

If we’re correct, video game publishers that are over-monetizing their intellectual

property (IP) by selling the game plus in-game content could see long-term top-line

pressures. How can incumbent gaming firms respond? We think there are five key

steps:

First, incumbents should deemphasize titles that aren’t tied to sports, have weak

IP, and don’t have a robust eSports (or live streamer) community. That’s because

sports titles tend to have a very loyal following (and are likely less prone to cloud-

based price competition). And, we expect eSports to play a larger role in the

gaming ecosystem as fewer very popular games (with robust IP) increasingly

dominate the gaming ecosystem.

Second, publishers should redirect developer time to refreshing existing titles to

keep in-game monetization robust and consumer engagement consistent.

Third, for non-sports titles with weaker IP, publishers should begin to gradually

lower the retail prices of the games while simultaneously investing in in-game

monetization. This will make the transition to free-to-play less disruptive.

Fourth, publishers should invest in eSports and develop games that are likely to

have a strong live streaming following.

Fifth, video game firms should ensure that every popular title has a viable mobile

version. This will prepare firms for the inevitability of cloud gaming (when

mobile/personal computer (PC)/console gaming platforms converge).

So, the ‘salad days’ for video game publishers — where the Internet enhanced

profits — probably won’t last. But, there are clearly steps video game publishers can

make today to ensure they still play a viable part in the new cloud-based, platform-

converged, eSports-centric video game ecosystem.

© 2019 Citigroup

10

To explore our thesis, we have divided this report into three main sections. First,

we’ll unpack the video game value chain tackling the console/PC market and the

mobile market separately. Second, we’ll suggest how the video game industry will

likely evolve. Third, we’ll review the strategic implications — and potential next

steps — for the video game incumbents.

Before we dive in, a quick disclaimer. As we did this work, we were struck by both

the level and quality of debate related to cloud computing and its impact on the

video game ecosystem. There are strong arguments on both sides of the debate.

Obviously, we have our view. But, we are conscious not all readers will agree with

us. With this in mind, we hope readers will find the ‘Expert Views’ section at the

back of the report helpful. These experts have decades of experience in the space.

We are also very open to feedback: Please do get in touch if you think we’ve

missed something or have drawn the wrong conclusions. We are keen to engage.

© 2019 Citigroup

11

The Console/PC Value Chain The video game industry has a long history. Back in 1958, a physicist, William

Higinbotham, created the first video game: Tennis for Two. It took about 15 years

before the business world took notice. The Magnavox Odyssey debuted in 1972.

Over the next 60 years, a rather complex industry organically evolved. In the PC

and console market, the video game value chain has seven layers:

Intellectual Property (IP): At the top of the stack are owners of intellectual

property. This includes sports leagues (FIFA, NFL), movies (Star Wars), books

(Tom Clancy), and toys (Lego). This IP is often licensed for a royalty payment.

Developers: Video game developers are one layer down the value chain. These

entities write code to create the game. They receive a fee and perhaps a royalty

(if the game is successful) from the game publisher. They may rely on — and pay

for — game engines to accelerate game development. If not, they’ll use specific

application programming interfaces (APIs) that allow the software to work easily

with a variety of hardware platforms.

Publishers: Toward the middle of the stack are game publishers. Publishers sell

and market video games. They make three types of payments: (1) payments to

the owner of the underlying IP (if applicable); (2) payments to the game

developer; and (3) payments to the manufacturer of the console (but not PC

firms). If the game is distributed digitally, they may also make a payment to the

digital storefront.

Hardware: The game developer and game publisher will agree to develop the

game for a specific type of hardware. It could be a console — like PlayStation,

Xbox or Nintendo — or a PC. In the future, this may be a ‘virtual hardware’

presence that is a streaming service across any hardware.

Distributors: Toward the bottom of the stack are the distributors. They sell the

game to the consumer. Delivery could be via a physical disc (GameStop,

Amazon) or a digital file (Steam, Electronic Art’s Origin).

Consumers: Near the bottom of the value chain, you’ll find the consumer. They

spend money to enjoy the underlying game.

eSports: The final layer of the value chain is eSports. eSports can include

professional teams (in tournaments). Or, it may capture consumers watching

amateurs play video games on a broadcast platform (like Twitch). These

amateurs are also called ‘live streamers’.

© 2019 Citigroup

12

Figure 3. The Console/PC Value Chain

Note: IP – Intellectual Property, SW = Software, T = Time. Source: Citi Research

Let’s walk through each step of the value chain in a bit more detail.

Layer I: Intellectual Property

Over the last 40 years, only 70 global video game franchise games have generated

over $1 billion in global sales. But, some of the highest grossing franchises — like

Pokémon or Mario Brothers— have been around for 20 years, or more.

And, some of these iconic franchises are still selling briskly. A recent examination of

the top-selling video games on Amazon.com in March 2019) shows that Pokémon

Sword was the 13th best-selling item, the Sims4 ranked 14th, and Grand Theft Auto

ranked 15th. So, brand recognition — that often leverages IP — clearly matters.

Intellectual Property

Game Developer

(Studio)

Game Publisher

Hardware

Manufacturer

Distributer

Consumer

Description

Owner of IP that is licensed to

publisher

Pitches ideas to publisher

Develops games for publisher

Economics

Share of game sales (may include

minimum payment)

Receives advances from publisher

Receives royalty payments from publisher

“Green lights” game

Sells markets and distributes game

Pays royalties to IP owner (if applicable)

Advances money to developer for game

Makes royalty payments to game developer

Makes royalty payments to HW mfg

Designs and manufactures hardware Receives revenue from hardware sales

Receives royalty payments from publisher

Distributes game in physical stores

Distributes game digitally

Plays game Pays retail price for game

Spend on in-game items after purchase

Pays wholesale price for game

Receives retail price for game

$

$

$

$

$

IP

SW

SW

SW

API

Game

Engine $

SW

eSportsConsumers watch professionals

play video games (in person or

over broadcaster like Twitch)

Players and leagues collect funds from

consumers (donations, subscriptions) game

developers, game publishers, advertisers

and sponsors

$

TAd

Sponsor

$

$

© 2019 Citigroup

13

Figure 4. Number of Franchise Games Generating > $1 Billion (1981-2018)

Source: Wikipiedia, Citi Research

But, how important is third-party intellectual property? Do non-video game brands

— like movies, sporting leagues, or books — propel video game sales? Over the

last 40 years, top franchises — or those that sold over 100 million units — can be

grouped:

First, some games rely on IP that was developed in-house. Grand Theft Auto,

Pokémon, and Fortnite are all good examples of in-house IP. And, nearly 80% of

the top franchises fall into this category. Since these native IP franchises sell, on

average, 72 million copies, these types of games make up nearly 80% of all

software sales.

Second, some top games rely on IP that’s non-sports based. These games

leverage IP from a variety of sources: physical games (Lego), books (Tom

Clancy), or movies (Star Wars). These games make up only 15% of the top-

selling franchises, but they sell slightly fewer units than a typical top-ranked

franchise (on average just under 50 million units per franchise). As such, this

genre makes up just 10% of total software sales.

Third, some top franchise games rely on sports IP. FIFA and Madden NFL are

good examples. There are six top franchises within this category, or just 7% of

top-selling franchises. But, on average, sports-based games sell more units —

about 100 million units per franchise. As such, sports games make up about 10%

of all software sales.

0

10

20

30

40

50

60

70

80

To

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ise S

ale

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$b

n)

Franchise

© 2019 Citigroup

14

Figure 5. Top Game Franchise Titles Sold by IP Category

Source: Wikipedia, Citi Research

Surprisingly, native IP comprises 80% of video game sales. And, non-native IP only

makes up 20% of video game sales. This observation doesn’t suggest franchises

aren’t important for video game sales. Clearly they are. But, as publishers seek to

build a new franchise, this data suggests publishers should probably focus on the

quality of the game (rather than making large royalty payments to an owner of third-

party IP).

Put in blunt terms, sports and non-sports franchises are really niches in the broader

gaming landscape. Sure, these niches have rabid fans. But, using third-party IP to

bolster a game’s prospects does not guarantee a game publisher’s success. It may,

however, reduce risks and lower customer acquisition costs and marketing outlays.

Layer II: Game Developers

Let’s say you’re a game developer. Of course, you want your game to be

successful. But, how can you ensure success? According to the Entertainment

Software Association (ESA), the most important purchasing factors for consumers

are: (1) the quality of the graphics; (2) the price of the game; and (3) an interesting

story. ESA’s data is consistent with our analysis of historical sales: IP actually ranks

last.

100

48

72

0 50 100

Average Units Sold (mn)

6

14

67

0 50 100

Sports IP

Non-sports IP

Native IP

Franchise Games Titles

(Number ‘81 to ‘18)

665

600

0 2500 5000

4,809

Total Units Sold (mn)

x

x

x

=

=

=

© 2019 Citigroup

15

Figure 6. Video Games: Most Important Purchasing Factors for Consumers

Source: Entertainment Software Association, Citi Research

Armed with this information, you set out to develop your game. But, how should you

proceed? Game developers typically divide their work into four stages:

Concept: In the first stage, you develop a short description of the game and the

genre (like role-playing game or shooter). And, you lay out some preliminary

sketches to give your team an idea of what the game would look like once it’s

developed.

Pre-production: In pre-production, you’ll create a storyboard with graphics and

text to explain each scene in the game. You’ll begin to think about the technical

limitations of the gaming platform. Then, you’ll lay out the game’s goal, the

mechanics, and the overall design of each level. During pre-production, you’ll

establish the intended player skill, game attributes, game design, and game play.

(See Figure 7 for specific examples of game play.) And, your team will lay out

due dates and key milestones for each software version including ‘first playable’,

the ‘alpha’ version, and the ‘beta’ version of the software.

Production: In the third stage, a larger team is brought in to assist with

development. This includes producers, designers, artists, and programmers. The

actual source code will be written for all key elements of the game including the

library, the game engine, and the artificial intelligence (AI) embedded in the

game. The production will end at the ‘code freeze’ which occurs a few months

before the release date. After ‘code freeze’, keyboards are put away. A team of

testers will play the game to identify bugs. At this stage, only bugs can be

removed from the software. Once the bugs are removed, the ‘gold master’ of the

game is locked down.

Post-production: In post-production, the game will be approved by the console

manufacturers — like Xbox, PlayStation, or Nintendo. Or, if the game is released

via PC, a distribution platform — like Steam — may approve the game. (Some

critics have suggested Steam’s approval process could be more robust.) Today,

many games are released via the Internet versus a cartridge or a disc, so

software patches and upgrades can occur post release. Indeed, some of the

most popular games — like Fortnite — receive weekly updates.

66%63%

61%

51% 50%47%

0%

10%

20%

30%

40%

50%

60%

70%

Qualityof

Graphics

Price InterestingStory

Contin-uation

of FavoriteSeries

OnlineGameplay

FamiliarIP

© 2019 Citigroup

16

Figure 7. Common Video Game Terms

Term Meaning

Player Skill

Skill floor Minimum skill to play a game well

Skill ceiling Difficulty reaching high level of performance

Game Attributes

Game pacing Rate of activity and tempo in the game

Ludonarrative dissonance (LND) Game play conflicts with narrative

Animation cancelling Allows player to keep playing before action is complete

Random number generator (RNG) RNG allows random events to occur in the game

Battle pass Rewards players with in-game content

Game Design

Bullshot Publishers artificially enhance promo materials vs. real game

Third-person shooter (TPS) Player is visible on the screen while shooting

Downloadable content Additional content released in the video game

Dynamic game difficulty Adjusting difficulty of game based on player ability

Expansion pack Adds extra game content to an existing game

Hit box Invisible box used for real-time collision detection

Loot and loot box Player obtains in-game content (currency, weapons)

Open world Virtual world where player can freely roam the game

Paper doll A way to display a character's inventory (weapons, bullets, etc.)

Power-ups Objects that confer extra power or benefits to a character

Season Pass Discounted package of in-game content

Hardware Design

Micro console Low-cost Android-based hardware used with app store games

Console game High-end hardware used for gaming (Xbox, PlayStation, etc.)

Game Play

Latency Noticeable delay between control inputs and action on screen

Frame rates How smooth games run; High frame per second is fluid

Pixelbitching Requires player to sweep screen to look for ways to progress

Career mode Allows player to take control of a single character

Spawning Live creation of a character

Respawning Recreation of an entity after death

Despawning Deletion of an entity within the game

Strafing Moving a character side-to-side (vs. forward and backward)

Player Behavior

Griefer Player derives pleasure from frustrating other players

Hate In MMOPRGs, mobs prioritize which character to attack

Let's Play (LP) Video commentary by the gamer

Multi-boxing Playing multiple characters at the same time. Often viewed as cheating

Noclip mode Prevents first person camera from being blocked by walls – a cheat command

Trickjump Techniques that enhance mobility of a player

Turtling Game play that emphasizes defensive behavior

Cooperative gameplay Allows players to work together

Crowd control Allows player to limit number in an MMORPG

Note: MMOPRG – Massive Multiplayer Online Role-playing Game Source: Citi Research

In total, the entire game development process may take three to four years. But,

some titles have been known to take 10 years (or longer) if significant changes are

made to the game’s look or feel after the pre-production phase. Somewhat

famously, Duke Nukem Forever was conceived in 1996. But, it took the developer

(3D Realms) 15 years to release the game. The total cost of a game can vary

considerably. But, it’s not unusual for AAA games to cost $100 million or sometimes

more to develop. (We should note there is no formal definition of AAA games. It’s an

informal classification.)

© 2019 Citigroup

17

Figure 8. Video Game Development Process


So, let’s say your concept is complete. The next key decision is whether to use a

game engine or develop the game organically. Game engines are used primarily for

PC games and mobile games (but not console games). Game engines provide a

software environment that allows developers to create games faster. They do this

using pre-built software for things like graphics, audio, logic, physics, and collision

detection. These engines are essentially frameworks that allow developers to avoid

reinventing the wheel for every game. So, by buying an engine for a little money,

developers can eliminate a lot of coding. Which engines are most popular? There

are two:

First, the market leader is Unity, which is owned by Valve. Valve also owns a

game distribution platform called Steam. Unity has a free version, a relatively

inexpensive option for $25 to $125 per month (depending on the version) and an

expensive option called Unity Pro (which costs about $1,500). Unity uses C++

and JavaScript as its two primary programming languages. For many years,

Steam collected 30% of a game’s revenue as a distribution fee. That sort of fee

isn’t dissimilar from what other digital distribution platforms like Apple or Google

take. But in the fourth quarter of 2018, Steam lowered the distribution fee it

collects from game developers given competition from a rival engine, UE4. For

games that generate $10-$50 million of revenue, the fee dropped to 25%. And for

very popular games that generate more than $50 million in revenue, Steam’s

distribution fee dropped to 20%.

Second, Unreal Engine (owned by Epic Games) has been around a bit longer

than Unity. Its latest engine is called UE4. UE4 uses C++ as its programming

language. UE4 has a royalty rate of 5% if the game is released on Steam, but is

free if it’s released in Epic Game’s site. On top of that, Epic Game only charges

game developers a 12% distribution fee.

ConceptPre-

ProductionProduction

Post-

Production

Develop short

description of

game

Genre identified

(RPG, shooter)

Rules established

Preliminary

sketches

Approval required

for console games

to ensure

standards are met

Software patches

created as needed

(for online

versions)

Full storyboard

created including

sketches and text

to explain each

scene.

Technical

limitations and

console standards

reviewed

Production plan

developed

including game

goals, level

designs and

gameplay

mechanics

Plan includes all

tasks and due

dates

Key milestones

established (first

playable, alpha

version, beta

version)

Larger team of

producers,

designers, artists

and programmers

added to team

Source code for

the game is written

for library, engine

and AI

Production ends

with ‘code freeze’

usually 3-4 months

before release.

Only bugs can be

fixed post code

freeze

Testers used to

identify bugs

‘Gold master’ is

final build used for

production

AAA games can cost

$100-200 million.

Typical development

time is 3-4 years for

a AAA game

© 2019 Citigroup

18

As a game developer that has to select a gaming engine and a distribution outlet,

there are clear economic incentives to use Epic for distribution and its UE4 engine.

The costs are far lower. But, Valve’s Unity engine and Steam distribution platform

have more scale.

Figure 9. Developer Economics by Game Engine

Distribution Valve's Steam Epic Games

Game engine Unity Unity Unity UE4 UE4 Unity

Game revenue <$10M $10-50M >$50M All All All

Revenue 100 100 100 100 100 100

- Engine 0 0 0 5 0 0

= Sub-total 100 100 100 95 100 100

- Distribution fee 30 25 20 30 12 12

= Developer net 70 75 80 65 88 88

Source: The Verge, Citi Research

If you don’t use a game engine, the graphics environment must be built from

scratch. And, if you build a game from scratch, you’ll need to use application

programming interfaces (or APIs). There are two basic APIs: Microsoft’s DirectX (for

Windows-based PCs and the Xbox) and OpenGL (for Sony’s PlayStation).

DirectX: Microsoft’s original operating system, MS-DOS, allowed programmers

to have direct access to a wide array of physical PC parts including the keyboard,

mouse, speakers, and video cards. However, in 1994, Microsoft was ready to

release Windows 95 but they feared that game developers wouldn’t create

games that were compatible with Windows 95. So, Microsoft began working with

NVIDIA to develop an API that developers could use for Windows-based PCs.

This API was called DirectX. Ultimately, Microsoft would use this platform to build

the DirectX Box, the original name for Microsoft’s console. (Later, the DirectX Box

was rebranded Xbox.)

OpenGL: OpenGL is the other primary video game API. Open GL was created in

1991 by Silicon Graphics for computer-aided design (CAD), flight simulation, and

video games. Since 2006, the API has been managed by a non-profit consortium

called Khronos Group. Key members of Khronos include chip manufacturers

(NVIDIA, Intel, AMD), operating system owners (Apple, Google), and hardware

firms (Sony, Samsung, Huawei).

Your next big decision as a game developer is to pick a hardware platform (or

platforms). Some developers write code for every platform upfront. This helps

increase awareness of the game. But, it also takes more upfront investment. As

such, independent developers often launch on a single platform (most likely, the

PC). And, if sales are robust, they will write new versions of the game for additional

platforms.

Next, you’ll have to make a decision about graphics quality. Recall, we learned

earlier that graphics quality is the most important factor to improve game sales.

And, higher quality graphics means they mimic reality. But, how do developers

mimic reality when they code? They use tricks. And, the tricks can be divided into

three windows:

First, in the early days, programmers used pixels. Pixels limited the granularity of

the image. And, the images were always 2D. But, in the early days of video

games, developers used pixels because the processing power of the computer

— like 8-bit or 16-bit CPUs — was limited.

© 2019 Citigroup

19

Second, as graphics processing moved from the central processing unit (CPU) to

the graphics processing unit (GPU), video games migrated from 2D to 3D. To

create 3D images, developers began to use polygons. A polygon is any two

dimensional shape formed with a straight line. Triangles, pentagons, and

octagons are all examples of polygons. The beauty of programming with

polygons is you only have to write code to move the vertices — the points — and

the entire polygon changes shape. That means granular movement can happen

on the screen with limited processing power. Programmers refer to this process

as rasterization. And, with software that can shade polygons — called shaders —

a polygon can look like wood, fire, water, or metal. Virtually all current video

games use polygons and rasterization to render lifelike images. But, rasterization

isn’t a science, it’s an art form. It simply tricks the brain into thinking it’s seeing a

‘real’ image.

The third and final trick programmers can use to mimic reality is ray tracing. Ray

tracing is the holy grail of graphics design. When the human eye processes an

image, it actually creates an image of reality (in the brain) by processing the way

light interacts with every physical object. If there was enough processing power

in computers, developers could actually follow a computer generated photon

from a simulated light source — like the sun or a candle — as it interacts with

every object in the game. Most games today don’t use ray tracing. Rather, the

programmer mimics what light should do by manually creating shadows or

reflections (off water or shiny objects). While ray tracing renders more realistic

graphics, it takes significant processing power. Parenthetically, most movies that

use computer-generated imagery (CGI) — like Avatar or Star Wars — use ray

tracing. But, movies can be carefully crafted and then released to the public.

That’s because when you view a movie, you don’t interact with the image….you

just sit back and watch. Gamers, of course, want to interact with the image. This

makes ray tracing far more challenging for video games than for movies. But,

game developers are moving in this direction.

Figure 10. Programming Tricks to Mimic Reality


NVIDIA’s GeForce RTX uses ray tracing versus screen space reflections that use

polygons and rasterization. Battlefield 5 is the first game ever released using ray

tracing. Although most gamers like the quality of the images, when gamers enable

the ray tracing option, it tends to reduce the frame rate (frames per second, or fps)

from about 130 fps to just 40 fps. In effect, today gamers have to trade-off the

quality of the image with a less fluid rendering of the game. Most gamers don’t think

the trade-off is worth it. Said another way, ray tracing may not be ready for the mass

market. But, as processing power improves, we expect ray tracing to become more

popular.

Indeed, NVIDIA recently patched its software with an enhancement called Deep

Learnings Super Sampling (DLSS). DLSS uses AI to boost the frame rate to 45fps.

Pixels

Polygons

(Rasterization) Ray Tracing

© 2019 Citigroup

20

The Genres

By this point in the process, you’ve already developed your concept. And that

means you are likely building a game in one of the six main genres: Action, Role

Playing, Simulation, Sports, Strategy or Other (including casual games).

In truth, there is some overlap among these genres. But, there are key attributes of

each type of game: (1) Action games require significant hand-eye coordination; (2)

Role Playing Games (RPGs) follow a predetermined storyline; (3) Simulation games

mimic the real world; (4) Sports games allow players to simulate a specific sport;

and (5) Strategy games require careful planning (either in real-time or turn-based).

Within each of these broad genres there are, of course, many sub-genres.

Figure 11. Video Game Genres


Action

Role Playing (RPG)

Simulation

Sports

Strategy

Other

Requires hand-eye coordination. Sub-

groups include: platform, shooter, fighter,

survival, and battle royale

Progress thru predetermined storyline. Sub-

groups include: Action PRG, sandbox (open

world), first-person

Mimics reality. Sub-groups include: life

simulation, vehicle simulation

Mimics sports. Sub-groups include: racing,

soccer, football, boxing, and wrestling

Requires careful planning. Sub-groups

include: real-time strategy and tactics and

turn-based strategy and tactics

Casual games, trivia games, logic games,

board games.

Description Examples

Pokémon, Final Fantasy,

Dragon Quest

FIFA, Madden NFL

Candy Crush

Legend of Zelda, Grand Theft

Auto, Assassin’s Creed

The Sims, RollerCoaster

Tycoon

StarCraft, Warhammer

© 2019 Citigroup

21

Figure 12. Types of Video Game by Genre

Group Sub-Group Class Description

Action Requires hand-eye coordination

Platform Game play centers around jumping and climbing

Shooter Lethal weapons used to damage opponents

First player Played from protagonists perspective

Third player Protagonist's body can be seen

Fighter Close range combat

Survival Player in an open-world, hostile environment

Battle Royale Blends survival with last man standing objective

Role-Playing Progress through predetermined storyline

Action RPG Action based role-paying game

MMORPG Massively multiplayer online role-playing game

Sandbox Open world role playing game

First-person RPG where player leads a party

Simulation Mimic a real or fictional reality

Life simulation Control one or more artificial lives

Vehicle simulation Flight or racing simulator

Strategy Requires careful planning to win

4X Four goals: Explore, expand, exploit and exterminate

Artillery Two or three player typically with tanks

Real-time strategy Action in the game in continuous

Real-time tactics Simulates real time warfare

MOBA Multi-player online battle areas; akin to Action Real-time Strategy

Turn-based strategy Allows period of analysis before committing to action

Turn-based tactics Mimics military tactics and operations

Sports Mimic a sport

Racing Auto racing

Sports games Non-auto racing sport games

Non-fighting Football, basketball, hockey, etc.

Fighting Boxing or wrestling

Other

Casual games Designed for short bursts of playing time

Trivia games Player answers questions

Logic games Puzzle games

Party games Designed for many players

Board games Games like chess, checkers and Othello

Card games Solitaire, poker, and games like Go


AAA Versus Independent Games

In broad terms, there are two types of game developers: (1) developers that work

for publishers and (2) independent publishers. Hardcore gamers typically divide the

world into two types of games: AAA games and Independent games. Although there

isn’t a formal definition of AAA games, there are widely agreed upon attributes: (1)

AAA games typically work on both consoles and PCs; (2) AAA games have large

1marketing budgets; and (3) AAA games are often developed and published by the

same firm. Independent games, on the other hand, usually only work on PCs. They

have smaller marketing budgets and, they are often distributed on third party sites,

like Steam.

The conventional view is that AAA games are high quality and Independent games

are lower quality. But, in truth, if you speak with avid gamers, there are exceptions

to this rule. That is, some Independent games are actually high-quality and garner

significant game play while some AAA games flop at the time of release.

© 2019 Citigroup

22

Figure 13. Independent vs. AAA Games


We recently took a snapshot (March, 2019) of the most popular games on Steam.

About one-third of the 30 most popular games were Independent games. These

games make up about 10% of players. For this grouping, we classified games

developed and released by Valve — like Dota 2 — as AAA games (even though

Valve is a private firm that facilitates distribution for independent game publishers).

Conventional View Nuanced View

Independent AAA

Hig

h Q

ua

lity

Lo

w Q

ua

lity

High budget

Console & PC

Heavy marketing

One firm develops &

publishes

Lower budget

PC

Lower marketing

Rely on third party

publisher

Independent AAA

Hig

h Q

ua

lity

Lo

w Q

ua

lity

Game Type Game Type

Rust

Rocket League

Witcher 3

Hearts of Iron IV

War Thunder

Mass Effect Andromeda

Mafia III

Home Front

Haze

Duke Nukem Forever

Overwatch

Grand Theft Auto V

Doom

Borderlands II

Many

© 2019 Citigroup

23

Figure 14. Top 30 Most Played Video Games on Steam

Game Title Players

Release Date Developer Publisher Parent

1 Dota 2 1,000,450 2013 Valve Valve Valve

2 Player Unknown's Battlegrounds 875,095 2017 PUBG PUBG Bluehole

3 Counter-Strike: Global Offensive 584,092 2012 Hidden Path Valve Valve

4 Tom Clancy's Rainbow Six Siege 126,308 2015 Ubisoft Ubisoft Ubisoft

5 Grand Theft Auto V 113,227 2015 Rockstar Rockstar Take-Two

6 Warframe 109,184 2013 Digital Extremes Digital Extremes Leyou

7 Path of Exile 78,420 2013 Grinding Gear Grinding Gear Tencent

8 Devil May Cry 5 74,719 2019 CAPCOM CAPCOM CAPCOM

9 Rust 64,227 2018 Facepunch Facepunch Facepunch

10 Football Manager 2019 55,630 2018 Sports Interactive SEGA SEGA

11 Sid Meier's Civilization VI 54,015 2016 Firaxis Aspyr 2K

12 Team Fortress 2 53,151 2007 Valve Valve Valve

13 ARK: Survival Evolved 49,795 2017 Studio Wildcard Studio Wildcard Studio Wildcard

14 Garry's Mod 36,772 2006 Facepunch Valve Facepunch

15 Rocket League 35,404 2015 Psyonix Psyonix Psyonix

16 Monster Hunter: World 34,214 2018 CAPCOM CAPCOM CAPCOM

17 Hearts of Iron IV 30,923 2016 Paradox Paradox Paradox

18 Sid Meier's Civilization V 28,428 2010 Firaxis Aspyr 2K

19 Euro Truck Simulator 2 25,927 2012 SCS SCS SCS

20 Dead by Daylight 24,495 2016 Behaviour Behaviour Behaviour

21 Terraria 23,529 2011 Re-Logic Re-Logic Re-Logic

22 The Invisible Guardian 22,246 2019 New One Studio New One Studio

23 Ring of Elysium 21,039 2018 Aurora TCH Scarlet Tencent

24 NBA 2K19 20,325 2018 Visual Concepts 2K 2K

25 The Witcher 3: Wild Hunt 19,210 2015 CD Projekt Red CD Projekt Red CD Projekt Red

26 Arma 3 18,968 2013 Bohemia Bohemia Bohemia

27 War Thunder 18,674 2013 Gaijin Gaijin Gaijin

28 Total War: Warhammer II 18,364 2017 Creative Assembly SEGA SEGA

29 Unturned 18,296 2017 Smartly Dressed Smartly Dressed Smartly Dressed

30 Assassin's Creed Odyssey 17,754 2018 Ubisoft Ubisoft Ubisoft

= Total 3,652,881

memo: Independent (bolded) 366,220

Source: Steam. Citi Research

So, how can we get a pulse of what game developers are thinking about the overall

marketplace? One place to look is an annual survey conducted at the 2018 Game

Developers Conference. The survey polled nearly 4,000 game developers. About

20% of these developers worked for very large firms (with over 500 employees).

The balance worked for smaller firms (with nearly 20% working alone). The results

are revealing.

First, the PC is still the most dominant platform for game development. It’s more

popular than and console platform (like PlayStation or Xbox).

Second, mobile devices are the second most popular platform for game

development capturing around one-third of developers.

Third, Virtual Reality is still relatively unpopular. Only 15-20% of game developers

are working on VR content.

Fourth, when developers were asked what new platform is most interesting,

around 35% of developers cited Nintendo’s Switch (a hybrid platform that

incorporates both console and handheld devices).

© 2019 Citigroup

24

Figure 15. Platform of Last Completed Game vs. Current Gamed Development

Source: 2018 Game Developers Conference, Citi Research

But, what is the preferred monetization model? Despite the success of free-to-play

(F2P) games — like Fortnite and Apex Legends — paid to download is still a bit

more popular than free to download (49% versus 39%). And, paid downloadable

content (DLC) is still a bit more popular than free DLC (23% versus 20%).

Figure 16. Most Popular Downloadable Content


20%

19%

26%

30%

36%

60%

0% 25% 50% 75%

Mac

VR

Xbox One

PS4

Smartphone

PC

14%

15%

19%

23%

32%

50%

0% 25% 50% 75%

Mac

VR

Xbox One

PS4

Smartphone

PC

Current Game Development Last Completed Game

39%

20%

14%

0%

10%

20%

30%

40%

50%

Free toDownload

Free DLC /Updates

AdSupported

Po

pu

lar

Fre

e M

od

els

(%

)

49%

23% 22% 21%

13% 11%

0%

10%

20%

30%

40%

50%

60%

Pay toDownload

Paid DLC /Updates

PaidIn-game

Items

PaidIn-gameCurrency

PaidSubscription

PaidItem Crates

Po

pu

lar

Pa

id M

od

els

(%

)

© 2019 Citigroup

25

Once the game is developed, how are developers marketing their games? There is

remarkably little agreement. While social media (Twitter, Facebook) are certainly

popular, this method of promotion only garnered 20% of the vote. Digital storefronts

(like Valve’s Steam) were almost as popular. Surprisingly, Amazon’s Twitch

garnered less than 10% of developer’s votes as the most effective method of

promotion. Moreover, there was remarkably little difference between preferred

methods to market the last game versus the next game. That is, marketing

preferences don’t seem to be changing.

Figure 17. Most Effective Ways for Developers to Promote, Market New Games


And, who will take the lead executing the marketing plan? About 40% of developers

plan to handle their own marketing. And, about one-third pay a full-time or part-time

public relations firm. Fewer (less than 25%) work with video game publishers. But,

for those developers that work with publishers, nearly twice as many get paid by the

publisher in advance (17%) versus a pure revenue share model (6%).

Figure 18. How Do Developers Market?


6%

7%

8%

10%

11%

13%

13%

16%

19%

22%

0% 5% 10% 15% 20% 25%

Discord, Slack

Forums

Live Events

Twitch

Press,Bloggers

Paid Ads

YouTube

Word ofMouth

Digital Store

Twitter,Facebook

5%

7%

7%

8%

11%

12%

12%

17%

19%

22%

0% 5% 10% 15% 20% 25%

Discord, Slack

Forums

Live Events

Twitch

Press,Bloggers

Paid Ads

YouTube

Word of Mouth

Digital Store

Twitter,Facebook

Effective Discovery of Last Game Effective Discovery of Next Game

38%33%

17%

11%

6%

0%

10%

20%

30%

40%

Self Marketing Pay InternalPR Firm

Publisher PaidUs in Advance,Takes Share of

Sales

Pay ExternalPR Firm

Publisher NotPaid in

Advance, TakesShare of Sales

© 2019 Citigroup

26

In terms of funding, more developers are relying on their firm’s internal funds (55%)

or personal funds (29%). Very few (about 15%) use a publisher for funding, similar

to the share of developers that use crowdfunding. Nearly three times as many

developers have no interest is using crowdfunding.

Figure 19. Source of Funds for Game Development


Layer III: Game Publishers

When most investors think about investing in video games, they focus on video

game publishers. But, who are the largest publishers? The answer depends on

whether you’re talking about mobile games or non-mobile games. While most

publishers don’t split console/PC revenues from mobile revenues, it can still be

useful to look at composite gaming revenues. What’s clear is that Tencent is the

largest publisher. But, publishing is quite fragmented.

49% 55%

34% 29%

16% 15%

0%

25%

50%

75%

100%

2017 2018

45% 45%

25% 25%

15% 15%

5% 5%

0%

25%

50%

75%

100%

2017 2018

Existing

Funds

Personal

Funds

Publisher

No

Interest

May Use

Have Used

Failed

Source of Funds for Game Development Use of Crowdfunding

© 2019 Citigroup

27

Figure 20. Largest Video Game Publishers – Global Console/PC/Mobile Revenue

Company Region Listing 2010 2011 2012 2013 2014 2015 2016 2017 2018E

Tencent China Public 1,812 2,260 3,264 4,318 7,236 9,238 11,926 16,847 18,343

+ Microsoft* U.S. Public 2,612 2,744 2,490 2,321 2,806 4,038 5,626 6,333 8,988

+ Activision U.S. Public 4,802 4,489 4,987 4,341 4,813 4,620 6,599 7,156 7,262

+ NetEase China Public 1,375 1,566 1,706 1,915 2,065 2,473 3,997 5,183 5,742

+ Electronic Arts U.S. Public 4,159 3,828 4,186 3,793 4,021 4,319 4,566 4,942 5,180

+ Nintendo Japan Public 3,316 2,352 2,395 2,013 1,820 1,493 1,541 2,993 3,968

+ Epic U.S. Private 200 250 300 350 450 540 636 2,400 3,800

+ Sony Japan Public 761 1,349 1,168 1,543 1,592 1,689 2,081 2,986 3,608

+ Take-Two U.S. Public 1,127 872 1,090 2,503 1,057 1,475 1,776 2,160 2,880

+ Bandai Namco Japan Public 1,162 1,512 1,728 1,529 1,536 1,661 2,170 2,688 2,824

+ Nexon Japan Public 1,122 1,155 1,313 1,541 1,559 1,571 1,678 2,103 2,272

+ Ubisoft EU Public 1,193 1,455 1,379 1,645 1,259 1,684 1,603 1,723 1,923

+ Square Enix Japan Public 749 909 1,076 943 1,017 1,323 1,834 1,725 1,844

+ Netmarble Korea Public 185 245 326 486 528 912 1,244 2,272 1,819

+ NCSoft Korea Public 583 529 709 721 769 326 816 1,647 1,544

+ Aristocrat Australia Public 31 56 122 216 351 617 852 1,100 1,339

+ Konami Japan Public 415 486 553 604 509 773 750 885 1,073

+ Sanqi China Public - - - - - - 655 798 1,033

+ PUBG Corp (Krafton Game Union) Korea Private - - - - 4 1 1 253 944

+ Zynga U.S. Public 166 298 358 429 515 618 741 861 907

= Top 20 publishers 25,770 26,355 29,149 31,210 33,906 39,372 51,092 67,054 77,291

+ Other 25,381 30,892 31,716 31,790 34,711 33,554 29,671 24,954 24,079

= Global PC, console and mobile 51,151 57,247 60,865 63,000 68,617 72,926 80,762 92,008 101,371

Note: Microsoft includes Xbox licensing revenue Source: Citi Research

If we try to isolate console/PC revenue from mobile revenue, a slightly different

picture emerges. First console/PC revenues comprise about 50% of total gaming

revenues. Second, Tencent falls a few spots, but Sony rises to the top of the list.

But, other than revenues, is there another way to assess which game publishers are

the most successful? One way to measure success is to look at the average

metacritic score for each developer over the last eight years (2010 to 2018).

(Metacritic is a website that aggregates consumer reviews.) We looked at two

dimensions: (1) the average score and (2) the average standard deviation across

various titles. The implications are fairly clear.

Figure 21. Largest Video Game Publishers – Global Console/PC Revenue

Company Firm Listing 2010 2011 2012 2013 2014 2015 2016 2017 2018E

+ Microsoft* U.S. Public 2,612 2,744 2,490 2,321 2,806 4,038 5,626 6,333 8,988

+ Tencent China Public 1,812 2,260 3,264 4,318 5,256 6,196 6,440 7,876 7,229

+ Activision U.S. Public 4,802 4,489 4,987 4,341 4,813 4,620 5,013 5,158 5,177

+ Electronic Arts U.S. Public 3,944 3,586 3,902 3,430 3,569 3,795 3,996 4,314 4,521

+ Nintendo Japan Public 3,316 2,352 2,395 2,013 1,820 1,493 1,374 2,701 3,623

+ Epic U.S. Private 200 250 300 350 450 540 636 2,400 2,800

+ Take-Two U.S. Public 1,120 860 1,063 2,455 978 1,337 1,585 1,914 2,580

+ Sony Japan Public 761 1,349 1,168 1,543 1,592 1,584 1,610 1,867 2,328

+ Ubisoft EU Public 1,193 1,455 1,379 1,645 1,259 1,684 1,603 1,723 1,923

+ NetEase China Public 825 985 1,056 1,154 1,215 1,395 1,622 1,705 1,777

= Top 10 publishers 20,585 20,330 22,004 23,570 23,758 26,680 29,505 35,992 40,945

+ Others 25,928 30,320 29,519 26,104 23,741 18,212 15,442 13,174 11,810

= Global console/PC revenue 46,514 50,650 51,523 49,674 47,499 44,892 44,947 49,166 52,755

Note: Microsoft includes Xbox licensing revenue Source: Citi Research

Firms with higher average scores also tend to have lower variance. Take Two,

Nintendo, Capcom and Electronic Arts all score particularly well. On the other hand,

Konami, Activision and Namco Bandi tend to receive lower average scores and

higher variance in those scores.

© 2019 Citigroup

28

Figure 22. Metacritic Scores for Top Developers

Source: Metacratic.com

0

1

2

3

4

5

6

7

66 68 70 72 74 76 78

Sta

nd

ard

De

via

tio

n

Average Quality of Title: 2010 to 2018

Take-Two

Nintendo

Capcom

EA

Microsoft

Square Enix

Sony

SegaUbisoft

THQ

Konami

Activision

Bandai Namco

© 2019 Citigroup

29

Layer IV: Hardware

The next layer in the video game value chain is hardware. There are actually five

distinct platforms: (1) Arcade; (2) Consoles; (3) PCs; (4) Mobile; and (5) Cloud.

(We’ll skip mobile hardware in this section since we treat this gaming ecosystem

separately in the next chapter.)

Figure 23. Types of Video Game Hardware


Arcades: Where the Games Begin

Early video game consoles — including hardware and software — were first housed

in large cabinets and cost about $2,500 per game. As such, consumers wouldn’t

buy a video game. Rather, they would visit an arcade and rent consumption (at

$0.25 per play). Just to recoup the original investment in the arcade game, an

arcade owner would need to see 4,000 plays ($2,500 / $0.25).

Early hit games like Space Invaders (1978), Asteroids (1979) and Pac-Man (1980)

were the pioneers in the arcade market. By 1982, global arcade revenues had

reached over $25 billion a year. The U.S. market comprised about one-third of all

arcade revenues.

But, in 1983, the video game market faltered. The decline was multi-faceted: a

recession, persistent inflation, arcade hardware saturation, and the advent of the

console/PC market. Today, the out-of-home arcade business is a shadow of its

former self. The largest U.S. arcade company — Dave & Busters — operates just

over 100 U.S. locations and generates $1.1 billion in revenue, with 50% stemming

from games (with the balance stemming from food & beverage). In effect, lower cost

and more powerful computing processing pushed the gaming industry from the mall

to the living room.

Arcade

Console

Cloud

PC

Mobile


Game play occurs outside the

home. Expensive computing

means consumers “lease” use

PacMan, Space Invaders

Specialized hardware for

gaming driven by lower cost

computing hardware

Atari, Odyssey, Coleco,

Nintendo Wii, Sony

PlayStation, Microsoft Xbox

Less demanding games (simple

graphics, lower processing power)

means PCs can be used for some

games.

PC, Mac

Rise of smartphone allowed

game play to occur outside

home

Gaming on demand. Can play

on any device without owning

processing hardware or a copy

of the physical game

Apple iOS or Google Android

© 2019 Citigroup

30

Figure 24. Global Arcade Revenues ($ billions)

Source: Fandom, Citi Research

Console and Handsets: Where the Market Expands

As hardware costs began to fall, consumers shifted their spending from arcades to

home consoles and handheld devices. Over time, these devices have been divided

into nine generations. In truth, the specific lines that separate one console

generation from the next are a little fuzzy. But usually, the delineation reflects a

discrete improvement in processing power. In the early days, the processing

improvement happened in the central processing unit (CPU). Today, most of the

improvement happens in the graphics processing units (GPU). As we walk through

the various platforms, a few things are worth keeping in mind:

First, an incredibly popular console (Sony PlayStation 2) or widely used handheld

(Nintendo DS) will sell about 160 million units globally over its lifetime.

Second, a successful console (Sony PlayStation 1) or successful handheld

(Nintendo GameBoy Advance) will typically sell about 80 to 100 million units.

Third, the handhelds and consoles of earlier generations (like the Sega

GameGear and Atari 2600) would only sell 10-25 million units. In effect, unit

volumes generally rose over time as gaming became more popular.

0

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© 2019 Citigroup

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Figure 25. Unit Sales of Consoles and Handheld Devices

Source: The Video Game Textbook, Citi Research

If we focus on consoles (but exclude handhelds for a moment), five important trends

are important:

First, in the 1st and 2nd generation, the console manufacturers were comprised

of four main firms: Atari, Magnavox, Mattel and Coleco. Only one of these firms

— Atari — would survive to the 4th generation.

Second, between the 3rd and 6th generation, three firms battled for dominance:

Atari, Nintendo and Sega. But, only one of these firms — Nintendo — would

survive to the 7th generation. Both Atari and Sega dropped out.

Third, during the 5th generation, Sony entered the market. And, two cycles later

(7th generation), Microsoft entered the market. During the 7th and 8th

generation, three firms competed for share: Nintendo (the stalwart), Sony, and

Microsoft.

Fourth, between the 1st and 7th generation, global console sales improved. Only

in the most recent generation — the 8th generation — have console sales

faltered. We suspect this is due, in part, to the rise of mobile gaming (which we’ll

review in more detail a bit later).s

Fifth, as we look at winners and losers within each generation, there isn’t a hard

and fast rule for who takes the most market share. While we ran many

regressions to crack the code for console sales, there doesn’t seem to be a clear

set of variables that drive market share in each generation.

0

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120

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160

180

Un

its

So

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mn

)

Console

Handheld

© 2019 Citigroup

32

Figure 26. Console Unit Sales Sold by Generation


Handheld Market

So far, we’ve focused on the console market. But, beginning in 1988 a new market

developed: the handheld gaming market. With the exception of a few short periods

(’90 to ’94) and (’04 to ’07), the console market sold more units than the handheld

market. More recently, we’ve seen the entrance of hybrid devices that serve the

console and handheld market with a single device (the 9th Generation Nintendo

Switch).

Figure 27. Console, Handheld & Hybrid Units Sold


0

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Un

its

So

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mn

)

Atari

Magnavox

Mattel

Coleco

Sega

Nintendo

Sony

Microsoft

Console Generation

In total, nearly 1

billion video game

consoles have

been sold.

Each generation

of improved

graphics with

richer colors,

faster processing

and improved

sound.

2nd 3rd 4th 5th 6th 7th 8th

0

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(m

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Console

Hybrid

(Console +

Handheld)

Handheld

© 2019 Citigroup

33

If we look at the various firms that sold handhelds, it’s quite different than the

console market. Since handhelds hit the market long after Atari, Magnavox, Mattel,

and Coleco exited gaming, there are far fewer handheld players. Moreover,

Microsoft has never rolled out a handheld device. As such, today, there is only one

firm that sells handhelds — Nintendo — and, it’s a hybrid device.

Figure 28. Handheld Units Solid by Generation


If we look at handheld market shares, there are a few important observations. First,

Nintendo is the clear market leader with about 20 million units sold in 2018. Second,

Sega exited the market back in the late 1990s. Third, Sony’s latest entry (the

PlayStation Vita) will cease production in 2019. As such, in 2020, Nintendo will be

the only firm selling handheld devices.

Figure 29. Handheld Units Sold by Manufacturer


0

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s S

old

(m

n)

Sega

Nintendo

Sony

Handheld Generation

In total, nearly 575

million video game

consoles have

been sold.

Each generation

of improved

graphics with

richer colors,

faster processing

and improved

sound.


0

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s S

old

(m

n)

Nintendo

Sony

Sega

In total, nearly

575 million

handheld video

game devices

have been sold.

Nintendo is the

market leader,

followed by Sony.

© 2019 Citigroup

34

If we add up the console market and the handheld market — nearly 1.6 billion units

have been sold over the last 40 years. And, we can get an idea of composite

hardware market share each year. While there’s been a fair amount of change in

relative rank over the years, today Nintendo is the leader, followed by Sony with

Microsoft securing third place.

Figure 30. Hardware Market Share


Hardware Performance: Console and Handheld

So, how much have consoles improved over time? Unfortunately, there isn’t a single

metric that encapsulates a computer’s performance into a holistic, unified

performance metric like a vehicle’s velocity (MPH) or broadband Internet speeds

(Mbps). But, in broad terms, there are four key variables that determine a machines

performance: CPUs, GPUs, MIPS and MFLOPS.

Figure 31. Four Variables that Determine Hardware Performance


0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

'76 '78 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16

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Mark

et

Sh

are

(%

)

Hardware Generation

In total, nearly 1.6

billion video game

consoles and

handhelds have

been sold.

Market is now

controlled by three

major players:

Nintendo, Sony &

Microsoft.


Atari

Other

Sega

Nintendo

Sony

Microsoft

Nintendo

Sony

Sega

Microsoft

Atari

Other

CPU GPU

MIPS MFLOPS

Central Processing

Unit (CPU): The bits

per second the

processor can handle.

A bit is required to

perform any logical

operation in software.

Millions of

Instructions per

Second (MIPS):

Measures the number

of machine instructions

a computer can execute

in one second.

Graphics Processing

Unit (GPU):

Bits of information that

can travel between the

memory and the GPU.

Mega Floating-Point

Operations per

Second (MFLOPS):

The speed at which

computers can perform

floating-point

calculations.

© 2019 Citigroup

35

Let’s start with CPU. The CPU measures the number of bits the processor can

handle. Early consoles had 8 bit processors but as the consoles moved into the 6th

generation, the CPUs improved to 128 bit processors. However, in the 7th

generation consoles, hardware firms scaled back CPU capacity and began to use

other levers to enhance machine performance. Indeed, the Microsoft Xbox

(released in 2001) as a 7th generation console only had a 32-bit CPU. (And,

parenthetically, the iPhone 6 only uses 64-bit CPUs.)

Figure 32. CPU Units Sold by Console Generation


So, how did hardware firms improve performance as we moved beyond 6th

generation consoles? They turned from the CPU — the brains of the computer — to

the graphics processing unit, or GPU. GPUs are often called the ‘heart of the

console’ because it’s the chip that handles graphics.

While CPUs retrenched for a while, GPUs — the number of bits that can travel

between the console’s memory and the GPU — generally improved. GPUs peaked

at 256 bits. And, unlike CPUs, GPUs generally improved as hardware firm moved

from 6th generation to the 7th generation consoles.

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50

100

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U (

nu

mb

er)

Atari

Magnavox

Mattel

Coleco

Sega

Nintendo

Sony

Microsoft

Console Generation

CPUs improved

between 2nd

Generations and

6th Generation.

Then, hardware

began to use

other ways to

improve

performance.


© 2019 Citigroup

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Figure 33. GPU Units Sold by Console Generation

Source: Forbes, Citi Research

Beyond CPUs and GPUs, there is one other way to measure a console’s

performance: the number of instructions a machine can perform per second. This is

often abbreviated with the acronym MIPS or ‘millions of instructions per second’.

The first console with its own processor — the Fairchild Channel F — could only

process 0.14 MIPS. Current consoles can process 200K MIPS. In effect, the PS4 is

akin to running 1.4 million Channel F’s.

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Atari

Magnavox

Mattel

Coleco

Sega

Nintendo

Sony

Microsoft

Console Generation

GPUs improved

between 3nd

Generations and

7th Generation.

Then, it peaked at

256 bits per

second.


© 2019 Citigroup

37

Figure 34. MIPS by Console Generation


The final metric used to measure a console’s performance is MFLOPS, or mega

floating-point operations per second. But, what are floating points? Since software

engineers deal with limited memory, they cannot store numbers with infinite

precision. At some point, they truncate the number. The easiest way to accomplish

this is to convert all numbers into scientific notation (for example 123 = 1.23 x102).

This means there are no fixed numbers before — or after — the decimal point.

Instead, it just floats based on how you decide to represent the number in scientific

notation. Floating point representations are less accurate than fixed point

representations. But, floating point representations can handle a larger range of

numbers.

If we look at the improvement in MFLOPS, it didn’t show up as a positive figure until

1982 when the Sega Model 1 could handle 80 MFLOPS. But, the Sony PS4 can

handle 1,843,200 MFLOPS. That’s an improvement of 23,000x.

0

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100,000

150,000

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250,000

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MIP

S (

mn

)

Atari

Magnavox

Mattel

Coleco

Sega

Nintendo

Sony

Microsoft

Console Generation

Millions of

instructions per

second – or MIPS

– have

dramatically

improved over the

last 40 years.


© 2019 Citigroup

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Figure 35. MFLOPS by Console Generation

`


PC Market

So far, we’ve spent all of our time on arcades, consoles, and the handheld market.

But, this isn’t to suggest that some gaming doesn’t occur on PCs. Indeed, on a

global basis the PC market comprises about 50% of (non-mobile) software sales.

PC gamers tend to fall into two groups: low-end gamers and very high-end gamers.

First, at the low-end, these PC players engage with casual games, strategy

games, and role-playing games (RPG). They don’t often play sports, action, or

shooter games. Those types of games are typically played by the segment that

uses consoles.

Second, at the high-end, there are some gamers that don’t find off-the-shelf

hardware — from Sony, Microsoft and Nintendo — robust enough. This small

segment will purchase robust (and often expensive) gaming rigs that have extra

performance and often have clever brand names like ‘Alienware ‘.

Figure 36. Some Game Genres Require Console Processing

Sports Action Shooter Other RPG Strategy Casual Total

Console 13% 23% 25% 23% 12% 4% 1% 63%

/ PC 0% 4% 6% 9% 19% 36% 26% 70%

= Ratio 66.0x 5.6x 3.9x 2.7x 0.6x 0.1x 0.0x

Source: NPD 2016

PC hardware volumes — including PCs for businesses — vastly outpace console

and handset sales each year. Indeed, in 2018, there were about 5x more PCs sold

than gaming hardware devices — like consoles and handhelds.

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

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2,000,000

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LO

PS

(n

um

be

r)

Atari

Magnavox

Mattel

Coleco

Sega

Nintendo

Sony

Microsoft

Console Generation

Floating point

calculations were

not introduced

until 7th

Generation

consoles.


© 2019 Citigroup

39

Figure 37. Global Units Sold by Gaming Device


We can take this annual shipment data and make a few assumptions to get an idea

for how much gaming hardware is in the field. We made the following assumptions:

For PCs, we assume 40% are consumer-owned and 60% are business-owned;

25% of consumer-owned PCs are used for gaming; a PC lasts five years.

For consoles, we assume 100% are for consumers; 100% are used for gaming;

like PCs, we assume a gaming console lasts five years.

For mobile devices, we assume 100% are used by consumers; the portion used

for gaming increases each year, reaching about 45% by 2018; we use a three

year mobile replacement rate.

All told, this suggests there are over 2 billion gaming devices in the field. But, nearly

90% of these gaming devices are mobile handsets. In 2018, this suggests there are

about 250 million non-mobile gaming devices in the market.

0

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(m

n)

There are 5x more

PCs sold each

year than game

consoles or

handheld devices.

PC

Console

Handheld

© 2019 Citigroup

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Figure 38. Global Video Game Units Sold by Device


What sort of hardware are PC gamers using? Perhaps the best source of data we

found is from Steam. Steam is one of the largest (if not the largest) distributor of PC

games on the Internet. And, the Steam data has some interesting statistics.

– First, only 36% of Steam users are in English-speaking countries while 25%

are Chinese and 12% are Russian. All other regions of the world make up

27% of Steam users. As such, we think this is a fairly representative set of

users around the world.

– Second, the core CPU is dominated by Intel (82%) followed by AMD (18%).

And the core CPUs have two (28%), four (56%) or six (11%) core processors.

– Third, as for the video card, a whopping 75% use NVIDIA’s chips, followed by

15% that use AMD and just 10% that use Intel.

– Fourth, only 1% of players use a VR headset.

Layer V: Distribution

So far, we’ve reviewed the IP layer and discovered it’s not too important. And, we

summarized the process video game developers follow to create games (including

the use of engines and rasterization) and reviewed the differences among games

genres. Then, we discussed the major video game publishers. This was followed by

a closer look at the various forms of hardware (including consoles, PCs, and

handhelds). Now, we’re in a position to move to layer five: the distribution of video

game content.

There are three main methods to distribute video games. First, in the early days of

video games, the consumer would purchase a physical disc at Wal-Mart or Best

Buy. More recently, consumers have been able to download digital copies of gaming

content from distributors like Xbox Live, PlayStation Network or Steam. And, in the

0

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Mobile

© 2019 Citigroup

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future, consumers may not need to download a game. Rather, they would just

purchase a license from a cloud-based service provider.

Figure 39. Methods of Distributing Video Game Software


Over the last decade, consumers have rapidly shifted away from physically

purchasing a game toward digital distribution. About ten years ago, over 70% of all

game revenues were physical game sales. Today, only 15% of game revenue

comes from physical software sales.

Figure 40. Game Revenue Breakdown: Digital vs. Physical

Source: NPD Group, Citi Research

However, since this data includes mobile — which is both large and 100% digital —

it may be more instructive to see how console/PC software sales are trending.

Sony provides some useful data called the ‘download ratio’. This data suggests that

in 2013, 92% of software sales were in disc form. By 2018, only 62% of console/PC

sales were in disc form. The balance of the sales were digital downloads.

Physical

Digital Download

Cloud


Physical delivery of software

to retail outlet

GameStop, Best Buy,

Wal-Mart

Download of the digital content

over the Internet

Xbox Game Store,

PlayStation Network, Steam

Access to license via the

Internet

GeForce Now, Parsec,

Hatch

69%65%

54%46%

39%31%

26%21%

15%

31%35%

49%54%

61%69%

74%79%

85%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2010 2011 2012 2013 2014 2015 2016 2017 2018

Digital:

Full-game downloads

Digital add-on content

Subscription services

Mobile games

Social network games

Physical:

Software available at

retail outlets

© 2019 Citigroup

42

Figure 41. Sony Share of Software Downloaded

Source: Sony, Citi Research

This shift has been driven by four distinct developments:

1. As Internet speeds have improved, consumers can readily download a full

game to their console or PC.

2. Video game developers have been adding downloadable content (DLC) into

games to help generate in-game sales.

3. Some video game publishers have created subscription services giving

consumers access to older titles for a fixed, monthly fee.

4. As processing power inside smartphones has improved, it has allowed

consumers to enjoy a wider selection of mobile games. These games generate

revenue from in-game content and from advertising.

Let’s review each of the key drivers toward digital consumption of video games.

According to Steam, 30 countries make up about 70% of all traffic on the site. And,

if we look at the broadband speeds in those 30 countries, it averages about

35Mbps. Moreover, the fastest ISP in each region can, on average, deliver 88Mbps.

And, even the slowest ISP connected to Steam in each region can, on average,

offer 17Mbps. These are remarkably robust speeds that make downloading video

games over the web a readily accessible proposition for many households.

8%

13%

19%

25%

33%

38%40%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

2013 2014 2015 2016 2017 2018 2019E

So

ny S

hare

of

So

ftw

are

Do

wn

load

ed

© 2019 Citigroup

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Figure 42. Broadband Connection Speed for Steam

Speed Fastest Slowest

Country (Mbps) ISP Speed ISP Speed

China 46 UNICOM Liaoning 54 CERNC 28

U.S. 47 Verizon 70 CenturyLink 15

Russia 24 OJS Moscow 45 PJSC MegaFon 10

Germany 28 Unitymedia 60 Vodafone DSL 18

S. Korea 100 Korea Telecom 96 Tbroad Suwon 49

U.K. 33 Virgin 55 TalkTalk 18

Brazil 17 COPEL 30 Oi Internet 6

Canada 42 Rogers 75 SaskTel 17

France 23 NVIDIA Ltd 567 Free SAS 14

Japan 61 Sony Network 109 Jupiter 46

Australia 20 Aussie Broadband 35 Dodo 9

Thailand 41 3BB 52 AIS Mobile 7

Poland 23 UPC 62 Play 8

Turkey 12 Turksat Uydu-Net 19 Demiroren 8

Sweden 68 Ownit 106 Telia 46

Ukraine 26 Lanet 42 PJSC 7

Spain 50 Jazztel 71 Orange 42

Taiwan 38 HiNet 42 Taiwan Mobile 18

Netherlands 58 NVIDIA Ltd 508 Euronet 23

Norway 51 Altibox 80 NextGen 21

Italy 20 Fastweb 22 Linkem 4

Finland 36 CSC-Tieteen 65 Elisa Oyj 29

Hungary 40 UPC 68 ZNET 16

Argentina 13 Telecentro 25 Telecom Personal 6

Belgium 47 VOO 57 M247 26

Indonesia 9 MyRepublic 30 Telkomsel 7

Mexico 16 Totalplay 29 Telcel 7

Malaysia 29 Tt Dotcom 73 U Mobile 4

Chile 27 VTR 48 Entel 6

India 15 Alliance 32 BSNL 4

= Top 30 35 88 17

Source: Steam

According to Sandvine, on a global basis, gaming now makes up about 8% of all

downstream Internet traffic, and 3% of upstream Internet traffic. (Downstream traffic

is from the cloud to the user; upstream traffic is from the user to the cloud.) That

makes gaming the third most popular application for downstream traffic on the

Internet (behind video delivery (i.e., Netflix) and generic web surfing). Xbox Live

makes up about two-thirds of all gaming sessions and about one-third of all traffic.

PlayStation Network makes up about 30% of all sessions and 40% of all traffic.

Steam is a distant third with less than 10% of all sessions.

Figure 43. Breakdown of Upstream and Downstream Internet Traffic

2018 PlayStation Network Xbox Live Steam

Down Up Down `Up Sessions Down Up Sessions Down Up Sessions

Video 58% 23%

+ Web 17% 21%

+ Gaming 8% 3% 45% 40% 29% 33% 27% 64% 24% 16% 7%

+ Social 5% 4%

+ Markets 5% 2%

+ File sharing 3% 22%

+ Messaging 2% 8%

+ Security 1% 7%

+ Storage 1% 9%

+ Audio 1% 0%

= Total 100% 100%

Source: Sandvine, Citi Research

© 2019 Citigroup

44

One reason gaming consumes such a large portion of Internet traffic is current

games are quite large. Sandvine estimates that to download Call of Duty: Black Ops

3 is a 100GB of data. That’s equivalent to 13 hours of 4K video streaming (100GB /

7.8 GB per hour = 13 hours). It’s also equivalent to nearly 60 hours of high definition

(HD) video streaming (100GB / 1.7GB per hour = 59 hours).

Figure 44. Download Times for Call of Duty by Video Standard

Video Standard

SD HF Full HD Quad HD 4K

Call of Duty download (GB) 101 101 101 101 101

/ Video GB per hour 0.3 0.8 1.7 6.9 7.8

= Hours of video 352 132 59 15 13

Source: Sandvine, Citi Research

For PC games, there are a handful of niche distributors. These include Steam, GOG

and Desura, just to name a few. Steam is, by far, the largest distributor of

independent PC-based games. Steam is a private company owned by Valve. Since

inception, Steam has released over 30,000 games on its platform. The number of

new releases has grown from under 600 per year in 2013 to over 9,000 a year in

2018. Although Steam is a private company so actual figures are hard to come by,

but industry observers (i.e., SteamSpy) suggests there are 90 million active monthly

users on Steam. And, they spent about $4.3 billion on video games in 2017. (This

includes fees paid for titles but excludes in-game purchases.)

Figure 45. Number of New Games Released on Steam

Source: Wikipedia; SteamSpy, Citi Research

Steam’s Main Rivals Include Epic Games and Discord.

Epic Games — the creator of Fortnite — recently launched a digital store front in

4Q18. And, as we showed earlier, Epic has given developers economic incentives

to use its game engine (UE4) along with its new storefront.

Discord is another private company with significant venture capital (VC) backing.

Discord raised $200 million from VC firms like Greylock, Benchmark, and Tencent.

0

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on

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games

© 2019 Citigroup

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Discord has focused on social features – like voice chat and instant messaging - to

drive growth. Steam has responded by incorporating social features into its

platform. In addition, Electronic Arts (EA) broke away from Steam in 2011 to form

EA Origin. But, EA service still isn’t very popular.

We used Google Trends to assess popularity of the digital storefronts of Steam,

Discord, and Epic. Discord has gradually grown in popularity over the past few

years. And Epic is a relatively new upstart. Steam, it seems, is still the leader. Most

gamers like Steam’s game selection, search functionality, and on-line support. Most

gamers still think Discord and Epic haven’t yet caught up to Steam.

Figure 46. Popularity of Digital Storefronts by Game Distributors

Source: Google, Citi Research

Cloud Gaming

Cloud gaming is relatively simple. Rather than processing video game content on a

PC or console, the processing is done inside the network, or in the cloud.

Cloud gaming has been a long-term aspiration for the video game industry. It all

began with OnLive. OnLive launched the first cloud gaming platform back in 2009.

Although OnLive officially had 1.5 million active users when the service shuttered,

the service was losing money. Press reports such as The Verge suggested OnLive

was burning through $60 million a year. Moreover, latency times were quite

significant at around 150 milliseconds.

Despite the demise of OnLive, industry observers are still drawn to the technical

elegance of cloud gaming. For the consumer, it eliminates the need to upgrade

console hardware. And, if the cloud gaming platform is designed properly, it makes

it easier for consumers to play games on different platforms (including smartphones

and PCs). For the game developers, it allows firms to support more devices and

reduces compatibility issues between software and hardware. And, for console

manufacturers, it allows revenues to migrate to monthly recurring revenues (versus

episodic hardware revenues). And, those transitions are usually good for valuations

(due to expansion of the multiple).

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© 2019 Citigroup

46

There are, however, three fundamental challenges with cloud gaming. First,

consumers must have sufficient broadband speeds. Second, the latencies must be

sufficiently low to allow users to play a cloud based game without any erosion in

game quality. Third, users will need a controller that works with any screen

(including mobile handsets). Let’s look at each of these impediments.

Broadband Speeds

Cloud gaming requires, at a minimum, 15Mbps broadband speeds. Among the 10

most populous countries, all but three — Nigeria, Pakistan, and Indonesia — offer

average broadband speeds in excess of 15Mbps. Moreover, most regions are

experiencing double-digit annual improvements in speeds. As such, we don’t see

broadband speeds as a major impediment to cloud gaming.

For gamers that want even better picture quality and higher frame rate, Google

recommends 25Mbps. That level of speed will deliver 1080p picture quality at 60

frames per second.

Latency

Cloud computing for video games is very different than streaming video (Netflix) or

music (Spotify). That’s because video and music content are pushed to the

consumer, with almost no consumer interaction. This gives the content supplier the

ability to buffer content (masking any connectivity or latency issues). Buffering isn’t

possible for cloud gaming. Moreover, gamers want to interact with the game. So,

low levels of latency are critical.

Most industry observers think latency — the time between a gamer’s command and

the subsequent screen action — must fall below 40 milliseconds. That’s not a lot of

time — 40ms is akin to 1/25th of a second. In that narrow slice of time, cloud

gaming hardware must to three things:

Process Delay: First, the cloud server must receive and process player

commands and encode and transmit the frame to the user’s thin client. This step

has four sub-elements: memory copy, format conversion, video encoding, and

packetization.

Playout Delay: Second, the thin client must receive and render the video frame

on the display. This step has three sub-elements: frame buffering, video

decoding, and screen rendering.

Network Delay: Third, the signal must travel between the cloud server and the

thin client

Figure 47. Broadband Speeds for 10 Most

Populous Countries

Country Population Nov '17 YoY Chg

(mil) (Mbps) (pct)

China 1,420 61.2 42%

+ India 1,369 18.8 77%

+ U.S. 329 75.9 37%

+ Indonesia 270 13.4 19%

+ Brazil 212 17.8 19%

+ Pakistan 205 6.1 16%

+ Nigeria 201 9.5 4%

+ Japan 127 73.5 21%

+ Bangladesh 168 16.1 14%

+ Russia 144 36.9 15%

+ RoW 3,270 nm nm

= Global 7,715 nm nm

Source: Wikipedia

© 2019 Citigroup

47

Figure 48. Sources of Cloud Gaming Latency

Source: Measuring the Latency of Cloud Gaming Systems, Citi Research

If you delve into the various building blocks of total Response Delay, about 60% of

the latency stems from Process Delays (the cloud server), 25% stems from Playout

Delays (the thin client in the home) and 15% stems from Network Delays (Internet

transit).

Moreover, you’ll notice that video encoding (within Process Delay) and video

decoding (within Playout Delay) are the two most significant causes of total latency.

In total, video encoding and decoding makes up about 20 milliseconds of delay, or

over one-third of the total. As such, if there is a way to improve on these speeds,

latency can decline further. Video encoding may hold part of the answer.

Response

Delay

Process

Delay

Network

DelayPlayout

Delay

Memory

Copy

Format

Conversion

Video

Encoding

Packetization

Frame

Buffering

Video

Decoding

Screen

Rendering

Time b/w user

command &

screen action

Time for info

to travel

between

cloud server

& thin client

Time for server to

receive & process

player command;

encode & transmit

frame to client

Time for client to

receive, decode

& render frame

on display

Time to copy

image out of

game

Time for

color-space

conversion

Time to

compress

video

Time to

segment

frame into

packets

Time to receive

all packets for

current frame

Time for video

decompression

Time to display

decoded frame

© 2019 Citigroup

48

Figure 49. Cloud Gaming Latency (milliseconds)

Source: Measuring the Latency of Cloud Gaming Systems, Citi Research

To understand how video encoding impacts latency, we need to learn a bit more

about video compression. There are two groups that set video compression

standards: (1) Moving Pictures Experts Group (MPEG) and (2) Video Coding

Experts Group (VCEG). The former (MPEG) began working on broadcast TV

several decades ago. The latter (VCEG) started in 1988 to deal with video

conferencing on circuit-switched copper phone lines (via ISDN). Since all forms of

video are moving to the Internet, these two groups — MPEG and VCEG — now

work together.

But, somewhat confusingly, each body uses different acronyms. The MPEG team

uses MPEG-1 to MPEG-4 to identify the evolution of their standards. In parallel, the

VCEG team use H.261 to H.265 to identify their standards. In 1993, the industry

was using MPEG-1 and H.261. By, 2004 the most widely adopted standard was

MPEG-4 and H.264. In the future, more equipment will support MPEG-H and H.265

(also referred to as HEVC).

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Transit

© 2019 Citigroup

49

Figure 50. Video Compression Standards

Year MPEG Part Layer Use VCEG

1984 N/A H.120

1988 N/A H.261

1993 MPEG-1 Video and TV Recording

I Systems

II Video VCD H.261

III Audio

I

II

III MP3

1999 MPEG-2 Broadcast, DVD

I Systems, Program, Transport

II Video H.262

III Audio

I

II

III MP3

2004 MPEG-4 Broadcast, Internet, Blu-ray

I Systems

II Video H.263

III Audio

X Advanced Video Codec MPEG-5 AVC H.264

XIV MP4 Container MP4

2013 MPEG-H

II Video HEVC H.265

Source: Wolfcrow.com

If we want to understand the various video standards — from HD to 4K — and map

these to specific bandwidth requirements (based on the type of compression), we

need to perform a little bit of math. It starts with the pixels per frame (in both the

horizontal and vertical directions). Better picture quality means more pixels per

frame. We then convert these pixels per frame to quantify uncompressed bandwidth

requirements.

A standard definition video signal (SD) would require 510 Mbps without

compression. But, a 4K video signal would require 40x as much, nearly 21,000

Mbps. Clearly, even with improving broadband speeds, without compression,

consumers couldn’t get a 4K signal. However, with MPEG-2, a 4K stream only

requires 125Mbps. And, if the stream is compressed to MPEG-4, it only requires

about 52Mbps. With the emerging H.265 compression standard, a home would only

need 31Mbps.

© 2019 Citigroup

50

Figure 51. Bandwidth Required by Video Standard and Compression

Video Standard

SD HD Full HD Quad HD 4K

Pixels per frame (horizontal) 720 1,280 1,920 3,840 4,096

x Pixels per frame (vertical) 480 720 1,080 2,160 2,304

= Pixels per frame (mil) 0.3 0.9 2.1 8.3 9.4

x Bits per pixel 8 8 8 12 12

= Total bits 2.8 7.4 16.6 99.5 113.2

x Colors (red, blue, green) 3 3 3 3 3

= Bits per frame (mil) 8 22 50 299 340

x Frames per second 60 60 60 60 60

= Bit rate (Gbps) 0.5 1.3 3.0 17.9 20.4

x Gbps per Mbps 1,024 1,024 1,024 1,024 1,024

= Bandwidth (Mbps) 510 1,359 3,058 18,346 20,874

x Compression (MPEG-2) 0.006 0.006 0.006 0.006 0.006

= Bandwidth (Mbps) 3 8 18 110 125

Bandwidth (Mbps) 510 1,359 3,058 18,346 20,874

x Compression (MPEG-4) 0.003 0.003 0.003 0.003 0.003

= Bandwidth (Mbps) 1 3 8 46 52

Bandwidth (Mbps) 510 1,359 3,058 18,346 20,874

x Compression (H.265) 0.002 0.002 0.002 0.002 0.002

= Bandwidth (Mbps) 1 2 5 28 31


Today, H.264 is the most popular video format. It’s used by Netflix and YouTube.

Most cloud gaming platforms use H.264 because there is plenty of hardware in the

field that supports this standard. However, H.265/HEVC is waiting in the wings. The

aim of H.265/HEVC is to reduce the bit rate by allowing for far more flexibility in the

video grid size. When there is little movement on the screen, the grid size can be

larger. And, where more movement occurs, the grid size is smaller. This, in turn,

means a larger grid may not need to be refreshed for every frame of video, reducing

bandwidth requirements and latency.

Figure 52. Comparing Video Formats – H.264 vs HEVC

Source: Boxcast, Citi Research

With HEVC, it may be possible to reduce the video encoding and video decoding

from about 20ms to just 10ms. And, if cloud gaming servers can be placed locally, it

may be possible to reduce total latency from 55ms to ~40ms.

H.264 HEVC

© 2019 Citigroup

51

Indeed, data from Wonder Network suggests latencies between New York and

Toronto are just 12ms. And, latencies between New York and Washington DC are

just 9ms. We suspect if the cloud server and the client were within the same city,

these network latencies could be cut in half.

Figure 53. Latencies Between Different Cities (milliseconds)

Destination

Source Barcelona Paris Tokyo Toronto Washington

Amsterdam 34 16 246 90 81

Auckland 313 293 206 228 230

Copenhagen 40 21 276 113 207

Dallas 145 109 146 41 32

London 30 4 225 88 76

Los Angeles 144 145 108 68 61

Moscow 66 50 207 140 132

New York 93 74 209 12 9

Paris 29 nm 222 86 78

Stockholm 48 26 285 108 103

Tokyo 297 231 nm 165 168

Source: Wonder Network

So, can improvements in video compression and cloud infrastructure (that sits

closer to the end-user) get latencies to 40ms or less? We think the answer is yes.

Ken Moss (EA’s Chief Technology Officer) suggested to Barron’s in 2018 that

technological impediments may be disappearing:

“The common view is that you can’t play high-end multiplayer games on the cloud

because of the latency. But you can, and the bandwidth and latency continue to

move in the right direction.”

Controllers

Although no cloud service has gone live, Google’s pending Stadia offer did release

pictures of its game controller. The device has connections for both a headphone

jack (3.5mm) and a USB-C port. It also has dedicated buttons for voice control

(powered by Google Assistant) and capture video.

It’s unclear if the controller will be sold separately or bundled with a Stadia

subscription. But, Google has suggested Stadia will support other gamepads.

Figure 54. Google Stadia Controller

Figure 55. Konami Code on Back of Google Game Controller

Source: Google Source: Wikipedia

© 2019 Citigroup

52

And, in a not so subtle nod to the hard-core gaming community, Google engraved

the “Konami Code” on the back of the controller. For readers that aren’t avid

gamers, the Konami Code dates back to 1985 when Kazuhisa Hashimoto was

working on the arcade game Gradius. During testing, Kazuhisa developed a

shortcut that would give him the full-set of ‘power ups’. Every time Kazuhisa pushed

this specific sequence of controller buttons, it would allow him to live long enough,

without dying, to test any part of the game. When the final game went live in 1986,

the code was still in the game. It will be interesting to see how far Google takes this

inside joke. That is, the Konami Code may not make it to final production. Or,

perhaps it will!

So, who is likely to capture the lion’s share of this potential new cloud gaming

market? We suspect cloud providers that already have scale have a distinct

advantage. Not only will their services likely have lower latency (since they probably

have cloud hardware closer to the gamer), but these scale players will likely be able

to charge less for the service.

Already, we are beginning to see early signs of a ‘winner-take-all’ dynamic for cloud-

based offers (beyond gaming). Collectively, Amazon, Microsoft, and Google

increased their share of overall cloud services from 53% to 58% between the end of

2017 and the fourth quarter of 2018. The smaller players, which have far lower

share, are ceding market to the larger players.

Figure 56. Cloud Market Share


This isn’t to suggest, however, that other players won’t enter the market. NVIDIA (a

chip maker) has created the GeForceNow alliance (GFN). The alliance includes

telecom providers like Softbank in Japan and LG Uplus in South Korea. NVIDIA will

develop the software and manage the service. But, it will share the subscription

revenue with alliance partners. NVIDIA claims they have 300K monthly active users

(in beta) with one million on the waitlist.

What could cloud gaming mean for developers and publishers? We can think of a

few things:

First, cloud gaming will likely expand the market. Since the processing is one in

the cloud, any screen can be used for gaming.

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© 2019 Citigroup

53

Second, cloud gaming means developers will have control of their digital rights.

Everything will be safely stored in the cloud.

Third, over the very long run, cloud gaming may eliminate the need to develop

software for specific platforms. Of course, if cloud services are expensive (and

consoles still play a meaningful role) developers will still have to program for

each unique hardware platform.

For consumers, there are also benefits:

First, gamers will be able to play games almost immediately. Download times (or

shipping times) will be a thing of the past.

Second, the types of games that are developed will likely change. Once the

market opens up to a larger audience — larger than the core gamer market —

we will likely see new types of games that take advantage of the larger market

and faster processing power.

Third, historically, mobile games have been limited by the processing power that

resides within the phone. This has given rise to casual, low-spec mobile games.

With cloud gaming, higher-end games can be played on any device — including

smartphones — with limited processing power.

Fourth, consumers will have a seamless user experience. Gamers can pause the

game their playing on one device and pick it up on another device.

Layer VI: Consumer

So, cloud gaming may be just around the corner. But, what is the potential

addressable market? To answer that, we need to begin by estimating the number of

global gamers. If we start with global gaming hardware in use (which we reviewed

earlier) and assume each mobile device is used by one person but each console

and PC is used by 1.5 people (for gaming), it suggests there are just over 2.1 billion

global gamers.

The vast majority — almost 90% — are mobile gamers. Handheld gamers are quite

small. And collectively, we estimate there are about 380 million gamers that use

PCs or consoles. Interestingly, the top-down data (based on hardware shipments)

suggests console/PC gamers have actually contracted over the last seven years.

Why is that?

Recall, we showed earlier that PC and console sales peaked in 2011. As such,

either these lower hardware shipments are a function of fewer non-mobile gamers,

or gamers are hanging on to their hardware for a longer period of time. We suspect

it’s the former. And, we can’t help but wonder if the explosive growth in mobile

gaming — which started in earnest in 2012 — has taken some of the wind out of the

console/PC market.

© 2019 Citigroup

54

Figure 57. Global Consumers Playing Video Games


So, excluding mobile, around 380 million consumers play video games. But, some

are casual players. And, others are hardcore gamers. Around 20% of gamers play

less than 1 hour a week. These light gamers make up just 4% of total game time. At

the other end of the spectrum, just 7% of gamers play more than 20 hours a week

and make up 24% of total game time.

Figure 58. Share of Gamers Based on Game Hours

Source: Limelight., Citi Research

Around 25% of total game play occurs on mobile devices. The balance — around

75% occurs on consoles, PCs, and tablets. PCs generate more game play per week

than any other type of hardware.

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play – engage with

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week.

© 2019 Citigroup

55

Figure 59. Video Game Hours by Device

Source: Limelight, Citi Research

Layer VII: eSports

Let’s shift to the bottom of the console/PC value chain: electronic sports and live

streamers. Live streamers gain viewers when individuals watch an amateur — albeit

a very good one — play games on a site like Twitch. Professional eSports is when

individuals watch a professional team. Between live streaming and professional

teams, there are a wide array of grassroots eSports competitions and events.

For older readers, eSports and live streaming might be a little difficult to understand.

Most readers in their 40s or 50s might wonder: “Who wants to watch someone else

play video games?” It’s a fair question. But, if you think about it, food lovers watch

others cook (Food Network) and sports fans watch others play sports (ESPN).

Video games shouldn’t be any different.

Mode of Distribution

But, video games didn’t always have eSports. What caused the change? We think it

was driven by the mode of distribution, which almost always changes the way

consumers use an application.

Voice services were the first application that experienced this shift when voice

migrated from a wired connection to a wireless connection. Since phone

conversations are often between two people, this shift in distribution didn’t alter

voice communications, per se. But, voice was supplanted by social media — apps

like Twitter, Facebook, and Instagram. As such, communication migrated from a 1:1

activity to a group activity.

Video was the second application that experienced a shift in consumption patterns

once distribution changed. From the 1950s to 2010, almost all TV shows were

delivered over the air — or over coaxial cable — according to a predetermined

schedule. Since content was ‘pushed’ the shows were consumed by groups. Today,

of course, a significant portion of TV consumption (non-sports and non-news

content) is ‘pulled’ off a server. As such, TV consumption is no longer a group

activity. Rather it’s often for a single user.

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© 2019 Citigroup

56

Figure 60. Shift in Consumer Patterns for Various Modes of Distribution


Something similar is going on with video games. In the past, a consumer would

purchase and play a game by themselves (or with friends and family in close

proximity). That is, the console or PC wasn’t connected to the Internet. But, with

nearly ubiquitous connectivity, gamers today are often playing games in groups.

This has spawned an entirely new type of gaming hardware: the gaming headset.

The headset allows gamers to listen to and communicate with other gamers within

the same virtual world. As communal gaming becomes more popular — augmented

by virtual reality headsets — it promises to become even more social and

immersive, a true ‘third space’.

Voice

TV

TV

GamesTV

TV

PC

TV

PCCloud

Cloud

TV

Mode of Distribution Mode of Consumption Voice moved

from wires to

wireless

Voice

remained 1:1 ,

but wireless

spawned

group chat

(like Twitter).

Video

distribution

moved from

wireless to

wires

Consumption

moved from

group to 1:1

Game

distribution

moved from

tethered to

cloud

Consumption

moved from

1:1 to groups

© 2019 Citigroup

57

Figure 61. Gaming & VR Headsets

Source: Shutterstock

This is particularly true for younger gamers. According to Nielsen, the average

eSports / live streaming fan is just 28 years old. And, over 70% of these fans are

male. But, how important are eSports / live streaming to this narrow slice of the

population? Collectively, this cohort spends about 30 hours a week — or 4 hours a

day — on screen-centric entertainment. eSports fans spend 25-30% of their total

screen time playing video games. And, they spend another 10% watching others

play video games. Collectively, the eSports / live streaming cohort spends more

time playing and watching video games (35%) than they do watching linear TV plus

streaming video on sites like Netflix (26%).

Figure 62. Hours Spent Streaming Different Forms of Media by Device

Video

Content -----> Pay TV Stream Videos General Social Games eSports

Example -----> Linear Netflix YouTube Websites Facebook Fortnite ESL Total

TV 4.3 3.5 7.8

+ PC, Console 4.5 3.7 2.8 6.2 2.2 19.4

+ Mobile 3.0 2.0 0.2 3.0

= Total 4.3 3.5 4.5 3.7 5.8 8.2 2.4 30.2

memo: share 14% 12% 15% 12% 19% 27% 8%

Source: Nielsen, Citi Research

In the U.S., a nonprofit group called The National Association of Collegiate Esports

(NACE) hopes to elevate eSports into a varsity sport. NACE has over 130 schools

as members and awarded $15 million in eSports scholarships and aid to students.

And several schools — including the University of Utah and University of California

at Irvine — offer eSports scholarships to students.

But, the business model for eSports and live streaming are quite different. So, first

we’ll review live streamers. Then, we’ll review professional eSports.

© 2019 Citigroup

58

Live Streamers

The live streamer model has five important entities: (1) the person who uploads the

their game play (the gamer); (2) the software firm that brings the gamer and the

viewer together (the broadcaster); (3) the business that wants to advertise to the

consumer (the advertiser); (4) the person that wants to watch an expert play the

game (the consumer); (5) and the business that wants to promote a video game or

other product or service (the sponsor).

Figure 63. Live Streaming Ecosystem


But, how can a consumer watch someone play video games? Well, any video game

player can upload their live game to the cloud via a broadcaster. There are a

handful of useful websites for this purpose. The most prominent site is Twitch

(acquired by Amazon in 2014 for about $900 million). But, there are many rivals

including YouTube (Google), Steam TV (Valve), Mixer (Microsoft), Facebook, Huya

(China), Douya (China), and Caffeine. These streaming services are often called

video game ‘broadcasters’. And, some of these broadcasters have purchased rights

to specific eSports (something we’ll discuss in more depth in the eSports section).

Gamer

Broadcaster

Consumer

Sponsor

Advertiser

$ (sponsorship)

Content

Content

$ (subscribe)

$ (subscribe)

$ (ads)

$ (ads)

$ (donate)

Description

Top 20% of gamers collect 80% of

revenue. Popular gamers can make

>$1M per year

Economics

Gamer collects funds from: (1)

Sponsors, (2) Consumer donations,

(3) Consumer subscriptions, and (4)

Ads

Broadcaster is the hub of the

ecosystem. Brings parties together.

Broadcaster collects up to 50% of (1)

Consumer subscription fees and (2)

Ads. Broadcaster does not collect

portion of donations or sponsorships

Advertiser pays for impressions on

Broadcaster.

Ads cost around $8 per 1000

impressions. Broadcasts can keep up

to 50%. Balance remitted to gamer.

Consumer gets to see how best

players play the game.

Consumer views game play for free.

Can donate or subscribe to gamer.

Sponsor can use gamer popularity to

promote products or services. Can

be game play, YouTube videos, live

appearances, Tweets, or Instagram

videos

Wide variance in economics. But,

game play typically worth $0.10 per

viewer hour

Views

© 2019 Citigroup

59

Figure 64. Video Game Broadcasters

Broadcaster Country Status Rights Comments

Caffeine U.S. Private $100M investment from Fox

No need for OBS or XSplit

Douya China Private Tencent investment

Facebook U.S. Public ESL Pro League

ESL One Series

Paladine Premier League

H1Z1 Pro League

Gfinity Elite Series

Huya China Public World Electronic Sports Games Tencent investment

Riot Games' League of Legends Korea in China U.S. IPO in 2018

Mixer U.S. Public Hi-Rez Studios Acquired in 2016

(Microsoft) ESL Low latency

Steam TV U.S. Private Dota 2

Counter-Strike

Twitch U.S. Public Overwatch League Acquired for $970M

(Amazon) NBA 2K DreamHack partnership

YouTube U.S. Public FACEIT Esports Championship Can rewind

(Google)


How do video game broadcasters work? Let’s say you want to share your game

play with others. First, you’d need to create a game channel on a third-party

platform (like Twitch). If you play on a PC, you need broadcast software, like Open

Broadcaster Software, or XSplit. You also need a headset and a webcam. For

console devices (Xbox or PlayStation) you’ll also need a capture card (Avermedia

LGP). This allows you to stream your gameplay. But, is anyone uploading their

gameplay? And, if so, is anyone watching?

Using data from Twitchtracker (not affiliated with Amazon), Twitch has seen very

rapid growth over the past eight years. In 2012, total viewers reached 0.1 million

with 5,000 gamers uploading their game-play (or channel). Today, there are nearly

1.3 million viewers and almost 50,000 channels.

Figure 65. Growth in Broadcaster Twitch

Figure 66. Viewers on Twitch by Time of Day

Source: Twitchtracker, Citi Research Source: Twitch, Citi Research

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© 2019 Citigroup

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And, according to Twitch, about 50,000 gamers are uploading their content at any

given time (Figure 65, dark-blue line). And, on average, about 1.2 million consumers

are watching these channels (Figure 65 light-blue line). So, on average, only about

25 people are watching each channel (Figure 66 grey line). That’s a very small

audience.

You may also notice that the peak viewing hour for Twitch is about 2pm. That differs

from TV (where the peak-hour occurs around 7pm). We suspect this speaks to the

younger Twitch demographic. Recall, the average eSports fan is just 28 years old.

As such, a large number of Twitch users are likely in school (rather than working).

So, peak viewing for gaming is far earlier in the day, when school ends. Peak TV

viewing is later in the day, when work ends.

In terms of geographic mix, around two-thirds of Twitch players speak English. The

remaining one-third is spread across nine different regions. But, Russian, German,

Spanish, and French users make up about 25% of the total user base. The reaming

15% are mostly in Asia-Pac (who typically converse in Korean, Chinese, and

Japanese). In effect, Twitch is still very concentrated in North America and

underrepresented in the rest of the world, particularly Asia.

Figure 67. Twitch Players by Language

Source: Twitch, Citi Research

Gamoloco is another site that isn’t affiliated with Twitch. But, they do give fairly

detailed information on Twitch users who upload their game (and create a channel).

Crucially, the Gamoloco data is organized by both game title and by channel.

In aggregate, Gamoloco has similar figures to Twitch: about 78K people are

uploading their game play at any given time. And, about 50% of all channels are for

the 10 most popular games. The average channel only has about 15 people

watching the live stream (versus 25 using Twitch data). While there’s some variance

by game title, the general rule is this: the more channels a game title has, the fewer

the viewers per channel.

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© 2019 Citigroup

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Figure 68. Viewership of Top 12 Live Stream Games on Twitch

Apex League of Counter- Just Over- Hearth- Top 10 All

Fortnite Legends Legends Strike Chatting Dota 2 watch stone PUBG GTA Sub-total Other Total

Average channels 18,436 8,254 2,660 1,123 1,155 797 1,217 182 1,552 1,001 36,377 41,767 78,144

x Viewers per channel 9 17 48 85 74 79 39 154 18 23 22 8 15

= Avg viewers 159,574 138,092 128,675 95,302 85,009 63,102 47,122 28,010 27,187 23,003 795,076 352,661 1,147,737

x Hours per viewer per day 24 24 24 24 24 24 24 24 24 24 24 24 24

= Hours watched (mil) 3.8 3.3 3.1 2.3 2.0 1.5 1.1 0.7 0.7 0.6 19 8 28

x Days per week 7 7 7 7 7 7 7 7 7 7 7 7 7

= Average viewer hrs per week (mil) 27 23 22 16 14 11 8 5 5 4 134 59 193

memo: sh of viewing from top player 8% 12% 13% 47% 8% 55% 20% 4%

memo: sh of viewing top 2 players 16% 16% 16% 58% 14% 6%

memo: sh of viewing top 3 players 23% 20% 69% 8%

Source: Gamoloco, Citi Research

For example, about 18K people upload their Fortnite game to Twitch. But, on

average, only 9 people are watching each channel. At the other extreme,

Hearthstone only has 1% of Fortnite’s channels, just 182. But, 154 people are

watching each channel, 15x more than Fortnite. Most other game titles fall in

between these two extremes.

Figure 69. Viewership on Twitch by Channel and Viewer


If we focus on the top channels for each game, it gets more interesting. Just seven

channels (out of 18,500) make up 34% of all Fortnite viewing. Similar results occur

for Apex Legends: just five channels (out of 2,700) comprise 26% of all the viewing.

A game like Counter-Strike is even more concentrated: just three channels (out of

1,100) make up 69% of all viewing hours. In effect, Twitch is serving significant

traffic. But, the viewers are highly concentrated among the best players. The Pareto

principle — 80% of consumption will occur on just 20% of channels — seems alive

and well.

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Just

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Dota 2

Overwatch

Grand Theft Auto (GTA)

Players’ Unknown Battleground

© 2019 Citigroup

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Figure 70. Share of Viewing and Number of Channels for Top Games


Using Gamoloco data we can also compare the average concurrent viewers to the

total viewing hours to infer how much time a channel is actually ‘on-air’.

Figure 71. Average Concurrent Viewers and Total Viewing Hours of Top Live Streamers

Riot Soda Overwatch

Gotaga shroud Games ESL CS:GO Pop League

Concurrent viewers per channel 36,808 51,340 55,963 44,816 21,709 67,104

x Max hours per week (24 x 7) 168 168 168 168 168 168

= Viewing hours (if playing all week) 6.18 8.63 9.40 7.53 3.65 11.27

x Portion on-air 36% 33% 30% 100% 32% 39%

= Viewing hours (mil) 2.2 2.8 2.8 7.5 1.1 4.4

memo: hours per week 60 55 51 167 53 65

Source: Gamoloco. Citi Research

When we perform these calculations, two things are clear:

First, three of the top channels are likely operating under a team structure: ESL-

CS:GO, gaules and SolaryFortnite. These channels are ‘on-air’ nearly 24 hours a

day, seven days a week. We doubt any single person can game that much. (A

little later, we’ll show why teams might pursue this strategy.)

Second, the remaining top channels are ‘on-air’ between 30 hours and 80 hours

a week. That’s reasonable as a part-time job or a full-time job (augmented with

some weekend gaming).

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© 2019 Citigroup

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Figure 72. Top Channels Hours of Gaming per Week vs. Viewing Hours


But, do these ‘Twitch stars’ play and then broadcast their game for 50 to 80 hours a

week for the fame induced psychic income? Fame certainly helps. But, fortune may

also play a role. Indeed, popular Twitch stars can make quite a bit of money. Let’s

see how they do it.

One popular Twitch channel uses the moniker Disguised Toast. He generates about

1.2 million viewers and typically has about 10,000 concurrent viewers (or about

1/5th the level of the channels we analyzed above). In a 2018 YouTube video, he

laid out how much money he makes on Twitch. Disguised Toast suggests there are

four main monetization levers: sponsorships, subscribers, ads, and donations. Let’s

take these in turn.

Sponsorships

Most sponsorship revenue comes from game publishers like Electronic Arts or

Activision. These publishers are keen to have popular gamers — the influencers —

play and promote their game. Sponsorships can cost as little as $0.01 per viewer

hour to as much as $1.00 per viewer hour. We’ll use $0.10 per viewer hour as a

reasonable average. If Disguised Toast plays sponsored games about 65 hours a

month, it’s akin to $66,000 a month.

Figure 73. Twitch ‘Star’: Monthly Sponsorship Revenue Potential

Low Mid High

Concurrent views 1,000 5,000 10,000 25,000 0,000

x Sponsorship per hour per viewer 0.10 0.10 0.10 0.10 0.10

= Revenue per hour 100 500 1,000 2,500 5,000

x Hours per month 66 66 66 66 66

= Monthly sponsorship revenue 6,600 33,000 66,000 165,000 330,000

Source: Twitch, YouTube

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80 hoursTfue

© 2019 Citigroup

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While we’ve modeled the sponsorship revenue based on gaming hours, a popular

gamer can get sponsorship revenue from a variety of sources. These include:

– Sponsored game play, which we reviewed above.

– Sponsored YouTube videos which typically generate $5,000 per video for a 30

second ad.

– Sponsored live appearances which typically cost a sponsor $5,000 and

$10,000 per event.

– Sponsored Tweets and Instagram posts are usually packaged into existing

sponsorship contracts.

We should note that in the U.S., if a sponsor is paying a gamer to play a specific

game, the Federal Trade Commission (FTC) requires specific disclosures so the

viewer knows the player is being compensated. The on-screen disclosures might

say “Sponsored by EA” or “#ad” or “#sponsored” in the title of the stream.

Subscribers

Twitch viewers can subscribe to an individual channel for $4.99 per month. For most

channels (those with fewer than 5,000 concurrent streams), Twitch keeps 50% of

this revenue. So the gamer gets $2.50 per subscriber per month. But, for premium

channels — those channels with 10,000 or more concurrent streams — Twitch

allows the gamer to keep 70% of the revenue, or $3.50 per sub per month.

Disguised Toast has about 4,000 paid subscribers. This is akin to $14,000 a month

(after Twitch takes 30% of the revenue).

A viewer might subscribe to a gamer’s channel(s) because they get the right to chat

with the gamer or use icons that the player makes available to paying subscribers. If

a viewer links their Amazon Prime account to Twitch, they become a Twitch Prime

customer. Twitch Prime customers get access to any single channel for one month,

for free. In this case, the player that broadcasts their game still gets paid. But, the

viewer doesn’t have to make a payment (because Amazon is making the payment

for the Prime customer). Disguised Toast has about 4,000 paying subscribers. As

such, he generates about $14,000 a month from subscriptions.

Figure 74. Twitch ‘Star’: Monthly Sponsorship Revenue Potential

Low Mid High


x Portion subscribing 40% 40% 40% 40% 40%

= Subs 400 2,000 4,000 10,000 20,000

x Fee per month 4.99 4.99 4.99 4.99 4.99

= Monthly sub revenue 1,996 9,980 19,960 49,900 99,800

x (1 - Twitch take) 50% 50% 70% 70% 70%

= Retained sub revenue 998 4,990 13,972 34,930 69,860


Ads

When viewers turn on Twitch, an ad plays automatically. But, the broadcaster can

elect to increase the ad load by simply hitting a button on their PC during play.

Every time the ad button is pressed, the viewers get another ad. Internet ads — like

all ads — are priced in cost per thousand viewers (CPM). We assume a CPM is, on

average, about $8.

© 2019 Citigroup

65

The Twitch live streamer known as Disguised Toast suggests he generates about

$4,000 a month in advertising and does not push the ad button. That is, Disguised

Toast only generates revenue from Twitch’s automatic ad. We’ll assume most

players do use the ad button, doubling the ad load to about $8,000 a month for

10,000 concurrent views. (Ad blockers, of course, can limit this source of revenue.)

Figure 75. Twitch ‘Star’: Monthly Advertising Revenue Potential

Low Mid High


/ 1000 1,000 1,000 1,000 1,000 1,000

= 1000s of viewers 1 5 10 25 50

x CPM 8 8 8 8 8

= Ad revenue per hour 8 40 80 200 400

x Hours per month 66 66 66 66 66

= Ad revenue per month 528 2,640 5,280 13,200 26,400

x (1 - Twitch take) 50% 50% 70% 70% 70%

= Retained ad revenue (auto load) 264 1,320 3,696 9,240 18,480

x Ad button factor 2 2 2 2 2

= Retained ad revenue 528 2,640 7,392 18,480 36,960


Donations

Donations are the fourth monetization lever for Twitch channels. Disguised Toast

suggests he generates about $2,500 a month in donations with 10,000 average

concurrent viewers. A payment platform often takes about 1% of this revenue. And,

the donation revenues can vary considerably by streamer. Some streamers, for

example, give incentives (like private Snapchats or agreeing to do something silly

on screen).

Figure 76. Twitch ‘Star’: Monthly Donations Revenue Potential

Low Mid High


x Donation per view per month 0.25 0.25 0.25 0.25 0.25

= Monthly donations 250 1250 2500 6250 12500

x (1 - PayPal take) 99% 99% 99% 99% 99%

= Retained donation revenue 248 1,238 2,475 6,188 12,375


If we pull all this data together — spanning sponsorships, paid subs, ads and

donations — it suggest a popular Twitch broadcaster can generates $1 million a

year if they generate about 10,000 concurrent viewers. Or, said another way, a

concurrent viewer is worth about $100 a year in total monetization, or about $8 per

month per concurrent viewer.

© 2019 Citigroup

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Figure 77. Twitch ‘Star’: Monthly Total Revenue Potential

Low Mid High

Sponsorship 6,600 33,000 66,000 165,000 330,000

+ Subscribers 998 4,990 13,972 34,930 69,860

+ Ads 528 2,640 7,392 18,480 36,960

+ Donations 248 1,238 2,475 6,188 12,375

= Monthly revenue 8,374 41,868 89,839 224,598 449,195

x Months per year 12 12 12 12 12

= Annual revenue 100,482 502,410 1,078,068 2,695,170 5,390,340

memo: revenue per concurrent viewer 100 100 108 108 108


But, can we take these revenue estimates for a popular live streamer and use them

to estimate how much revenue all live streamers generate? And, can we use the

same data to estimate how much revenue Twitch generates? We think we can. But,

we need to take seven steps.

First, recall Twitch has about 50,000 concurrent channels at any moment in time. If

we decompose the broadcasters — separating ‘stars’ like Disguised Toast from

niche broadcasters — while adhering to the Pareto principle (20% of broadcasters

will capture 80% of views), it suggests the 50 top channels (0.1% of the total) make

up about 40% of Twitch traffic.

Figure 78. Share of Viewing by Type of Live Streamer

Stars Popular Niche All

Concurrent channels 50,000 50,000 50,000 50,000 50,000 50,000

x Cum share of channels 0.1% 1.0% 5.0% 10.0% 20.0% 100.0%

= Concurrent channels 50 500 2,500 5,000 10,000 50,000

x Avg concurrent views 10,000 1,200 300 175 96 24

= Total concurrent views 500,000 600,000 750,000 875,000 960,000 1,200,000

/ Total concurrent views 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000

= Share of viewing 42% 50% 63% 73% 80% 100%


Second, we can decompose the cumulative figures (from above) to isolate each

cohort. The top cohort — the Stars — will generate $108 in revenue per concurrent

viewer per year. But, any live streamer that doesn’t fall in the top 500 is unlikely to

collect any Sponsorship revenue. They’ll rely on subscriber revenue, ads, and

donations. As such, revenue drops to ~$20 per concurrent viewer per year. All told,

this is akin to ~$75 million in revenue per year for the 50K concurrent live

streamers.

Figure 79. Cohort Revenue to Live Streamer

Channel 1 to 51 to 501 to 2,501 to 5000 to 10,001 to

Rank ----------> 50 500 2,500 5,000 10,000 50,000 Total

Avg concurrent views 10,000 222 75 50 17 6 24

x Streamer revenue per concurrent viewer 108 100 21 21 21 21 64

= Annual revenue per concurrent channel 1,078,068 22,222 1,596 1,064 362 128 1,533

x Number of concurrent channels in cohort 50 450 2,000 2,500 5,000 40,000 50,000

= Cohort revenue to Live Streamer 53,903,400 10,000,000 3,192,300 2,660,250 1,808,970 5,107,680 76,672,600


© 2019 Citigroup

67

Third, Twitch will collect about $11 per year per live streamer among the Stars. But,

they will collect more — about $18 per year — for the other cohorts. Recall, Twitch

collects 70% of ad and subscriber revenue for the less popular live streamers

(versus 50% for popular live streamers). All told, Twitch collects about $18 million in

revenue for the 50K concurrent live streamers.

Figure 80. Cohort Revenue to Twitch


Rank ----------> 50 500 2,500 5,000 10,000 50,000 Total

Avg concurrent views 10,000 222 75 50 17 6 24

x Streamer revenue per concurrent viewer 11 18 18 18 18 18 15

= Annual revenue per concurrent channel 109,872 4,069 1,373 916 311 110 366

x Concurrent channels 50 450 2,000 2,500 5,000 40,000 50,000

= Cohort revenue to Twitch 5,493,600 1,831,200 2,746,800 2,289,000 1,556,520 4,394,880 18,312,000


Fourth, the total number of Twitch channels is far larger than the number concurrent

channels (or channels that are ‘live’ at any moment in time). Twitch Tracker

suggests there are about 3.4 million total monthly broadcasters. This suggests that

only 1.2% of broadcasters are ‘live’ at any moment in time. Or, there are about 80

broadcasters for every broadcaster that is actually on Twitch streaming their game

play.

Figure 81. Portion of Time Broadcaster is On-line

2012 2013 2014 2015 2016 2017 2018

Concurrent broadcaster 3,700 4,858 9,004 15,854 18,808 24,616 41,108

/ Total broadcasters 300,000 400,000 750,000 1,300,000 1,550,000 2,000,000 3,390,000

= Portion of time broadcaster on-line 1.2% 1.2% 1.2% 1.2% 1.2% 1.2% 1.2%

memo: total to concurrent ratio 81 82 83 82 82 81 82


Fifth, from earlier analysis we know the Stars spend most of their time (30-80 hours

a week) broadcasting game play. As such, the ratio of total live streamers to

concurrent live streams must be low. We assume a ratio of 2:1. And, in step four we

showed, on average, there are ~80 broadcasters for every concurrent live channel.

Using these two data points, we can get a rough idea of the total live streamers to

concurrent broadcasts for each cohort.

Figure 82. Number of Broadcasters On-line to Concurrent Broadcasts


Rank ----------> 50 500 2,500 5,000 10,000 50,000 Total

Concurrent broadcaster 50 450 2,000 2,500 5,000 40,000 50,000

/ Total broadcasters 100 2,430 40,800 76,000 252,000 3,720,000 4,091,330

= Portion of time broadcaster on-line 50% 19% 5% 3% 2% 1% 1%

memo: total to concurrent ratio 2 5 20 30 50 93 82


Sixth, using these ratios and multiplying by the revenue per concurrent live streamer

(from step three), it suggests Twitch generates about $635 million in revenue. The

live streamers generate about $875 million in revenue. All told, then, live streaming

generates about $1.5 billion in total annual revenue. This suggests Twitch captures

~40% of the aggregate revenues. Twitch’s capture of revenue from the stars is

lower (since Twitch doesn’t collect a portion of sponsorship or donations).

© 2019 Citigroup

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Figure 83. Twitch Revenue and Live Streamer Revenue by Cohort


Rank ----------> 50 500 2,500 5,000 10,000 50,000 Total

Revenue to Twitch per concurrent channel ($ mil) 5.5 1.8 2.7 2.3 1.6 4.4 18.3

x Ratio of total channels to concurrent 2 5 20 30 50 93 35

= Twitch revenue by cohort ($ mil) 11 10 56 70 78 409 634

Revenue to Live Streamer per concurrent channel ($ mil)

53.9 10.0 3.2 2.7 1.8 5.1 76.7


= Live Streamer revenue by cohort ($ mil) 108 54 65 81 91 475 874

Total revenue per concurrent channel 59.4 11.8 5.9 4.9 3.4 9.5 95.0


= Total Live Streamer and Twitch revenue ($ mil) 119 64 121 150 170 884 1,508

memo: share to Twitch 9% 15% 46% 46% 46% 46% 42%


Seventh, earlier we showed that Twitch’s viewership has growth from 200 million in

2012 to 1.25 billion in 2018. Our $1.5 billion live streaming forecast suggests total

revenue from live streaming is about $1 per sub per year. This, in turn, suggests

Twitch was probably generating less than $250 million a year in 2014 (when

Amazon acquired the service). This suggests Amazon may have paid about 4x

Twitch’s revenues.

Figure 84. Total Live Streaming Revenue

2012 2013 2014 2015 2016 2017 2018

Twitch revenue 88 153 241 274 358 526 634

+ Live Streamer revenue 121 211 333 378 494 726 874

= Total Live Streaming revenue ($ mil) 209 364 574 652 852 1252 1,508

memo: Twitch share 42% 42% 42% 42% 42% 42% 42%

Twitch - Average viewers 207 350 536 591 749 1069 1250

x Total revenue per viewer 1.01 1.04 1.07 1.10 1.14 1.17 1.21

= Total Live Streaming revenue 209 364 574 652 852 1,252 1,508


But, is this forecast reasonable? We suspect it is. We estimate Twitch generates

$635 million in total revenue. We estimate about half of this is from ads (which the

balance from subscriber revenue). That suggests about $350 million of ad revenue.

In 2018, Bloomberg reported that Twitch’s CEO (Emmett Shear) suggested $1

billion in ad sales as a target for Twitch.

© 2019 Citigroup

69

Professional eSports

So, if they have a robust following, live streaming can be lucrative for amateur

gamers that broadcast game play. But, there is another side to the broadcaster’s

business model: eSports. However, eSports is still nascent. As such, it doesn’t (yet)

closely follow the traditional sports ecosystem. And, this makes it a little confusing.

To understand the differences, we’ll need to explore the traditional sports value

chain. It begins with the consumer. The consumer typically subscribes to a pay TV

platform (like Sky in the U.K. or AT&T in the U.S.). The pay TV platform pays for

specific sports-centric TV channels (like ESPN or Fox Sports). These channels then

secure TV rights to specific sporting events from a league, like the National Football

League (NFL) or National Basketball Association (NBA). And, the sports league

does many other things beyond selling TV rights. For example, the league approves

additional teams or changes to a team’s host city. The league organizes a formal

draft. The league organizes the season — and rule play — which culminates with a

championship game (like FIFA World Cup or the NFL Super Bowl). And, the league

can receive sponsorship revenues and facilitate sponsorship payments to specific

teams or even specific players.

Figure 85. Traditional Sports vs. eSports Ecosystem


5 4

League

Team / Venue

ConsumerPay TV

FirmChannel

Advertiser

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Players

TV

fee

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fee

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Ad $

Tickets

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rights

Ad $

Tickets

$

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VenueOrganizer$$

Traditional

Sports

eSports

1

23

© 2019 Citigroup

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If we compare the value chain for traditional sports versus eSports at a conceptual

level, today there are five key differences. First, the consumer can get access to

eSports for free (via broadcasters like Twitch). Second, the consumer doesn’t buy a

ticket from the team. Rather, they purchase a ticket to a specific eSports venue,

which is often leased (while most traditional sports teams own their own facility).

Third, since eSports events are episodic, organizers often help promote the event.

Fourth, for some eSports events, it’s possible for broadcasters (like Twitch) to

acquire rights directly from a game publisher, like Activision. (There are instances

where media rights are sold by event organizers as well.) Fifth, in eSports, it’s

possible for the publisher to act like a league owner in traditional sports.

This leads to a subtle, but important, point. For traditional sports, in the U.S., the

league has a commissioner. The commissioner is hired by the team owners and,

collectively the team owners decide if they want to change the rules of the game,

add a team to the league, or make any other rule change. In other markets, even if

there is a more fluid system — where grassroots teams can access top tier leagues

without buying a franchise — there is usually a body who controls the parameters

which determines league access.

For eSports, the public firms that sell the franchise rights (i.e., Activision) are public

companies. As such, they serve the interest of shareholders. And, the intellectual

property associated with the league is owned by game publisher. So, any eSports

team tethered to particular IP is beholden to the game publisher. Of course, in

traditional sports, team franchise owners aren’t beholden to anyone. That’s one

reason — but not the only reason — why a traditional sports franchise in the U.S.

might sell for several billion while an eSports franchise in the U.S. might only sell for

tens of millions.

Beyond these five major differences, however, there are a slew of other subtle

differences between eSports and traditional sports. The key differences include: (1)

the drafting of players; (2) professional team structure; (3) sports leagues; (4)

venues to watch live event; (5) tournament play; (6) ways to watch less popular,

niche events; and (7) ways to watch popular events. For five of these seven

attributes, it is clear that eSports is at a much earlier stage of evolution than

traditional sports. Let’s take a closer look:

© 2019 Citigroup

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Figure 86. Traditional Sports vs. e-Sports


Draft

Unlike traditional sports, most eSports don’t have a formal draft to recruit teams.

There are two exceptions in the U.S.: NASCAR and the NBA. Both of these

traditional sports leagues have instituted a formal draft for the video game version of

the traditional sport. For example, the National Basketball Association (NBA)

historically had three leagues: (1) the NBA for professional men; (2) the WNBA for

professional women; and (3) the G League for developing players. But, the NBA just

launched a fourth league: the 2K League managed by Brendan Donohue. The NBA

2K League gets its name from Take-Two’s game NBA 2K. NBA 2K has sold 90

million copies of its software making it the third highest grossing video game title in

the sports genre (behind FIFA and Madden NFL). And, in 2018 the NBA held a draft

recruiting 102 players after a three month winnowing process that began with

72,000 gamers.

Professional Teams

In traditional sports, a team plays a single sport. However, some of the best eSports

teams play multiple games. For example, Counter-Strike is played by 16 of the top

20 eSports teams. At the other end of the spectrum, Madden and World of Warcraft

are only played by one or two top eSports teams. Most other game titles fall in

between. Although each of these eSports teams do have dedicated players that

specialize in a specific video game, this provides some anecdotal evidence that

eSports is still nascent.

Traditional Sports Electronic Sports

TV

1st

Place

Stadium

Mass

Viewing

PCNiche

Viewing

Tournaments

Venue

Draft

Professional

teams

A B C DLeagues

Formal process

to identify best

players

Informal process to

identify best players

except NBA and

NASCAR

Tight link between

team and sportBest teams play

multiple games

Formal league

structure. Teams

tied to a city

Some leagues

in place

Each team has

dedicated venueVenues leased

or shared.

Formal structure to

find best team

Tournaments in

place

Outlets for niche

viewing (NFL Sunday

ticket, RSNs, ESPN+)

eSports

broadcasters

(Twitch)

Most economics from

TV rights

Some TV rights

sold

© 2019 Citigroup

72

Figure 87. Games Played by Best eSport Teams

Team Country Counter Strike

League of Legends PUBG

Hearth- stone Dota 2 Fortnite

Rainbow Six Siege

Call of Duty

Over-watch FIFA

Star- craft Madden

World of Warcraft

Team Total

FaZe Clan U.S. x x x x x 5

Team Liquid Holland x x x x x x x x x x 10

Cloud9 U.S. x x x x x x x 7

Team SoloMid U.S. x x x x 4

OpTic Gaming U.S. x x x x x x 6

Fnatic U.K. x x x x x x 6

G2 Esports Spain x x x x x x 6

100 Thieves U.S. x x x 3

NRG eSports U.S. x x x x 4

Luminosity Gaming Canada x x x x x x x x 8

Team Envy U.S./France x x x x x x x x 8

Astralis Denmark x 1

Evil Geniuses U.S. x x x x 4

Ninjas in Pyjamas Sweden x x x x 4

Team Secret Turkey x x x 3

Natus Vincere Ukraine x x x x x x 5

compLexity Gaming U.S. x x x x x x 6

SK Gaming Germany x x x x 4

SK Telecom T1 S. Korea x 1

Virtus.pro Russia x x x x 4

Total 16 11 10 9 9 9 9 8 6 6 3 2 1

memo: publisher Valve Riot Bluehole ATVI Valve Epic Ubisoft ATVI ATVI EA ATVI EA ATVI

memo: game type FPS MOBA BR Card MOBA BR TS FPS FPS Sports Strategy Sports MMORPG

memo: avg Twitch viewers 95,302 128,675 27,187 28,010 63,102 159,574 47,122

Source: Ranker Citi Research

Leagues

All traditional professional sports have a league. For example, domestic English

football has the Premier League and U.S. football has the NFL. However, only the

most popular video game titles have a formal league:

– Overwatch: Activision recently created two divisions for the Overwatch

League (Atlantic and Pacific). And, they sold franchises to 20 new team

owners. The first round of teams sold for about $20 million. Some of the

buyers were quite prominent. Robert Kraft (owner of the NFL’s New England

Patriots) bought the Boston Uprising. Comcast acquired the Philadelphia

Fusion. The expansion slots sold for $30-60 million each.

– Call of Duty: Activision is currently selling Call of Duty franchises for around

$25 million per franchise.

– League of Legends: Riot Games has sold 10 franchises to the North

American League Championship Series (NA LCS). Each team paid around

$10 million in franchise payment to Riot Games.

– PlayerUnknown’s Battleground (PUBG): Bluehole plans to roll-out

professional leagues for the PUBG video game in four major global regions in

2019.

– NBA 2K: While the traditional NBA has 30 teams around the U.S., the NBA

launched 17 teams for the 2K League. Each team is named after the

traditional team. So, for example, in Los Angeles, the 2K League is called

“Lakers Gaming”.

© 2019 Citigroup

73

Other titles — like Counter-Strike: Global Offensive — appear to be more oriented

toward tournaments versus leagues. This is similar to PGA golf or tennis versus

NFL football. And, for these games, it looks like multiple tournaments (and even

titles) can coexist. This is similar to boxing where different boxers can be

recognized as world champions by different boxing organizations. We look at this in

more detail below.

Some game publishers — like Valve and Electronic Arts — appear to be less

focused on forming game franchises. Epic games (owner of Fortnite) struggled with

early tournament play. Many players complained about the on-line lag and the

tedious game play. Fortnite will likely have to figure out tournament play before it

can consider setting up a league and selling the rights to specific teams in particular

cities.

Venues

Fans can watch any professional sport in person at an area or stadium. The tickets

are sold for both regular season play and championships. And, professional sports

team usually own and operate a venue in each city. For eSports, consumers can

also watch game play in person. But, these venues are usually repurposed for

eSports. There are many, many venues that are general purpose facilities that have

been used for various eSports tournaments. These repurposed facilities typically

seat more than 10,000.

Figure 88. Venues Repurposed for eSports Tournaments

Seating Size

Venue City Country Capacity (sq ft) Example Tournaments

Air Canada Center Toronto Canada 19,800 665,000 League of Legends N.A. Finals

Bill Graham Civic Auditorium San Francisco U.S. 6,000 31,140 League of Legends World Champions

Chicago Theatre Chicago U.S. 3,533 4,500 League of Legends Quarterfinals

Commerzbank Arena Frankfurt Germany 55,000 429,480 ESL One Dota 2 Tournament

Copper Box London U.K. 5,000 25,833 Gfinity G3

Key Arena Seattle U.S. 17,072 400,000 International Dota 2 Tournament

Lanxess Cologne Germany 20,000 86,111 ESL One Cologne – Counter-Strike

Madison Square Garden NYC U.S. 19,830 20,976 League of Legends - N.A. Finals

Rotterdam Ahoy Rotterdam Netherlands 40,000 581,251 League of Legends - EU Spring Finals

Royal Opera House London U.K. 2,268 11,349 Call of Duty EU Championship

Sang-am World Cup Stadium Seoul S. Korea 45,000 115,674 League of Legends - World Championship

SAP Center San Jose U.S. 19,190 450,000 Intel Extreme Masters Tournament

Staples Center LA U.S. 20,000 950,000 League of Legends World Champions

Wembley Arena London U.K. 12,500 56,000 EU League of Legends LCS Champions

Source: Journal of Applied Sport Management, Citi Research

© 2019 Citigroup

74

Figure 89. eSports Dedicated Venues

Venue City Country Seating Capacity

Size (sq ft) Example Tournaments

Blizzard Arena Los U.S. 450 50,000

Angeles

Blizzard eStadium Taipei Taiwan 250 17,500

eLeague Arena Atlanta U.S. 300 10,000

eSports Arena Santa U.S. 1,000 15,000

Ana

Dota 2 (2015 to present)

Counter-Strike: Global Offensive

Starcraft II

GaneSync Gaming San U.S. 100 6,000 League of Legends

Diego Minecraft

Counter-Strike

World of Warcraft

Gfinity Arena Fulham U.K. 600 12,000 Call of Duty

Microsoft Mixer Center NYC U.S. n/a n/a Madden 18 Launch event

Gears of War 4 Tournament

MLG.tv Columbus Columbus U.S. 500 14,000 MLG Counter-Strike: GOMC

Nexon eSports Stadium Seoul S. Korea 500 6,000 EA Sports FIFA

Kart Rider League

Street Fighter V Crash

UCI eSports Arena Irvine U.S. 80 3,500 n.a.

Ultimate Weapons Grade Huntington U.S. 300 20,000 eSports training

Studio Beach eUnited Call of Duty Training broadcast

Yongsan eSports Seoul S. Korea 1,000 9,000 ONGameNet

Source: Journal of Applied Sport Management. Citi Research

Less often, eSports organizers use facilities that are dedicated for eSports. But,

given the nascent nature of eSports, even these dedicated venues are shared

among various game titles. In Figure 89 we provide a non-exhaustive list of eSports

venues that are dedicated to eSports. These facilities tend to be far smaller,

typically seating less than 1,000 people. But notice, several game titles are played

in each venue. We think this speaks to the nascent eSports industry.

Each year, publishers and third parties host several hundred major eSport events.

In 2016, Newzoo suggested there were 425 events with at least $5K in prize money.

In 2017, the number of events grew to almost 590.

There are a number of firms that organize these live events. The largest firm is

Electronic Sports League, now known as ESL. ESL launched in 2000. And, it was

acquired by Modern Times Group (MTG) in September, 2015 for about $85 million

(for a 76% stake). We conduct an interview with its founder and Co-CEO, Ralf

Reichert, in the Expert Commentary section at the end of this report. ESL used to

compete with DreamHack, a rival events and production company founded in 1994.

In 2018, about 300,000 people attended a DreamHack event (13 shows across 8

countries). Current eSports events include Counter-Strike GO, Dota 2, and

Hearthstone (among others). In November, 2015, Modern Times Group acquired

100% of DreamHack for an EV of $25 million.

© 2019 Citigroup

75

Figure 90. ESL One, Cologne aka The Cathedral of Counter-Strike (2018)

Source: MTG

Tournaments

Both traditional sports and eSports often offer prize money during tournaments.

When we compare these prize pools it’s clear that eSports offer prizes that are

similar in size to many professional sporting events. Independent game publisher

Valve tends to pay higher prices. Activision, on the other hand, pays toward the low-

end of video game publishers. Although the prize money hasn’t yet been awarded,

Epic Games agree to offer a $100 million prize pool for the top Fortnite players in

2019. If this does occur, eSports will likely eclipse the prize money for the most

lucrative traditional sport: the U.S. Open (which awards $50 million in prizes).

© 2019 Citigroup

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Figure 91. Top 25 Prize Pools in Sports

Event Sport Publisher Prize Pool

U.S. Open - 2017 Tennis 50.4

The International -2017 Dota 2 Valve 24.7

Counter-Strike: Global Offensive CS: GO Valve 22.5

Confederations Cup - 2017 Football (Soccer) 20.0

Fortnite Fortnite Epic 20.0

League of Legends League of Legends Riot 14.1

Indy 500 Racing 13.1

NBA Championship Basketball 13.0

US Open - 2017 Golf 12.0

The Masters - 2017 Golf 11.0

Stanley Cup - 2018 Hockey 7.0

Player Unknown's Battlegrounds PUBG Bluehole 6.7

Overwatch Overwatch Activision 6.7

Heroes of the Storm Heroes of the Storm Activision 6.5

Melbourne Cup Horse Racing 6.2

LoL World Championship - 2016 League of Legends 5.0

Hearthstone Hearthstone Activision 4.9

ICC Championship - 2017 Cricket 4.5

StarCraft II StarCraft Activision 4.2

Call of Duty Call of Duty Activision 4.2

Dota 2 Asia Championship - 2015 Dota 2 Valve 3.0

Halo World Championship - 2016 Halo 5 2.5

PDC World Darts - 2018 Darts 2.4

Tour de France - 2017 Cycling 2.3

World Snooker Championship Snooker 2.0

Source: Business Insider, Citi Research

Niche Viewing

Traditional sports fans have many ways to consume less popular content (or

content that won’t garner a sufficient audience to warrant scare linear TV time). In

the U.S., there are regional sports networks that air all the games of a local sports

team (even if it’s not very popular). The NFL (through AT&T) sells Sunday Ticket

allowing subscribers to watch all the games played by a specific team. That is,

Dallas Cowboy fans that live in NYC, will struggle to find every Cowboys game on

TV. But, with Sunday Ticket, you can get access.

eSports does quite well with niche viewing. After all, the same broadcasters that air

game play for live streamers also broadcast the most popular eSports teams and

the most popular tournaments. Consumption of eSports on sites like Twitch and

YouTube is not small. Dota 2 garners about 18 million hours of professional eSports

consumption in 1Q18. (Nearly as many hours — about 20 million — occurred from

amateur play.) So, if you are an avid fan of professional eSports, there are ample

ways to consume the content.

© 2019 Citigroup

77

Figure 92. eSports Average Monthly Viewing Hours vs. Total Monthly Viewing Hours

Source: NewZoo, Citi Research

Mass Viewing

The most popular traditional sports are typically aired on free-to-air broadcast TV

networks (like ABC, NBC, CBS, and FOX in the U.S.). Games that are less popular

are typically aired on specialized cable networks (like ESPN or Fox Sports).

There are a few — but only a few — eSports events that are popular enough that

warrant distribution on traditional TV platforms. In 2017, there were only 30 U.S.

telecasts of eSports events. Disney partnered with the publisher of Overwatch

League (Activision) and aired various Overwatch telecasts across several Disney

owned channels (Disney XD, ESPN2, and ESPN). AT&T, owner of TBS and CW,

aired events for ELeague’s Counter-Strike tournaments. And, the NFL Network

(owned by the NFL) aired eSports related to the Madden NFL gaming franchise. So,

while mass market distribution via the television does exist for eSports, it is still

relatively limited. And, until eSports can garner very large audiences, it won’t be

able to approach the economics of traditional sports.

Figure 93. Telecasts of eSports in 2017

Network Telecast Count

Duration (mins)

Description

Disney XD 13 1,015 Overwatch League

TBS Network 7 1,135 ELeague: CS:GO

ESPN2 5 439 Overwatch League

NFL Network 3 230 Madden 2017

ESPNU 1 188 Overwatch League

CW 1 60 ELeague: CS:GO

ESPN 1 60 Overwatch League

Source: Nielsen. Citi Research

To put traditional sports in perspective, if we look at the top 40 U.S. broadcasts

during 2018, live sports — including the NFL, Olympics and college sports —

comprised 33 of the top 40 broadcasts and made up about 82% of all viewing. So,

0

5

10

15

20

25

30

0 20 40 60 80 100 120 140 160

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po

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Mo

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ly V

iew

ing

Ho

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rag

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Total Monthly Viewing Hours – 2018 Average(millions)

Fortnite

League of Legends

PUBGApex Legends

Dota 2

CS:GO

Hearthstone

Overwatch

World of Warcraft

Rainbow 6

© 2019 Citigroup

78

clearly live sports dominate linear TV. And, that’s what makes owning a traditional

sports franchise so lucrative.

Figure 94. Viewership of Traditional Sports Telecasts

Source: Nielsen .Citi Research

For big events in the eSports arena, most consumers just use Twitch. For three

popular video games — Dota 2, League of Legends and Counter-Strike: Global

Offensive — the Twitch viewership increased during major tournaments during 2015

and 2016. But, in truth, the bump is fairly modest: usually a 2x to 6x increase in

Twitch followers. And, this lift is transitory, typically helping just one month. Far more

viewership, it seems, occurs outside the episodic, one-time events.

Figure 95. Twitch Viewership for Three Popular Video Games


Rank Telecast Network Viewers Rank Telecast Network Viewers

1 Super Browl LII NBC 103.4 11 Olympics Opening NBC 28.3

2 State of the Union Multiple 45.6 12 NFC Division Playoff FOX 27.1

3 AFC Championship CBS 44.1 13 This is Us NBC 27.0

4 NFC Champtionship FOX 42.3 14 104th Rose Bowl ESPN 26.9

5 NFC Division Playoff FOX 35.6 15 AFC Divison Playoff CBS 26.7

6 AFC Division Playoff CBS 31.4 16 90th Academy Awards ABC 26.5

7 NFC Wild Card Playoff FOX 31.1 17 Thanksgiving Day Game CBS 26.5

8 Thanksgiving Day Game FOX 30.5 18 Winder Olympics NBC 26.0

9 Royal Wedding Multiple 29.2 19 SCOTUS Broadcast Multiple 25.6

10 College Championship ESPN 28.4 20 AFC Wild Card Playoff CBS 25.3

= Total 421.6 = Total 265.9

memo: sports share 82% memo: sports share 70%

Rank Telecast Network Viewers Rank Telecast Network Viewers

21 National Window (NFL) FOX 25.1 31 Winder Olympics NBC 22.6

22 National Window (NFL) CBS 24.6 32 Winder Olympics NBC 22.3

23 Winter Olympics NBC 24.2 33 AFC Wild Card ESPN 22.3

24 National Window (NFL) CBS 23.9 34 National Window (NFL) FOX 22.2

25 Sunday Night Football NBC 23.7 35 60 Minutes CBS 22.2

26 National Windown (NFL) CBS 23.7 36 National Window (NFL) FOX 22.1

27 Macy's Thankgiving Parade NBC 23.7 37 Sunday Night Football NBC 22.1

28 National Window (NFL) FOX 23.3 38 National Window (NFL) FOX 22.1

29 National Window (NFL) FOX 23.2 39 Thanksgiving Day Game NBC 21.9

30 NFC Wild Card Playoff NBC 22.8 40 84th Sugar Bowl ESPN 21.7

= Total 238.2 = Total 221.5

memo: sports share 90% memo: sports share 90%

0

10

20

30

40

50

60

Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

Tw

itc

h V

iew

ing

Ho

urs

(m

n)

League of

Legends

CS::GO

Dota2

ESL One

Cologne

2015

World

Championship

2015

The Frankfurt

Major

2015

North America

League

Legends

Championship

Intel

Extreme

MastersMLG Major

Columbus

Manila

Major

2016

ESL One

Frankfurt

2016

© 2019 Citigroup

79

So, professional eSports isn’t nearly as mature as traditional sports. And, the lack of

a large TV audience is another reason — alongside the power of the publishers —

that eSports teams can be acquired for so little. But, how much does the eSports

business generate in revenues? Collectively, the eSports business is growing about

30-40% per year and generates just under $1 billion in revenues. Sponsorship and

advertising make up the bulk of the revenues, or about $500 million. The fees

broadcasters pay for media rights is about $160 million. And, the fees game

publishers make to eSports is about $100 million. Ticket sales for the live events

(along with merchandise) make up another $100 million of revenue.

Figure 96. eSports Business Total Revenue

2012 2013 2014 2015 2016 2017 2018

Sponsorship 31 55 88 123 178 235 359

+ Advertising 23 37 55 80 113 140 174

+ Media Rights 8 13 23 36 58 93 161

+ Game Publisher fees 28 43 58 75 94 105 116

+ Merchandise & Tickets 40 46 27 12 50 82 96

= Total 130 194 250 325 493 655 906

memo: growth 49% 29% 30% 52% 33% 38%


Turnover of eSports Titles a Key Consideration

Recall, there are just a handful of very popular terrestrial sports — football, soccer,

cricket, basketball and baseball. But, it’s very difficult for a new terrestrial sport to

become popular. There are powerful network effects that help explain this:

First, younger players watch and learn how to play just a handful of the most

popular sports.

Second, this creates large amateur pool of young fans and young players.

Third, some of the players become quite proficient. The best players can receive

scholarships to college. Some are even drafted into the professional leagues.

Fourth, as better players enter the game, the quality of the game improves. This,

in turn, attracts more fans.

Fifth, some fans become interested in the ‘story’ around a particular team, even if

the team isn’t very good. Chicago Cubs fans famously waited 108 years to win

the World Series. But, the Cubs still had a loyal following even during the difficult

years.

Sixth, since large audiences that are willing to watch sports — whether a team is

winning or not - TV broadcasting is economically viable.

Seventh, economic viability allows professional players to become famous and

earn large salaries.

Eighth, the fame and wealth of the most popular players captures the attention —

and imagination — of younger players. And, the cycle repeats.

© 2019 Citigroup

80

Figure 97. Network Effects in eSports


Against this backdrop, it is very difficult for a new terrestrial sport to launch. It’s even

difficult for rival leagues to challenge incumbent leagues for popular sports. For

example, in the U.S., a rival professional football league called the XFL tried in

2001, challenging the NFL. The league only played one season (2001). There are

currently attempts to relaunch the XFL. But, even at the league level, the economic

challenges are daunting.

eSports, hitherto, has had a very different experience. There are game titles that

have had sustained success. Counter-Strike: Global Offensive (CS:GO) stands out

as a good example. But, there are also a number of examples of significant

disruption. Fortnite is, perhaps, one of the better examples.

So, as eSports becomes more popular, it is an open question whether similar

network effects will take hold. Our suspicion is that there is still scope for new

games to become very popular and disrupt established IP (even games with

established eSports infrastructure). But, as the video game industry matures, we

expect successful entry by new games to become increasingly difficult.

Grassroots Competition

So far, we’ve explored ‘masters’ or ‘pro-level’ eSports competition. But, below the

large stadium events and mass-streamed competitions, there are a significant

number of ‘challenger’ and ‘open’ competitions that arguably are just as important to

player engagement for both eSports and the game title itself.

And, even beyond pure competition, we should also consider ‘digital festivals’ like

those organized by firms like DreamHack. For these festivals, competition is often

secondary to community.

Attracts

Young

Players

Large

Amateur

Pool

Best Players

Drafted

Quality of

Game Play

Improves

Fans

Grows

Fan Interest

in the

“Story”

Grows

TV Broadcast

Economically

Viable

Good Players

Capture

Large Wages

© 2019 Citigroup

81

Figure 98. Understanding Competitive Style, Prize Levels, and Target

Audience for eSports

Figure 99. MTG: Number of Owned & Operated Properties by Type

Source: Company Reports Source: Citi Research

Figure 100. DreamHack BYOC (2018)

Source: MTG

Live Streaming vs. eSports: The Broadcaster’s Perspective

Before we delve into the next chapter (Mobile Games), it’s worth highlighting one

very important point about broadcasters. We suspect Amazon acquired Twitch

because it thought eSports would become a very big business. And, we’ve shown

that wasn’t a bad hypothesis. Indeed, eSports is growing.

But, we suspect Amazon didn’t fully appreciate the growth in live streaming. And,

when we look at the broadcaster business model, it’s clear that live streaming is

superior to eSports. Why do we say this? There are two reasons:

Mass-Market

Enthusiasts

Friends &

Family

Teaser Prizes &

Online

Large Prizes

& Stages +

Online

Mega Prizes

& Stages +

Online

MASTERS

Watch & Play

CHALLENGER

OPEN

Watch & Play

Watch, Play, Engage, Learn

COMPETITION STYLE; Event Example Prize Level &

Venue Size

Target

Audience

ESL

National

Championships

ESL

ONE

ESL

Pro

League

Intel

Extreme

Masters

ESL

Open

9 10 12 17 20 23 26 29 32

6068

8286

9196

101106

111

12

16

18

2023

2629

3235

0

20

40

60

80

100

120

140

160

180

200

2017 2018 2019 2020E 2021E 2022E 2023E 2024E 2025E

Nu

mb

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of

Eve

nts

Master

Challenger

Open

© 2019 Citigroup

82

First, in the live streaming business model, a broadcaster collects two sources of

revenue: (1) 50-70% of the subscriber fees that a live streamer collects and 2)

50-70% of the ad revenue a live streamer generates. In the eSports world, there

aren’t any subscribers. As such, in eSports, the broadcaster only collects one

revenue stream: ads.

Second, in the live streaming business model, a broadcaster doesn’t have any

costs associated with rights. But, in the eSports model, the broadcaster has to

pay a publisher for the right to stream a particular eSport event. These payments

can be material. For example, press reports suggest Twitch paid $90 million for

two years of Overwatch League rights.

So, live streaming likely has higher revenue and lower costs. As such, if we had

visibility into Twitch’s P&L, we’d probably find that live streaming is the better

business. This will have important implications as we get deeper into the likely

evolution of the gaming industry.

Figure 101. Live Streaming vs. eSports Business Models


Broadcaster

SubscribersLive

Streamer

Broadcaster

Subscribers eSports100% 50-70%

AdsLive

Streamer

100% 50-70%Ads eSports

100% 100%

Donations100%

Donations eSports

Sponsorship100%

Sponsorship100%

Live

Streamer

Live

StreamereSports

Publisher50%

Live Streaming eSports

© 2019 Citigroup

83

The Mobile Value Chain In the last section, we reviewed the value chain for PC and console gaming. But, we

(largely) avoided talking about mobile games. There’s a reason for this omission.

The mobile value chain is very distinct from console and PC gaming. But, what

caused the value chain — and the business model —- to evolve so differently?

In the early days of mobile data, third party application development — including

mobile gaming — was stifled. There were three main reasons for this:

First, handset screen sizes were small. That made gaming difficult.

Second, bandwidth was limited. With nascent air interface standards — like 1G

or 2G — spectrum (MHz) couldn’t efficiently be converted into bits of information.

As such, game software had to be preinstalled and reside on the device when

the hardware left the factory. Downloading games just wasn’t feasible.

Third, wireless carriers only let specific handsets work with their networks.

Moreover, the application (preloaded on the device) had to be pre-approved by

the wireless carriers. This, of course, was in sharp contrast to the desktop

environment where application development was (relatively) open, particularly for

the Windows operating system.

Figure 102. Evolution Desktop vs. Early Mobile


Over time, Apple and Google altered the mobile ecosystem by developing

competing mobile operating systems (OS). Apple created iOS and Google launched

Android. While Apple only deployed its operating system on Apple handsets,

Android licensed its OS to a large number of device manufacturers: Samsung, LG,

Huawei, Lenovo, and Sony (just to name a few).

In parallel, app development was opened up to third parties. This helped propel

Android and Apple market share because consumers could get more utility from an

open device relative to the closed devices (like Symbian or Blackberry). And, as

Apple and Google took more share, developers stopped creating apps for less

popular devices. In effect, the virtuous cycle kicked in: more apps prompted more

device sales which, in turn, caused more app development on those devices.

Desktop Early Mobile

Service

Apps

User Interface

Form Factor

Hardware

Network

User

Yahoo, AOL

Web browser

Windows, iOS

Keyboard, mouse, monitor

X86 (Intel, AMD)

Motorola, Nokia, Blackberry

Various

© 2019 Citigroup

84

Given Android’s ubiquity, these devices capture a far larger share — about 85% —

of the global smartphone market. Apple controls the balance. Symbian and

Blackberry are almost extinct.

Figure 103. Share of Smartphone Market


With that bit of history, let’s shift gears and review the mobile game value chain.

There are seven main layers:

Intellectual Property: Similar to the PC and console markets, owners of IP sit at

the top of the stack. IP can include everything from sports leagues (FIFA) to toys

(Lego).

Developers / Publishers: Similar to the console/PC market, the developers

write code for the game and the publisher sells and markets the game. Unlike the

console/PC market, however, these two functions are typically performed by the

same entity.

Installs: Faced with many mobile games, publishers often pay third parties — an

app store, a search engine or a website — a fee for every consumer that installs

the game. This is called the CPI, or cost per install.

Mobile OS: Once the game is installed on the device, the firms that control the

mobile operating system — Google and Apple — collect about 30% of the money

a consumer spends on a game. The app stores do not typically collect a slice of

the ad revenue.

Ad Revenue: In the mobile world, there’s a fairly complex ecosystem that

matches ad buyers (marketing firms and ad agencies) with the ad sellers (mobile

game publishers). To match the buyer and seller — with the right inventory and

the best price — typically reduces a mobile game publisher’s gross ad revenue

by 40-60%. Most publishers report net revenue (after the AdTech fee).

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

3Q

09

1Q

10

3Q

10

1Q

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3Q

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1Q

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3Q

17

AndroidAppleSymbianBlackberryOther

© 2019 Citigroup

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Advertiser: Mobile advertising is one of the fastest growing segments of overall

advertising. Within mobile advertising, gaming represents about 20% of total

(non-search) mobile advertising. But, since mobile gaming firms have to share

this revenue with the AdTech firms, the global ad opportunity is quite small, just

$10 billion per year.

Consumer: The consumer typically enjoys the game for free. But, they have

options to spend money within the game for things like extra lives or virtual

tokens.

Figure 104. Mobile Gaming Ecosystem


When you compare console/PC gaming to mobile gaming, you’ll notice that the

value chain is similar at the top of the stack. But, things look quite different at the

bottom of the stack. Indeed, we see four key differences between console/PC

gaming and mobile gaming:

First, in mobile games, subscriber acquisition is far more important.

Second, there are fewer gatekeepers in the mobile gaming world: the global

mobile OS platforms.

Third, the complex AdTech ecosystem is used for both subscriber acquisition

(encouraging game installs) and ad-based revenue within the game.

Fourth, advertising plays a more prominent role in mobile gaming.

Intellectual Property

Game Developer

(Studio)

Game Publisher

Mobile OS

Consumer

Description

Owner of IP that is licensed to

publisher

Develops games

Sells, markets and distributes

Developer & Publisher usually a

single entity

Economics

Share of game sales (may include

minimum payment)

Pays royalties to IP owner (if applicable)

Publisher pays $2-3 in cost per install (CPI)

Publisher looking for “whales”

App store, search engine or

web site gets paid for each

consumer that installs game

(CPI)

Receives revenue from publisher if

game installed.

Distributes game digitally

within Apple or Android app

store

Plays game

High churn rates80% of games are free

May pay for virtual currency

May watch ads for game benefits

Mobile app store keeps 30% of

consumer spend on game

$

$

IP

Game

Engine $

Software API

Advertiser

Ads

Installs

(AdTech)

Installs

Ad Revenue

(AdTech)

$

$

$

Game

Game

Advertiser pays AdTech firms

for access to consumersAdTech may keep up to 50% of

total ad spend

AdTech firms matches buyer

(advertiser) & seller (game

publisher) of inventory

AdTech firms remit as little as 50%

of ad dollars to game publisher

Inventory

Inventory

Views

$

© 2019 Citigroup

86

With those differences in mind, let’s dig into each layer of the value chain.

Layer I: Intellectual Property

We learned that for console/PC games, external IP isn’t particularly important.

Recall, for PCs and consoles internally developed IP (versus third-party IP)

accounted for 80% of game sales (with 10% of sales coming from sports IP and

10% of sales from non-sports IP). But, are mobile games any different? We looked

at the data in two ways.

First, we examined the most downloaded mobile games and mobile games that

generated the most revenue. These data are from App Annie for Google Play

over the last seven years: 2012 to 2018. (The data excludes China.) The data

suggest there isn’t a single title among the top 10 that relies on third-party IP.

That holds true whether we rank the games by number of downloads or by

revenue. In addition, the correlation between downloads and monetization is

poor. That is, only Candy Crush and Clash of Clans rank in the top 10 for both

downloads and revenue. But, third-party IP didn’t cause that tight linkage. Rather,

it was the design of a mobile game that caused downloads and monetization to

both rank well.

Figure 105. Mobile Games on Google Play: Download Rank vs. Spend Rank

Source: App Annie for Google Play Jan 2012 to Aug 2018 (excludes China)

Second, we looked at the top 100 Apple Store mobile game in the U.S. during

March of 2019. And, 92% of the most downloaded games relied on internal IP.

Around 7% of downloads relied on third-party, non-sports IP including Marvel,

Game of Thrones, Star Wars, Star Trek, and Yu-Go-Oh! (a card game). Only 1%

of mobile game downloads relied on third-party sports IP.

Figure 106. Most Downloaded Games on Apple Store by IP Type

Game Examples of Third-party IP Daily Downloads Share

Internal IP None 1,302,314 92%

Sports IP Madden: NFL Overdrive 11,461 1%

Non-sports IP Marvel, Game of Thrones, Yu-Gi-Oh!, Star Wars, Star Trek 96,650 7%

= Top 100 iPhone Mobile Games in U.S. 1,410,425 100%


Subway Surfer

Candy Crush

My Talking Tom

Pou

Temple Run 2

Hill Climb Racing

Clash of Clans

Minion Rush

8 Ball Pool

Fruit Ninja

Puzzle & Dragons

Monster Strike

Fate / Grand Order

Lineage M

Pokémon Go

Lineage 2 Revolution

Game of War – Fire Age

Clash of Kings

Download Rank Spend Rank

1

2

3

4

5

6

7

8

9

10

Outside top 10

Outside top 10

Outside top 10

Outside top 10

Outside top 10

Outside top 10

Outside top 10

Outside top 10

Outside top 10

4

Outside top 10

Outside top 10

Outside top 10

Outside top 10

6

Outside top 10

Outside top 10

Outside top 10

1

2

5

6

7

8

9

10

Kiloo

Activision

Outfit7

Zakeh

Imangi

Fingersoft

Supercell

Vivendi

Miniclip

Halfbrick

Gung Ho

Mixi

Sony

NCSoft

Niantic

Netmarble

MZ

Elex

Game Title Company

© 2019 Citigroup

87

What does all this mean? Anyway we slice the data, third-party IP doesn’t seem to

be very important for mobile games. In fact, third-party IP is actually less important

for mobile games than it is for PC or console games. Why is this? We can think of

two reasons:

First, the monetization of a mobile game is far lower than it is for a console or PC

game. That may make mobile game publishers reluctant to incur incremental costs

related to IP licenses. Second, since the IP can’t be fully leveraged with a small

screen — or a fancy controller—- third-party IP may be less valuable in a mobile

game relative to a PC or console game.

Layer II: Developers and Publishers

In the PC and console market, the game developer is often distinct from the game

publisher. But, for mobile games, the developer and publisher are almost always the

same entity. There are five main reasons for this:

First, the cost to develop a mobile game is typically far lower than the cost of a

console or PC game. This means third-party assistance — particularly for funding

— isn’t as necessary.

Second, unlike PCs and consoles, mobile devices have limited computing power

(typically 1-3 Gigabytes of RAM). This makes game development easier and far

less expensive.

Third, the game developer doesn’t need to make multiple versions of the

software (PC, PlayStation, Xbox, Nintendo). There are only two mobile platforms:

iOS and Android. This helps lower upfront launch costs diminishing the need for

a publisher.

Fourth, there is a fairly robust mobile AdTech ecosystem. This ecosystem can be

used to: (1) acquire subs and (2) generate in-game ad revenue. As such, one of

the key publisher roles — sales and marketing — is diminished relative to PC

and console games.

Fifth, there are two primary ways to distribute your game: Apple’s app store and

Google’s app store (with a small slice coming from Facebook). That’s in sharp

contrast to the legacy PC and console gaming market. Historically, distribution

would include a wide array of physical stores (Wal-Mart, Best Buy, GameStop),

e-commerce sites (Amazon) and pure digital distribution (like publisher’s own

digital storefronts). So, the publisher’s role — for marketing and distribution — is

less prominent in mobile gaming.

We don’t mean to suggest game developers don’t need help. Some developers do.

But, third-party assistance usually comes from firms with expertise related to

effective subscriber acquisition given the complex AdTech ecosystem.

So, let’s say you want to develop a mobile game and you’ve decided to eschew

third-party IP. How many apps — both gaming and non-gaming — will you compete

with? It turns out there are about 3.3 million apps for both Android and Apple

phones. And, while these apps can come in many flavors — business apps,

education apps, travel apps — the largest category is gaming.

Indeed, back in 2008 around 50% of all apps were for mobile games. Today, that

figure has dropped to about 25% of all apps. But, this means there are nearly

825,000 gaming apps available on both Android and Apple phones! That’s quite a

bit of competition.

© 2019 Citigroup

88

Figure 107. Game Apps vs. Total Apps on Apple Store

Figure 108. Game Share of Total Apps on Apple Store

Non-Game Game Non-Game Game Free 1,967 663 78% 81% + $0.01 to $0.99 228 85 9% 10% + $1.00 or more 314 75 13% 9% = Total (1Q19) 2,509 823 100% 100%

Source: Pocketgamer.biz Source: App Annie, Citi Research

So, entry barriers for mobile gaming seem pretty low. Virtually anyone can make a

mobile game. But, as a developer, how much are you going to charge for your app?

The vast majority of mobile game apps — over 80% — are free. Another 10% cost

less than $1. Very few — just 10% of mobile games — cost more than $1. This

means the vast majority of mobile gamers need to make voluntary purchases within

the game for the business to be viable.

Developers can — and do — insert ads to supplement revenues. And, although

there is a wide degree of variance by firm, in rough terms in-game monetization

generates about $2 in revenue for every $1 of net advertising (after AdTech firms

take a cut of the gross ad revenue). Most mobile game firms report net ad revenue.

Who are the largest publishers / developers in mobile gaming? Although our

revenue figures are just estimates — since many firms don’t disclose mobile gaming

revenues separately — it should give readers a rough idea of the key players. In

2018, we estimate the top 10 mobile game firms generated about $26 billion in

revenue. Smaller and independent firms generated another $19 billion in revenue.

Figure 109. Top 10 Mobile Game Firm Revenues

Company Firm Listing 2010 2011 2012 2013 2014 2015 2016 2017 2018E

Tencent China Public - - - - 1,980 3,043 5,486 8,971 11,114

+NetEase China Public 550 581 650 761 850 1,079 2,375 3,478 3,964

+Activision U.S. Public - 58 64 164 1,890 2,284 1,586 1,998 2,085

+Bandai Namco Japan Public 215 425 712 682 749 865 1,463 1,801 1,903

+Netmarble Korea Public 185 245 326 486 528 912 1,244 2,272 1,819

+Aristocrat Australia Public 31 56 122 216 351 617 852 1,100 1,339

+Sony Japan Public - - - - - 106 471 1,119 1,280

+Epic U.S. Private 10 20 30 40 50 75 100 600 1,000

+Zynga U.S. Public 166 298 358 429 515 618 741 861 907

+NCSoft Korea Public - - - - - - 14 932 822

=Top 10 Publishers 1,157 1,683 2,262 2,778 6,912 9,598 14,332 23,131 26,234

+Others 480 1,914 4,079 7,548 11,206 15,435 17,983 16,211 18,882

=Global mobile revenue 1,637 3,597 6,342 10,327 18,118 25,033 32,315 39,342 45,116


If we group these firms geographically based on the location of each firm’s

headquarters — not based on consumer spending in each region — it’s clear that

firms in China, Japan, Korea, and Australia dominate the sub-sector. U.S. firms rank

second and European firms lag far behind.

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© 2019 Citigroup

89

Layer III: Installs

So, there are many, many mobile games and many mobile game firms. As such,

competition is fierce. And, most games are free. This means you can’t offer a lower

retail price to attract installs. So, as a developer/publisher, how are you going to get

consumers to install your game on their smartphone? Well, there are a few

important steps:

First, after your game is developed, you’ll need to tailor the app to each region.

Local customization will certainly include language changes. But, it may also

require other tweaks — like cultural modifications.

Second, with your geographically tailored app in hand, you have three broad

options to encourage local users to install your app:

– Adjust Keywords in the App Store: Developers can adjust keywords

associated with the app. By doing this, when consumers go to an app store,

your app can rank toward the top of the list. Many developers will use App

Annie and Sensor Tower to help with keyword adjustments. These websites

allow you to see where your app ranks relative to other apps for each

keyword. If a user types “candy game” in the keyword, where does your game

compare to Candy Crush? Of course, a higher ranking app is more likely to be

installed.

– Tap into Firm’s Internal Audience: You can encourage your internal

audience to use your app. This might mean promoting your game on your

social media page, your firm’s website, or promoting the game by using an

internal email list of customers.

– Purchase Access to External Audience: The last option is to tap into third-

party audiences. If you pursue this last option, you’ll need a marketing budget.

You can pay for ads on social media, in the app store, on third-party websites,

or on video sites like YouTube.

© 2019 Citigroup

90

Figure 110. Blueprint for Getting Mobile Installs


If you tap into third-party audiences versus tinkering with app store keywords or

using your internal audience, you’ll typically pay $2-3 for every install. Recent data

from the Chartboost Network suggest game publishers were willing to pay a higher

CPI for Apple versus Google. This seems reasonable since Android has a higher

share of mobile devices outside the U.S. (where game spending tends to be lower

than the U.S.). The recent data suggests the CPI has compressed a bit. More

recent data suggests a $2 CPI may be more typical. Historically, $3 was closer to

the mark.

Final

Game

App Store Key Word Search

Your

Audience

Email

Video Links

Own Web Site

Blogs

Social Media

Geo

Tailor

Third-Party

Audience

Search in App

Store

Social Media

3rd Party Web Site

Description

Use App Annie or Sensor Tower to

find relevant keywords used by

games similar to yours

Available on internal web site

Promote on social media

Free

Yes

Yes

Yes

Promote on blogs Yes

Promote game on internal email

list

Yes

Pay for ad on Facebook, Twitter

or other site

No

Pay for ad within Google Play or

Apple Store

No

Pay for ad on third-party site No

Pay for ad on YouTubeNo

Email Promote game on acquired email

list

No

Cost per

Install

(CPI) typically

runs $2-3

© 2019 Citigroup

91

Figure 111. Cost per Install: Apple vs. Google

Figure 112. No. of Apps Downloaded vs. Used on Android

Source: ; eMarketer; Chartboost, Network Citi Research Source: App Annie, Citi Research

Although averages can be a misleading, according to App Annie, the average

Android smartphone uses between 35 and 40 apps (including games and non-

games). And, in most countries, smartphone users download 1-2x more apps than

they actually use. In emerging economies — like India or Brazil — the ratio of

downloaded apps to used apps is 1:1. But, in developed economies — like the U.S.

or Australia — the ratio of downloaded apps to used apps is closer to 2:1.

This dynamic poses a bit of a conundrum for mobile game firms. In markets where

disposable income is higher — which results in greater in-game spending and

higher ad revenues — the likelihood of a consumer downloading, but not using,

your app increases. That suggests in developed markets, you may pay for more

installs but not generate as much revenue.

So, let’s say that you get some consumers to download your gaming app. How long

will these new users stick around and play your game? With such a heavily reliance

on free subs, it may not come as a surprise that mobile game churn rates are very

high.

Although mobile game firms don’t disclose churn rates, many do disclose Monthly

and Daily Active Users (MAU and DAU, respectively). If we compare DAUs to

MAUs, it suggests that about one-quarter of the monthly users use the gaming app

daily. This highlights a truism about mobile gaming: avid fans drive most of the

economics. But, most players only occasionally play the game.

Figure 113. Monthly & Daily Active User Rates for Zynga and Glu

2016 2017 2018

Zynga + Glu Daily Active Users (DAU) 23 25 26

/ Zynga + Glu Monthly Active Users (MAU) 100 110 110

= Share of subs engaged daily 23% 23% 24%

memo: Zynga daily engagement 30% 26% 26%

memo: Glu daily engagement 12% 14% 16%

Source: Company Report, Citi Research

We can come at the data one other way. Both Zynga and Glu disclose beginning

and ending period DAUs. They also disclose marketing outlays to get new installs. If

we assume a cost per install (of $2.50), it suggests monthly churn rates run 25-

30%.

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0 20 40 60 80 100 120

Australia

U.S.

S. Korea

Japan

U.K.

Germany

France

Mexico

Brazil

Indonesia

India

Used Installed

© 2019 Citigroup

92

Figure 114. Monthly Churn Rates for Mobile Games

2016 2017 2018

Revenues 942 1,148 1,274

x Share spent on sub acquisition 18% 20% 19%

= Sub acquisition costs 169 225 243

/ Cost per install 2.50 2.50 2.50

= New installs (gross adds) 67 90 97

Beginning subs (DAU) 23 23 25

+ Annual gross adds 67 90 97

- Annual churned subs 67 88 96

= Ending subs (DAU) 23 25 26

Annual churned subs 67 88 96

/ Months per year 12 12 12

= Monthly churned subs 5.6 7.4 8.0

/ Average monthly users (DAUs) 23 24 26

= Monthly churn rate 24% 30% 31%

Source: Company reports, Citi Research

A 25% monthly churn rate would imply that a game had 100 initial installs would

only have three original subs playing the game 12 months later.

Figure 115. Decline in Retained Subs for Mobile Games

Source: Statista

Layer IV: Mobile OS

Clearly, most mobile subs don’t play a game for very long. But, if you wanted to pick

a mobile operating system to focus on, which one is better: Google or Apple?

Google, of course, has 85% of the global smart phone market. But, Google Play

only captures about 70% of downloads and 35% of spending. In effect, Google’s

customers tend to download far fewer apps and spend far less on apps than Apple

customers. (Note: Google Play isn’t available in China.)

100

75

56

42

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20

30

40

50

60

70

80

90

100

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tain

ed

Su

bs

Months

© 2019 Citigroup

93

Figure 116. Apple vs. Google: Global Share of Downloads vs. Spend

Source: App Annie

Layer V: Generate Advertising

In addition to generating revenue within the game — called in-app purchases (IAP)

— mobile games serve ads. There are four basic types of ads for mobile games:

Rewarded Video Ads: These ads grant a player access to some in-game item or

feature as an incentive. The ad could grant extra points, extra lives, or access to

a coveted item in the game. These types of ads must be integrated into the

game’s design.

Full-screen Picture Ads: Full-screen ads place a static picture across the entire

screen at predetermined points in the game.

Banner Picture Ads: Banner ads place a static ad above or around the game

during gameplay.

Interstitial Video Ads: Interstitial ads interrupt game play at a predetermined

point in the game. These videos can, however, be skipped by the gamer.

So, let’s assume you’ve decided on the types of ads you’re going to integrate into

your game. What’s the next step? We’re going to delve into the world of mobile

advertising. Our intent isn’t to go into all of the nuances (and there are many).

Rather, our aim is to give a basic overview of the mobile AdTech ecosystem.

The process begins with an advertiser or an ad agency, like WPP or Omnicom.

(See left side of Figure 117). The agency wants to spend money on an ad campaign

and believes mobile ads should be part of the mix. But, there are ~4.5 billion mobile

devices scattered around the world and each mobile user has unique attributes:

country of origin, user interests, age, etc. So, to make your advertising spend more

effective, you’d like to place your ad on a subset of mobile devices that reach your

intended target audience.

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'12 '13 '14 '15 '16 '17

Global Share of Worldwide Downloads Global Share of Worldwide Spend

iOS App

Store

Google Play

© 2019 Citigroup

94

Perhaps you sell energy drinks. And, as a marketer you know the target audience is

men, aged 18-24. Your research also suggests that energy drink consumers also

over index on first person shooter (FPS) games. You might want to push your ad to

that specific subset of mobile games. But, how would you go about that? The best

place to go is a Demand Side Platform, or DSP, which allows ad buyers to bid for ad

space on specific digital sites. Google’s DV360 is a good example of a DSP.

At the other end of the process is the mobile game publisher like Zynga or Glu. (See

right side of Figure 117). The game publisher has a specific amount of inventory

that it wants to monetize. The game publisher would make the inventory available to

a Supply Side Platform (SSP), which allows publishers to sell inventory to

advertisers at a competitive price. Examples of SSPs include Google’s DoubleClick

or Unity Ads.

Since the DSP has an idea of demand and the SSP has an idea of supply, there

needs to be a way for the market to clear in an efficient way. And, there are two

main options — an Ad Exchange and an Ad Network.

Figure 117. Advertising Ecosystem


Ad

Agency

Game

Publisher

Ad

Exchange

Ad

Network

Ad Exchange: Sales channel for buying &

selling inventory. Prices determined via

bidding.

Example firms: Google’s DoubleClick,

Facebook Exchange

Ad Network: Outsourced sales capability for

publishers. Sorts audiences from various sources.

Provides value to both agency & publisher (like

targeting, optimization)

Example firms: Google, Media.net

Demand Side

Platform

(DSP)

Supply Side

Platform

(SSP)

SSP: Allows

publisher to sell

inventory to

advertisers at

competitive prices

Example firms:

Google’s

DoubleClick, Unity

Ads

DSP: Allows ad

buyers to bid for

space on digital

sites.

Example firms:

Google’s DV360

f/k/a DoubleClick

Bid Manager,

MediaMath, ONE

by AOL

© 2019 Citigroup

95

But, what’s the difference between an ad exchange and an ad network?

An Ad Exchange — like Facebook Exchange or Google’s DoubleClick — is a

sales channel where prices are determined via bidding. The ad buyer bids on

available inventory. If they place the highest bid, the have the right to place their

ad on that specific slice of inventory.

An Ad Network — like Google or Media.net — is just an outsourced sales

capability that can sort audiences from various game publishers. They provide

value to both the buyer (ad agency) and the seller (game publisher) by matching

the supply and demand in a way that helps the buyer get a higher price and the

seller meet their marketing objectives.

Figure 118. Ad Networks vs. Ad Exchanges


Layer VI: Advertiser

With 4.5 billion mobile devices and a relatively easy way to target a subset of the

aggregate users, mobile advertising has emerged as one of the fastest growing

types of ads. According to Magna Global, total global ad outlays for all mediums —

Internet, TV, print, outdoor — has grown from $368 billion in 2010 to $535 billion in

2018.

Interestingly, in 2010 mobile advertising didn’t exist. But, today, the mobile ad

market generates about $150 billion in revenue. Said another way, over the last

eight years, 90% of the growth in total ad spending has accrued to mobile platforms

(90% = $150B / ($535B - $368B)).

Within mobile advertising, however, there are two basic types of ads: search and

non-search. As a mobile gaming company, therefore, the addressable market is

closer to $80 billion a year (with the balance accruing to search firms like Google).

But, virtually every social media company and every mobile website is vying for that

$80 billion. We estimate mobile gaming captures ~20% of the $80 billion, or just $18

billion a year. And, the AdTech players are going to capture about 40% of this

spending since they match the ad buyer (say Omnicom) with the ad seller (Zynga).

This means mobile gaming firms are competing for just $10 billion of net mobile ad

revenue each year.

Transaction:

Innovation:

Ad Target:

Ad Network Ad Exchange

Arbitrage Auction

Offload unsold inventory

Sell inventory across sites

Competitive bidding

Better rules (set ad budget,

maximum bid)

BehavioralContextual

Limited for rich mediaLimited transparencyChallenge:

© 2019 Citigroup

96

Figure 119. Global Ad Spending; Mobile Ads vs. Non-Search Mobile Ads

Source: Magna, Citi Research

Layer VII: Consumer

The propensity of global consumers to play mobile games varies significantly.

Consumers in North America generate, on average, $2 per month per smartphone

in advertising and in-game purchases. But, in Asia and Latin America, the revenue

per smartphone is about half as much. And, the figure gets cut in half again when

you look at Latin America. (Since we are using all smartphones in this calculation —

not just smartphones that play games — the revenue per device among gamers is,

of course, higher.)

However, given the sheer size of the smartphone market in Asia, the region

represents over 50% of the aggregate mobile game market. North America, on the

other hand, is less than 20% of the total.

Figure 120. Mobile Game Revenue by Region

Asia Europe

North

America LatAm RoW Total

2018 installed base of smartphones (mil) 2,422 653 321 448 684 4528

x 2018 mobile game revenue per device 11.38 9.70 23.91 5.95 1.30 9.96

= 2018 mobile game revenue 27,559 6,334 7,668 2,667 889 45,116

memo: monthly ARPU 0.95 0.81 1.99 0.50 0.11 0.83

memo: ARPU index to average 114% 97% 240% 60% 13%


368386

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200

300

400

500

600

'10 '11 '12 '13 '14 '15 '16 '17 '18

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Total Mobile

Ads

Non-Search

Mobile Ads

Total Global Ad Spending ($bn)

79

61

18

7

10

0

10

20

30

40

50

60

70

80

90

Non-Search

Non-Gaming

Gaming AdTech MobileGame Ads

2018 Non-Search Mobile Ad Spending ($bn)

~20% of

non-

search

mobile ad

spend is

for gaming AdTech

captures

~40% of

ad spend

Mobile

gaming

firms

capture

~$10B a

year

© 2019 Citigroup

97

Mobile Economics

Now that we’ve walked through all these layers of the mobile value chain, let’s

synthesize some of the key learnings.

If an advertiser spends $1 on ads, the mobile gaming firm would report about $0.60

after the AdTech firms take their portion of the revenue. The consumer then typically

spends about 3x more on in-game revenue. All told, revenues would be $2.40. The

app store would collect 30% of the in-game spending. And, if the consumer plays

within another ecosystem — like Facebook or Kakao — they would take 30% of the

remaining revenue. Finally, if the game relies on third-party IP (which is atypical),

we assume the IP holder collects 10% of revenue. The remaining funds are left for

the game publisher and game developer.

Figure 121. Mobile Gaming Monetization


However, aggregate margins are far lower than this. That’s because in our example

(from above), we excluded subscriber acquisition costs. And, we’ve ignored churn.

So, let’s take a look at the economics over time including acquisition costs. We’ll

assume a few things:

First, we begin with 100 app installs. We assume 90% cost $2.50 per install (with

the remaining 10% captured via ‘free’ distribution channels like the mobile game

company’s website).

Second, we’ll assume 30% monthly churn.

Third, we start with a very low average revenue per user (ARPU) of $1.25 per

month. But, as subscribers defect, we’ll assume those that remain (that like the

game), spend $8 a month, augmented by $2 of ads.

100%15%

10%

15%

60%

180%

240%54%

36%

24%

126%

64%

64%

0%

50%

100%

150%

200%

250%

AdvertiserAd

Spend

DSP AdExchange

SSP PublisherAd

Revenue

ConsumerIn-gameSpend

TotalRevenue

Mobile OS Platform IP MobileGaming

Publisher Developer

Mo

bil

e G

am

ing

Mo

ne

tiza

tio

n (

%)

© 2019 Citigroup

98

Fourth, we assume the app stores collect about 30% of in-app spending and the

AdTech firms capture 40% of ad revenue.

Figure 122. Mobile Gaming Economics

Months

0 1 2 3 4 5 6 7 8 9 10 11 12

Gross ad\ds 100

x Portion paid 90%

= Paid installs 90

x Cost per install -2.50

= Marketing cost (225)

Begin subs 100 70 49 34 24 17 12 8 6 4 3 2

x Churn (pct per month) 0.3 30% 30% 30% 30% 30% 30% 30% 30% 30% 30% 30%

= End subs 70 49 34 24 17 12 8 6 4 3 2 1

Begin ARPU 1.25 1.50 1.80 2.25 2.93 3.80 4.94 6.43 8.03 10.04 12.05

x ARPU growth 120% 120% 125% 130% 130% 130% 130% 125% 125% 120% 115%

= End ARPU (with gross ad revenue) 1.25 1.50 1.80 2.25 2.93 3.80 4.94 6.43 8.03 10.04 12.05 13.86

memo: ARPU with net ad revenue 1.07 1.18 1.41 1.74 2.22 2.88 3.75 4.87 6.20 7.75 9.47 11.10

memo: consumer outlay 0.80 0.88 1.06 1.30 1.66 2.16 2.81 3.65 4.65 5.81 7.10 8.33

Avg subs 85 60 42 29 20 14 10 7 5 3 2 2

x Avg ARPU (monthly) 1.25 1.38 1.65 2.03 2.59 3.36 4.37 5.68 7.23 9.04 11.05 12.95

= Contribution to annual revenue 106 82 69 59 53 48 44 40 35 31 27 22

memo: share of revenue 17% 13% 11% 10% 9% 8% 7% 6% 6% 5% 4% 4%

Ad spend 38 29 25 21 19 17 16 14 13 11 9 8

+In-app spend 68 53 44 38 34 31 28 26 23 20 17 14

= Monthly revenue 106 82 69 59 53 48 44 40 35 31 27 22

- App store share of spend (30%) 20 16 13 11 10 9 8 8 7 6 5 4

- AdTech share of ad spend (40%) 15 12 10 8 8 7 6 6 5 4 4 3

= Monthly EBITDA 71 54 46 39 35 32 29 26 24 21 18 14

Begin cum EBITDA (225) (154) (100) (54) (15) 20 52 81 107 131 151 169

+ Period EBITDA 71 54 46 39 35 32 29 26 24 21 18 14

= End cum EBITDA (154) (100) (54) (15) 20 52 81 107 131 151 169 183


With these assumptions, the Lifetime Value (LTV) of a subscriber is about $185.

This reflects an outflow of $225 when we first acquire 100 subscribers offset by

$410 of earnings before interest, tax, depreciations, and amortization (EBITDA)

over the course of the year. Of course the LTV would be a bit higher than this

because some subscribers — perhaps the most attractive ones — would continue

to play the game beyond 12 months. In this hypothetical example, the mobile

gaming firm would recoup their upfront marketing spending after about five months.

If you work through the math on this hypothetical game, those subscribers that

continue to play the game for a year generate about 20% of all game revenues

(even though they comprise less than 2% of the original subscribers that were

acquired). Some games are even more skewed toward the best customers. Some

gaming firms suggest they a single player (out of 650) can drive 50% of aggregate

revenues. As such, mobile game marketers aren’t really trying to get many installs.

Rather, they are hunting for what the industry calls “whales”. These highly attractive

customers keep the ‘free’ mobile gaming market viable.

© 2019 Citigroup

99

Figure 123. Time to Recoup Upfront Marketing Cost in Mobile Games


Mobile Gaming Revenues

How big is the mobile gaming market? With about 4.5 billion smartphones, we

estimate about 40% (or 1.8 billion people) play mobile games. If the monetization

rate per player is $2 per month (spanning both net ad revenue and in-game

monetization), it suggests the mobile game business is worth about $45 billion a

year.

Figure 124. Global Mobile Game Revenues

2010 2011 2012 2013 2014 2015 2016 2017 2018

Global population (mil) 6,558 7,043 7,128 7,213 7,298 7,383 7,467 7,550 7,633

x Smartphone adoption 8% 13% 17% 22% 32% 40% 47% 54% 59%

= Installed base smartphone units (mil) 555 888 1,216 1,602 2,339 2,968 3,529 4,067 4,528

x Share play games 15% 20% 25% 30% 35% 37% 39% 40% 40%

= Active mobile gamers (mil) 83 178 304 481 819 1,098 1,376 1,627 1,811

x Monthly ARPU 1.64 1.69 1.74 1.79 1.84 1.90 1.96 2.02 2.08

= Monthly revenue 136 300 528 861 1,510 2,086 2,693 3,279 3,760

x Months 12 12 12 12 12 12 12 12 12

= Mobile game revenue ($ mil) 1,637 3,597 6,342 10,327 18,118 25,033 32,315 39,342 45,116

memo: growth 80% 120% 76% 63% 75% 38% 29% 22% 15%


(300)

(200)

(100)

0

100

200

300

0 1 2 3 4 5 6 7 8 9 10 11 12

Cu

mu

lati

ve

Va

lue

(To

tal

EB

ITD

A l

es

s C

PI)

Months Since Acquisition

CPI

Breakeven

Only 2 customers remains

But, generates $11 per month

Acquire 100 subs @ $2.25 per install

© 2019 Citigroup

100

Industry Evolution So far, we reviewed the value chain for both the Console/PC market and the mobile

market. If we pull the various segments together — mobile, console, PC, and

handhelds — it suggests the industry has experienced fairly rapid growth over the

past few years. Indeed, we estimate total spending on video games (excluding

hardware sales) generates just over $100 billion in annual sales. Ten years ago,

revenues were just half as much.

Figure 125. Click here to add title


But, three crucial points are masked by these composite top-line figures.

First, historically, the Internet-enhanced video game profitability.

Second, the foundations are in place for a new business model for gaming that

could impinge on the publisher’s profits.

Third, new providers will likely bundle hardware and game access for a single

monthly fee. This will be driven by three forces: (1) consumer’s desire to rent

versus buy hardware and software; (2) the rise of cloud gaming; and (3) the

growing popularity of free-to-play titles.

Let’s delve into each issue.

Internet-enhanced Gaming Profits

The video game industry has been remarkably adept at using the Internet — in both

fixed and mobile forms — to improve the attractiveness of the business. Video

game companies accomplished this four ways:

First, gaming firms leveraged high-speed Internet connections to sell consumers

in-game content (often in addition to upfront outlays for the game itself).

0

20

40

60

80

100

120

'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18

Glo

ba

l V

ideo

Ga

me

Re

ve

nu

es

($

bn

)

Arcade

Console

PC

Handheld

Mobile

eSports /

Live Stream

© 2019 Citigroup

101

Second, publishers distributed full-versions of the games using the Internet as a

means of distribution. So, instead of capturing ~$40 of wholesale revenue per

game by selling the software to a retailer (like Amazon or Best Buy), the gaming

firm would capture ~$60 of retail revenue per game by selling it over the web.

Parenthetically, this pivot also reduced costs associated with: (1) the physical

product including the disc, case, and artwork; (2) the warehousing and

distribution of physical games; and (3) damaged and returned physical goods.

Third, the Internet allowed publishers to sell subscription services to access the

deep libraries of older gaming content.

Fourth, many traditional console/PC gaming firms began to make mobile

versions of their game available on Android and Apple smartphones. These

mobile revenues were largely incremental.

Although we don’t have industry level data to assess how much each of these four

pivots is worth, we used disclosures from Electronic Arts (EA) between 2010 and

2018 to get a rough idea. Over the last eight years, EA’s revenues have increased

2.8% per year (from $4.2 billion to $5.2 billion). And, in parallel, EBITDA improved

25% per year from $0.3 billion to $1.8 billion.

Figure 126. Electronic Arts: Use of Internet to Grow Business

CTG CAGR

2010 2011 2012 2013 2014 2015 2016 2017 2018 '10-'18 '10-'18

Packaged goods 3,589 2,995 2,959 2,130 2,228 2,089 2,023 1,908 1,642 -191% -9.3%

+ Live services 281 497 722 1,079 1,018 1,287 1,459 1,682 2,196 188% 29.3%

+ Mobile 215 242 284 363 452 525 570 628 659 43% 15.0%

+ Full-game downloads 74 94 221 221 323 418 514 724 683 60% 32.0%

= Non-GAAP revenue 4,159 3,828 4,186 3,793 4,021 4,319 4,566 4,942 5,180 100% 2.8%

x EBITDA margin 7.2% 10.8% 11.9% 12.8% 21.0% 27.8% 31.1% 34.1% 35.5% nm nm

= Adjusted EBITDA (Non-GAAP) 298 415 499 485 843 1,202 1,419 1,684 1,837 nm 25.5%

Source: Electronic Arts. Citi Research

We explore five potential drivers of the EBITDA improvement:

First, we estimate the largest contribution to the EBITDA improvement stemmed

from the sale of in-game content (a subset of what EA calls ‘Live Services’). That

innovation likely contributed about $1.3 billion to the firm’s EBITDA growth over

the last eight years.

Second, full game downloads (FGD) are likely the second biggest contributor to

the firm’s improvement in EBITDA adding about $0.2 billion.

Third, subscription services to older games — like EA’s Origin Access —

contributed an additional $0.2 billion to EBITDA over the last eight years.

Fourth, a smaller EBITDA lift likely came from mobile gaming. That’s because

mobile gaming generally garners lower margins than the console or PC gaming

market (and EA is a smaller player in mobile games).

Finally, offsetting these benefits, increased costs (below cost of goods sold) for

things like marketing, sales, G&A, and R&D likely pushed EBITDA about $0.15

billion lower over this timeframe.

© 2019 Citigroup

102

Figure 127. EA Adjusted EBITDA


So, the Internet has been a boon to video game publishers and there are several

underlying drivers of the EBITDA improvement. But, in-game monetization is by far

the most important driver.

Foundation In Place for a New Model

What’s striking about these findings is this: most other media businesses have

actually been damaged by the Internet. These include: ad agencies, phone

directories, newspapers, magazines, radio stations, and cable networks. (And, there

are some non-media victims as well, including traditional retail, travel agencies, and

cab services.)

In effect, video game publishers are members of a fairly exclusive club: media

businesses that haven’t been harmed by the Internet. This club includes only a

handful of U.S. media companies: sports franchises (Formula One, WWE), concert

promoters (Live Nation), and video game publishers (EA and Activision).

298

1,284

203

218211

1,837

0

300

600

900

1200

1500

1800

2100

2008 In-game Full game Mobile Subs Other 2018

EA

Ad

jus

ted

EB

ITD

A($

mil

lio

ns

)

© 2019 Citigroup

103

Figure 128. Effect of the Internet on Industries


So, what is the root cause of this dichotomy? And, why have video games, thus far,

been immune? Is it because video games are ‘digital’? We don’t think that’s the

underlying cause because both concert promotion and sports franchises are non-

digital. Is it because video games are highly concentrated with a few dominant

players? That’s also true for sports franchises and concert promoters. But, the video

game industry is highly fragmented.

Something else, it seems, has kept video games immune to Internet threats. To get

to the bottom of this mystery, we need to explore how web-centric rivals usually

disrupt traditional businesses. There are typically five steps in the process:

First, the Internet attackers wait until several enabling technologies are in place:

fast Internet connections, ubiquitous wireless connectivity, and robust computing

power.

Second, the attacker builds a new ecosystem.

Third, the attacker needs to demonstrate the superior value proposition of its new

offer.

Fourth, as more consumers become aware of the superior value proposition,

consumer behavior begins to change.

Fifth, the attacker begins to capture a larger share of the diminished profit pool.

In tandem, the attackers build a competitive moat around the business.

Crucially, investors can be slow to realize the nature of the threat posed by Internet

insurgents. But, once the realization crystalizes, value destruction can also be

abrupt.

Radio Stations

Cable Networks

Magazines

Newspaper

Phone Books

Cabs

Ad Agency

Travel Agency

Retail

Concerts

Sports Franchises

Video Games

Internet

© 2019 Citigroup

104

Figure 129. Disruption Pyramid


Here’s one simple example: the impact ride sharing services had on taxi cabs

medallion prices. (Recall, a taxi medallion is required to operate a yellow cab in

Manhattan.) Fifteen years ago, a NYC taxi medallion cost about $275K. Medallion

prices peaked in 2014 at about $1.3 million. Today, a NYC taxi medallion is worth

less than $200K. There are two interesting facts about these trends.

First, peak medallion price occurred six years after Uber was founded and two

years after Lyft was founded.

Second, ten years of medallion appreciation — from 2004 to 2014 — unwound in

just four years. In effect, investors were slow to realize the impact, but then the

quantum of value destruction occurred rather abruptly.

Faster Internet

Connections

Ubiquitous

Connectivity

Faster Computing

Power

Build New Ecosystem

Offer Better Value Proposition

Change Consumer

Behavior

Capture

Large

Share of

Profits

Netflix

Firm shifted from DVDs by

mail to streaming video once

these elements were in place

Licensing content

Vast server capacity

Software installed on hardware

Lower price point

Video available on demand

No commercials

Reduced viewing of TV

begins to cause pay TV

penetration rates to fall

Firm still FCF breakeven.

But, Street ascribes EV/sub

of $1000

Lyft

Firm burns FCF

Reduce taxi share &

create new demand

Lower price point

Track vehicle

Get consumers to

install app

Sign up drivers

Firm needed mass

adoption of

smartphones

© 2019 Citigroup

105

Figure 130. NYC Taxi Medallion Value

Source: Citi Research, AEI, Wikipedia

So, what about video games? The base of the disruption pyramid — including all

the enabling technologies — is well established. Who doesn’t have access to a

robust console, a fast PC, a fast Internet connection, or a 4G wireless smartphone?

But, nobody has built a new video game ecosystem. Steam has given independent

game developers a way to distribute their games. But, Steam hasn’t radically

disrupted the legacy video game publishers. AAA games and independent games

co-exist. Amazon has levered ubiquitous connectivity and its acquisition of Twitch to

create a new business model: a video game broadcaster. But, the business isn’t

designed to disrupt the legacy players. Indeed, it could be argued that Twitch

enhances the awareness of video games. In effect, no Internet-based rival has

challenged the legacy video game business model.

0

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400

600

800

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1,200

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$ 0

00

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Individual

Corporate

Uber

founded

Uber NYC

launch

Lyft NYC

launch

Lyft

founded

© 2019 Citigroup

106

Figure 131. Disruption Pyramid for Video Game Industry


So, it’s clear that the Internet often disrupts traditional media businesses. But, to

date, video game publishers have not only survived, they’ve thrived with ubiquitous

Internet connectivity. In parallel, it’s also clear that no web-based rival has built a

competing ecosystem to challenge the incumbents. The key question, therefore, is

this: is this about to change? We think the answer is ‘yes’. But, what will shape the

attacker’s strategy?

Faster Internet

Connections

Ubiquitous

Connectivity

Faster Computing

Power

Build New Ecosystem

Offer Better Value Proposition

Change Consumer

Behavior

Capture

Large Share

of Profits

Steam

Steam leverages robust

PCs and fast Internet

connections

Get developers to upload

game to platform

Games often lower cost

Steam is growing, but

has not materially

disrupted incumbents

N/A

Amazon

Twitch leverages PCs,

mobile devices and fast

Internet connections

Allow consumers to

watch others play games

Novel business model

Niche service for avid

gamers. Doesn’t

directly disrupt

publishers

N/A

© 2019 Citigroup

107

What the New Model Might Look Like

We suspect the new business model will lease access to console/PC processing

and a stable of games for a single monthly fee.

Figure 132. Cloud-Based Gaming and Video Game Ecosystem


Why do we think this is likely? There are three reasons: (1) Young consumers prefer

renting to owning; (2) Cloud gaming is poised to replace PC and console sales; and

(3) The rise of free-to-play games will help facilitate the cloud transition since it will

be frictionless for the cloud firm to offer processing and content for a single, bundled

price. Let’s look at each of these items a bit more closely.

Young Consumers Prefer Renting

First, in the distant past hardware was purchased discretely; software was

purchased discretely. But, consumers — particularly younger consumers — like the

idea of monthly recurring expenses without the burden of ownership. Uber

(transport), Spotify (music), and Netflix (video) are all good examples of the rental

model. We don’t think video games should be any different. As such, we expect the

cloud-based firms to bundle hardware access and software access into a single

monthly fee.

Cloud will Replace PC and Console Sales

For 60 years, a single variable has shaped the video game industry: the cost and

processing power of computers.

In the beginning, processing was expensive. Heavy upfront costs forced

consumers to the arcade to enjoy the game at $0.25 per play. As such, both

hardware and software were rented.

Next, as processing power improved — and processing costs declined —

consumers were able to buy their ‘personal arcade’ for in-home use. The console

and game cartridge market was born.

Finally, as processing power improves further, we expect consumers to migrate

to cloud gaming. In effect, consumers will again rent access to hardware and

software, just like the old arcade days. The only difference: rental access will

occur in the comfort of your home.

Hardware

+

Software

Hardware

+

In-game

Spend

+

Hardware

FTP

+

+

Cloud

Gaming

+

Present FuturePast

FTP

Distant Past

Buy

New

Monetization

FTPFTP

eSports

Mobile

AdTech

Rent

Free

© 2019 Citigroup

108

So, improved computing processing power pushed gaming out of the arcade and

into the living room. Faster broadband speeds gave rapid access to software

downloads. And, in the final phase, improved processing power and bandwidth will

allow the rental model — for both software and hardware — to flourish once again.

Figure 133. The Shift From Renting to Owning to Renting


In effect, if you take a long-term perspective, the notion of purchasing a specific

piece of hardware — like an Xbox or Nintendo — to perform a specific task like

video gaming will likely be viewed as an aberration, not dissimilar to phone

answering machines (to record messages), cameras (to take pictures), and VCRs

or DVRs (to record TV shows).

If we get a bit more granular with our high-level description, we can see this broad

pattern from a rental market, to an owned model, back to a rental model. And while

the rental model started with software (old games), it will eventually move to

hardware and may ultimately include newly released video games.

Rent

Buy

Arcade

Arcade

Console

Disc, Download

Cloud

Stream

Hardware

Software

Hardware

Software

Delay

Cheaper Processing Power

Mo

re P

rocessin

g P

ow

er

© 2019 Citigroup

109

Figure 134. Video Game Ecosystem and Shift from Buy to Rent


Indeed, over the past year, there’s been quite a bit of movement on the cloud

gaming front from big, well established cloud providers:

Microsoft: In 2018, Microsoft announced Project xCloud. The service is designed

to allow gamers to stream high-quality console and PC games to any screen. While

Microsoft already has a cloud based service called Game Pass, with xCloud

Microsoft hopes to expand the availability of the service to many additional devices,

including mobile devices with the Android operating system. (Recall, Microsoft no

longer has a mobile phone platform of its own.)

Google: In 2019, Google announced its new cloud gaming service called Stadia

(formally known as Project Stream). Google has called its service “the future of

gaming”. With Stadia, Google hopes to allow users to play any game on any device

without a console or PC. And, Stadia will embrace cross-platform play. That means

software developers can create games that allow owners of various forms of

hardware — PlayStation, Xbox, Switch, PC, Mac, or mobile — to play together.

Moreover, it promised to deliver games in 1080p at 40fps. With Stadia, Google

hopes to bring together a number of discrete assets:

1. Users will need a Chromecast dongle to access video content on TV. The

dongle plugs into the HDMI port on the TV and can be used to access a wide

array of other apps on the TV (Netflix, YouTube, Hulu, or the Google Play

Store).

2. Stadia will leverage the Android OS. By leveraging Android, gamers will also be

able to play games on Android mobile devices.

So

ftw

are

Cloud Gaming

Arcade

Console/

Handheld

PC /

Mac

Buy

Rent

Buy

Rent

Gaming on

Demand

Rig

Rental

Ha

rdw

are

Console/

Handheld

Software

Publisher

Dave &

Busters

Sony

Nintendo

Microsoft

Shadow

GeForce

Dell

Lenovo

Apple

Tencent, Sony, Microsoft, Nintendo, Activision, EA, Bandai Namco, Independents

N

A

Hardware

Design

Software

Distribution

Sony

Nintendo

Microsoft

Bandai

Capcom

Wal-Mart

Amazon

GameStop

Microsoft xCloud

Google Project

Stream

Amazon

Dig

ita

lP

hysic

al

Buy

Rent

Ph

ysic

al

PlayStation Now

EA (Origin) Access

Xbox Game Pass

Physical Digital

PC /

Mac

Wal-Mart

Amazon

Steam

Dell

Lenovo

Apple

Console/

Handheld

PC /

Mac

Sony

Nintendo

Microsoft

Dell

Lenovo

Apple

© 2019 Citigroup

110

3. Stadia will also incorporate YouTube.

4. Google will perform game processing using Google’s data centers.

5. Stadia launched with a game controller. The controller communicates using

WiFi with the router. This allows a gamer to seamlessly transition from one

screen — like a TV — to another — like a smartphone — seamlessly.

Unfortunately, to date, Google hasn’t disclosed Stadia’s retail price point. Nor has

Google disclosed the business model. At launch, Google will have access to some

games from Ubisoft and a game from id Software: Doom Eternal. (Prior id Software

titles include Wolfenstein, Doom, Quake and Rage.)

Amazon: The Information reports that Amazon may enter the cloud gaming market

as soon as 2020. And, The Verge reported four job listings at Amazon for ‘cloud

gamers’.

New Model App to Embrace Free-to-Play

So, a cloud-based rental model seems poised to launch relatively soon. When

Google, Amazon, and Microsoft do enter the market, we expect each of them to

leverage free-to-play titles. Recall, earlier we showed that ~90% of mobile games

are free-to-play (FTP). But, fewer PC and console games are free, although they do

exist.

We used a list from Digital Trends that reviewed 35 high-quality FTP titles that span

all popular genres: action, battle royale, role play, and shooter. Virtually all of these

games are available on PCs, with about 50% available on Xbox or PlayStation

platforms. We cross-checked these games with Metacritic to ensure (most) of the

games were high quality (with a score of 70 or above).

© 2019 Citigroup

111

Figure 135. Availability of Free-to-Play Games

Metacritic Platform

No. Title Publisher Score Genre PC Xbox One PS4 Switch Mobile Comments

1 Warframe Digital Extremes 71 Action Yes Yes Yes Yes Like Mass Effect of Halo

2 World of Tanks Wargaming 83 Action Yes Yes Yes Yes WWII game

3 World of Warships Wargaming 81 Action Yes WWII game

4 War Thunder Gaigin 81 Action Yes Yes Yes WWII game

5 Let it Die Gung Ho 72 Action Yes Yes Hack and slash video game

6 PUBG - Mobile Bluehole 82 Battle Royale Yes Yes Yes Yes Yes Realistic Battle Royale game

7 Fortnite Epic 78 Battle Royale Yes Yes Yes Yes Yes Like PUBG with cartoon overlay

8 H1Z1 Daybreak 70 Battle Royale Yes TBA Yes In b/w PUBG and Fortnite for realism

9 Apex Legends Electronic Arts 88 Battle Royale Yes Yes Yes Viewed as potential rival to Fortnite

10 Darwin Project Scavenger na Battle Royale Yes Yes Dystopian landscape

11 Hearthstone Activision 88 Card Game (CCG) Yes Yes Builds on Warcraft series

12 Gwent CD Projekt 80 Card Game (CCG) Yes Yes Yes From Witcher 3: Wild Hunt

13 Elder Scrolls: Legends Bethesda 80 Card Game (CCG) Yes Yes Yes Yes Yes Richly detailed open worlds

14 Killer Instinct Microsoft na Fighting Yes Yes Like Street Fighter, Mortal Kombat

15 Brawlhalla Blue Mammoth na Fighting Yes TBA Yes Like Super Smash Bros

16 League of Legends Riot Games 78 MOBA Yes Inspired by Warcraft III

17 Dota 2 Valve 90 MOBA Yes Popular eSports game (The International)

18 Heroes of the Storm Activision 86 MOBA Yes Yes Yes Activision pulling back on investment

19 Smite Hi-Rez 83 MOBA Yes Yes Yes Yes Successful eSports franchise

20 Eve Online Simon & Schuster 69 Role Play Yes Difficult to get into; dedicated fans

21 Star Wars: Old Republic Electronic Arts 85 Role Play Yes Started as subscription based game

22 Neverwinter Perfect World 74 Role Play Yes Yes Yes Like Diablo and Dungeons & Dragons

23 Path of Exile Grinding Gear na Role Play Yes Yes Like Diablo

24 DC Universe Online Daybreak 84 Role Play Yes Yes Yes Top free-to-play on PS3/PS4

25 Guild Wars 2 NCSoft 90 Role Play Yes Started as subscription based game

26 Pokémon Go Niantic 69 Role Play Yes AR video game

27 MapleStory 2 Nexon na Role Play Yes No game goal; improve character status

28 Trails Frontier Ubisoft na Sports Yes Yes Yes Yes Yes Egregious microtransactions (fuel)

29 Rec Room Against Gravity na Sports Yes Yes VR game

30 Kingdom Rush Armor Games 89 Strategy Yes Yes Tower defense game

31 Starcraft II: Wings of Liberty Activision 93 Strategy Yes Science fiction; free to play in 2017

32 Total War: Arena Wargaming 75 Strategy Yes Ceased live operation in Feb 2019

33 Team Fortress 2 Valve 92 Shooter Yes Yes Yes Went free-to-play in 2011

34 Paladins: Champions Hi-Rez 83 Shooter Yes Yes Yes Yes Like Overwatch

35 Planetside 2 Sony 84 Shooter Yes Yes Massively Multiplayer Online FPS

Source: Digital Trends; Metacritic, Citi Research

But, are these games popular? We went to Twtichmetrics.net for clues. It turns out

that 50% of the 12 most popular games on Twitch are free-to-play games. On

average these top 12 games have 2,200 gamers uploading their play and 66K

people watching. At peak, 250K people watched these popular games being played

by others. Crucially, the FTP games over-indexed on all metrics:

Nearly 3,400 gamers were uploading FTP games — or channels — versus just

1,100 non-free games. That’s a 3:1 advantage for free games.

Nearly 80K viewers were watching FTP games versus just 53K for non-free

games. That’s nearly a 2:1 advantage for free games.

At peak, nearly 300K viewers were watching these FTP games versus 200K for

non-free games. That’s a 1.5:1 advantage for free games

© 2019 Citigroup

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Figure 136. Popularity on Twitch of Free-to-Play Games

Twitch: Last 30 days

Platform Peak Avg Channels

No. Title Publisher Free-to-Play Genre PC Xbox One PS4 Switch Mobile (000s) (000s) (000s)

1 League of Legends Riot Games Yes MOBA Yes 348 143 2.6

2 Fortnite Epic Yes Battle Royale Yes Yes Yes Yes Yes 384 132 10.9

3 Grand Theft Auto V Rockstar No Action Yes TBA Yes 300 91 0.7

4 Just Chatting nm No nm nm nm nm nm nm 192 77 1.2

5 Apex Legends Electronic Arts Yes Battle Royale Yes Yes Yes 305 75 4.8

6 Sekiro: Shadows Die Twice Activision No Action Yes Yes Yes 279 69 1.3

7 Dota 2 Valve Yes MOBA Yes 356 66 0.7

8 Counter-Strike: Global Offensive Valve Yes Shooter Yes Yes Yes 291 39 1.2

9 Overwatch Activision No Shooter Yes Yes Yes 248 31 1.1

10 Player Unknown's Battleground PUBG No Battle Royale Yes Yes Yes 110 28 1.1

11 Hearthstone Activision Yes Card Game Yes Yes 108 20 0.2

12 World of Warcraft Activision No Role Play Yes 79 19 1.0

Average 250 66 2.2

memo: avg free-to-play 299 79 3.4

memo: avg not free 201 53 1.1

Source: Twitchmetrics, Citi Research

We cross checked the Twitchmetrics data by looking at another source: NewZoo.

NewZoo publishes total viewing time for the top 10 games on Twitch and YouTube

each month. And, total broadcaster viewing of the top 10 games is growing about

20% per year.

Figure 137. Total Viewing Hours, Top 10 Games by Broadcaster

Figure 138. Total Viewing Hours, Top 10 Games

Source: New Zoo, Citi Research Source: New Zoo, Citi Research

If we look at the average viewing hours — between January, 2018 and March, 2019

— it suggests that five of the top seven games are free: Fortnite, League of

Legends, Dota 2, Counter-Strike and Hearthstone. PlayerUnknown’s Battleground

(PUBG) and Overwatch are the only two titles that are both popular and paid

games.

Here’s a little color on the free broadcast titles:

Fortnite: The game launched in 2017 as a free-to-play game. Fortnite players

purchase the in-game currency call “V-Bucks” (with $1 equal to 100 V-Bucks).

League of Legends: The game launched in 2009 as a free-to-play game.

Players can purchase in-game currency (called Riot Points) or earn another type

of currency (called Blue Essence) by playing the game and leveling up.

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Hearthstone: The game was released in 2014. It is a free digital card game

developed and published by Activision’s Blizzard Entertainment.

Apex Legends: Apex Legends was released in 2019 by EA as a free-to-play

game. Respawn Entertainment created both Titanfall (2014) and Titanfall 2

(2016) as an independent studio. In 2017, Electronic Arts acquired Respawn. As

Respawn looked at the evolution of the gaming community — particularly the

popularity of PlayerUnknown’s Battleground, Respawn elected to not developer

Titanfall 3. Rather they pivoted their development efforts to Apex Legends, a free

game.

And, for the handful of titles that still charge a fee for the game, there seems to be

downward pressure on selling prices:

Player Unknown’s Battlegrounds: PUBG is an online multiplayer battle royale

game developed by South Korean video game company Bluehole. The game

was released in 2017. The game originally cost $30. But, in 2018 the firm

lowered the price. The game now costs just $20 on Steam. Some believe the

discount is designed to respond to the success of Fortnite. In Thailand, PUBG

recently began offering a separate free title called PUBG Lite.

Dota 2: This game was released in July, 2013 by Valve. While the game

originally had some restrictions that prevented everyone from playing for free, by

December of 2013 Valve opened up the game to everyone for free. It is often the

most popular game on Valve’s site Steam.

Counter-Strike: Global Offensive: Counter-Strike was first released about 20

years ago (in 2000). The game migrated to free-to-play in June 2018.

Overwatch: Overwatch was released in 2016. Over the last two years,

Overwatch’s retail price has dropped from $60 to $40. In January, 2019, EA

dropped the price again to $20. Many expect it will soon be available for free.

How do the trends look for free-to-play games versus paid games? About 15

months ago, free-to-play games were generating about as many viewing hours as

paid games. But, today, there are more than two minutes of broadcast consumption

on free games versus paid games.

© 2019 Citigroup

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Figure 139. Top Viewing Hours, Top 10 Game by Cost


There are five main drivers behind this rapid shift in consumption from paid to free

games:

First, Fortnite’s consumption has doubled from about 60 million hours in January,

2018 to about 120 million hours of consumption in March, 2019.

Second, Apex Legends didn’t exist in January, 2018. But, by March of 2019, it

was generating about 60 million hours of consumption (about half the level of

Fortnite).

Third, League of Legends — a popular eSports title — has remained relatively

steady at 100 million hours of consumption over the last 15 months.

Fourth, Player Unknown’s Battlegrounds — a paid title — has seen consumption

on Twitch and YouTube fall from 65 million hours to about 30 million hours.

Fifth, Counter-Strike: Global Offensive was a paid title until June, 2018. At that

date, the game converted to a free-to-play title. We suspect the shift in

monetization was driven by the steep decline in consumption in early 2018.

Pricing of Cloud Gaming Services

So far, we’ve suggested nobody has launched a new gaming business model that

could hurt publishers. But, we also suggested that consumer’s preference for

renting, the rise of cloud computing, and the growing popularity of free-to-play all

strongly suggest that new cloud based firms — Microsoft, Google, Amazon — will

likely launch the ‘Netflix of gaming’. That is, a single monthly subscription for both

hardware access and software access.

How will the services be priced? If the price is too high, adoption will be limited and

disruption to existing publishers will be limited. On the other hand, if the price is very

low, it could be quite disruptive to the existing ecosystem. So, how can we think

about the potential pricing for these new services?

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Figure 140. Pricing of Cloud Gaming


We suspect five factors will determine cloud gaming retail prices: (1) The consumer

must find utility at the retail price point; (2) The cloud provider will need to earn a

return based on the cost of providing cloud processing; (3) Cloud providers that

currently sell consoles — like Microsoft — may incorporate cannibalization risks into

their pricing calculus; (4) The business model used by the cloud provider will almost

certainly impact pricing; and (5) Some cloud providers may subsidize pricing based

on ‘shadow’ gaming revenues like Broadcasters (Google, Amazon) and mobile

AdTech (Google, Apple). Let’s take a closer look at each.

Consumer

A recently released game console — like the Xbox One or the PlayStation 4 —

costs around $350. Since cloud gaming still requires a thin client — a small device

that does minimal processing that’s connected to a TV — it suggests the consumer

would save about $300 in upfront capital costs (assuming the thin client costs $50).

Depending on the console’s replacement rate — which we assume varies from 3 to

8 years – the breakeven monthly costs for cloud gaming is probably $3-8 per

month.

Figure 141. Cost to Consumer of Cloud Gaming

Fast Slow

Replacement Replacement

High-end console price 350 350 350 350 350 350

- Thin client 50 50 50 50 50 50

= High-end processing hardware cost 300 300 300 300 300 300

/ Replacement rate 3.0 4.0 5.0 6.0 7.0 8.0

= Annual replacement cost 100 75 60 50 43 38

/ Months per year 12 12 12 12 12 12

= ARPU 8 6 5 4 4 3


Consumer

Cloud Cost

Console Cost

“Shadow” Revenue

Business Model

Does the consumer

derive utility at the

offered price?

What does it cost to offer

cloud gaming services?

If the cloud provider sells

consoles, will pricing be

influenced by cannibalization

risk?

Does the cloud provider

bundle software access?

Are these free-to-play

games?

Does the cloud provider cross

subsidize with shadow revenues

(Broadcaster, mobile AdTech)?

5

4 3

2

1

Pricing of

Cloud Gaming

© 2019 Citigroup

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Cloud Cost

But, is there anything we can use to test these hypothetical cloud price points?

There are around 10 cloud gaming services available today (excluding those in beta

testing). On average, these services cost about $18 per month, $2.25 per day, or $1

per hour of game play. As such, these start-up price points suggest that consumers

will likely be spending more on cloud gaming than they do on console hardware.

The average gamer might spend $160 per year ($18 for cloud gaming less $5 for

console costs per month = $13 incremental fees x 12 months a year). But, the

larger cloud firms – like Google, Microsoft and Amazon – could probably see some

cost benefits from scale. As such, we view these prices as the high-end of what the

scaled players will likely charge.

Figure 142. Likely Cost of Cloud Gaming

Firm Windows

Chrome

macOS

Android

iOS

Linux

Xbox One

$ per month

$ per day

$ per hour

Shadow Y Y Y 29.95

LOUDPLAY Y Y Y Y 0.26

PLAYCLOUD Y Y Y Y 2.25

Vortex Y Y Y Y 9.99

GeForce Now Y Y N/A N/A N/A

Project Stream (Google) Y N/A N/A N/A

Project xCloud (Microsoft) Y Y Y N/A N/A N/A

Blacknut Y Y Y Y Y 16.90

Gaming: Solved Y Y 1.49

GLOUD Y Y 7.69

PixelStellar Y 1.30

WADE Y Y 13.00

PlayKey Y Y 32.37

Average 18.32 2.25 1.02

Source: Company websites, Citi Research

Console Cost

If a cloud provider wants to protect legacy console revenues, we suspect they will

perform analysis that’s similar to the consumer analysis (from above). That is, if the

retail price point for a console is $350 and the retail mark-up $50, then the console

manufacturer would probably need to charge about ~$5 per month for a cloud

gaming service to not erode the firm’s top-line (assuming a firm’s cloud market

share is equivalent to their console share).

Business Model

Some cloud providers may only sell access to a hardware platform. Others may

bundle game access as well. As such, the cloud providers could open a digital

storefront. Or, they could acquire a digital store (like Steam, Discord, or Epic). This

would allow the firm to generate revenues from any game sale (including a portion

of any in-game content).

Since Valve is a private company, our estimates of Steam’s historical revenues

should be taken with a grain of salt. But, to give readers a rough idea, we think

Steam generates about $1-2 per month from every monthly active user. As such, if

a cloud gaming firm also operates a digital store (and charges a 25% distribution

fee, similar to Steam) they could lower the cost of cloud gaming by $1-2 a month.

© 2019 Citigroup

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Figure 143. Steam: Estimated Revenue

2015 2016 2017 2018 Comments

Total users 178 228 291 321

Monthly users 50 64 82 90 Wiki suggests 90 million in 2018

Daily users 26 33 43 47

Monthly users 50 64 82 90

x Upfront game spend per month 5.18 4.56 4.39 4.25

= Monthly spend 258 292 358 383

x Months 12 12 12 12

= Annual revenue 3,100 3,500 4,300 4,590 SteamSpy suggests $4.3 billion in 2017

x Steam share 30% 30% 30% 25% Lower fee due to UE4 rivalry

= Steam revenue 930 1,050 1,290 1,148

Monthly users 50 64 82 90

x In-game spend per month (30%) 1.55 1.37 1.32 1.28 Assume 30% of upfront spend

= Monthly spend 78 88 108 115

x Months 12 12 12 12

= Annual revenue 930 1,050 1,290 1,377

x Steam share 30% 30% 30% 30%

= Steam revenue 279 315 387 413

Total Steam revenue 1,209 1,365 1,677 1,561 Excludes hardware, merchandise

/ Monthly users 50 64 82 90

= Revenue per user per year 24.23 21.35 20.55 17.34

/ Months 12 12 12 12

= Monthly Steam revenue per user .02 1.78 1.71 1.45

Source: Wikipedia; StreamSpy, Citi Research

Shadow Revenue

The last area worth exploring is ‘shadow’ gaming revenues. We call these ‘shadow’

revenues because they aren’t in the purview of traditional game publishers. But,

these revenues do exist. And, large shadow revenues mean the cloud gaming firms

can monetize their new services in indirect ways.

Shadow revenues include two things: (1) payments made to the AdTech ecosystem

in the mobile gaming world and (2) eSports and live streaming revenues from

players like Twitch. Earlier, we showed that traditional gaming revenue (mostly

software) just topped $100 billion in revenues in 2018. Shadow revenue is worth

about $8 billion with an additional $33 billion in gaming hardware sales.

© 2019 Citigroup

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Figure 144. Total Gaming Revenue


If we allocate 70% of eSports Broadcast revenues to Amazon (Twitch) and 30% to

Google (YouTube) plus 20% of mobile AdTech to Apple and 80% to Google, it

suggests $6.1 billion of shadow revenue collected by Google and $1.1 billion by

Amazon. These figures are not immaterial within the context of total hardware

revenues for gaming. This suggests there is some scope for cross-subsidization

among cloud providers.

Figure 145. Cloud Gaming Shadow Revenue

2011 2012 2013 2014 2015 2016 2017 2018

Amazon (70% Broadcaster) - 0.2 0.2 0.3 0.4 0.6 0.8 1.1

+ Apple (20% AdTech) 0.1 0.2 0.3 0.6 0.8 1.0 1.2 1.4

+ Google (30% Broadcast, 80% AdTech) 0.4 0.8 1.4 2.4 3.3 4.2 5.2 6.1

= AdTech and Broadcasters 0.6 1.2 1.9 3.3 4.4 5.8 7.2 8.5

+ Hardware 32.9 28.9 25.5 26.3 26.0 27.3 33.2 32.6

= Shadow revenue 33.4 30.1 27.4 29.6 30.4 33.1 40.5 41.1


Summing Up

Let’s put these various pieces together. If we start with the cloud pricing of the start-

up firms of $18 a month, remove $0 to $6 per month for scale benefits from larger

cloud providers (like Google, Amazon and Microsoft), remove $0 to $2 for revenues

from a digital store and remove $0 to $1 for shadow revenues (like broadcasters or

AdTech) it suggests a new, vertically-integrated scale player with ancillary assets

could charge as little as $9 per month. That’s akin to a three-year life for a console

or PC. As such, we would not be surprised if these new services launch with a

monthly price point of $9.99. Of note, we have not given any benefit from game

titles that could also be owned by the cloud provider. Recall, Amazon purchased

video game developer Double Helix in 2014. And, Microsoft is a large game

publisher (Xbox Game Studios).

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© 2019 Citigroup

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Figure 146. Retail Monthly Price of Cloud Gaming

Low High

Avg cloud cost from private firms 18 18 18 18

- Scale of larger cloud firms 6 4 2 0

- Revenue from digital store (e.g. Steam) 2 2 2 0

- Shadow revenue 1 1 1 0

- Software ownership 0 0 0 0

= Retail monthly price of cloud gaming 9 11 13 18

x Months 12 12 12 12

= Annual cloud pricing 108 132 156 216

/ Implied PC or console useful life 2.9 2.3 1.9 1.4

= Console cost (less thin client) 300 300 300 300


So, if we’re right, cloud gaming will adopt the mobile model for upfront purchases:

the up-front payments will go away for both hardware and software. And, the in-

game monetization — including ads, game monetization and eSports — will mirror

the console/PC market. That’s because the game’s functionality on the mobile

screen will be the same as the console/PC screen.

Figure 147. Where Cloud Plays in Global Gaming Ecosystem


If we look at legacy gaming revenue — for hardware, software, in-game ads, and in-

game monetization — the three large cloud providers aren’t particularly exposed.

Microsoft, with its legacy Xbox revenue, is the exception.

And, if we look at emerging cloud gaming revenue — for leased cloud hardware, the

AdTech ecosystem (in mobile) and eSports broadcasters — the three large cloud

providers are heavily exposed. Google, in particular, seems particularly well suited

to benefit given the nearly ubiquitous nature of Android’s operating system and

YouTube (as a game broadcaster).

MobilePC Cloud

Hardware

Purchase

Console

Software

Purchase

Ads

Game

Monetization

eSports

Comments

Upfront

In-game

Cloud will not require expensive

hardware

Cloud providers likely to offer free-to-

play games (Fortnite, Apex Legends)

Likely that cloud will adopt PC /

console ad loads (i.e. less than

mobile)

Cloud will expand eSports opportunity

since PC/console games can be

played on mobile devices

Games will mirror PC / console game

play. As such, in-game monetization

will be similar

Legacy New

© 2019 Citigroup

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Amazon is also well positioned with Twitch. Microsoft isn’t as well positioned to

monetize future revenue streams (with the exception of direct cloud leasing

revenues).

Figure 148. Where Large Cloud Providers Play in Global Gaming Ecosystem


If we summarized the dynamics we’ve reviewed so far, we would divide the key

developments into five waves. Items toward the top of the page have already

occurred. Items toward the bottom of the page are still apt to unfold. The five waves

include:

The first wave was enabled by pervasive broadband Internet access. This

prompted four second-wave developments.

In the second wave, we’ll see (or have seen) enhanced video game profits,

higher levels of group play, the rise of eSports, and the enablement of cloud

gaming.

In the third wave, we’ll likely see game complexity rise, lower barriers to entry for

consumers, the console/PC and mobile market converge, and the rise of new

gaming entrants with cloud infrastructure (like Google and Amazon).

In the fourth wave, we’ll see game updates and refresh rates accelerate (like

Fortnite), low-end games — particularly casual games — struggle, and new

business models (from cloud providers) evolve.

In the fifth wave, we’ll likely see far fewer games supported by the video game

publishers and a rapid rise in free-to-play. The new business model — from the

cloud gaming firms — is apt to be supported by cloud lease payments, in-game

monetization, and the mobile AdTech ecosystem (for Google and Apple).

GoogleAmazon EA

Hardware

Microsoft

Software

In game ads

Game

monetization

Broadcaster

Comments

Only Microsoft will be incented to protect

legacy HW revenue (Xbox)

Only EA has material legacy software

revenue to protect

Most cloud providers don’t generate

material in-game ad revenue

Amazon (Twitch) and Google (YouTube)

will be able to monetize gaming via

broadcasting assets

EA has material in-game monetization

revenue to protect

Apple

Cloud

hardwareAmazon, Microsoft and Google are the

large cloud providers

Ad Tech

(Mobile)

Due to Android and iOS, Google and

Apple apt to benefit from mobile ad

growth

Legacy

Em

erg

ing

Large Cloud Providers

© 2019 Citigroup

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Figure 149. Five Cloud Waves


Regulations

As the industry evolves, one area worth keeping an eye on is regulation. A number

of countries — including China, Japan, and South Korea — have imposed some

form of regulation on the video game industry. Lawmakers in Europe and the U.S.

are also raising concerns. The general fear is that video gaming can be addictive

and may be particularly harmful to children.

Indeed, the World Health Organization (WHO) recently named video game

addiction an official disease. All 194 members of the WHO voted unanimously to

add this addiction to their list. The classification goes into effect on January 1, 2022.

Internet

Connectivity

In-Game

Monetization

Allows New

Corporate

Entrants

Enables

eSports

Games

Complexity

Rises

Enables

Cloud

Gaming

Encourages

Group

Play

Refresh

Rate

Accelerates

Lowers

Barriers for

ConsumersFewer

Games

Supported

Mobile &

PC/Console

Converge More Free-

to-Play

Adopt New

Business

Models

Low-end

Games

Struggle

1st Wave 2nd Wave 3rd Wave 4th Wave

3rd Wave 4th Wave 5th Wave

© 2019 Citigroup

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Prudent Strategic Responses So far, we’ve reviewed the value chain for the console/PC and mobile markets. And,

we’ve suggested cloud-based providers will likely offer a relatively low-priced

service that gives consumers access to both processing and many free-to-play

games.

In this section, we want to address two questions. First, what M&A, if any, is likely to

occur as cloud gaming moves to the forefront? Second, what steps, if any, should

incumbent game publishers take to thrive in this emerging world of video games?

Potential M&A

We’ve mapped each of the major player’s assets in 10 different categories (from IP

at the top down to eSports at the bottom). What’s clear from this graphic is the video

game space is fairly complex. No single firm has assets that span the entire value

chain. As such, we could see three types of M&A:

First, we suspect that the emerging cloud gaming firms — including Amazon,

Google, and Microsoft — might be keen to acquire firms that distribute video

games over the web today.

Second, we could also see consolidation among the various video game

publishers. This would put more game titles in a single firm and (perhaps) allow

these firms to launch their own cloud gaming platform.

Third, we don’t think large publishers should acquire standalone mobile games

firms. As cloud computing gains share, lower-end mobile games will likely

diminish in importance.

© 2019 Citigroup

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Figure 150. Major Game Player Assets by Category


How Publishers Should Respond

Beyond M&A, how should incumbent video game developers and publishers

respond to these potential changes? We would suggest a handful of steps:

First, incumbent publishers should segment their existing games into titles based

on very strong IP, sports-centric titles, popular eSports titles, and ‘Other’. The

‘Other’ titles should be deemphasized over time.

Second, publishers should redirect developer resources to keep existing popular

titles fresh. This will encourage current players to stay engaged. It will also help

in-game monetization.

Third, for non-sports titles, publishers should begin to gradually lower the retail

prices of the games to make the migration to free-to-play less disruptive.

Fourth, publishers should embrace eSports and the live streaming business. Any

popular game that doesn’t have an eSports or live streaming following, should

cultivate one.

Fifth, video game publishers should ensure all popular titles have a mobile

version. This will ensure a seamless transition for popular titles as cloud gaming

gains share.

Intellectual

Property

Game

Developer

Game

Publisher

Graphics

APIs

Distributer

Broadcaster

Cloud

Activision EA Ubisoft Microsoft GoogleSonyNintendoEpic Amazon

Call of

DutyAnthem

Assassin’s

CreedHalo

Gran

TurismoPokémonFortnite

Treyarch Respawn Red StormMicrosoft

StudioSonyNDcubeEpic

Double

Helix

Activision

Blizzard

Electronic

ArtsUbisoft

343

IndustriesSonyNintendoEpic

Amazon

Games

DirectXOpenGL GameOn

Origin

Access

Game

Pass

Google

Store

Play-

Station

Now

UplayEpic

GamesAmazon

Mixer YouTube Twitch

Project

xCloud

Stadia /

Stream /

Yeti

Beta

eSportsMajor

League

Gaming

Hardware

ManufacturerXbox

Play-

StationSwitch

Valve

Dota 2

Valve

Valve

Steam

Steam

Tencent

League

of

Legends

Riot

Games

Riot

Games

WeGame

Huya

Douya

(stakes)

Start /

Instant

Play

Game

Engine

Unreal

Engine

(UE)

Lumber-

yardUnity

Unity

© 2019 Citigroup

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#1 - Segment Existing Titles

We showed earlier that sports-based franchises play a niche role in the broader

gaming ecosystem. But, we suspect this segment of the gaming population will

remain relatively immune to many of these secular changes. Titles with a heavy

eSports following, immersive AAA games — particularly if they are free-to-play —

should also perform well. We also suspect immersive AAA games with high

production value (and commensurately high production budgets) — games like Red

Dead Redemption, Grand Theft Auto or the forthcoming Cyberpunk 2077 — will

also continue to play a role. Finally titles with heavy a heavy eSports following —

particularly if they are free-to-play — should also perform well. But, titles that don’t

have a live streaming or eSports following or don’t mimic a real sport or don’t have

high-quality IP should probably be de-emphasized.

#2 - More Frequent Software Updates

As developers focus on fewer games that span both the cloud and mobile

environments, we expect more resources to be spent refreshing game titles. That is,

the rate of software updates is apt to increase. Indeed, since the launch of Fortnite

in 2017, the Epic Games development team has been updating the software at a

breakneck pace. A new update to the software occurs (almost) every week. While

the pace of update was a little more rapid in 3Q17 (when the game was new and

had bugs), since then the cadence has been relatively consistent. By the first

quarter of 2019, Fortnite players have benefitted from nearly 100 updates. Updates

don’t just fix bugs, they add features: like new weapons and new maps. This helps

keep in-game monetization at robust levels.

Figure 151. Number of Fortnite Updates

Source: IGN. Citi Research

#3 - Lower Retail Prices of Non-sports Titles

We showed earlier that many titles are gradually lowering up-front prices for the

game as in-game monetization becomes more prevalent. We think this is a prudent

step and would encourage publishers to gradually migrate to a free-to-play portfolio.

This will make the inevitable transition to free-to-play less disruptive.

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#4 – Embrace eSports and Live Streaming

Viewing hours on broadcasters like Twitch are growing rapidly. But, some games —

like Fortnite and League of Legends — have a more robust following. Game

developers should focus on games that lend themselves to third-party viewing. We

think it’s less important, however, to focus on the mix of consumption that is true

eSports versus live streaming. Either mode of consumption is attractive.

Figure 152. Average Viewing Hours – eSports and Live Streaming

Source: Twitchmetrics, Citi Research

#5 - Add Mobile Game Functionality

The largest cloud providers — Microsoft, Google, and Amazon — are all gearing up

for cloud gaming. The most important implication of this shift is this: every screen

will be able to play PC or console quality game. As such, the processing power of

the mobile device will no longer restrict the quality of the game. It also means the

potential market for video games will likely expand (since there are far more mobile

devices than PCs or consoles).

In the current world of gaming, smartphones are typically less powerful than off-the-

shelf PCs. And, gaming consoles like the Xbox are typically less powerful than

gaming rigs. This disparity is processing does two things: (1) it influences the types

of games that are created by developers and (2) it segments the market, allowing a

gamer to spend more (on high-end gaming rigs) if they are avid fans.

Once the cloud is used for gaming, the performance of any TV, smartphone, or off-

the-shelf PC will be similar. We suspect that consoles and gaming rigs will still offer

superior performance. But, by elevating the performance of low-end devices, game

developers will no longer need to limit the quality of mobile games. Standalone,

low-end mobile games will likely be far less prominent in the marketplace.

0%

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20%

30%

40%

50%

60%

0 50 100 150

Sh

are

of

Ho

urs

fro

m e

Sp

ort

s (

%)

Average Viewing Hours – Jan ’18 to Mar ’19 (mn)

Fortnite

Rocket LeagueCounter-Strike

StarCraft II Dota2

Overwatch

League of Legends

Hearthstone

FIFACall of Duty

PUBGWorld of

Warcraft

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Figure 153. Screen Capability With Cloud Gaming


If true, then it suggests that existing publishers should be extending existing

console/PC games to mobile devices. Today, this effort will just cement in the eyes

of consumers that their favorite titles are indeed mobile games. But, when cloud

gaming becomes more popular, the mobile functionality of the game will be better

since it will mirror the console/PC game.

But, where are publishers today? If we look at Activision, the firm has mobile

versions of Skylanders, Spyro Reignited, and Hearthstone. But, popular titles like

Call of Duty do not have a mobile version. Activision, it seems, is moving in the right

direction, however, because both Call of Duty and Diablo are slated to get a mobile

version soon. More Activision titles may follow.

Figure 154. Activision: Mobile Readiness of Popular Titles

Mobile Mobile

Title Console/PC Currently Planned Comment

Call of Duty x x Announced on 1Q19 earnings; no timeline given

Sekiro x

Skylanders x x Launched February 2019

Spyro Reignited x x

Overwatch x

World of Warcraft x Industry speculation of mobile development but no confirmation from ATVI

Hearthstone x x

Starcraft II x

Heroes of the Storm x Industry speculation of mobile development but no confirmation from ATVI

Diablo x x Announced at Blizzcon 2018; no timeline given

Candy Crush Saga x


Processing Power

Nintendo

Xbox

PlayStation

Android

iOS

Gaming

Rig

Screen Capability Before and After Cloud Gaming

Cloud

TV

Off-the-

Shelf

PC

TV

Current

Cloud

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Electronic Arts, on the other hand, seems to be further along the mobile path. Only

a handful of games — NHL, Anthem, Apex Legends, Battlefield and Titanfall —

don’t have mobile versions. But, like Activision, the firm is poised to make more

progress. Both Apex Legends and Battlefield may soon get mobile version of the

game.

Figure 155. Electronic Arts: Mobile Readiness of Popular Titles

Mobile Mobile

Title Console/PC Currently Planned Comment

FIFA x x

Madden x x

NBA Live x x

NHL x

Anthem x

Apex Legends x x Announced on F4Q19 earnings; no timeline given

The Sims x x

Star Wars x x

Command and Conquer x x

Need for Speed x x

UFC x x

Plants vs. Zombies x x

Warfriends x

Battlefield x x EA said several years ago that a mobile version is in development. No updates since

Need for Speed x x

A Way Out x

Unravel Two x

Mass Effect x x

Titanfall x


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Expert Views from the Gaming Industry

In this section we include the transcripts from three separate discussions we have

had with prominent industry experts on the video games industry focusing on their

view of the landscape and the opportunities/challenges for various stakeholders as

ecosystem evolves.

In these conversations we not only try to get some insights on how the landscape is

likely to evolve more broadly but have tried to focus in on some of the key layers in

this quite complex ecosystem:

Ralf Reichert is co-CEO of ESL, one of the world’s largest organizers and

producers of video game competitions worldwide. eSports is an area that has

seen significant growth both in terms of audience over the years and Ralf’s

commentary is a reminder of how big the opportunity could be, not only for the

event organizers themselves but for all the stakeholders in the landscape,

including the publishers, the teams and brands using eSports as a platform for

branding/sponsorship.

Wil Stephens is CEO and Founder of Fusebox, a mobile game developer and

publisher focused on developing interactive narrative games. Wil talks about the

challenges associated with building successful mobile games, in particular with

regard to customer acquisition and retention, but also reminds us of the power of

non-native IP (Fusebox’s games are based on hit TV shows like Baywatch and

Love Island) as well as the importance of cultivating new demographics (around

85% of Fusebox’s players are women) to drive returns in what is a ferociously

competitive landscape.

Finally, Luke Alvarez is an industry veteran and Founding Managing Partner of

Hiro Capital. He talks more broadly about the evolution of the industry and paints

a picture of the future where we see both significant disruption but also value

creation. His view is ultimately positive: with 4-5 bullion gamers worldwide he see

the video games industry moving from being an important part of the TMT

landscape to being ‘a central pillar of the mid-21st century economy’.

Although wide-ranging, obviously these conversations don’t capture all the layers of

the gaming landscape, nor will they capture the full range of views held by people in

the industry. At the same time, each of our experts agree that the landscape is

evolving fast and that this will no doubt create some extraordinary businesses as

well as some high profile casualties along the way. In summary, it is an exciting time

to be looking at video games.

With that summary, let’s dive into the discussions…

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A Conversation with Luke Alvarez

Founding Managing Partner, Hiro Capital

Before we start and to set the scene, can you give us a bit of detail on your

background in the video games industry?

I am a lifetime gamer and sportsman. My first video game experience was Pong in

an arcade on holiday in a small town in Italy in the mid-1970s. I was born in 1968,

so I’m proper Gen X — we’re the first generation that grew up with video games, but

we didn’t get the Internet until our late 20’s. The best present I ever got in shabby,

messed-up 1970s London was a LED screen handheld proto-Space Invader type

game that my godfather brought over from the U.S. — amazing. Then I had Atari’s

and Nintendo’s in the 1980s and a Sega Dreamcast (Streetfighter!) in the 1990’s.

That really sparked my enthusiasm for the sector.

I also come from a family background where games — poker, chess, backgammon,

monopoly — featured very prominently in my upbringing. Games and sports and

competition are at the heart of human life and I see video games as a huge and

expanding part of that.

My background in the industry is co-founding a business called Inspired Technology

Group in 2001, which became Inspired Gaming Group. We initially started making

mobile casual games for GSM LCD phones. This was the first generation of phones

that had SMS and we were making games for that environment together with a kind

of software platform that distributed those games and other content across all the

mobile operators in the U.K. and Europe and charged for them.

In candor we were a bit too early. It was six or seven years before the iPhone and

the App store. But having started with that we moved into ‘skill with prize’ and quiz

games. We then pivoted into virtual sports which were photorealistic sports games

for the regulated lottery and sports betting sector.

I first met Ian Livingstone, who’s my co-founding Partner in Hiro Capital, in China in

about 2014. Ian (co-founder of Games Workshop/Warhammer and Eidos) is

obviously a video game pioneer and a true legend in the industry. We worked

together on a couple of projects at the intersection of mobile casual games and skill

games. We had a lot of fun and got to like working together.

Can you talk a bit about the founding philosophy of Hiro Capital? How it came

about and how you approach the landscape?

As a consumer and a player and also having spent 20 years in games and

regulating gaming, I have seen the sector evolve significantly, driven by technology

disruption, and globalization.

With this in mind, the fundamental thesis of Hiro Capital is based on two things.

One, this sector has gone from niche to very, very large over the past 10 years. It

has gone from 100 million players of video games in the mid-1990s, to 200 million in

the mid-2000s and to almost 3 billion now. So it's gone from niche to mass and our

thesis is that this will now go from being mass market to being an absolutely central

pillar of the mid-21st century economy and society and humans’ lives. So we have

seen it move from small-ish to very large today to being absolutely pivotal in the

future.

Luke has 28 years’ experience in technology

and 18 years in digital Gaming and Sports.

He was founder & CEO of Inspired

Entertainment Inc., a Nasdaq listed mobile

games and virtual sports technology

company with operations worldwide. Luke

was a founding board member of The Cloud

Network, the UK’s largest public access Wi-

Fi operator, and Gmatica SRL, one of Italy’s

first government gaming concessions.

Luke was a Case Leader at the Boston

Consulting Group, earned a First Class

Honours in Philosophy at the University of

Cambridge and was a Fulbright Scholar to

the University of California Berkeley.

Luke is also an old skool rock climber

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Thesis two is that the financial investment community has been slow to catch on to

the pace of that growth. In particular in the U.K. and Europe, where as a creative

continent we are extraordinarily good at creating both the games and the

technology around this sector, there's a real gap in capital not so much at the seed

or angel stage, where there's quite a lot, but at the level after that where there is

very, very little. So that covers the economic and market logic for why we started

Hiro.

I suppose the personal story part of this comes from my own experience. As a

climber for the last 45 years I get to hang out (sometimes literally) with a wide range

of people including younger millennials and post-millennials and it really strikes me

that these guys consume media in a very different way. They consume video on

platforms like Twitch and Instagram and Tick Tock and they play games, or watch

people play games, often with family or friends. Their media consumption is almost

all interactive and social.

This is what they're spending their time doing. And the 30 hours a week I would

have spent watching TV when I was their age — when I wasn’t working or playing

or in school/uni — they spend on gaming. I know it is an anecdotal thing but I think

those conversations at the climbing wall woke me up to how profound this

generational shift, even between the 35-year olds and the 20-year olds, has been.

This is another key motivation behind why we are doing Hiro.

The pace of evolution within the video games sector is dramatic and this must

make investing in the space challenging. With the move to

subscription/services, do you think it will become more predictable over

time?

My co-founder Ian Livingstone over the years built and invested in many great

games companies including a couple of 1990s unicorns (including Eidos Lara Croft)

but he makes the point that the investment community has historically been

skeptical, and occasionally has had its fingers burnt, by the video games industry

because of the traditionally non-recurring nature of it. In the 1990s/2000s that hit all

sorts of publishers in the U.K., U.S. and internationally who had extraordinary

periods of growth but then screwed up a big sequel and struggled. Even more

recently we've had a couple of mobile- and Facebook-driven stories of growth and

subsequent decline for games businesses.

But fundamentally, the business model is now clearly moving and shifting and

although a great majority of the income in the industry is still from upfront sales or

downloads, you've got this move to new models. And that's good because it’s long-

term and recurring. Free-to-play with all the in-app purchases is great and you can

see that model doing very well on mobile and more recently doing well cross-

platform with Fortnite and many others.

But this is just the start. We are now seeing the advent of the subscription model

from a number of providers, Apple and Google Stadia and others. I recognize

people tend to make portentous predictions around future adoption, but I do see

parallels with the evolution of retail and eCommerce: Multiple models co-existing.

What we are learning in retail is not that traditional retail is dead but that it is having

to transform. Mid-tier, undefined retail is suffering severely but all sorts of innovative

and new retail and niche retail is flourishing while ecommerce continues to grow

and expand.

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And I think this industry will be like that from a pricing model point of view. I think

there will be very successful subscription ecosystems, no doubt Apple and Google

and Amazon and other FAANGs and BATs. Netflix will also probably move into

games and add games to their subscriptions. And of course Sky/Comcast, Disney,

and AT&T and people like that may end up moving in orthogonally as well.

So I think we're going to see all the media players and the games players trying to

create subscription services for games alongside their TV and movie subscription

services if they have them. And those will converge in interesting ways and some of

them will succeed, and some of them won't.

But I think you're also going to have big ‘free-to-play’ ecosystems with lots of money

inside them and lots of ways to spend that money and new ways being invented all

the time.

And I think there’ll still be a sales and download upfront market place: On Steam,

Epic, Discord, the App Stores etc. There are certain developers who remain

passionate about that and who have a particularly authentic, artist-driven,

independent vision that they don't want to be interfered with, with any kind of

advertising or in game commerce, or with other barriers to the player. And you will

have others who stick to the traditional AAA model, and there will be a hardcore

niche of players who still like that, probably bigger than it is today.

In short, I suspect in 10 years we will have lots of different games products and

ecosystems. I think there's going to be some extraordinary, new entities and models

created along the way and probably some savage casualties. Music is a really

interesting analogy in this context because we have already seen something similar

happen there.

So, building on the analogy with the music industry: some of the parallels are

perhaps obvious — for Twitch we should perhaps think about the similarities

with Spotify — but how should we think about other stakeholders in this

analogy? Should we think of ‘developers’ in the same way we do ‘music

artists’ and, if so, will they be better or worse off in this new world?

Actually, I think the real analogy is between Twitch and YouTube just because,

crudely, they are doing the same thing. They enable watching and self-publishing of

videos. They are both business models that you wouldn’t have conceived of only 20

years ago. And they are both huge and owned by competing FAANGs.

But the one in a way I think is most like Spotify is Epic with Fortnite. Because

Spotify is not just about watching/listening content, it's about downloading an

experience and of course paying for it, while Twitch and YouTube are mostly free.

Fortnite, like Spotify has an entry level free-to-play experience, but you pay more as

you get more committed to it. We should also remember that both companies are

‘new entrants’ (even if Epic has been around forever) that have up-ended their

respective industries and taken share from everybody. The Netflix CEO cites

Fortnite (not HBO) as his biggest threat. But coming back to developers, from their

perspective I think what’s happening is extraordinarily beneficial. Twenty years ago,

if you had games and you wanted to get them to market, you needed distribution,

manufacturing, and expensive advertising for mostly physical titles. And if you were

small you probably had to go to a publisher, and it was hard to get cut through.

In some ways, it's harder now because there are so many games in the App Store if

you are going mobile or cross-platform, and there's so much creativity out there and

so much noise.

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But on the other hand, you've got both the app stores, you've got the whole Tencent

/ NetEase / Asian ecosystem, you've got Steam, you now have the Epic store,

you've got Discord, you've got what Sony are doing, what Microsoft are doing, and

of course Google Stadia and the Apple Arcade.

You have got so many different routes to market. And they've all got slightly different

spins. And actually, if you want to be independent, you can get your publishing tool

off the shelf, you can run your servers in the cloud, and you can buy in a lot of

affiliates and marketing and all sorts of services. There are all these routes to

market to generate money.

Now within all of that, there are loads of other developers to compete with, so if

you're going to cut through, you have got to have something special and unique and

interesting and good.

When we invest in a front end studio — which is going to be about half of our

investment allocation, we look for something that's really, really good, and very

different, because that's how you get cut through.

At an industry level there is a lot of focus on AAA games, free-to-play, and

multiplayer, but how do you as an investor consider the value in legacy IP and

AA formats? In the physical world we are seeing board games and vinyl

seeing a resurgence — is there an analogue in the video games world?

There absolutely is. My partner Ian is a kind of Yoda on gameplay. Judging whether

the core mechanic of a game is compelling or not is fundamental and this applies

both in the physical world and in video games. And of course owning your IP, so you

can monetize across channels and across time.

As regards physical formats, I think the reason why vinyl and physical board games

are in vogue is because digital is amazing and increasingly ubiquitous but it flattens

things. Interestingly, the new generations who have grown up with the Internet are

fascinated by the early 1990s, which in the U.S., Japan, and Western Europe was a

completely modern era that just didn't have the Internet. It was as modern as today

in pretty much all respects — styles of music, clothes, street style, hip hop, extreme

sports — all the same stuff as now and people were pretty prosperous and happy in

a lot of the West but we didn't have the Internet or mobile phones until the mid-90’s.

Digital media is extraordinary but the digital experience is still quite thin and being

able to touch and feel a record and hear that analogue crackle is cool — the fractal

detail goes much deeper than in a stream. Equally, we've seen a resurgence in

board games, Warhammer is doing extraordinarily well with physical figures and so

on. You're seeing all sorts of clubs and bars and pop up venues doing ‘Dungeons

and Dragons’ competitions and things like that on board game nights. And you have

things like Escape Rooms where people are going to play a physical game or

adventure in the real world. And I think that's a good thing.

At Hiro, from a fund point of view, we invest in three sub pillars. Video games over

PC, mobile and console is one, as well as AR/VR/MR. eSports is the second. But

Digital Sports (DSports) — meaning the digitization of real world sports — is the

third. And that's because we think the physical world and the digital world are

converging in interesting ways. Games and sports are the sharp end of where that's

happening for the consumer, and they will continue to be and that will accelerate

over the next decade or so. The really interesting action is going to be in where

those things come together. Ultimately, we want games where people aren't just

sitting on their backsides all the time; they are up and interacting with the real world

and taking pleasure in physical movement while shooting aliens and all that.

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Coming back to the bleeding edge of gaming, clearly there is a lot of focus at

the moment on alternative revenue models e.g., advertising, licensing &

merchandising etc. Two questions: first, what does this mean for paid-for

titles longer term? Will we inevitably move to a free-to-play world? Second,

what other revenue models have you seen/are excited about that could get

traction?

I do think we'll still have paid-for titles in a decade in a market that is much bigger

than it is today. But we strongly feel that ‘free to play’, ‘in-game’ spend and

‘subscription’ is going to eat much of the new income.

There’s going to be a much larger market overall in ten years’ time but it is going to

be a majority free-to-play and subscription market but with still a very substantial

upfront ecosystem. If I had to quantify it, if upfront sales are 80% today, I would

guess it will be a third of a much larger market in 10 years’ time and subscription,

free-to-play and in-game will be the rest.

There will be all sorts of gyrations about what the right level of pricing for a

subscription model will be and who has the scale and breadth of content to make a

subscription platform attractive but most players probably will have capacity for two

or three subscription services at most so some won’t succeed.

When we talk about ‘free-to-play’ and in-app purchases, I think that's a small set of

words for what is going to become a much more interesting thing. At Hiro, we often

talk about the ‘third space’; how platforms like Fortnite are becoming a community

like Second Life was before but with much better graphics and a much larger user

base. And I think in those worlds, clearly money is going to be spent on stuff like

skins or equipment that relates to the game and the core gameplay. But once they

are in, they are in this third space where they're making friends and the kids’ status

in the playground next day at school is based on what they did in the game the night

before, partly. And not necessarily just on how they played, but often on stuff that

isn't so helpful, like how cool their skin is, and sometimes stuff that is helpful, like

how they communicated or problem solved.

And that’s turning this environment into a social space, part of people's extended

friendship networks, community, and sense of themselves. Their self-esteem is

based on what they're doing in the game, and how they are playing and what they

look like. And that creates as many opportunities for spending money and earning

money as there is in the real world.

Our long-term thesis is that the range of digital goods and in-app purchases in

games today is very narrow relative to where it's going to be in a decade or so.

These games aren’t just games. Some of them are on their way to becoming social

communities where you do most of the things you do in the real world.

It is clear with the announcement around Google Stadia that we are on the

cusp of a significant evolution in the rise of cloud computing. How disruptive

do you think this will be? What are the barriers to take up in your view?

I think it will be hugely disruptive and hugely liberating. Thinking back to the late

1990s, I remember how hard it was building data centers if you wanted to do

anything Internet-based and this was the case all the way through to nearly five

years ago. The cloud, more generally, has completely transformed that and many of

us forget how recent it is and how painful and expensive and specialist it was

having to do that stuff yourself and what a barrier to entry it was. I think it's

extraordinary that it's happening and I think it's great that it's happening to games.

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Cloud-based gaming is great for developers because, first of all, you can find your

dev kit in the cloud and you don't have to develop it yourself. And any software

platform outside the game that you do develop, is contributing to your uniqueness

and allowing you to make a special kind of game. So that's a good thing. Obviously,

then, when you want to push that game and publish it and get it out there AWS or

Azure or AliCoud or whomever is there.

And then obviously, the specific cloud-based gaming services: we have all heard

about Google Stadia and Sony's had its subscription initiative for a while, although

this has flipped from streaming only to download as well. Rovio has a spinoff,

NVIDIA has a platform, Intel and Tencent have been investing, no doubt Amazon

etc. will do things - all the big guys are going to do something around it,.

That said, it will likely take a while to be really good. There are some interesting

technical, unit economics scaling challenges with how you build out your gaming

cloud service. You want it to have 10s of millions, ultimately, 100s of millions of

users worldwide but you don't want to have it architected such that you have to put

loads of physical GPUs in all the data center near where all those users are playing.

And some of the models online seem to have taken that approach. And this means

someone that has 10 million users around the world playing a game, you're going to

need many millions of GPUs and that is an awful lot of capex and depreciation of

physical assets and stuff like that.

So you need the right technical approach and we look have looked at a lot of

streaming solutions and approaches and startups and so on and some of them

have very clever streaming approaches, and some of them less so.

And then when it's out there, there will be lots of ecosystems and there will be lots

of competition and this will, generally, be very good for developers, particularly

independent developers who get taken up by these guys.

I think it will be quite painful for some of the big and medium sized publishers, some

of whom will get disintermediated by the big services and their role in the value

chain and their ability to capture margin will struggle. Ultimately, though, I think it will

be really good for the industry, because it will open up the ecosystem and you will

have a lot more self-publishing, smaller developers.

Can we talk a little bit about hardware? In a cloud computing world, what in

your view happens to consoles and handhelds?

Our view is ‘yes and no’. This is all about time horizon. In the next five years or so

we've got another generation of consoles coming, and those will probably do really

well because the market is continuously expanding and that's good.

I think 10 years out, we see a more bifurcated ecosystem where, if you've got 4 or 5

billion people playing games, most of them will be playing games on their next

generation smartphone or communication device. And indeed that will have a much

more powerful chip and graphics than anything in today's consoles, so will be able

to run full AAA mega games. And of course, you will be able to attach to that thing

through next generation Bluetooth all sorts of peripheral devices, including

controllers as well as AR/VR/MR wearables.

At the same time, obviously, we have an eSports ecosystem which is accelerating

and growing very fast, and has now got big sports owners and media companies

and advertisers and brands getting behind it.

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That grew out of countries like South Korea, where people couldn't afford consoles,

so everything was done on PCs in Internet cafes. What we think we're going to see

is, as we've already got, to some extent with today’s specialized PCs, you're going

to see hyper-specialized, athlete-level PCs and gaming consoles, that allow people

to really refine their performance and that are the equivalent of the Sky Tour de

France team, carbon fiber, mega bikes. And there will likely be a halo market of very

good amateurs who want to play on the same kit that their heroes play on and that

will be huge.

This is not wildly dissimilar to today. Consoles today are kind of mid-market — they

have some mass market fun games but they skew a bit towards the hardcore gamer

base, but it is still a compromised experience — you mostly can’t play as

aggressively and as precisely as you can with a PC. So we think the mid-market

disappears long term and you have hardcore athlete consoles and PC’s and a vast

mass market on smartphones with peripherals.

There is a lot of excitement about VR and AR in the context of video games do

you think this hype is justified?

Again, it's all about timing. We first the saw commercial VR companies being set up

in the 1980s, so we have already been through a few VR Gartner Hype Cycles —

periods of over excitement, followed by a trough of disappointment. VR has been

through a few of those over the past thirty or so years. The current headsets have

not crossed the technology adoption curve chasm, they're not mass market, and,

although they are getting better, it still does not feel imminent. The next gen are

definitely closer, but I think still for the early adopters not the mass. AR is possibly a

little bit ahead. And smartphone based AR just isn’t very good and won’t be for a

while.

So we think both of those things are coming. They are a big theme for us. We will

probably make one or two investments related to that space on the tech and

platform side rather than the game side in our first fund. I would expect by fund two

or three will be making a lot more.

We prefer to be investing at the point when the tech is crossing the chasm and is on

the way to becoming mass market.

I'm a big reader — and I still read a lot Sci-Fi. I still think the world of your

imagination can create a more compelling environment than any digital media can

today. There are three canonical texts of science fiction about virtual reality. One is

William Gibson’s Neuromancer from the 1980s. In the 1990s, there was Neal

Stephenson’s Snow Crash. And in the 2000s there was Ernest Cline’s Ready Player

One. I fundamentally believe that world is coming and loads of people who run the

big tech companies have also read those books, grew up thinking about that stuff,

and also playing video games and wanting to build those worlds. So they're coming,

it’s just the tech is not great yet so they’re not coming tomorrow. (Hiro Capital by the

way was inspired by Hiro Protagonist, the VR hero of Snowcrash. And of course,

when you play a game, you’re a hero, and so are our entrepreneurs.)

You have talked in the past about the opportunity in eSports which could be

very significant. Can you scale this and also tell us who do you anticipate is

the main winner from this longer term? Will it be the IP owners, the teams, the

event organizers or the streaming platforms? Or can it be all four?

It's a weird industry at the moment, because you’ve got 600 million people watching

video games online and some eSports but almost all the corporate participants in

the industry are not making much or any money for the moment.

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A lot of them are venture funded and losing venture funded money. The winners

today, and I think the winners in perpetuity, are going to be the really talented

athletes and teams as in other big audience sports like football. And I would expect

that, as the industry matures, the current dynamics between multiple independent

and publisher-owned or -controlled leagues will shake out.

We probably won’t end up with a FIFA-style overarching body but will end up with a

well ordered ecosystem of privileged leagues. In certain games we might have

competing leagues like we have competing boxing belts.

An important point is to remember that “eSports” isn’t like football. It is like physical

sports. There are loads of sports within it correlating to the different games. Some of

those sports will be very profitable like football is and some of them won’t be very

profitable like rock climbing, because it's just too small. DOTA and League of

Legends are soccer and NBA equivalents and there are a bunch of games that you

might consider as being the equivalent of rock climbing. There are lots of small

games with an eSports component that aren’t making any money today as eSports

and still won't be in 10 years’ time.

The athletes will make money. Some of the leagues will make money. And

advertisers and brand owners will spend money and do very well out of it targeting

the next generation.

How do you see the developer/publisher/distributor landscape developing longer

term? Will we see consolidation amongst the larger players do you think? And what

form do you think it will likely take – vertical integration (distribution merging with

developer/publishers) or horizontal consolidation amongst publishers/developers?

I think we will see all of those things. We already see lots of vertical integration, with

e.g., Tencent and Microsoft (both platforms) investing in and acquiring and JVing

studios (Supercell/Epic/Minecraft/Roblox and many many others). That’s active

vertical integration. We’ve also seen defensive vertical integration.

Of course we will continue to see lots of horizontal integration with big publishers

buying small studios. Will we see mega mergers between big publishers? I think we

probably will — it’s a classic response in a transforming industry with big new

entrants, partly because even our biggest game publishers are minnows compared

to the FAANGS and the BATS and some of the big publishers will end up stuck in

the middle: too big to innovate great new games, too small to take on Google or

Apple or Tencent on Cloud Streaming. This has already happened in Music.

And will we see Netflix or Disney buy a big publisher? As Video streaming and

subscription morphs into Game streaming? Maybe so.

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A Conversation with Ralf Reichart

Co-CEO of ESL

Before we begin, can you give us a bit of detail on your background?

Being born in 1974 gave me one big advantage and it is probably one of the

reasons why I am here within eSports now. I received an Atari gaming console at

the age of six, so I grew up with video games. In those days video games were a

very niche entertainment but even then I was using them for normal entertainment

very much like we do today.

I grew up with two brothers and we were very competitive. We competed in football,

tennis, and video games. Video games back then were not online multiplayer but

there were sports simulation games, fighting games, strategy games or second

person shooter games. Playing digital games competitively is sort of the basis for

eSports nowadays; I grew up doing this from a young age without knowing that it

was eSports.

Can you give us a bit a bit of background on how you got into the eSports

business? What made eSports interesting in the first place and what were the

major milestones in bringing together the ESL assets under one roof?

The first milestone was when I started university in 1993, where I had more access

to the Internet and online video games. These weren’t necessarily competitive yet

— these were more role playing and strategy games — but in combination with my

formal studies in Economics this led to the next milestone in 1996, which was when

Quake was released. This was the first game that had an online community of size

which competed. Players could found teams called ‘clans’ and clans could compete.

So my brothers who I used to compete against became my teammates and we

would compete with people from all over the internet. As a result, in June 1997 we

founded the team SK Gaming (which still exists) with my brothers and a few friends.

We found it so fascinating because (1) the thrill of competition was the same as the

traditional sports we were used to competing in; and (2) there were fewer logistical

challenges to competing in this game as we could do it from home, at virtually

anytime. The flexibility of time and physical space was a big advantage compared to

football, where you may have to wait until Sunday to compete whilst ensuring you

practice on a Monday and Wednesday. As with Quake you could play a practice

game immediately or a competitive game within the hour.

It was also a lot more international than traditional sports. In my football career I

probably played 200 official matches and maybe only two were with teams from

other countries. In eSports of our first 200 official matches, half were with people

from other countries, albeit most of these would have been in Europe where the

internet connection was good enough. This opened a totally new world and online

community for us.

In 1998 when my brother and I took an opportunity to go to a tournament and my

mum actually joined us. At this point it was already clear to us that it was going to be

a competitive sport but what changed that weekend was that we realized it could

also be a spectator sport. My brother ended up finishing second — which was

exciting and depressing at the same time because second place is really the first

loser — but the main thing was that my mum said that she would probably be happy

to watch us compete regularly as it is not very different from watching us play

soccer.

Ralf founded Turtle Entertainment in 2000.

He is also a Board member of WESA. Ralf

was previously a Member of the Board of

GIGA Television GmbH (2006-2007),

Managing Director of SK Gaming (1997-

2001) and Assistant to the Managing

Director of BMW Zwirner (1991-2000). Ralf

holds a Master’s degree in Economics from

the University of Duisburg-Essen.

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We already knew this was going to be a participatory sport because we were so

excited about it but knowing your mum is willing to watch it as well, told us that it

could be a spectator sport.

Fast forward two years to 2000, I finished university and met a few guys from

Cologne who want to start a gaming company and I said we should focus on what I

then called ‘Fiber-Athlete Competitive Gaming’, as the term eSports wasn't coined

back then. This is the founding story of ESL.

My logic at the time was that there was no true infrastructure, no organized league,

and no organized tournaments on a global scale. There were a few individual

projects but nothing of the size we were thinking. We wanted to build these amazing

stages and tournaments for players to become star players and to make a living out

of it, because at that stage it was such a niche. It was the social aspect we wanted

to bring to it. Even if the business model was unclear, our view was that it would

become a spectator sport and that if enough people watch it, the revenue will follow.

There’s a simple saying ‘revenue follows relevance’. So, like in football, we believed

we could make a living if we could get enough people watching.

We expected it to take three to maximum five years, we were incredibly wrong. We

definitely got the vision right but the timing was a little more challenging. From 2000

to 2010 we start to build products, with the launch of Extreme Masters in 2006 a key

milestone, but it took time for it to become a true market, it was still too niche.

It was between 2009 and 2012 it went from being really niche to become lot more

mainstream. The business model began to change to ‘free-to-play’ with more live

video streaming via YouTube Live and Twitch. Social media was also a key platform

for extending awareness. On the back of this, eSports became a market.

Then the most important breakthrough came between 2013 and 2015, when we

started to do stadium events. This was the point where eSports became something

that everyone could ‘touch’. Seeing a full stadium, hearing people shout in an even

more enthusiastic way than seen at most traditional sports, has taken our vision

through from being a fairy tale for a digital first kid, into becoming something

everyone can relate to and understand.

That is certainly one of the most striking developments because before that I had to

explain in every single interview why it was a sport and why it was a business model

worth pursuing. After that everyone who entered the arena understood that this was

a sport. The debate now is how big it will be, whether it will be an Olympic sport in

time. That fundamental question of this being the next generation of sport was

finally answered.

Fast forward three to five years and eSports has become a massive phenomenon, it

is now one of the largest sports in the world and we already have some of the

largest brands involved. The sport is well on its way to becoming a multibillion dollar

business. Now we are really focused on scaling it and building the right models

behind it. Even though it is still incredibly early we know that gaming video is going

to become the primary entertainment channel for the generations to come. We are

just scratching the surface of what the potential could be in 20, 30, or 40 years.

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ESL is now one of the biggest eSports businesses in the world. Can you tell

us a little bit about what makes it different?

Firstly, we organize tournaments and leagues. We are a promoter of eSports and it

is our mission to create the most exciting content. I think it is important to highlight

what we don’t do: we don't build games, we’re not primarily a distribution platform,

and we don't produce hardware around video games or eSports.

We carry out our mission by creating ecosystems; this means it is incredibly

important that whenever we talk about competitions, we don't talk only about the

stadium events. Yes, they are the most exciting and visible competitions but we

want to really build a story from zero to hero, from amateur to the big stage.

That is the idea we aspire to and we're building this not only in North America but

globally. I think that distinguishes us and is unique about what we are doing.

Together with our sister company DreamHack, we're doing it in a very layered

process starting from the online competition, to festivals, to national championships

all the way to what we call ‘Pro League’. ‘Pro League’ is our Champions League

equivalent. The Intel Extreme Masters-Katowice or ESL One-Cologne (known as

the Cathedral of Counter-Strike) or ESL One-New York are what we compare

internally to Wimbledon or the PGA Masters in Augusta.

Looking at this space from the perspective of the publisher/developer, how in

your view has the approach to ‘community’ changed in recent years? What

does this do to the life time value of a particular property/brand?

Pre-2010 there were a handful of publishers who cared about the community and

really invested into it even if there was no direct return on investment (ROI) because

the publisher model was still based on selling games every now and then for $60; it

could be yearly or every four years.

For these publishers, investing in the customer more than three months after the

game release didn't have a direct ROI. It only had a long-term effect which was that

it increased loyalty to the publisher or the game IP which then may be monetized if

a sequel was ever released. So back then only a minority invested in directly into

the community.

I think this all changed in 2010 when the game as a service model began to evolve.

This fundamentally changed the model. The key point is that where you start is not

as important as where you finish. Having 100 million players on day one of the

game is not as important as how many players you have after one, two or three

years. It is the opposite of the traditional model.

We have seen these stories like Counter-Strike, like League of Legends, or like

Zelda which have continued to grow, even after a decade.Games and publishing

used to be a sprint and now it is a marathon. This totally changed the economics

around it as well.

In this context, eSport is one of these incredible tools that will help you to create

such a curve. eSport allows you to create additional content outside of the game,

which creates touch points for your consumer. If the content is of a decent/good

enough quality it can add to the retention of the game, maintaining consumer’s

interest and possibly exposing the game to people who probably haven’t heard of it

or had large engagement with the game previously. It all boils down to additional

marketing.

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One of the pushbacks on the eSports space is the view that IP owners will

want to organize eSports events in house. With this in mind, can you talk

about the different stakeholders in the ecosystem and why, from your

perspective, you feel there is long-term opportunity for independent eSports

businesses?

The overarching philosophical discussion is insourcing vs. outsourcing or vertical

integration vs. focus on the core of the business.I think that there are a few reasons

why we are fairly relaxed on this topic.

We believe that game publishers will try and are already trying to do it all

themselves but it is important to remember there is a lot of variety amongst

developers. Some are two students in a dorm room trying to become incredibly

successful. Others are multibillion dollar companies such as EA and Activision.

Each of these groups of developers will have a very different approach.

If you look at the most successful eSports games in history, they were mostly

created by developers in the ‘two kids in a dorm room’ category.

This variety in developer backgrounds makes it very clear that there will be very

different approaches to running eSports. Also the variety leads to plenty of

opportunities for a company like ESL.

Looking at the skill set, running an eSports live entertainment business is very

different from running a games and services business. I don't think there are

operational synergies between doing it in house just because fundamentally they

are different businesses. Also it boils down to the company's philosophy: do they

want to be the best in the world in one thing or very vertically integrated? I don't

think that there's a right or wrong answer.

A final point to make is that while eSports dramatically increases the life cycle,

games come and go. Yes there are a few cases such as Counter-Strike which has

been around for nearly 20 years, there is a high probability that games will only live

so long. If a person’s goal was to industrialize eSports on a large scale, then I feel

there is a good argument to suggest you need a portfolio of eSports games to

efficiently build it on a global scale. This supports what we see with ESL on a global

level.

We feel good about industrialization and we want to find a diverse way of

approaching it. There is probably no right or wrong way of doing it. As long as we

deliver a significant value to our partners, we are excited for the future.

Can you talk a bit about some of the other stakeholders, for example the

relationship you have with the teams?

As I came from being a team owner (SK Gaming), we are generally big fans of

teams. We understand the role of the team and we know we need to work jointly to

create monetization models, so that both of our businesses can be sustainable.

Running a team is a tough business because there's a lot of competition. Going

back to the founding story of ESL, we needed to build these ecosystems to create

stages for players and teams. We want ecosystems that give longevity and allow

teams to thrive. Our ecosystems can be operated alone, with a publisher or as a

service for a publisher.

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We started WESA as a body to work with teams directly. We now have a many

relationships with team owners; there are a few teams who have worked with us for

more than a decade. However, when we look at this as a whole industry there is a

lot to be figured out. We need to grow the pie and create value for all the

stakeholders we're working with, so that the pie is big enough to provide for

everyone. In my opinion this is extremely similar to traditional sport but with a

couple of key differences: yes, there are lower barriers to entry at each level but

then there is a lot more potential digital scale.

Let’s talk a little bit about the pie. Looking at industry trends, it’s clear that

Sponsorship has been the key driver of industry revenues hitherto. Can you

talk about how the opportunity in sponsorship has evolved? How much of

this is the game/tech industry advertising to itself and how much is the

platform being used as a genuine new medium for more ‘traditional’ brands?

There are a few ways to look at it. If we start by looking how this has evolved over

time, we can learn a lot. Looking back at 2000 when we founded ESL, there was no

market; the product was still in development so we had to sell a vision, which was

challenging. This said, I think we did a good job.

A key achievement in the first 10 years was creating a global relationship with Intel.

You could say Intel is equivalent to the Nike or Adidas of football. They were an

endemic partner which was wholeheartedly supporting the growth of the sport at a

very early stage.

We had plenty of other endemic partners in there, but they were mostly in for

campaign reasons. From 2006-2007, we started to see opportunistic sponsorship

start to become a bit more strategic with the endemic sponsors. From 2010 the

market became a lot stronger and by 2013-2014 the same process started with non-

endemic companies. At this stage, it shifted from more campaign driven, individual

marketer-oriented engagements (e.g. specific deals with Adidas and DHL as early

as 2008) to long term contracts.

From 2013-2015, non-endemic companies really began to look strategically into

sponsorship and nowadays, we have a number of engagements with brands like

Mercedes, DHL, Vodafone, and AT&T which are multiyear, multimillion dollar

engagements and are comparable to where we started with the endemic umbrella

brand Intel. It's a completely different world from where we came from. Today

sponsorship is strategic both with endemic and non-endemic brands and that

makes it extremely sustainable longer term.

The second point is that we have seen the size of the pie dramatically grow over the

last decade but compared to traditional sports I feel we are still under monetized in

terms of media value.

Traditional sports create around 3-5x more than we do compared to the media they

generate. The amount of partners is much higher for traditional sport as well, so

arguably there is still scale to be created, although, I think from a pure ESL

perspective, we'd rather work with a handful of partners in a very deep way, than 20

partners in a very shallow way.

When we look forward and consider new revenue opportunities, clearly the

big one is media rights. Can you talk about how you see this opportunity

evolving? Is this something that is only an opportunity for so-called Masters

events?

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Looking at traditional sports, a lot of the value (around 70-80%) is in media rights

revenue. This is still very different to eSports. Sponsorship is probably the largest

revenue stream in eSports. We look a bit similar to Formula One when you put in all

the host city fees and local contributions; however, the more media-live sports have

a very different profile.

So for us, media rights are in an early stage of evolution. We expect it will contribute

dramatically more to eSports in the coming years. Looking back at our pyramid we

believe it will be a bigger opportunity for the ‘Challenger’ and the ‘Masters’ level

events; as in any other sports the bigger the competition, the bigger the relevance

and the more aggressive the media rights competition is likely to be.

We believe that in the future local content will play a significant role, more so on the

‘Challenger’ level. So there is scope for at least half of the pyramid to see significant

further growth from media rights over time.

Can you talk about the interplay with eSports in a live setting and the

streaming platforms like Twitch and YouTube? Are they a threat to your

business or a complement?

They have a very different business model to us.

The question is not unusual as the industry is still relatively new, so people try to

find boxes to put companies in. A good way to compare us is asking the question,

are documentaries going to be a substitute to Hollywood movies? Both platforms

are primary distribution channels, they have been incredibly important and are one

of the reasons why the sport inflected in around 2010.

Yes, they are competing as content creators with us but that is only 5% of our

business, maybe less. There are always certain things companies from different

segments will do at the same level, this may lead to the occasional competition for a

team or sponsorship but it is really minimal.

I think the key question here is how we as an industry can improve monetization

around content and build premium content offerings that are being presented in the

right way. This is where the industry is lagging behind in my opinion.

Looking at the CPM (cost per thousand impressions) model in the old traditional

linear world, they're still a lot higher than they are on digital media platforms like

Twitch and that's without any data.

So that is one challenge, combined with ad blocking, which is a big challenge for the

industry and that means we need to keep working on a way to improve the

monetization for these distribution platforms. This is where the Asian distribution

platforms are really interesting. In Asia, the distribution platforms have mostly

replaced advertising models with consumer payments, with consumer engagement,

with micro transactions. I'm not saying that one or the other model is better, but the

combination of both and the continuous shift from traditional media toward digital

media, will play a big role in filling the gap and making digital content more

monetizable.

There is a lot of potential excitement about the rise of cloud computing –

what’s your take on platforms like Google Stadia and next gen consoles in an

eSports setting?

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The overarching message here is more people will have access to higher quality

and more complex video games. This is great news for me because it increases

engagement with video games and this increases the probability of deeper

engagement with eSports. It increases the chance that developers will create better

and more eSports-ready games as well as more viewership-capable games.

As a micro trend, it usually takes a while for eSports to pick up on a platform.

Looking back, PC games didn’t really take off until the late 90s with Quake,

Starcraft, and Counter-Strike. Touchscreen mobile games have been around 2007

and this took about 9-10 years: Clash Royale is the game I label as the early

eSports mobile game. In both cases it took about a decade for the platform to

develop and the software to cater for a rich multiplayer experience which is actually

watchable.

With cloud streaming, it's probably going to take a while to find the right game genre

and quality that really distinguishes the platform vs. PC or mobile. As a micro trend

it will probably take a while for it to make a real impact. Longer-term, though the

biggest opportunity will be the ability to really create participatory tournaments at

scale as it should be a really accessible platform but this will take a while.

Battle Royale games, have been a bit more of a challenge in terms of how you

make an eSports proposition exciting. Can you give us your latest thoughts

on why this has been a challenge and how you think it will evolve?

The technical challenges in broadcasting a Battle Royale game go deep and are

very obvious as the first half of the match is impossible to capture from a spectator’s

point of view as so much is going on. In the first five minutes 50 people leave the

match and every three seconds something significant is happening. In Counter-

Strike, by contrast, the first few minutes are quite slow and then the match begins to

climax.

For a spectator watching a Battle Royale game, you have a situation where they

move from a situation where they may not understand what is happening in the

beginning, to a midgame which you can start to get a grip on what is happening, to

an endgame which is very similar to all the traditional games.

Trying to make these first 10 minutes, or 50%, of a match interesting is a story

telling, technical and experience challenge. We did this big Katowice Royale

Fortnite tournament where we believe we implemented a few tricks/technical things

that made the first 10 minutes a decent experience, but there is still a way to go but

this is more of a development and technical challenge. To tackle this we need to

create more content and do tournaments and then iterate again.

Eventually, we will get to the point where the start is not super confusing and is

decent to watch. If we can tell that story from the beginning to the climax, it's going

to be good enough. The sheer amount of players and interest in Battle Royale in

general, and Fortnite specifically, is certainly helping to make it a viable eSports

business.

Do you think the video game ecosystem will consolidate longer-term or will it

become more fragmented?

Looking at the game landscape we think we will see both. There is a concentration

at the top with Tencent, Electronic Arts, Activision etc. they have dramatically grown

in the last 10 years.

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Also, at the same time Epic Games, PUBG Corp, Valve, Supercell, and many, many

others (even companies like Innogames which is owned by MTG) show that there

are a myriad of highly successful medium sized corporations being built, even if I

am not sure we can label Epic as medium-sized now or not — that is a little bit more

of philosophical discussion.

But the opportunity of distribution being easier than ever will certainly lead to more

and more creativity being out there and having direct access to large audiences.

I believe that there will be more amazing games and more amazing game

companies, and at the same time we will have a handful of huge ones with

awesome portfolios. But we are fundamentally not going to see an oligopolistic

market. This confirms the trend of the last 10 years.

Creativity is still the core piece to it and it's not scale or distribution it’s not all the

other things. It is a creative industry at its heart and that is the beauty of it.

How does being part of a bigger group like MTG impact you at ESL?

We made a very conscious decision in 2015 to join the MTG family. The clear logic

behind this was to have a relationship a larger strategic. There were a few reasons

for this.

First, we didn’t want to be constantly raising money because we didn't know how

fast the industry would scale. Being part of MTG helped us to really focus on our

business and it has allowed us to grow at the pace we have done over the last for

four and a half years, which has been quite a fast pace.

The second point was that MTG has been a media company and a games company

but not in a way that it was competing with some of our key clients, i.e., the

publishers. I think that was always important as well because it was like the

‘Switzerland’ of the entertainment industry in the past and now the games/eSports

industry of today.

Lastly, with our sister company DreamHack, we have some economies of scale but

more knowledge and R&D synergies there too. So the last four and a half years this

has been have been the right decision and the right track to move on.

Looking beyond ESL and MTG, how do you think about the future? What do

you think are the key challenges?

One of the reasons why we're so incredibly excited about what we're doing is that

we're in a linear growth industry. When there is hockey stick growth, you face a lot

of operational and sustainability challenges because there is a risk that growth

might prove temporary.

Gaming and eSports have always been a much more linear experience albeit with

the odd bump — certainly the Battle Royale issues have definitely levelled up the

industry — but most of the areas we are exposed to have long-term sustainable

growth potential.

In this context, we are trying to grow a tree with very strong roots. We have the time

to make sure that these roots stick across a certain amount of games on a handful

of platforms. I am more excited about building this than rushing to build a

‘skyscraper’ in the next 12 months which is at risk of falling part because we were

too crazy.

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A Conversation with Wil Stephens

CEO / Founder of Fusebox Games

Before we start and to set the scene, can you give us a bit of detail on your

background in the games industry?

I’ve spent 10 years building businesses at the cross-section of television and

gaming, seeking opportunities within the seismic shift in viewing, consumption and

participation of media.

As part of that process, I’ve been fortunate enough to found, build and exit

businesses in this space giving me a front row seat to the rapidly evolving media

landscape.

Can you talk a bit about Fusebox? How did the business come to be founded

and what are your key franchises so far?

Fusebox was founded in 2016 on the premise that the cost of acquiring users at

scale was becoming prohibitively expensive for small mobile players, therefore we

needed to use well-known brands as a catalyst to drive our downloads. At the same

time television companies revenues were at best flatlining and at worst falling and

were therefore actively looking for new revenue streams. At the intersection of that

particular Venn diagram we created Fusebox.

Our flagship titles are Love Island in partnership with ITV, The X Factor in

partnership with RTL Group’s Fremantle and Baywatch.

Figure 156. Love Island

Source: Fusebox Games

Wil is a Welsh entrepreneur with extensive

experience of building transformational

businesses in television, games and

interactive entertainment. Wil is CEO of

Fusebox Games, an interactive

entertainment company he co-founded in

2016 that develops and publishes mobile

games based on hit TV shows.

Wil founded his first business aged 23 and

as CEO of Cube Interactive, led the

company to win BAFTAs and Broadcast

Digital Awards for their ground-breaking TV

formats and games. After growing Cube

Interactive to offices in Cardiff and London,

he joined the leadership team at New York

based video streaming company Boxee to

build out their international business, later

acquired by Samsung.

Wil was born and raised in Aberystwyth and

now lives in Brixton, London. He is a

member of ‘Speakers for Schools’ which

provides talks to state schools to empower

the next generation, is a Fellow of the RSA

and a member of BAFTA.

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The gaming sector is a fast-paced industry at the best of times but mobile

gaming can be especially frenetic. For those of us who are uninitiated with the

space, what are the key attributes/variables that you think drives success in

the space? How has this changed or evolved over the time you have been

active in the industry?

Firstly, quality is paramount. The start and end point is a great game crafted by an

exceptional team. Nothing beats raw unfiltered feedback from millions of players

and if you haven’t delivered on their expectations, you’ll know about it. Negative

reviews and sentiment kills good games and only the great survive.

Secondly, on metrics, the market is shifting (again) and it’s becoming very hard if

not impossible to play the short-term acquisition/monetization arbitrage game. You’ll

see consolidation and a huge shakeout in the hyper casual market as this new

reality bytes.

The reality of mobile now is you’re better be building your franchises for the long

haul, say 3-5 years plus, to capitalize on the repeat monetization of your user base

you’ve worked so hard to acquire. Returns are getting longer to deliver but

ultimately end up being much bigger. Scale matters.

In an industry which appears to be obsessed with the importance of creating

proprietary IP, what is interesting about Fusebox is that you have partnered

with third parties like ITV to bring established TV brands into a gaming

context. Can you talk about the pros and cons of the partnership model vs.

internally generated IP?

Firstly, scale is hugely important in mobile games. We got to scale quickly through

leveraging IP to rocket us forward and by giving players an opportunity to play

within familiar worlds. This familiarity led to increased and faster monetization,

strong retention and all other key metrics indexing higher than our peers. It’s a great

model that’s worked out well for us and our commercial partners.

However, you only have to look at the Netflix playbook to see how scale can

translate into an opportunity to create and deploy original IP. Netflix took years in

building its platform on catalogue content before moving their vast eyeballs onto

their own content. A similar opportunity will present itself for Fusebox as all the

users we acquire, we control and we learn through data about their interests,

behavior and gameplay patterns.

When to make that move is a big question and all I know today is we’re some way

off being ready to do that shift.

Fusebox games are centered on choice-based narrative. Do the points you

make about IP apply only to this genre or could it apply more broadly?

We chose choice-based narrative games as it’s a great genre to be in: huge

monetization opportunities and long gameplay retention. It’s unbeatable as a

category in terms of return on investment on your development costs. It also fits

with our belief of creating mass-market entertainment for all, not only for niche

gamers. Everyone loves a good story.

The opportunity to work with IP is across all genres, however, and there are a

number of successful studios deploying different styles of games for all sorts of IP.

For now, we’re staying focused and will continue to innovate the narrative genre.

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Can you also talk about the behavior of gamers how this differs by

age/gender and across different gaming genres in mobile? Can we make

generalizations about different cohorts of mobile gamers?

Absolutely. Different genres of games appeal to different demographics, as you’d

expect. Games are typically categorized as hyper-casual, and as the name

suggests are fleeting players with zero loyalty, mid-core that tend to attract a wider

group of non-gamers and then core gamers who are really the more stereotypical

gamer who’d traditionally been heavy console players.

Looking at Fusebox in particular, as you have mentioned in the past, your

games are extremely popular amongst the female demographic. What impact

do you think this has had on your performance and how does this impact

what kind of IP/genre you focus on going forward?

Fusebox targets the mid-core market, so players that don’t necessarily identify

themselves as gamers and have a wide range of interests. We have a strong

female demographic, around 85% of our players are women, and that’s been a

deliberate move on our part. Our players spend more money, are more loyal and

are more open to sharing the game within their friendship groups. All three of those

core metrics, monetization, retention and virility are a huge driver of our success.

Looking at broader industry developments, with services like Google Stadia

we are on the cusp of a significant evolution in the rise of cloud computing

where mobile devices could end up being used for much more sophisticated

gaming experiences. How disruptive do you think this will be for the so-called

casual (mobile) gaming sector?

It will likely make casual games easier to plug into vast networks and become multi-

player by default. This has historically been an arduous task where each develop

re-writes an entire software platform to facilitate real-time social action within their

games. That could send us back to the early days of Facebook games with

FarmVille updates taking over your social feeds or could lead to more innovation

and more interesting co-development between studios that have a similar player

base.

It looks like the mobile game development industry is relatively fragmented.

Can you talk about the benefits of scale in this context? What is the ideal size

for a mobile game developer? And is there any benefit in being part of a

bigger group?

Scale matters. To compete in this market you need a very strong balance sheet to

continuously deploy vast UA budgets until you get to such size that that the network

effects of being able to move your players around your network of games becomes

a material advantage over those still having to purely pay for players.

How do you see the developer/publisher/distributor landscape developing

longer term? Will we see the mobile gaming segment begin to consolidate?

And what form do you think it will likely take — vertical integration

(distribution merging with developer/publishers) or horizontal consolidation

amongst publishers/developers?

In mobile, we’ll start to see the classic studio model deployed, a model successfully

rolled out for years by the TV industry, where a common owner controls a number of

studios each autonomously creating their own games and run as independent

creative endeavors.

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The key to mobile game studios is understanding that it’s all about the people and

the talent, disrupt that and you’ve lost all the goodwill you’ve paid a lot of money for,

so we’ll start to see these common controlled network of studios all share support

services but operate fiercely independent of each other. Tencent do this very well

and its model that will become more prevalent.

The market is dividing into three key groups: the sub $100m companies are all a

tasty snack for the big $1bn+ players, anything between $100 and $500 are largely

orphaned and are finding it very hard and finally the big $1bn+ players are all going

around eating the world.

The key for the small snack sized companies such as Fusebox is to cross the

chasm to become their own $1bn player. It’s a perilous journey; you don’t want to be

stranded half way across but if you do make it, well, wouldn’t it be great to see a

British player emerge to join the elite group of the $1bn+ mobile powerhouses.

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COMPANY NOTES Amazon

Amazon is one of the largest firms in the world. The firm began in Internet retailing.

But, it has expanded into a wide array of adjacent businesses, including gaming.

The major push in gaming began in 2014. That year, Amazon acquired Twitch, a

video game broadcaster, for $970 million. That same year, Amazon acquired Double

Helix, a video game studio.

Double Helix was formed in 2007 after The Collective and Shiny Entertainment

merged. Double Helix developed seven titles including Silent Homecoming (2008),

G.I. Joe: The Rise of Cobra (2009), Front Mission Evolved (2010), Green Lantern:

Rise of Manhunters (2011), Battleship (2012), Killer Instinct (2013), Strider (2014),

and UFOs Love COWs (2014).

In 2018, Chris Hartmann joined Amazon Games. He will lead the entire studio and

marketing organization including development teams in Seattle, Orange County,

and San Diego. Mr. Hartmann spent two decades at Take-Two. And, while he was

there helped develop key video game franchises (NBA 2K, Borderlands, Bioshock,

and Civilization). Currently, Amazon is working on two new titles: New World and

Crucible. In a recent interview, Mr. Hartmann said:

“Between the teams at AGS, the incredible tools and technology from AWS, the

global communities of Twitch and Twitch Prime, and all of the other assets around

Amazon, there are few companies in the world set up to take gaming to the next

level.”

Amazon recently developed a gaming API called GameOn. GameOn is made for

video game developers to integrate competitions, leagues and prizes. The API is

platform agnostic across PCs, consoles, and mobile devices. In 2016, Amazon

created Lumberyard which is a game engine for independent developers.

Lumberyard is still a niche service relative to more established game engines (like

Unity and Ultimate Engine).

Apple

Although Apple is a key hardware (Mac, iPhone) and software player (macOS, iOS),

the firm plays a relatively small role in the broader video game ecosystem. Of

course Apple does operate the Apple App Store. In their app store, Apple collects

30% of any one-time purchase. And, if a consumer subscribes to a service – and

remains a subscriber for a year — the distribution fee drops to 15%. The installed

base of iOS is about 900 million units. And the installed base for Mac is about 100

million units. As such, we suspect Apple is generating the lions’ share of the service

fees from the mobile platform.

Apple recently announced Apple Arcade. The service will allow a user to subscribe

to the arcade and get access to many game titles for a fixed monthly fee. At this

time we don’t know the retail price point of the service. Nor do we know now many

games will be available at launch. But, we don’t expect iconic hit games to be part

of the offering. We expect the service to launch in 2H19. We suspect Apple Arcade

will appeal to casual gamers and families who want to control the content of their

child’s games.

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Aristocrat

Aristocrat is a publicly listed Australian based gaming company. The firm began by

manufacturing slot machines in 1953. In 2017, the firm began to expand into mobile

gaming via M&A. It first acquired Plarium, a mobile game developer. Plarium made

games like Vikings, War of Clans and Sparta. In 2018, the firm acquired Big Fish.

Big Fish published game titles like Gummy Drop, Cooking Craze and Big Fish

Casino. (Previously, Big Fish was owned by Churchill Downs.)

Bandai Namco Entertainment

Bandai is a Japanese video game developer. Best known for developing PacMan

and Tekken game franchises. Owned by Bandai Namco Holdings, a Japanese

entertainment conglomerate. Formerly known as Namco Bandai.

BioWare

A game development studio acquired by EA in 2007. Best known for its

development of Mass Effect, Anthem, and EA’s previous Star Wars titles.

Bluehole

South Korean game developer best known for its development of PlayerUnknown’s

Battlegrounds (PUBG) via its PUBG Corp. subsidiary. Bluehole rolls up to a holding

company called Krafton Game Union. Bluehole is privately held; its second largest

shareholder (after the founder) is understood to be Tencent.

Bungie

An independent game development studio founded in 1991. Best known for its

development of Halo (for Microsoft) and Destiny (for Activision). Acquired by

Microsoft in 2000 and spun out again in 2007. Made news in early 2019 by

announcing a termination of its partnership with Activision on Destiny; Bungie plans

to self-publish future iterations of the game. Bungie has significant equity backing

from NetEase.

Caffeine

Livestreaming platform founded in 2016. Still small relative to other livestreaming

platforms. Founded by former Apple TV programmers with backing from (new) Fox.

Competes with Twitch, Mixer, and UStream (IBM Cloud Video).

Capcom

Japanese video game developer founded in 1979. Best known for development of

Street Fighter and Resident Evil. Publicly traded.

CD Projekt

Polish developer/publisher and owner of GOG.com, the digital distribution platform.

As a developer/publisher, best known for The Witcher 3: Wild Hunt. Also

responsible for development of Cyberpunk 2077 franchise (we expect to be

released in 2020).

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Discord

Owner of a communications software application popular among gamers as well as

a recently-launched online game storefront. Discord’s chat software is popular on

live streaming services like Twitch. In 2018, Discord introduced a digital storefront to

compete with Valve’s Steam and Epic’s Games Store. Initially, Discord’s revenue

split is lower than those of Valve and Epic.

DoubleU Games

DoubleU is publicly listed Korean casino mobile games firm that makes four popular

games for Android and iOS. They include DoubleU Casino, Take 5, Hello Vegas,

and DoubleU Bingo. As games require an in-app purchase but are ad free. DoubleU

Games acquired Double Down Interactive (a subsidiary of International Game

Technology) in 2017 for 2.9x LTM revenue. DDI’s flagship game is DoubleDown

Casino but the firm also has smaller games including Texas Tea, Golden Goddess,

Ultimate Poker, and Firehouse Hounds. The pro forma entity is poised to generate

more revenue than Zynga.

Epic Games

A developer/publisher of video games, the developer of Unreal Engine, and owner

of the Epic Games Store. As a game developer, Epic has been active for nearly 30

years and is best known for Fortnite Battle Royale. As the developer and owner of

Unreal Engine, Epic has provided the architecture upon which many titles (both

independent and publisher-backed) have been written. The Epic Games Store was

opened in late 2018 and competes with Steam. Epic has equity backing from

Tencent and KKR, among others.

GameStop

Retailer that’s traditionally focused on physical game and game

hardware/accessory sales. Has recently made investments in both professional and

amateur eSports initiatives in an effort to diversify its business as physical game

sales have declined. Put itself up for sale last year; announced early in 2019 that no

deal had been struck.

Google

One of the world’s largest firms. A pioneer and key player in Internet search. Google

developed the mobile Android operating system (used on many non-Apple

smartphones). Heavy exposure to the mobile AdTech ecosystem. Firm also owns

YouTube, which is increasingly competing with Amazon’s Twitch and is a significant

player in the cloud ecosystem (competing with Amazon and Microsoft). Recently the

firm announced new cloud gaming platform: Stadia. Google has a significant

number of other material ‘moonshot’ investments: Waymo (driverless cars), Verily,

Calico, etc.

IBM

Tech conglomerate who owns and operates IBM Cloud Video (formerly Ustream),

which it acquired in 2016. IBM Cloud Video is a service that allows users to stream

and host videos and is used in the gaming community to broadcast games and

other content. IBM Cloud Video is a competitor to Twitch.

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Jam City

Jam City is a private mobile games company (formally known as SGN). Popular

titles include Cookie Jam and Jam Juice. The firm recently released Harry Potter:

Hogwarts Mystery which press reports suggest generated 30% of the firm’s total

revenue. The firm is private, but press reports suggested management was

considering an IPO. They recently acquired the mobile games rights for the Peanuts

cartoon series. In 4Q19, the firm also reached an agreement with Disney to license

the firm’s Disney Emoji Blitz characters. Key investors include Netmarble (South

Korean mobile games company) and Jeff Bezos’ Bezos Expeditions.

Kabam

Kabam was a private mobile games company founded in 2006 under the moniker

Watercooler. The firm changed its name in 2010. In 1Q17, Netmarble acquired the

vast majority of the firm. Kabam does still retain some IP.

Konami

Japanese entertainment conglomerate whose holdings include a video game

development studio and publisher. Best known for developing Yu-Gi-Oh, Metal

Gear, and Dance Dance Revolution. Publicly traded.

Microsoft

Microsoft is perhaps the most vertically integrated video game firm in the world. The

firm own IP (Halo), has a game development arm (Xbox Game Studio), a publisher

(343 Industries), controls graphics APIs (DirectX), makes hardware (Xbox),

distributes games (Game Pass), is testing cloud gaming (Project X Cloud) and owns

a game broadcaster (Mixer). Phil Spencer aims to bring Game Pass to every device

(including Android mobile phones) with the Project X Cloud initiative. Moreover, the

firm has begun to invest is more first-party games, albeit on a limited basis. The firm

formed a new studio — called The Initiative — and acquired four studios to help

jumpstart the process: Ninja Theory, PlayGround Games, Undead Labs, and

Compulsion Games.

Modern Times Group

Modern Times Group is a pure play video games business with operations across

eSports and mobile/web gaming. The group started life as a free and pay TV

broadcaster with operations across the Nordic region as well as Central and Easter

Europe. In 2015 the group began to diversify into eSports with the acquisition of

ESL (82% owned) and DreamHack (100%) and in 2016/2017 expanded into

mobile/web games with the acquisitions of Innogames (51%) and Kongregate

(100%). In 2019 the group spun-off its broadcasting business and now operates as

a pure play video games business.

MZ

MZ is a private U.S.-based mobile games company which was founded in 2008.

Previously, the firm was called Addmired and Machine Zone. The firm’s breakout

game is Game of War: Fire Again which was released in 2012. The firm launched

Mobile Strike in 2015. In 2016, MZ partnered with Square Enix to develop Final

Fantasy XV.

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Netmarble

Netmarble is a publicly-listed Korean mobile games company. Key titles include

Lineage 2: Revolution and Seven Knights. The firm tends to focus on massively

multiplayer online role-playing games (MMORPG). But, in 1Q17 it acquired Kabam

(who developed video games for the Marvel franchise, among other games).

NetEase

NetEase is a publicly-listed Chinese Internet company. Around 50% of the firm’s

total revenues come from online games (with the balance from e-commerce, ad

services, email and other services). Key titles include Fantasy Westward Journey,

Onmyoji, New Ghost as well as a number of games licensed from Activision

Blizzard (including Hearthstone).

Niantic

Niantic Labs was started in 2010 as an internal start-up of Google. The firm became

an independent company in 2015 but it is still private. Niantic has made a number of

acquisitions. In 2017, the firm acquired Evertoon, an app that allows consumers to

make short films. In 2018, the firm acquired three firms focused on augmented

reality (AR): Escher Reality, Matrix Mill and DigiLens. Later in 2018, Niantic

acquired Seismic Games, the co-developer of Marvel Strike Force. Niantic also

created Pokémon Go in partnership with Nintendo. Pokémon Go was downloaded

over 750 million times.

Nintendo

Japanese developer/publisher and hardware manufacturer that’s been focused on

gaming since the 1970s. As a developer/publisher, best known for Mario, Zelda, and

Pokémon franchises (Nintendo has partial IP ownership of Pokémon). As a

hardware manufacturer, best known for Nintendo 64, GameCube, Wii, GameBoy,

and Switch. The Switch product has broken ground as a hybrid handheld/console.

Publicly traded.

Nvidia

A manufacturer of electronics components, including semiconductors, that has a

significant presence in the video game market. Its primary gaming products are its

GeForce and Grid graphics processing units (for consoles and cloud gaming,

respectively), which enable real-time 3-D graphics to be displayed. Also produces

Nvidia Shield, a set-top box that facilitates gameplay (via either downloaded or

streamed games).

Oculus Rift

Manufacturer of a virtual reality headset that can be used to play video games. To

play a game using Oculus, the game must support Oculus specifically; the hardware

is used in conjunction with specific software from distributors such as Steam.

Oculus is owned by Facebook (acquired in 2014). Competes with other VR

hardware products such as HTC’s Vive and Sony’s PlayStation VR.

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Playtika

Playtika is a mobile game company owned by Caesars Entertainment. The firm

focuses on social casino games. Titles include Caesars Slots, World Series of

Poker, and Poker Heat. Playtika competes with firms like Aristocrat. But, many

believe Playtika is the market leader in social casino games. In 2016, a consortium

of Chinese firms (led by Giant) agreed to acquire Playtika for $4.4 billion from

Caesars.

Respawn

A game development studio acquired by EA in 2017. Best known for its

development of Titanfall and Apex Legends. Also responsible for the development of

EA’s latest Star Wars adaptation, due for release in 2019.

Riot Games

U.S. video game developer founded in 2006. Best known for developing League of

Legends. In addition to game development, Riot is active in eSports: it operates the

League of Legends competition (in which team franchises and broadcast rights

were sold). Fully acquired by Tencent in 2015.

SciGames

Scientific Games is a U.S. public listed company that focuses on the gaming

business. About 10-15% of the firm’s revenues come from their interactive division.

Notable apps include Jackpot Party Social Casino, Gold Fish Casino Slots, and

Bingo Showdown.

Sega Games

Japanese company whose current activities include developing and publishing

video games. As a publisher, best known for Sonic the Hedgehog. Until 2001, was

also active as a manufacturer of gaming hardware, including consoles. Operates as

a subsidiary of Sega Sammy Holdings.

Slack

Slack is a communications software company whose web chat technology can be

used within video games. Within the context of gaming communications, it

competes with companies like Discord and Vivox (Unity).

Sony

Sony is a Japanese tech-driven entertainment conglomerate. It has been behind the

PlayStation brand console game business for more than two decades now.

Recently it has taken the PlayStation as a platform and expanded it, as the PS Plus,

into a networked business, which has more than 36mn paying subscribers. It is

expanding the franchise still further, with the PS VR virtual reality headsets, the PS

Now cloud game services, and the PS Vue TV broadcasts. Some 20% of game

software is developed in-house and recently Sony has been turning out hits such as

Spider-Man and God of War.

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Square Enix

Japanese game developer founded in 1975. Best known for developing the Final

Fantasy franchise, which has sold >115 copies since 1987. Known to use both

Unreal Engine and Unity Engine for game development in addition to its internal,

proprietary game engines. Has made entrees into the cloud gaming market (with

limited initial success). Publicly traded.

Supercell

Supercell is a publicly-listed Nordic company focused on the mobile games

business. The firm was founded in 2010. In 2013, Softbank bought 51% of

Supercell for about $1.3 billion. Softbank increased its stake to 73% of the firm over

the next few years. In 2016, Tencent acquired 84% of Supercell for $8.6 billion. Key

titles include Clash Royale and Brawl Stars.

Take-Two Interactive

Video game publisher founded in 1993. Best known for developing Grand Theft

Auto and Red Dead at its Rockstar Games studio. Also develops sports titles, such

as NBA 2K.

Tencent

A Chinese tech conglomerate considered to be the world’s largest gaming company.

Has also invested aggressively in Western gaming companies in recent years,

including having acquired or taken equity stakes in Riot Games (fully owned), Epic

Games (minority stake), Activision (minority stake), Ubisoft (minority stake), and

Bluehole (minority stake). Owner of Honor of Kings, the world’s highest-grossing

mobile game, and League of Legends (via Riot). Also active in eSports via the latter

title. On the cloud front, Tencent recently began testing a cloud-based gaming

platform in China with Intel called “Tencent Instant Play”.

Treyarch

A game development studio acquired by Activision in 2001. Best known for its

development of the Call of Duty franchise.

Ubisoft

Ubisoft Entertainment is one of the world’s leading vertically aligned developers,

publishers and distributors of video gaming content for consoles, PCs, smartphones

and tablets in both physical and digital formats. The group’s key franchises, all

developed organically, include Assassin’s Creed, Tom Clancy’s Ghost Recon, Tom

Clancy’s Rainbow Six, Tom Clancy’s The Division, Watch Dogs, For Honor, and The

Crew. The group has a strong market position (about 10% share) within console

and PC gaming in developed Western markets but has a much smaller share

(around 2%) when compared with the broader global video game market, with

significant underweight positions in Asia Pac (by geography) and mobile (by

platform). In 2018, the group signed a long term strategic partnership agreement

with Tencent.

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Unity

A game engine used to power a significant portion (~50%) of games, both in the

mobile and console/PC setting. Especially popular among developers due to

economic arrangement: Unity takes a fixed fee for use of its technology rather than

a split of revenues, as some other engine owners do. Competes with Epic’s Unreal

Engine.

Valve

Valve is a game developer, best known for Counter-Strike and Dota 2. Also

coordinates and operates professional tournaments and match play for both titles.

As owner of Steam, Valve offers a large distribution platform for independent game

developers.

Vivendi (Gameloft)

Vivendi is a publicly traded French company with a diversified collection of media

assets. One of those assets is Gameloft, a video game publisher. Gameloft was

founded in 1999 by one of the five founders of Ubisoft. In 2015, Vivendi acquired a

6% stake in Gameloft. By 2016, Vivendi owned over 95% of in the firm. Popular

Gameloft titles include Asphalt and Gangstar New Orleans OpenWorld.

Vivox

A communications service owned by Unity. Used primarily for text and voice chat

within games. Prominent due to its use in Fortnite, PUBG, and League of Legends.

Competes with Discord’s chat product (among others).

Zynga

Zynga is a publicly listed U.S. company focused on mobile games. FarmVille was

one of the firm’s best known games (which was launched in 2009). Every year, it

seems, Zynga acquires another mobile games entity. Prior acquisitions include

OMGPop (2012), NaturalMotion (2014), Harpan (2017), Peak Games (2017), and

Small Giant Games (2018).

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VIDEO GAMES: CLOUD INVADERS - CitiFirst

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