Global Video Games Investment Review

Digi-Capital's Global Video Games Investment Review update for November 2010 is now live and downloadable from SlideShare.

Merel to present investment review at Shanghai World Expo

This interview by Phil Elliot, ahead of Tim's presentation at Shanghai World Expo, UK Pavillion was first published by Games Industry. Biz on September 15, 2010.

New GamesIndustry.biz monthly columnist, Tim Merel, is to present the latest version of his Global Video Games Investment Review at this year's Shanghai World Expo, UK Pavilion - and he's offering five readers free passes to the invitation-only event.

The session and following meetings will focus on both Chinese companies and investors operating internationally, as well as international companies and investors seeking to co-operate with Chinese firms within the country itself.

"I'm grateful to have been asked to talk to some of China's greatest games companies, media companies and investors in their home country, and in particular at the spectacular Shanghai Expo UK Pavilion," said Merel.

"I'm hoping that the session and following meetings will help Chinese companies and investors to broaden their investment horizons internationally, while also providing a new way for international companies to work in partnership domestically with leading Chinese firms."

The review focuses on investment, merger and acquisition, and joint venture opportunities in videogames (including MMO, casual/social online, mobile, console, online gambling, skill based, and in-game advertising sectors) for industry players and investors (including major and independent videogames companies, private equity and venture capital firms, and major media, telecommunications and technology companies).

Money Games: Tencent

This article was first published by Games Industry.biz, on Sept 14, 2010, as part of Tim's monthly column 'Money Games'.

As the business of videogames moves ever more into the spotlight, GamesIndustry.biz is pleased to bring you a new monthly column from Tim Merel.  Each month he'll be examining a subject or sector of interest, beginning here with China-based company Tencent - and why it could be the biggest videogames company you might not have heard of.

Who am I?

Let me start by apologising - I used to be a lawyer, then I worked for Rupert Murdoch... and now I'm an investment banker. But - I'm also a software engineer, I write adventure stories, and I play a mean guitar, so life is a balance!

We're starting my monthly column with a profile of the greatest games company you may not know, Tencent. "No!" I hear you cry. "Surely Activision Blizzard, Electronic Arts, Take-Two or Zynga is the greatest?" Well, this all depends on your perspective, and when your perspective happens to be money, things change.

So who is Tencent?

To explain the praise for Tencent, let's start with some data. And again, I apologise; I tend to use a lot of data. For the innumerate, please look away now.

• China has 29 per cent internet penetration, but 382 million users.
• China is forecast to reach 56 per cent internet penetration (754 million users) by 2015.
• Tencent holds dominant or leading stakes in many Chinese online/mobile markets (IM, games, eCommerce, search, mobile services).
• Tencent's Chinese games market share was 20 per cent in 2009, forecast to hit 27 per cent by 2012.
• Tencent's market capitalisation - which is in the order of ¥241 billion ($35 billion) with an enterprise value of 35x 2009 EBITDA in August 2010 - was greater than Activision Blizzard, Electronic Arts, GameStop, Take-Two, THQ, Atari, Game Group and Ubisoft combined.

So what about Sony, Microsoft and Nintendo? Okay, so Tencent is about halfway between Sony and Nintendo's market caps, and nowhere near as large as Microsoft. But (a) we're talking about game software not hardware and (b) Sony and Microsoft do a couple of other things too.  

Tencent's integrated model is where the market is headed

Tencent generates around a 50 per cent operating margin. Online/mobile games (MMO, board & chess, casual/social) generate more than 40 per cent of its revenue. Tencent's business model appears to be migrating from virtual items (higher Average Revenue per User) to subscriptions (short term revenue reduction, but lower volatility), which is a reversal of the trend they started. Expect to see the same thing happening in Western markets in 12-18 months time, which is roughly the lag between China's pioneers and the West's followers. Of great importance, Tencent has an integrated business model with upgrades and privileges across online, mobile and offline (not just games), delivering a significant advantage for customer acquisition, development and retention. It capitalises on enhanced capabilities to cross-promote, upsell and cross-sell. Facebook could learn a lot from them about how to make even more money.

Tencent has some natural advantages which help enormously

I like this first chart a lot, because it contrasts the growth in online/mobile games with the flat console games market, which is great if you're a pure online/mobile company like Tencent.

The next chart helps to clarify things further, forecasting that Asia-Pacific will become the number one market by revenue, with Europe at number two and North America at number three. A very large proportion of Asia's strength comes from China - Tencent's home market - where online/mobile games account for the bulk of revenue.

Whether or not you have faith in the forecasts themselves, directionally they're correct. The videogames market is going online and mobile, with China a large part of those markets. Again, that's great if you're the leading player in online/mobile games in China.

While not going into depth on how Chinese online/mobile videogames business models work, there are a few key elements to note:

• Community focus around the games experience
• Active interaction with gamers to refine both user experience and commercialisation
• Focused commercialisation based around high volume, micro-transaction subscriptions, virtual items and some advertising
• Games as a service, not a product, with multi-year revenue streams, revenue sharing post recoupment of development budgets and continuous, low cost development through game lifecycles post-launch

The charts below help to understand Chinese online game dynamics in general.


Chinese Gross Game Revenue Profile (¥) Example*

Chinese Total Staffing per Game Profile Example*

And what does all of this produce? 49 per cent games revenue growth over the last five quarters, and around seven million peak concurrent users of Tencent's mini casual games alone. Snap your fingers, and more than the population of Ireland are playing a Tencent mini casual game - not 7 million uniques per month, 7 million uniques right now.


Tencent Quarterly Game Revenue (¥ million)

 

Tencent will be in your market soon, if it isn't already


Across the full Tencent games portfolio, you reach around 20 million peak concurrent users, or slightly less than the population of Australia. That's what happens when you're the number one Chinese games company.


Tencent Mini Casual Game Concurrent Users

Chinese Game Company Revenues ($ million)*

 
I was lucky enough to have lunch with Bo Wang from Tencent recently, and it is clear that despite Tencent's advantages the company is actively expanding into new areas. Now annual market growth has cooled to a mere 30 per cent (from 70 per cent-plus), Tencent is looking to leverage its strengths across segments domestically and internationally. But as with all things Tencent, this isn't just talk and it isn't small. There are domestic partnerships:

• China Unicom (fixed line, 3G, operations, "QQ Wallet")
• Hunan TV (talent, animation, online/mobile games)
• China Merchants Bank (financial services)

There are also international partnerships/investments:

• Digital Sky Technologies (Facebook, Zynga, Mail.ru investor)
• Vina Games (Vietnamese online games/internet)
• MIH India Global Internet (licensed software, content & trademarks)
• Naspers (36 per cent Tencent investor) with global reach in high growth markets

All the major videogame, technology and media companies in North America and Europe are both fascinated and slightly nervous about the major Chinese companies entering their home markets. The only advice I can give is to learn from Tencent fast, because these guys mean business and they know what they're doing. It is only a matter of time before they become as strong internationally as they are at home, so watch out!

The UK Government has asked Tim to present his Global Video Games Investment Review to 100 senior executives from videogames companies, media companies and investors at the Shanghai World Expo UK Pavilion on September 28. The session and following meetings with will focus on both Chinese companies and investors investing internationally, and international companies and investors seeking to co-operate with Chinese firms in China.


Sources: PWC, Capital IQ, Credit Suisse, Companies, *presented by Bo Wang at GDC Europe 2010

Online and Mobile Games should generate more revenue than console games

First published by Venture Beat, on August 10, 2010 (reappeared in New York Times).

The video games industry is big and getting bigger. But it’s changing. Console games are getting riskier to make, while online and mobile games are taking over the market (see my updated Global Video Games Investment Review, which I’ll be using to open GDC Europe).

Today online and mobile games generate about a third of all games software revenues globally. In five years’ time they are forecast to generate 50 percent of all games software revenue, or around a fifth more revenue than pure console games. This morning, market researcher iSuppli said that cell phone games are growing fast as console and handheld games sputter. Whether you have faith in the forecasts or not, executives from the major U.S., European and Asian publishers all tell me that this is what keeps them awake at night.

What excites me about the online and mobile games markets is that they are both high-growth and profitable, which is pretty rare. The leading competitors are growing revenue 100 percent-plus annually while also delivering 20 percent to 30 percent EBITDA (earnings before income tax, depreciation and amortization) margins. Add to that a fragmented industry structure, no dominant leaders yet, plus clear strategic exit options, and it looks like this is the time for strategic game and media companies, as well as financial investors, to invest.

However, major publishers aren’t structured to invest in online and mobile. Their core competencies focus on management of $20 million-plus serial, high risk, complex developments, launches and commercialization. Online and mobile games require rapid, multiple, small-scale parallel development platform investments. It’s a completely different business culture. As a result, major publishers aren’t driving investment in those games the same way they did console games.

In parallel, generalist venture capitalists are investing less in video games. Despite the rapid growth of the online and mobile games markets, VentureBeat’s own analysis shows investment in games companies dropping 36 percent from 2008 to 2009. Our analysis (which uses different definitions) shows VC investment across video games in 2009 had dropped by 60 percent from its high point in 2007. The drop has come from general VC market weakness, combined with limited knowledge and relationships across the complex, fast-moving online and mobile games sectors.

I am constantly being approached by high-quality, high-growth online and mobile video games companies from the U.S. and Europe who are finding it harder than you’d expect to get the funds they need to drive growth during this critical stage, before the industry consolidates. Quality demand is exceeding quality supply of investment and board representation.

Why a growth capital games fund could fill the investment gap

The opportunity now exists for major strategic video games, media and financial investors to maximize returns from online and mobile, so high quality deal flow is needed. Yet entrepreneurs typically avoid direct corporate investment prior to exit, so major strategic players aren’t seeing quality deals until merger and acquisition time when valuations are full or already prohibitively high. As before, the generalist VC market isn’t putting enough money to work here either.

I believe that a growth capital game fund is the most promising approach, investing in online and mobile games companies rather than more common and higher risk project-funding of individual games. A true growth capital game fund would invest in working capital (debt convertible into equity via convertible loan notes), venture capital first, second, or third rounds (early stage equity) and growth equity (later stage mix of equity and some debt) in multiple, parallel game business development platforms (not “one game” hit driven companies). That’s where the strategic and financial investors should be looking to invest across the U.S. and Europe. Asia is also interesting, but you need local partners to make it work.

In terms of focus, I like companies like Bigpoint, with a portfolio approach for both games (DarkOrbit, Deepolis, Farmerama) and distribution (limited reliance on Facebook). I also like online/mobile games B2B middleware companies like Live Gamer. I’m less enthusiastic about predominantly single game companies like Jagex (Runescape), and the Facebook players (Zynga, EA Playfish). These companies aren’t diversified enough. Primary dependence on one game or one distribution channel is a bit risky for my tastes, as any game can decline or Facebook can turn you off or charge increasing rents.

The real difference with this approach is the delivery of earlier stage investments than otherwise possible, meeting the needs of high-growth companies independent of stage while also managing investment risk. With the right relationships and management, this could yield high growth capital returns (greater than 30 percent internal rate of return) or three to six times money multiple (where the company sells for several times what went into it) due to investment at lower, earlier stage valuations than typical acquisitions. So long as the rules of engagement are clear, there is substantial opportunity to make money by investing in the growth of the best online and mobile games companies.

In short, the video game funding model needs to be reinvigorated in the same way that online and mobile are reinvigorating the video games industry as a whole. The console industry today looks a lot like the old media industry 10 years ago: cash generative, revenues flat to down and cost focused. Fortunately there is a real opportunity for the games industry to attract investment in online and mobile to avoid a declining future. I believe it will happen.

'Time is right' for mobile and online investment: GDC Europe Presentation

Interview by Phil Elliot, first published by Games Industry.biz on 27 July 2010, ahead of opening presentation at GDC Europe in Cologne, August 2010.

Tim Merel will be discussing the opportunities for investment in the videogames space at next month's GDC Europe, taking place in Cologne.

According to the investment bank's director, the mobile and online sectors are ripe for investment, and he'll be outlining some of the findings from the company's updated Global Videogames Investment Review.

"The videogames industry is big, getting bigger and changing, with console game costs, revenue and risks accelerating and online and mobile games growing and fragmenting the market," he said. "Investment dynamics are entering a new phase, with growth investment opportunities in online and mobile games, as pure console sector growth is flat (and risky).
"Today online/mobile games generate around a third of all games software revenues globally. In five years' time they are forecast to generate 50 per cent of all games software revenue, or around a fifth more revenue than pure console games.

"Whether you have faith in the forecasts or not, CEOs and senior execs from the major US, European and Asian publishers all tell me that this is what keeps them awake at night. What excites me about the online and mobile games markets is that they are both high growth and profitable, which is pretty rare. The leading competitors are growing revenue 100 per cent-plus annually while also delivering 20-30 per cent EBITDA margins.

"Coupled with a fragmented industry structure, no real market dominance and clear strategic exit options to the major videogames and media companies, the time for investment is now."

More information on GDC Europe is available from the official website, and GamesIndustry.biz will be on hand to report on the event.