EDITOR: | February 5th, 2020

Esports doesn’t have to be high risk

| February 05, 2020 | No Comments
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Last week I was chatting with a new investor who came into our company and I asked him, “What was the main reason you deciding to invest?” He told me that last year, the stocks that I suggested outperformed the ones he picked himself and therefore felt comfortable coming into our company. While I was flattered, I humbly mentioned to him that the S&P 500 was up 29% in 2019 so everyone should have had a great year. #Perspective.

It’s for this reason that I hate making stock recommendations because I have no idea where the broader market is going to go. Black Swan events which have been sparse in the past decade seem far more plausible with Coronavirus, trade wars and political instability. Not to mention the fear of mockery if my picks turn out to be duds.

Generally speaking, in uncertain times, investors tend to avoid small caps, and perceived higher risk sectors, such as crypto, cannabis, esports, etc. (not that I agree). But there must be a way to have your cake and eat it too. It got me thinking, what would be a ‘low’ risk stock pick that would still give investors exposure to the esports and gaming sector.

My Methodology

Criteria # 1:  Esports, video game and media exposure

It’s hard to just pick a pure-play esports company given that the video gaming market is ~$150 billion compared to ~$1.2 billion for esports. It’s important that a company has both exposure to esports, which will drive higher growth, but still has gaming and media diversification.

Criteria # 2:  Global reach

2020 is the year where esports brands will go truly global. Between Activision, Riot and Valve game titles, the competitive scene and fan base transcend borders and thus the big winners will be those that monetize this trend.

Criteria # 3:  Monetize multiple verticals.

The esports industry is not a monolith and its parts are all very different and sometimes completely unrelated. You have venues, content, media, teams, franchises, technology, betting and game publishers who are all vying for a piece of the pie.

Criteria # 4: Liquidity + Market cap

To pick a more ‘defensive’ esports play, we need to see a min. $500 million market cap and a company that has been trading for at least 1 year.

Criteria # 5:  Mobile gaming

In my opinion, this will be the biggest part of the industry over the next 1-2 years and can’t be understated. Mobile gaming is here to stay and will surpass traditional PC and console gaming in that timespan.

After going through about 20 companies and rating them on the 4 criteria, there was a clear winner, but not the one I wanted. So, I went back to the drawing board and added another 10 companies, hoping I could find something better and more creative to write about. But it was not meant to be. There is one company that truly meets these criteria and that company is none other than Tencent (OTC: TCEHY).

With a market cap of nearly $500 billion, this is as large of a cap as it gets in the gaming world.

Who is Tencent?

In short, they own almost everything. Many of their best gaming titles are very unknown in North America, but one title that should be on everyone’s radar is Honor of Kings. The game falls into the multiplayer online battle arena genre, known as MOBA, and has the accolades of the highest-grossing and most downloaded app of all time. Outside of China, the game is known as Arena of Valor. They have continued to build on their mobile strategy having launched PUBG Mobile and Call of Duty Mobile which are two of the top games in the Battle Royale genre.

While there are a lot of top game publishers in the market, at the end of the day, Tencent has a piece of almost all of them including:

  • RIOT Games; League of Legends,– 100%
  • Ubisoft; Rainbow Six Siege – 5%
  • Supercell; Clash of Clans – 84%
  • Epic Games; Fortnite – 40%
  • Activision; Overwatch, Call of Duty – 5%

The list goes on and on, and that’s just games. I’ll touch on social media, and media platforms as well. All you need to know is Tencent is the largest game publisher in the world…by a long shot.

Overall Financial Performance 

They had a blowout Q3 with revenues of USD$13,748 million and profits attributable to shareholders of USD$3,451 million, representing a 21% and 24% YoY increase respectively. Not only was there a 27% YoY increase in operating profit, an operating margin of 29% also showed a 1% increase from the previous year. There are some concerns under the IFRS basis as the operating profit was down 7% and the margin showed a significant decrease of 7% as well. However, this is largely due to the net gains from investee companies as Q3 2018 had a large gain from these other businesses, and do not necessarily reflect the core earning potential of Tencent. The adjusted EBITDA of USD$5,495.84 million (an adjustment of USD$395.72 million were made for equity-settled share-based compensation) also shows a 29% YoY increase, reflecting Tencent’s great performance over the year. Furthermore, the cash flow from operations has also seen a 34% YoY increase even though capital expenditures were 11% from the previous year. This indicates a 36% YoY increase in FCF, which is a positive given relatively stable short and long-term debt. 

Online Games 

Online Games produces the largest amounts of revenue for Tencent. In Q3 2019, online games saw revenues of USD$4.12 billion, a YoY increase of 11%. This growth was driven by smartphone gaming (not including games attributable to Tencent’s social media applications) as it represented almost 60% of total gaming revenues for the company. With popular mobile gaming titles such as PUBG mobile, Call of Duty Mobile, Honour of Kings and Peacekeeper Elite to lead the charge, Tencent witnessed a 9% YoY growth in mobile gaming revenue in Q3 2019. On the PC side of things, the revenue is down by 7 % YoY and represents only USD$1.66 billion (40%) of the total. The reason for this is most likely the cannibalization of PC gaming by mobile and reduced revenue of popular titles such as Dungeon Fighter Online. Not all is lost in the PC domain, however, as other large titles such as League of Legends and TFT, another Riot Games IP, continues to bring increasing amounts of revenue for Tencent. 

Communication and Social Media 

During the Q3 the MAU (monthly active users) of QQ, Tencent’s IM service and web portal for social media, games, blogs, shopping, etc. saw a YoY decrease of 8.9% and 6.4% for desktop devices and smart devices respectively. Tencent claims this is largely due to enhanced security protocols that actively delete spam and bot accounts. WeChat on the other hand, perhaps of the biggest stand-alone applications in the world, has a total of 1.151 billion MAUs, an increase of 6.3% from Q3, 2018. This may be largely in part due to the implementation of the “Growth Program” which trains Mini Program owners to run their business through WeChat and is backed by a fully blown analytical tool to allow these owners to gain valuable insights. This explains why DAU (daily active users) for Mini programs has increased past 300 million and why commercial transactions have doubled YoY. Their fee-based subscriptions for digital content, which totals 170.6 million also saw a YoY increase of 10.7%. This includes the growth of Tencent video and music subscriptions by 22% and 42% YoY, respectively. Recently, Tencent has announced a 10% stake in UMG effectively increasing its capabilities. Tencent even highlighted the integration and improvement of these services as one a focus in their strategic highlights. Overall this synergy of the sector has allowed it to grow alongside many of Tencent’s other verticals and has allowed it to achieve revenues of USD$3.175 billion by Q3 2019, a YoY growth of 21%.

FinTech and Business Services 

The FinTech and business services sector had revenues of USD$3.857 billion by Q3 2019, a 36% YoY growth. This immense growth was possible due to an infrastructure that takes advantage of all the different monetization verticals coupled with the improvement of their cloud services. Within Fintech, the growth of WeChat’s Mini Programs in terms of the numbers of transactions and the DAU, helped flood the payment ecosystem. Their business services grew as a result of expanding their cloud services to cover education, financial, municipal and retail sectors. The Tencent Cloud not only contracts the Luohu School district of Shenzhen with the largest software project in China, but also provides SaaS for various other businesses. This has allowed its cloud revenues to grow by 80% over the same time period.

Online Advertising 

With large amounts of users on its platforms, it is only natural to see an increase in advertising revenue. Even though Tencent took a hit through its media advertising, in which revenues were down 28% YoY in Q3 2019, the social media advertising revenues were quick to rekindle that flame. Overall this sector also experienced a revenue growth of 13% to total USD$2.65 billion. 

Exposure in Esports 

As mentioned above, esports and gaming do in fact have a point of separation. Esports is fueled by these popular games yet operates in an industry of its own. This vignette is best described by a quote from Wei Jizhong, former secretary-general of the Chinese Olympic Committee and honorary life vice president of the Olympic Council of Asia, saying “the most significant symbol is that we start to differentiate what is esports and what is just playing video games. So that esports has developed its own field”. Tencent understands this unique relationship which is evident in its partnership with the Global Esports Federation and has dedicated considerable resources to further esports. These resources include investing in all the different esports verticals including media companies, publishers, streaming sites, infrastructure, education and talent acquisition to just name a few. The company is also backed by various Chinese governments and helps to develop a professional and amateur infrastructure in China. For example, in the summer of 2019, Tencent and Hainan government held the Tencent Global Esports Annual Summit where Tencent and the local government would relay their plans for esports prosperity locally and globally. Now I understand that to build a global esports ecosystem will take a lot of work, but Tencent will be in the fourth year of its five-year plan and continues to show its dedication towards esports progression. Also, if there was a business that had the resources to pull off such a feat, it would be Tencent.

Games and Their Prize Pool 

Now for the fun stuff, the games, tournaments and their prize pools. Tencent already caters to a plethora of esports titles including League of Legends, Honour of Kings, PUBG mobile/ Peacekeeper Elite and Clash of Clans. They not only continue to support professional leagues but amateur leagues and competitions as well. The company runs its own Chinese league for League of Legends called the LPL which is sponsored by Nike. Furthermore, Riot a wholly-owned subsidiary of Tencent, puts on one of the largest esports events in the world, the League of Legends World Championships. In 2020, Tencent also has plans to develop the professional league for Honour of Kings called the Kings Pro League (KPL) with six home team venues. The game already has a winter and world championships that Tencent hopes to make global mobile esports events. To provide support for amateur competition, the league will have 6 open slots that will be filled via its semi-pro league, the KGL. The game also supports a Korean League which Tencent will change to a global format with a new name (King Pro League Global Tour) to attract talent worldwide. With a global reach in mind, Tencent focuses on PUBG mobile due to its immense popularity, announcing a USD$5 million prize pool for 2020 and Clash Royale, which has an established league in China, Asia and the Western World. With the emergence of 5G, it does not seem like mobile esports will slow down, and Tencent seems well-positioned to capitalize on this trend.

Largest Tournaments/Events 

Games Tournament Peak Viewership Prize Pool
League of Legends World Championship 2019 3.9 Million USD$2.225 Million
Honour of Kings World Championship 2019 0.764 Million USD$4.533 Million
Peacekeeper Elite Championship 2019 0.130 Million USD$0.429 Million
PUBG Fall Split Global Finals 0.525 Million USD$0.5 Million
Clash Royale CRL World Finals 2019 0.133 Million USD$0.4 Million

2020 could be another extension of the longest bull market in history, or we could see a pullback, no one knows. But market uncertainty shouldn’t stop any investor from investing in some of the highest growing industries in the world, like esports and video games. In a maturing industry, there are still ways to play the sector and reduce some of your risk by picking companies that have a diversified strategy in the industry. For the exhaustive list of reasons above, my pick for 2020 is Tencent. 

Full disclosure: Ben Feferman has a position in Tencent Holdings.


Ben Feferman

Editor:

Ben Feferman is an esports analyst and CEO of Amuka Esports. Since the age of 5, Ben has been an avid gamer and has fused ... <Read more about Ben Feferman>


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