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The coming video game super cycle

Joel Lim
Joel Lim • 8 min read
The coming video game super cycle
Sony previewed the PlayStation 5 (PS5) on June 12 and gave the world a glimpse of its flagship product. The reveal event had gamers around the world rubbing their hands in gleeful anticipation at the launch of this next-generation gaming console.
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Sony previewed the PlayStation 5 (PS5) on June 12 and gave the world a glimpse of its flagship product. The reveal event had gamers around the world rubbing their hands in gleeful anticipation at the launch of this next-generation gaming console in the year-end holiday season.

The PS5 is a powerful and alluring gaming machine, capable of delivering 8K video resolution and 360° audio for an immersive gaming experience. By incorporating a customised 825GB Solid State Drive (SSD) into its arsenal, the PS5 promises faster loading speed for seamless ingame transitions too.

More importantly, beneath the facade of a juiced-up hardware, the PS5 is expected to kick off a seismic shift in the gaming industry.

The start of another super cycle

Sony’s original PlayStation first hit the shelves in 1994 and the product line has earned a Guinness World Record for being the best-selling home video game console brand ever. As of November 2019, Sony has sold more than 450 million units across the entire line, from PlayStation to PS2, PS3 and PS4.

It is of little surprise that Sony’s top business unit among the group’s diverse range of products and services since 2014 is the game and network services division.

Each generation of Sony’s PlayStation has an average cycle of 6.4 years, with each new console outdoing its predecessor in terms of expectation and performance.

However, Sony’s direct competitors, Microsoft and Nintendo, will not be sitting idly at the sidelines and let Sony capture the lion’s share of the console gaming pie. Microsoft’s new Xbox console, Xbox Series X, is scheduled for release later this year to give the PS5 a run for its money.

The Nintendo Switch, which was launched in 2017, has proven to be immensely popular among casual gamers. When several countries started implementing lockdown measures during the Covid-19 pandemic, demand for Nintendo Switch was so high that the console encountered a worldwide shortage.

The biggest gainers

Historically, the release of a new generation of consoles has positive spillover effects for game developers. The newly souped-up machine not only offers unparalleled gaming realism for gamers, it also provides a new platform for game developers to unleash their creativity and break through the bottleneck caused by outdated hardware in the current ageing consoles.

Video games and video game consoles are perfect examples of complementary goods; the demand for either products will rise and fall in tandem. A new game console is a huge investment, typically costing in the range of US$400 to over US$500 ($548 to over $686). Consumers will most likely want to get their money’s worth by buying new video games to keep themselves entertained for years.

Additionally, the release of blockbuster video game titles will further drive up demand of game consoles from the mass-market consumers. The end result is a self-perpetuating cycle whereby the sales of both video games and video game consoles are sustained throughout the console’s life cycle. For example, Nintendo’s exclusive franchise gaming series, like Pokémon and Animal Crossing, are helping Nintendo compete for consumer dollars in the video game console war.

With the new super cycle heating up, video games companies have the potential to gain the most out of this cyclical event. Based on the previous video game boom in 2013, some video game stocks surged over 1,000% in just six years.

Both Electronic Arts (EA) and Take-Two have risen over 800% while Activision has gained over 600% since 2013.

The announcements of console launches in the past have also provided a boost to video game stocks in the short term. According to Investment Bank Cowen, shares of Activision, Take-Two and EA outperform the broad market index by an average of 26% during the 12 months preceding major console launches in 2000, 2005 and 2013.

The gaming ecosystem

Besides benefitting video game companies, nextgen gaming consoles have a trickle-down effect on other technological and consumer discretionary sectors. The e-gaming ecosystem flowchart below gives a brief description of how other companies can benefit from the new gaming consoles.

Sony will be releasing two versions of the PS5; the PS5 Standard Edition (with disk drive) and the PS5 Digital Edition (without disk drive). While elimination of an optical disk drive represents minimal manufacturing cost savings for Sony, it has the potential to generate substantial recurring income for the company through its PlayStation Network (PSN) and PlayStation Store.

The digitalisation process helps expedite the transition from a transaction-based to a subscription-based business model. Currently, consumers can buy or sell pre-owned physical game copies via traditional retailers like GameStop or share their games with other users. As a result, a single physical game copy, which originated from a one-off transaction, may have multiple users but does not signify an efficient revenue stream for console providers and game developers.

Digital Edition users will have to purchase or stream digital game copies from PlayStation Store or PlayStation Now respectively. The digital game copies are tied to individual PSN accounts and are non-transferable. Hence, this business model has the capacity to increase video game sales dramatically.

For every game sold on the PlayStation Store, Sony retains about 12% in platform royalties. Furthermore, users must pay recurring fees to subscribe to PlayStation Plus and PlayStation Now to gain access to additional features like online multiplayer and cloud streaming functions, which can also be found on Microsoft’s Xbox Live Gold.

Contrary to popular belief, Sony and Microsoft do not reap huge profit margins from the sale of their gaming consoles. After factoring marketing, shipping and production cost, it is likely that the two companies incur losses for each console sold. Both companies adopt a loss-leading strategy with the intention of recouping their losses through recurring game and subscription sales.

Through the subscription-based business model, game console providers are essentially squeezing out more revenue per gamer on their respective online platforms.

Cloud gaming means that games are operated from a remote server and streamed across multiple devices via a fast internet connection. These subscription-based cloud gaming services could be more attractive alternatives to Sony, Nintendo and Microsoft’s traditional gaming console platforms, which rely on customers buying both dedicated consoles and games.

The arrival of Google Stadia, Apple Arcade, PlayStation Now, Nvidia’s GeForce NOW and Project xCloud have provided us with a sneak peek of a console-less future. They allow gamers to instantly play a variety of selected games and/or pre-owned games seamlessly across any laptop, desktop, tablet or mobile devices.

Owning a video game does not make economic sense when subscriptions can offer customers diversity and novelty via a library of games on the cloud platform — similar to what Netflix is providing to its subscribers in terms of video content. The scalability and flexibility of this business model also allow subscribers to cancel their subscriptions whenever the needs arise.

Today, most graphically-intensive games require top of the line hardware to run. Video game consoles are an expensive investment and high-end Graphic Processing Unit (GPU) for PCs may cost upwards of US$1,000 ($1,371). Cloud gaming lowers the entry cost for consumers by transforming a range of everyday devices into powerful gaming rig. With the advancement of 5G and cloud computing technology, cloud-based gaming could threaten and displace traditional console gaming in the near future.

E-sports and e-games ETFs

There is tremendous growth potential in the e-games industry. To illustrate, there are more than 2.5 billion gamers worldwide and the gamer base continues to grow across different age groups and genders. The industry total revenue of US$152.1 billion in 2019 surpassed the combined revenues of the movie and music industries. Growing at around 10% annually, it is estimated that revenue will reach US$196 billion in 2022.

With four gaming and e-sports-themed ETFs listed within the last three years, ETF issuers are racing to meet the growing demand for financial products with exposure to the industry.

To capture this growing market, Nikko Asset Management launched the first actively-managed ETF in Asia on the Hong Kong Exchange on June 16. The NikkoAM Active E-Games ETF has the flexibility to rebalance its underlying assets daily to adapt to the ever-changing landscape of the e-games industry. These five gaming and esports-themed ETFs will provide investors with a convenient investment vehicle to ride on the structural growth opportunity.

Looking into the future

The next-generation gaming consoles will provide a near-term catalyst to the gaming industry. Game publishers and hardware producers will look to capitalise on the improved technology to develop complementary products for the new gaming consoles.

Secondly, game console providers are also looking towards building long-term relationships with their customers as they gradually shift towards a subscription-based business model to enhance the revenue generated from their consumer base on the console platforms.

However, the e-games industry is driven by several key disruptive innovations that could threaten the profitability of the traditional console gaming industry. Just as smartphones disrupted the business model for portable entertainment devices, cloud gaming could have a similar impact on the gaming industry.

In conclusion, the advancement in 5G and cloud computing technology enable the conception of new business models that could help create the next structural shift in the gaming industry.

Joel Lim is an ETF Specialist at Phillip Securities

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