Tim Merel is Managing Director of Digi-Capital (www.digi-capital.com), and this analysis is based on Digi-Capital’s new Global Games Investment Review 2015 at www.digi-capital.com/reports.
2014 saw a record $24B of game company exits across acquisitions and IPOs, with mobile driving over half of all value to management and early stage investors. For perspective, that’s 10 Minecrafts (at $2.5B). $15B of this was acquisitions, and of that number 5 megadeals took $8.1B, with the other $9B coming from IPOs dominated by Asia. You might think this is a bubble, but you would be wrong. Something more subtle is going on, and you can see it when you follow the money.
At the start of 2014 we forecast $100B games revenue by 2017. Other analysts followed with similar forecasts throughout the year. We were wrong.
Having tracked what’s happening across sectors through 2014, from the go-go markets of Asian mobile games to the recovering Western console space, we’ve seen the nature of growth changing. It’s stabilized. So while we still forecast games software hitting $100B revenue (more including hardware), we think it’s going to take another year to do it – not until the end of 2018. Mobile is the only sector showing strong double digit growth, although virtual reality could become a breakout. Asia is the #1 games market, set to hit $45B revenue in 2018 driven by China, Japan and South Korea. We forecast 8.8% CAGR (an acronym for growth) for games software/hardware between 2014 and 2018. That sounds healthy, but it’s single digit growth and that changes things. A lot.
In markets with single digit growth, a rising tide no longer lifts all boats. Competition becomes about the difference between the great and the good.
In this phase of the market, corporates with hit IPs, user scale and cashflow can invest in the high costs of marketing and infrastructure to compete in a stable growth market, although this reduces everybody’s margins. Indies don’t have hit IPs yet or the scale advantages, but they don’t have the costs either. Both can produce hit games, even if they are few and far between. Mid-tier games companies have no hit IPs yet, no scale advantages, but infrastructure and marketing costs. They can produce hit IPs too, but their cost bases increase their risk.
The other challenge for the mid-tier is the nature of acquisitions and investments in a stable growth market. Corporate buyers are managing their own cost bases, and are broadly less interested in team acquisitions. So the last thing they want is to buy someone else’s costs. Mid-tier games companies without major traction also struggle to raise money, as even though games investment grew to $1.5B in 2014 that amount is still 25% lower than in 2011.
Add to this how hard it is to leapfrog the big guns in the mobile top 100, and the market is putting the Big Squeeze on mid-tier games companies.
With games stocks broadly down 14% in 2014, corporates are managing their cost bases and looking to buy indies with unrealized hit potential to plug into their infrastructure and marketing, or breakout companies with high quality games (i.e. great ratings) and high downloads on mobile (or that can be adapted to mobile). In that context America and China had the top 10 acquirers in 2014, and that’s where we still see demand. Indies are doing what indies have always done: try to bootstrap great games for fame and glory (and maybe get bought). The squeezed mid-tier now has a choice: become great and get bought, or slim down to become nimble like an indie and survive. Just being good is no longer good enough.
• Until the next innovation wave accelerates market growth, consolidation rules. Time to get great.
About Digi-Capital (www.digi-capital.com): San Francisco based Digi-Capital advises mobile internet, games & digital clients across America, China, Japan, South Korea and Europe.