Analysts from investment bank Berenberg visited E3, the annual gaming expo held in Los Angeles, and in a comprehensive report provided a valuable analysis of the importance of the event to the industry, and pay-subscription patterns.
Berenberg’s first comment is that there is an abundance of structural tailwinds that are likely to drive the games industry forward over the coming years.
The bank’s Theme 1 is that streaming is the dawn of a new age: “Leading up to and during E3, Google announced that its streaming platform, Stadia, will launch in November 2019, and Microsoft stated that public testing for its xCloud streaming service will begin in October 2019. Streaming offers new avenues for game companies to monetise their IP, with these platforms offering publishers minimum revenue guarantees or licence agreements to their secure content. Those companies with strong back catalogues, such as THQ Nordic and Team17, and those that lead a genre, such as Codemasters, are currently benefiting most from streaming. Streaming will also provide a strong tailwind for Keywords Studios (Keywords) and Sumo, which have both announced agreements with streaming platforms also. While exciting, streaming platforms do still have some challenges to overcome and, in our view, will likely need to evolve technically and in business model to secure wide adoption.”
Its Theme 2 is that digital distribution competition is accelerating: “At E3, it was clear that competition in digital video game distribution is only intensifying further, with Xbox and Ubisoft launching new PC distribution and subscription platforms. Furthermore, Epic Games Store announced that many big games will be joining its exclusive platform as it looks to build its audience base. These developments have strengthened our view that platform fees are likely to fall over the short to medium term, providing a strong gross margin tailwind for video game publishers. The rising competition is also resulting in platforms offering publishers licence payments to secure content.”
Theme 3 focuses on the ever-contentious argument over who might win the next console war:“A new console war dawned at E3 between Xbox and PlayStation, with both announcing new consoles to be launched in Q4 2020. With both consoles supporting backwards compatibility – the ability to play old generation games on new hardware – it should alleviate any lagged release in content, making for a smoother industry transition compared to prior cycles. Equally, this will be supportive for companies with larger back catalogues. Both consoles will house physical disk drives, which is positive for THQ Nordic’s distribution business. Lastly, there is some concern from publishers that the increased graphical power of the new consoles will increase the cost, and risk, of new game development. Publishers may look to offset this risk by securing upfront licence agreements for new content. In terms of the outsourcing companies – Keywords and Sumo – backwards compatibility and the potential increase game development costs are supportive dynamics.”
Berenberg suggests that, because of increased competition among digital PC platforms, “the introduction of streaming platforms and our conversations at E3 conference have only strengthened our view that PC platform fees are likely to fall further over the short to medium term. With the introduction of streaming on the horizon also, which will begin to break down the segmentation between hardware platforms, it is likely that the pressure currently on PC platform fees will migrate to console also. As these platform fees make up the significant majority of the cost-of-goods-sold of digital revenue and most of the operational leverage in video game publishers’ business models, any reduction in platform fees would result in material improvements to gross and operating margins for all publishers in our coverage.