Morningstar - Q2 2021 - 19

Video Games Power Up
in Pandemic
Video games have been around for over
50 years, but the industry continues to grow
and evolve. The pandemic and associated
stay-at-home regulations provided a tailwind to
the secular trends underpinning the growth
of video games as well as some potential
evolutionary shifts. The secular trends include
the switch to digital downloads and
microtransaction growth, with more evolutionary
changes including subscription plans and
cloud gaming. The fourth quarter also saw the
launch of the ninth console generation
with the debuts of the Sony PlayStation 5 and
Microsoft Xbox Series S and X.
Here, we take a look at how these trends
affect the four major game publishers we cover:
Activision Blizzard ATVI, Take-Two Interactive
Software TTWO, Electronic Arts EA, and Ubisoft
Entertainment UBI:FR.
With the surge of video gaming in 2020,
Sony SNE and Microsoft MSFT launched their
next-generation consoles to very high
demand in November. Despite the closures of
retail outlets in many markets, the new
versions of the PS5 and Xbox quickly sold out,
and subsequent restocks at every retailer
have been snapped up by consumers and
scalpers. We think the publishers can
capitalize on either given the ease of crossplatform development.
Subscription services, specifically multipublisher
ones like Xbox Game Pass, have grown
much faster than our initial expectations in 2019.
Due in part to the pandemic, aggressive
promotional pricing, and increased investment
by Microsoft, Game Pass had surpassed
15 million users as of September. However, we
think this growth will slow or even reverse
when pandemic restrictions are fully lifted. Last
year also saw a rise in microtransactions.
While this growth is also likely to taper off
after the pandemic, it shows that consumers,
particularly younger ones, have become

Secular Trends Benefit These Game Publishers
Company

Moat

Activision Blizzard ATVI

Price

Fair Value

Morningstar Rating

Narrow

$89.58

$92.00

QQQ

Electronic Arts EA

Narrow

$128.00

$134.00

QQQ

Take-Two Interactive Software TTWO

Narrow

$167.22

$184.00

QQQ

Ubisoft Entertainment UBI:FR

Narrow

EUR 76.01

EUR 81.00

QQQQ

Source: Morningstar Direct. Data as of 03/18/2021.

increasingly used to making additional purchases
after paying for a game.
We believe that demand for cloud gaming
will be weaker than the suppliers and the market
expect, at least over the next three years.
Content is king here, and stand-alone cloud
platforms like Google's GOOGL Stadia and
Amazon.com's AMZN Luna will need to develop
or purchase exclusive video games to entice
gamers to join. Microsoft, in contrast, is
using cloud gaming not to replace console or PC
gaming, but to extend it. It launched xCloud in
2020 and added it to the Xbox Game Pass Ultimate
tier for no additional charge.
Consoles will thus remain an important segment
for the four publishers we cover. Take-Two still
generates well over 70% of revenue from consoles
despite branching out into PC and mobile.
Console games still produce over 55% of revenue
for Ubisoft and 65% for EA, even though both
companies have increased their output of mobile
and PC games. Activision Blizzard derived less
than 40% of its 2020 revenue from console games
because of the importance of Blizzard on
the PC side and the acquisition of mobile gaming
publisher King Digital (Candy Crush) in 2016.
However, we still project that console revenue for
the company will hit $2.3 billion in 2020.
Both ninth-generation console launches feature
a version without a disc drive. This reflects
a secular trend of full game downloads that had
been gaining traction before the pandemic,
particularly in markets with strong broadband
infrastructure. We believe that physical sales will
still contribute significantly to publishers'
revenue over the next five years, albeit declining

as a percentage of the total. Consumers may
prefer physical media for potential resale value,
archival purposes, lower stress on broadband
caps, and gift giving, which makes up a sizable
portion of sales, especially for annualized
franchises like Madden, FIFA, NBA 2K, and Call
of Duty. Still, one of the tailwinds behind gross
margin improvements at EA and other publishers
is a 70% margin on digital games compared
with about 50% on physical games.
We expect that the prices of console games will
remain mixed for the next few years as publishers
gain a better understanding of gamers' price
sensitivity. The standard retail price has been stuck
around $60 since 2006, even as the complexity of
games has progressed from the sub-high-definition
graphics of the Xbox 360 and PlayStation 3 to the
4K graphics of the Xbox Series X and PlayStation 5.
Now the $60 price ceiling is starting to show
some cracks. Take-Two was the first publisher
to break the barrier, announcing a $70 price for the
next-generation releases of NBA 2K21. But
with the rise of free-to-play games with massive
audiences, like Fortnite, $70 may be a hard sell for
all but the most-wanted and must-have titles.
Given the number of positive factors that have hit
the industry, including the ninth-generation
console launches, the increased time spent playing,
and the lockdown-related boosts to recurring
revenue and full-game downloads, we recently
re-examined our projections for the four
major publishers we cover. We increased our fair
value estimates for all of them, but even so, three
of the four were fairly valued as of mid-March.
Neil Macker, CFA, is a senior equity analyst at Morningstar
Research Services LLC.

morningstar.com/lp/magazine

19
http://www.morningstar.com/lp/magazine
Morningstar - Q2 2021

Table of Contents for the Digital Edition of Morningstar - Q2 2021
