The DeanBeat: Has the game industry hit its peak with crazy valuations or just begun its growth?

Money is pouring into the game industry, and I’m not just talking about GameStop’s crazy stock rise. I wrote about this last week, and now I find I have even more to say about this. I’ve been debating with myself and others about whether the market has gone crazy or if the game industry deserves all of the growth it has seen during the pandemic.

I moderated a panel this week about this subject at the WN Winter ’21 conference. Our speakers included Elena Egorova, the director of corporate development at Enad Global 7 (owner of Daybreak); Andrey Iones, the chief operating officer at Embracer Group’s Saber Interactive; and Sergey Evdokimov, an investment associate at MyGames and the cofounder of InvestGame.

I also went on the new social audio app Clubhouse to talk with game industry people on various panels about all of the deal activity. I heard the refrain everywhere. We’re at a historic point in gaming where more money is coming in than ever before, bigger than the boom year of 2016 when virtual reality got off the ground, Evdokimov said. His InvestGame found that deals hit a record $33.6 billion over 664 transactions in 2020 when it comes to all the money that went into game acquisitions, investments, and public offerings.

“I am even more impressed with the mega-deals we have in 2021,” Evdokimov said. “I expect more from 2021. A lot of companies are sitting on a lot of cash. There is synergy from a roll-up strategy. There is a great question actually about what shall the independent gaming business do nowadays, either go public on their own or join someone big.”

Above: InvestGame’s M&A activity in games in 2020.

Image Credit: InvestGame

It’s a seller’s market, Evdokimov said. As much as we would all like to celebrate this, having a sustainable financial market around games would also be a good thing. We should have rational explanations for why the industry is so strong, beyond the fact that some investors have become foolish. Evdokimov said the pandemic, as horrific as it is, has provided the dynamics for people to enjoy games more and choose them over other distractions, and that has led to the surge in sales and the improvement in valuations. The surge in sales has led to a surge in the stock market, and that has given more companies the added opportunity of using their stock to buy other companies.

The price is right

Above: Left to right: Andrey Iones, Dean Takahashi, Sergei Evodokimov, and Elena Egorova.

Image Credit: WN

But not everybody agrees about what’s the right price to pay for a company. And so the debate goes on.

On Monday, Take-Two Interactive CEO Strauss Zelnick explained to shareholders that financial discipline was the reason that it allowed Electronic Arts to outbid Take-Two in acquiring Codemasters for $1.2 billion. And as Zelnick was saying that, EA announced that it was buying mobile game company Glu Mobile for an enterprise value of $2.1 billion, or 36% more than the stock market valued it. Zelnick is clearly a pretty rational person, but now he has to second-guess whether it’s wise for him to sit on the sidelines while his rivals go nuts.

This came just a week after we saw Las Vegas-based PlayStudios and Russia’s Nexters announce they were going to go public in special acquisition purpose corporations (SPACs), which offer a way to go public quickly. And last week Embracer Group bought three big companies in one day: Gearbox Entertainment for up to $1.3 billion, Aspyr for up to $450 million, and Easybrain for $640 million.

One CEO of a big company joked to me that this makes him want to sell one of his game studios for a premium price.

“I think this is all short-lived,” the CEO said. “I feel like this is 1999 or 2000. I don’t see this being a sustainable environment. There is no rationale for any of this stuff.”

Above: Glu Mobile’s collection of games.

Image Credit: Glu

Another seasoned investment executive told me that the Glu deal won’t be the last one to happen, but the number of quality acquisition targets in the West is starting to dwindle. That means that the rest of the gaming ecosystem, the small companies that are being fueled by the game venture capital funds, need to step up.

And Tilting Point has a strategy of lifting up the promising game studios and fueling their growth with user acquisition funds. It announced this week that it would pump as much as $60 million into user acquisition for Loop Games’ Match 3D puzzle game in 2021. That’s a pretty incredible figure for finding new users for a game, but Loop Games doesn’t have to give up equity. Samir Agili, the president of Tilting Point, said in an interview that his company plays a kind of kingmaker role, identifying the up-and-coming firms.

“We’re here to find the smallest company that can scale to the max and doing it without being acquired,” Agili said. “There’s definitely a path for acquisitions now. But in our initial positioning, we help indies scale and raise their game.”

Big publishers often say that their central services can make game marketing, publishing and other tasks far more efficient for game studios. So they collect a bunch of studios, take care of them with central services, and boost their games in the market. Companies such as EA, Playtika, and Scopely say they do this.

Above: Borderlands made Gearbox an attractive acquisition target.

Image Credit: Gearbox Software

But Embracer is more like a holding company with 50 or so people at its core. Stillfront, Enad 7, and others are similar. They’re looking to acquire companies that are already being run well, Iones said. If one company has an intellectual property that isn’t being exploited, another studio within the company can get to work on a game based on it.

“I don’t think these types of acquisitions make sense,” said one CEO that I spoke with. “They have almost no synergy with each other. I don’t understand that. A company needs a strategy. I don’t know what they’re building. It’s really crazy.”

The currency that these companies like Embracer are using is stock, enabling it to acquire so many companies that it now has more than 6,000 employees. Embracer has a market value of $12 billion, and it can get access to capital at historically low-interest rates. It has been raising more money to finance its acquisitions, and it was able to announce last quarter that it had acquired a dozen new studios in a day.

Iones defended his parent company, Embracer, and its behavior. He noted that deals such as the Gearbox one were structured so that only some of the money ($363 million) comes up front in cash and stock, while the rest of the $1 billion or so comes after six years. That motivates Gearbox CEO Randy Pitchford to stick around and help grow the company so it becomes a great deal for Embracer.

Zynga’s example

Above: Zynga’s biggest games are its “forever franchises.”

Image Credit: Zynga

As I noted last week, Nick Tuosto (the managing director of advisory firm Liontree) has advised parties in 15 major transactions in the game industry in the past year. In his mind, some of the froth is justified as investors are finally catching on to the value that has been created by many game companies that have been delighting users and waiting for this day.

At our GamesBeat/Facebook: Driving Game Growth event, Tuosto brought up how Zynga is a prime example of using acquisitions to boost its overall position in the market.

Zynga went public in 2011 at a value of $9 billion, only to see its value collapse to less than $2 billion as it struggled in the transition from Facebook games to mobile gaming.

Under then-new CEO Frank Gibeau, the company went on an acquisition spree, spending billions of dollars acquiring Gram Games, Peak Games, Small Giant Games, and Rollic. And that has paid off in hot games like Empires & Puzzles that have fueled Zynga’s earnings.

In other words, the acquisitions have quickly paid off.

“Zynga’s performance has been driven over the last 3.5 years by M&A,” Tuosto said at our event. “They have been able to buy assets at a cheaper multiple than they themselves trade.”

Zynga’s stock price has gone up four-fold in the past five years, bringing the company back to its original IPO value in 2011. It has done through its aggressive acquisition strategy, Tuosto said. And this week, Zynga reported record financials with fourth-quarter bookings of $699 million, and it saw its valuation rise to $12.9 billion. What was perhaps most promising about Zynga’s results was that we saw no sign of a decline in the systemic increase in users and their appetite for playing games during the pandemic.

Warning signs and fateful questions

Above: Zombies swarm in smart ways in World War Z.

Image Credit: Saber Interactive

I’ve warned that Apple’s stance on user privacy over targeted advertising could trigger a slowdown in games that takes all the air out of the bubble. And if the something in the broader stock market breaks down, then the relatively small game industry can suffer as a result.

“This larger market will influence the gaming market as well,” Evdokimov said.

But Iones noted that the gaming market has proven it is resilient in recessions, as it has a very low entry price (free-to-play, for instance) that enables consumers to spend money on it (or time) even during a difficult time.

Tuosto believes that the game industry is just beginning to exploit the opportunities and financial deals that lie before it. He believes that the game industry was undervalued before and that investors have finally noticed it, because the game industry’s strong results stand out as other industries collapse. Advances such as free-to-play, subscriptions, and live operations have strengthened game companies, and now they’re ready to grow even further with a fresh injection of capital.

“I agree that the industry is maturing,” Iones said. “The game industry was viewed for many years as a super risky industry. It wasn’t investable. Now the games are making money, and we’re keeping costs in check. Once an industry is more predictable, it is more investable. Then you can scale your operations and build things all over the world.”

For those who have been making games for a long time, the window of opportunity offers new options.

“Saber was around for a very long time. My partner and I worked together forever and we made a decision we wanted to join a larger organization,” Iones said. “I wanted to make sure the company outlived my partner and I. If you become a part of a larger organization, and reflect your journey, nobody lives forever. Somebody else will step in and keep running the show.”

Embracer says it gives the studios autonomy to determine their own fate and run their own businesses. And it doesn’t have to worry if one game is delayed, as it has a whole portfolio of companies that can smooth out such problems.

It’s hard to believe that just a year ago people were wondering how we would ever get any deals done, given that everybody was in lockdown and it was so hard to get deals done via Zoom, said Egorova at Enad Global 7 during our WN panel. She said that the secret sauce of the game companies are the developers with the knowledge about their craft and their love for the industry and putting gamers first.

The important thing is to enable developers to be braver in their decision making and take risks, she said.

“Our goal is to be enablers,” Egorova said. “People are always going to play. Games have been with us since the cradle of humanity. And they will be here always.”

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