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Weak economy favours gaming stocks as consumers opt for cheaper entertainment

Discretionary spending shifted to out-of-home this year, but that may be about to change.

The fortunes of the video gaming industry have faded with post-pandemic reopening, but paradoxically better days may lie ahead as the global economy slides into recession.

Stay-at-home trends gave a big boost to the industry in 2020 and 2021, but this year discretionary entertainment spending has gone elsewhere as everyone itches to get on the move again. This renewed interest in travel, sports and other outside-the-home entertainment has slowed subscription revenues for online games, although the pace of the decline is slowing.

As a result, share prices have slumped, though less than the broader technology retreat. At the time of writing, the Nasdaq Composite Index is down 35 percent year-to date, but big gaming software names like Nintendo Inc. (OTC: NTDOY) and Electronic Arts Inc. (NDQ:EA) are down less than half that at 12 per cent and 11 per cent respectively. Activision Blizzard Inc. (NDQ:ATVI) subject to a U.S. $69 billion takeover by Microsoft Corp. (NDQ:MSFT) is up 8 per cent, roughly equal to the price of the takeover offer.

Analysts say two energizers may move the sector higher. One is the underlying global trend that favours strong gaming growth. The analytics company NewZoo.com estimates 3.2 billion people will play online games this year with a market value of U.S. $197 billion. The market is growing by 5 per cent annually with mobile gaming, played on phones or tablets, now the largest single segment.

The other tailwind is the deteriorating economy: As consumers tighten their belts and travel and dine out less, they look for cheaper forms of entertainment such as gaming.

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 “Gaming was a bit of a pandemic darling,” says Elliot Johnson, chief investment officer at Toronto-based Evolve Funds Group Inc., adding that in a contracting economy the sector offers recession resilience.

“I went to a Blue Jays game recently and you can buy a lot of monthly video game subscriptions for the price of a ticket to a Jays game,” Mr. Johnson said.

The sector has been hurt by broader economic trends including rising inflation and higher interest rates. An added pressure has come from the Chinese government’s crackdown on video game licenses. Roughly 20 per cent of gamers are in China, according to NewZoo, where the  government worries about the corrupting western influence of the games. It has tried to manage access to online gaming and in the first quarter stopped issuing new licenses.

Elliot Johnson is Chief Investment Officer at Evolve ETFs in Toronto. Credit: Supplied Photo

 Despite these pressures, Tejas Dessai, an AVP and research analyst with Global X ETFs Ltd. in New York, says he is extremely bullish on the theme.

“This is a market that’s already bigger than Hollywood and the U.S. sports industry combined,” he says. “We think we are at the beginning of a massive secular growth trend.”

As people trickle back to the office time spent on gaming has fallen and the analysts see weakness through the end of this year. Some of the companies are young, high growth and unprofitable, so markets view them as riskier than value stocks. Once interest rate increases peak, they expect a rebound with a strong holiday season acting as an early indicator of recovery.

“There are some hiccups that need to play out,” Mr. Dessai says. “But in the longer term the opportunity is strong. A large portion of gamers are hardcore enthusiasts. They don’t view gaming and eSports as discretionary. It’s a staple of their social lives.”

 His thesis for a 2023 rebound draws on the 2008 financial crisis. He notes that in 2008-2009, global egaming spending fell 8 per cent but recovered to the previous level by the next year.

“I think we could see something like that happen in 2023,” Mr. Dessai says.

 Both analysts are optimistic that Microsoft will close its purchase of Activision Blizzard despite current regulatory holdups. They say the purchase is a way for Microsoft to enhance its Xbox platform and maintain a strong presence in the sector. The gaming component of Microsoft’s business is already 11 per cent of revenue and grows considerably with the acquisition.

Tejas Dessai is an assistant vice president and research analysts with GlobalX ETFs in New York. Credit: Supplied photo

Mr. Dessai says the deal adds 400 million gamers to Microsoft’s orbit. Mr. Johnson adds that the acquisition would allow Microsoft to release blockbuster titles on Xbox first, if not exclusively and then cross sell other Microsoft products and services to the new gamers.

The Evolve E-Gaming Index ETF (TSX: HERO) with $32 million in assets under administration (AUM) and the Global X Video Games & Esports ETF (ARCA: HERO) with U.S. $168 million AUM were both launched in 2019 and have similar holdings. They invest in companies that develop video games, facilitate the streaming of games, operate esports leagues and teams, and sell gaming hardware.

 The top three for both – though with different market capitalization weightings – are Nintendo, Electronic Arts and Activision Blizzard. The companies account for 34 per cent of Evolve’s ETF which tracks a market cap weighted index and 20 per cent of the Global X fund.

“Right now everybody’s concerned about macro risk,” Mr. Johnson says. “Generally speaking, those are good times to go shopping for stuff that’s been beaten up. During times of crisis is when people can make multi-decade winning decisions.”

This article appeared in the Globe Advisor section of the Globe & Mail’s Report on Business on Oct. 17, 2022. For reprint information please view this page.

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