An

Investor’s Guide to the US Video Gaming Industry

By Adam Rogers
Jun 06, 2016. 09:31 PM

The History of the Gaming Industry

How did it all start?

In 1940, American nuclear physicist Edward C ondon designed a computer that allowed people
to play the first game, called Nim. Thousands played this game, although the computer won more
than 90% of the time.

A decade later, C laude Shannon wrote the first programming guidelines for a chess-playing
computer. In the 1960s, the US Department of Defense created a war game known as STAGE.
The idea that video games could be played on a television set was conceived by engineer Ralph
Baer. Baer completed two TV games in the 1960s. Later in the decade, C omputer Space
became the first video arcade game to be released.

Console introduction and technological advances

The world was introduced to the video game console in the 1970s. The evolution of the gaming
console was rapid and a few years after their introduction, consoles utilized microprocessors as

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well as programmable ROM cartridge–based games. This allowed players to change games just by
switching cartridges. Leading gaming company Activision (ATVI) was founded in 1979.

The gaming industry continued its evolution in the 1980s with improved video game graphics.
Electronic Arts (EA) was founded in 1982. The 1980s saw the introduction of 3D games as well as
the release of Japan’s (EWJ) Nintendo Entertainment System.

In the 1990s, Sony (SNE) introduced the P layStation system, which has been considered to be
the most popular console with 20 million units sold. In the last decade, Sony’s popularity has
continued to rise. Microsoft (MSFT) and Nintendo also released their own next-generation
consoles.

This series will look at the various trends and highlights that impact the gaming sector.

Action and Sports Genres Dominate the Video Gaming Space

Shooter and action games account for 45% of total video game
sales

According to Statista, shooter and action games dominate video game sales and account for
24.5% and 22.9%, respectively, of total sales in the US (SP Y). This was followed by the sports,
role-playing, and adventure genres, which account for 13.2%, 11.6%, and 7.7%, respectively, of
total sales.

The best-selling video games of 2015 include Electronic Arts’s (EA) Star Wars Battlefront, with
more than 12.4 million units sold. FIFA 2016 and Batman: Arkham Knight sold 14.3 million units
and 6.7 million units, respectively. Activision’s (ATVI) C all of Duty: Black Ops III was also one of the
top-selling games in the last year.

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Important statistics of video game players in the US

According to the Entertainment Software Association (or ESA), more than 155 million Americans
play video games. Each game-playing household has an average of 1.7 gamers.

Approximately 80% of these US households own a device to play video games, and 48% of these
households own a dedicated gaming console such as the Xbox (MSFT) and the P layStation
(SNE). More than 42% of Americans regularly play video games, totaling more than three hours
per week.

According to the C EO of ESA, Michael Gallagher, “Video games are ingrained in our culture.
Driven by some of the most innovative minds in the tech sector, our industry’s unprecedented
leaps in software and hardware engages and inspires our diverse global audience. Our artists and
creators continue to push the entertainment envelope, ensuring that our industry will maintain its
upward trajectory for years to come.”

Video Gamers Cross All Age Groups in the US

29% of video gamers are between 18-35 years

According to the Entertainment Software Association (or ESA), 29% of all video game users are
between 18–35 years of age, whereas 27% of players are below the age of 18. A surprising
number—26% of gamers—are above the age of 50, while the remaining 18% lie between ages of
36 and 49 years.

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The average game player is 35 years old, while women account for almost 42% of the total
gaming community. Another interesting statistic is that women over the age of 18 account for a
greater proportion (33%) of the game-playing population compared to boys who are 18 or
younger.

The average age of the most frequent game player is 43, compared to the average age of the
most frequent male player, which is 35.

Why gaming is the preferred source of entertainment

According to an ESA survey, the most frequent gamers feel that computer and video games
provide the most value for their money. The research report notes that 47% feel that video
games provide more value for their money. Approximately 28% prefer DVDs, while 14% prefer
going to the movies and 12% opt for listening to music.

According to Barbara C hamberlin, project director at the New Mexico State University Learning
Games Lab, “Games offer immediate feedback, you can see your progress, you can try
something and be frustrated but later learn more…that’s why game play is so engaging to us.”

The gaming space in the US is dominated by Electronic Arts (EA) and Activision (ATVI). The most
popular gaming consoles are the Xbox (MSFT) and Japan’s (EWJ) Sony (SNE) P layStation.

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How Did the US Video Gaming Industry Perform in 2015?

Revenues of $23.5 billion in 2015

According to data released by the Entertainment Software Association (or ESA) and NP D Group
earlier this year, the US (SP Y) computer and video gaming industry generated $23.5 billion in
revenues for 2015.

In comparison, reported sales for 2014 stood at $22.4 billion, indicating an increase of 5% YoY
(year-over-year) in total consumer spending.

Sales of software content projected to reach $19.6 billion in 2019

Sales of software content rose by 7% YoY from $15.4 billion in 2014 to $16.5 billion in 2015.
Software content includes mobile games, physical packaged goods, subscriptions, and
downloadable content.

“The video game industry excels because it anticipates demand—giving people what they want
before they realize that they want it—and drives trends in entertainment and across countless
other sectors. Our products are revolutionizing how we consume and interact with media,” said
Michael D. Gallagher, president and C EO of the ESA, which represents the US video game
industry. “We know that hardware and software innovations have established this industry as a
leader in high-tech development.”

Electronic Arts’s revenues rose by 15.8% between fiscal 2013 and fiscal 2016. In comparison,
revenues of its peers Activision (ATVI), TakeTwo (TTWO), and Zynga (ZNGA) returned -4%, 16.4%,
and -17%, respectively, in the last three years.

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Video game industry growing rapidly in the US

The ESA stated that the video game industry in the US is one of the country’s fastest-growing
sectors. In 2012, the video game industry added $6.2 billion to the US economy. Between 2009–
2012, employment in the video game sector grew at a C AGR (compounded annual growth rate)
of 9%.

In 2012, employees in the entertainment software industry earned an average of $95,000 per
year. This was almost twice that of the average US household income.

EA and Activision account for 1.2% of the Technology Select Sector SP DR ETF (XLK).

Sony PlayStation and Microsoft Xbox Sales Drive Console Market

Gaming consoles and PCs most commonly used platforms

According to a research report by the Entertainment Software Association (or ESA) and the NP D
Group, the personal computer is the most common device used by players, with 56% of gamers
opting for this platform.

Gaming consoles rank second at 53%, followed by smartphones, wireless devices, and dedicated
handheld systems at 36%, 31%, and 17%, respectively.

PlayStation 4 and Xbox One saw best YoY sales in December 2015

In December 2015, the sales of the Japan-based (EWJ) Sony (SNE) P layStation 4 and Xbox One
(MSFT) recorded their best sales ever.

Since its launch, the total sales of Sony P layStation stands at approximately 40 million units
worldwide. Although Microsoft has not released its Xbox One figures in the last 12 months,
Electronic Arts (EA) notes that the installed base for Xbox One is approximately 19 million units.

Nintendo (NTDOY) is expected to announce the launch date of its next hardware system, NX, in
2016. Analysts do not expect Sony and Microsoft to announce the launch of their next-generation

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consoles in the near future, however, as the P layStation and Xbox One were launched in 2013.

As seen in the previous part of this series, software sales rose by 7% YoY in 2015. This is likely to
drive hardware sales, and analysts expect the overall growth rate to continue in the future.

“The industry’s sales performance helped to make 2015 a banner year for video games; and we
anticipate continued growth in multiple industry sectors for 2016,” stated Joanne Hageman,
president of the NP D Group.

Is the Shift to Digital a Key Driver for the Gaming Industry?

Global video games revenue expected to reach ~$93.2 billion in

2019

According to a research report by P ricewaterhouseC oopers (or P WC ), revenue from global video
games should grow at a healthy rate through 2019. Total video game revenue is expected to rise
at a C AGR (compounded annual growth rate) of 5.7% and expected to reach ~$93.2 billion by
2019.

The research report states, “The peak of hardware sales for the latest generation of consoles is
likely to be between 2017 and 2018, followed by a decline regardless of whether new consoles
arrive.”

The global distribution of digital games is expected to reach $12.9 billion in 2019 and should
account for 19.6% of the industry’s overall gaming revenue. However, P WC stated that the
physical console market is also expected to drive revenues due to “the ability to trade in physical
games, frequently higher digital pricing and a lack of network infrastructure will keep physical
distribution relevant.”

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In the previous part of this series, we saw that Xbox One (MSFT) and the Japan-based (EWJ)
P layStation (SNE) reported a record for console sales in December 2015.

Social gaming revenue set to increase rapidly

The social gaming space is set to reach ~$22.5 billion by 2019, with the number of users playing
on social media sites such as Facebook (FB) experiencing an increase. According to P WC , India
(INDA) and South Africa are expected to drive social gaming revenues in the future.

How Is the Digital Gaming Market Growing?

Mobile gaming to reach $52.5 billion by 2019

According to a research report by Newzoo, the global gaming market should reach $99.6 billion in
revenues for 2016. This indicates a growth of 8.5% YoY (year-over-year) compared to 2015.

Newzoo is a global market research firm with a focus on the gaming industry. The firm provides
market intelligence, transactional data, and financial analysis to clients around the world, including
Amazon (AMZN), Facebook (FB), and YouTube (GOOG).

Mobile gaming revenues are expected to surpass P C gaming revenues for the first time ever.
Mobile gaming is expected to account for 37% (or $36.9 billion) of total revenues, indicating a rise
of 21.3% YoY.

Asia-P acific (or APAC ) countries are expected to dominate the mobile gaming market. These
countries are expected to account for 47% of total mobile gaming revenues in 2016. C hina (FXI)
accounts for 16% of global revenues in this segment.

Newzoo also expects the global market to grow at a C AGR (compounded annual growth rate) of
6.6% until 2019, reaching revenues of $118.6 billion. Mobile gaming is expected to account for
revenues of $52.5 billion.

Top countries by mobile revenue in 2015

As shown in the above chart, C hina led the mobile gaming space in 2015 with revenues of $6.5
billion, followed by Japan (EWJ) and the United States at ~$6.2 billion and ~$6.0 billion,
respectively. India was the fastest-growing country in the mobile gaming segment, with a C AGR

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of 75%, followed by Indonesia and the P hilippines at 72% and 63%, respectively.

In the next part of this series, we’ll see how companies such as Electronic Arts (EA) and Activision
(ATVI) are focusing on the digital gaming space.

Digital Revenues: Key to EA's and Activision's Long-Term Growth

Focus on recurring digital revenue streams

Electronic Arts (EA) was previously a hits-driven business. This means that if a game was one of
the top games launched, the firm would benefit greatly in that particular period, but it would also
suffer financially if it didn’t become a hit. Gamers usually play a game for six to eight weeks and
then move on to the next available game on the market.

EA also focused mainly on the P C and console segments, with very little exposure to the free-to-
play and mobile businesses. Andrew Wilson, the C EO of Electronic Arts, and the company’s
management team have started to expand within the recurring digital revenue segment.

Massive move toward the consumption of digital products

Like other product categories, the gaming space has also seen a transition toward digitalization. In
November 2015, Activision Blizzard (ATVI) announced the signing of a definitive agreement with
King Digital Entertainment (KING), a major player in the online gaming sector. Zynga (ZNGA) also
has a strong online presence.

Electronic Arts (EA) wants to create a business model in which users engage more with something
they find interesting. Online sports games are popular as users enjoy creating fantasy teams,
allowing them to compete online and against friends.

Activision Blizzard

In May 2016, Activision Blizzard (ATVI) announced its 1Q16 results and reported revenues of $1.5
billion. This was a YoY (year-over-year) increase of 13.9% compared to revenues of $1.3 billion in
1Q15. Digital revenues accounted for 64% of total revenue, or $926 million, in 1Q16. In
comparison, digital revenues accounted for 46% of revenues in 1Q15.

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Digital revenues have grown rapidly for peer company Electronic Arts (EA) as well. In 1Q16, EA’s
digital revenues rose by 18.3% YoY to $712 million from $602 million in 1Q15 for the firm. EA
generates ~$1 billion per year from FIFA.

Activision (ATVI) comprises 4.2% of the iShares North American Tech-Software ETF (IGV).

Growth of e-Sports a Key Driver for the Gaming Industry

The e-sports market expected to reach $1 billion

According to SuperData Research, the total global e-sports market was valued at $748 million at
the end of 2015. Its YoY (year-over-year) revenue growth is driven by an increase in advertising
as well as more brands entering the segment.

The global e-sports market is expected to reach $1 billion in 2017.

Betting and fantasy sites are attracting investments

P latforms such as e-sports betting and fantasy sites have attracted investments of more than
$150 million. Revenues earned in 2015 are expected to be $56 million. According to SuperData,
“Fans remain more comfortable wagering virtual gaming content over cash, causing real-money
sites to gain traction slower than anticipated.”

Approximately one-third of the e-sports fans in the United States (SP Y) participate in online
amateur tournaments. As the number of players increases, the number of sites has also
increased, leading to saturation in the e-sports market. The next big thing in this market is
expected to be the mobile e-sports space, where audiences have increased by 19% YoY in the
US.

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Market potential

Because there is immense potential in this segment, Activision (ATVI) and Electronic Arts (EA)
should look to increase market penetration. Asia and Europe (EFA) remains a huge market for
these companies. Investors and analysts will be looking closely at this sector as it inches toward a
billion-dollar valuation.

The next two articles will provide insights into the e-sports segment and how this space is
attracting major players such as Amazon (AMZN) and Google (GOOG).

Activision Acquired Major League Gaming to Enter the e-Sports

Segment

Activision acquired Major League Gaming for $46 million

Earlier this year, Activision Blizzard (ATVI) announced the acquisition of the US-based (SP Y) Major
League Gaming (or MLG) for $46 million in cash. MLG is a leader in creating and streaming live
gaming events and organizing professional competitions and competitive gaming leagues.

The acquisition is expected to help Activision build what it calls a new ESP N of e-sports and enter
the business of streaming online e-sports matches. According to MLG, MLG.TV attracts ~25
million viewers per month on mobile devices, computers, and video game consoles.

Focus on e-sports

In October 2015, Activision created a new e-sports unit and hired MLG’s co-founder, Mike Sespo,
and Steve Bornstein, the former president of ABC /Walt Disney (DIS). In December 2015,
Electronic Arts (EA) also announced that it intends to create an e-sports unit. Live events attract

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players and spectators in huge numbers. At these worldwide events, professional gamers can win
millions of dollars in prizes.

According to Activision, the e-sports audience comprises more than 100 million viewers and is
projected to be bigger than the audience for professional sports leagues. The main driver in this
market is the creation of premium content that should increase ticket sales, advertising, licensing,
merchandising, and sponsorships.

The e-sports market is projected to have more than 300 million viewers by the end of 2017,
according to market researcher Newzoo. “We’ve seen the interest in e-sports grow up faster than
the revenue model,” said Evan Wilson, a P acific C rest Securities analyst.

Activision constitutes 4.2% of the iShares North American Tech-Software ETF (IGV) and 5.4% of
the P ower Shares Dynamic Software ETF (P SJ).

Amazon and Google Share the Online Gaming Space

Amazon acquired Twitch to enter the mobile gaming segment

As we’ve already seen in this series, Activision Blizzard (ATVI) is acquiring Major League Gaming
(or MLG) to leverage the fast-growing streaming gaming market. Amazon (AMZN) entered this
field in 2014 when it acquired Twitch, a popular website for video game enthusiasts.

Twitch, founded in 2011, has grown at a rapid pace since then. At the end of 2014, it had more
than 100 million monthly unique users. In 2015, it had 1.7 million unique broadcasters compared to
1.5 million in 2014.

Twitch has more than 13,000 partners, up from 10,000 in 2014. More than 58% of its users spend
more than 20 hours per week watching content on Twitch.

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In the last two years, its viewership has grown by more than 100% in India (EP I), the Middle East,
Germany (EWG), Indonesia, Turkey, Italy, and Ireland. Google (GOOGL) was also interested in
acquiring Twitch.

Google’s 2015 launch of YouTube Gaming

In 2015, Google launched YouTube Gaming, beefing up its efforts to make it a preferred platform
among players and streaming at 60 frames per second. This was a positive development, as
gamers don’t want videos to lag while streaming live gaming sessions.

In June 2015, Google announced its YouTube Gaming app and website. This allows video game
enthusiasts to broadcast their video games to other people or watch other people play video
games in real time. In terms of downstream Internet traffic, YouTube is currently in second place
after Netflix (NFLX) in North America.

Initially, YouTube’s focus was on gaming videos recorded and uploaded on its site. Twitch was a live
streaming space for games. YouTube then launched its gaming app and competed directly with
Twitch.

Twitch has now announced plans to enable broadcasters to upload videos to its channels, just like
YouTube does. Google’s development of its own gaming platform should help Google grow its user
base, similar to Twitch’s. This should also help improve its ad rates.

Is Virtual Reality the Next Big Driver in the Gaming Space?

What is virtual reality gaming?

In virtual reality (or VR) gaming, players can experience a 3D environment and interact with that
environment throughout the duration of the game. A research report from Forrester estimates
that 52 million VR displays will be used by customers and enterprises by 2020.

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Virtual reality technology is expected to be the next step in gaming innovation. At the E3 2015
Live Streams and P ress C onference in July 2015, Facebook (FB) and Microsoft (MSFT) announced
the combination of Facebook’s Oculus Rift and Microsoft’s Xbox One.

This clearly indicates Facebook’s and Microsoft’s growing interest in the virtual and augmented
reality space, the latest innovation in the gaming world. The leading players in the gaming space
are Microsoft’s Xbox One and Japan-based (EWJ) Sony’s (SNE) Nintendo (NTDOY).

The virtual reality market expected to reach $5.2 billion by 2018

According to a KZeroWorldswide report, and as the chart above shows, the consumer VR market
is expected to total $5.2 billion by 2018.

Technology firm NVIDIA (NVDA) also uses its platform and network approach and leverage and
scale approach in the gaming sector. The company is tapping the opportunity for advanced
technology brought by the upgraded gaming consoles such as Sony’s P layStation 4, gaming
content such as mods, and VR.

Why Are Facebook and Microsoft Eyeing the Virtual Reality Space?

Facebook acquired Oculus in 2014

In March 2014, Facebook (FB) acquired Oculus, the leader in immersive virtual reality technology.
Oculus has built a strong interest among developers.

According to a press release from Facebook, the company plans to expand the Oculus Rift
headset’s applications beyond gaming to broader fields such as media, entertainment,
communications, and education.

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Microsoft acquired Havok last year

In line with its aim to dominate in the VR (virtual reality) space, Microsoft (MSFT) announced the
acquisition of Havok in early October 2015. Havok develops 3D physics engines, which is the
middleware used by game developers to create the physics for their games.

Havok’s popularity in the video games space can be gauged from the fact that all leading game
developers have employed it, including Activision (ATVI), Electronic Arts (EA), Sony (SNE), and
Japan’s (EWJ) Nintendo. Its products have become the de facto software for various popular
games such as Halo, C all of Duty, Assassin’s C reed, Destiny, Dark Souls, and The Elder Scrolls.

Microsoft has also stated that it is looking to make its virtual reality software, Windows
Holographic, available to hardware and software developers.

Microsoft’s blog stated, “For our partners, this creates new business opportunities, unlocking
mixed reality experiences across devices. For developers, Windows Holographic apps can be
written today with confidence that they will run on the broadest set of devices.”

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