What’s Wrong With the Video Game Industry? 10 Stocks to Watch

Published on February 17, 2022 at 10:40 am by Usman Kabir in Hedge Funds, News

In this article, we discuss what’s wrong with the video game industry and the 10 stocks to watch in the sector. If you want to skip our detailed analysis of these stocks, go directly to What’s Wrong With the Video Game Industry? 5 Stocks to Watch.

The video gaming sector is one of the fastest-growing sectors of the market but this record growth has slowed in recent months. According to market research firm NPD Group, overall video game sales dropped for a second month in a row in December 2021, bringing to an end a six-month long streak of gains. The monthly sales were 1% down year-on-year, compared to a 10% year-on-year decline in November, representing a $7.5 billion dip keeping in mind the numbers for December 2020.

However, the overall spending in the video game sector remained high in 2021 despite a disappointing last two months. NPD claims that video game spending hit a record $60 billion in 2021, up over 8% when compared to 2020. Another gaming research firm, Newzoo, contends that the gaming market generated close to $180 billion in revenue in 2021, up over 1% compared to the pandemic-ravaged 2020.

Some of the top video game stocks to buy now according to hedge funds include Microsoft Corporation (NASDAQ:MSFT), Sea Limited (NYSE:SE), and NVIDIA Corporation (NASDAQ:NVDA), among others discussed in detail below.

Problems In Gaming Industry and Consolidation

Over the past few months, video game stocks have trailed the benchmark S&P 500. The share prices of many firms that operate in the sector are also near 52-week lows. Certainly, some of the pessimism relates to the overall state of the industry where new releases are not being received well at the market. Since the video game industry is cyclical by nature, with sales peaking around the holidays, this dip in popularity right around the holidays caused a huge dent in revenues for these firms.

A tightening of policies in China, where parents have been advised to limit the video game times of young children, has also hit sales since the Chinese market is the biggest video game market for many firms. To get through this lean period, many firms in the sector are looking towards mergers and acquisitions. These mergers, like the purchase of Activision by Microsoft and Zynga by Take-Two, both a few days apart from each other, are being touted as tech plays into the “metaverse”.

In addition to being possible metaverse investments, it is certainly true that both purchases advance the footprint of the buyers in the mobile gaming market. Newzoo estimates that mobile gaming revenue will climb to more than $116 billion in the next two years, up from just around $60 billion in 2019. In 2021, the global mobile gaming revenue was around $90 billion, up 4.4% year-on-year and representing more than half of the total global gaming revenue.

New Version of Old Stuff Not Working Anymore

Big video game firms are also having difficulty selling new versions of old games, a strategy that has proved successful in the past. For example, Take-Two Interactive Software, Inc. (NASDAQ:TTWO) came up with the idea of a “Remastered” edition of the popular Grand Theft Auto game. The release of the new version flopped at the market. Combined with criticism around the Zynga purchase, the flop served to add insult to injury for Take-Two Interactive Software, Inc. (NASDAQ:TTWO).

Activision Blizzard, Inc. (NASDAQ:ATVI) underwent a similar experience with the release of Battlefield 2042. Along with allegations of workplace misconduct against high-ranking officials at the company, the flop served as fodder for competitors to paint a “all is doom and gloom” scenario for Activision Blizzard, Inc. (NASDAQ:ATVI) that brought the shares crashing down, paving the way for a blockbuster acquisition by software giant Microsoft.

The Microsoft purchase of Activision Blizzard, Inc. (NASDAQ:ATVI) makes sense because it helps the former complement gaming hardware sales with software offerings. In the video gaming industry, gaming hardware, like the Xbox, can present a steady source of revenue for years. The same strategy, as the GTA and Battlefield flops indicate, cannot work as flawlessly in the software side. It also shields Activision Blizzard, Inc. (NASDAQ:ATVI) from shareholder pressure regarding new offerings, making for a more balanced business/creative relationship with customers.

Our Methodology

The companies that operate in the video game sector and lost value in 2021 were selected for the list. The problems that these firms are facing are also discussed to provide readers with some additional context for their investment choices.

Data from around 900 elite hedge funds tracked by Insider Monkey was used to identify the number of hedge funds that hold stakes in each firm.

What's Wrong With the Video Game Industry? 10 Stocks to Watch

What’s Wrong With the Video Game Industry? Stocks to Watch

10. SciPlay Corporation (NASDAQ:SCPL)

Number of Hedge Fund Holders: 23

Percentage Loss in Share Price in 2021: 5.1%

SciPlay Corporation (NASDAQ:SCPL) develops and markets social games. The firm mainly focuses on casino-related offerings for mobile and web platforms. Since 2018, the company has grown revenue, through in-app purchases, at close to 20% annually. The company is using the surplus cash it is generating to fund acquisitions and grow the customer base. It also has low debt levels and thus a lower risk of bankruptcy as compared to peers in the gaming industry. SciPlay Corporation (NASDAQ:SCPL) is also growing cash flow at a rate of 20% every year.

The strong fundamentals of SciPlay Corporation (NASDAQ:SCPL) have attracted the attention of institutional investors. Among the hedge funds being tracked by Insider Monkey, New York-based investment firm TIG Advisors is a leading shareholder in SciPlay Corporation (NASDAQ:SCPL) with 1.7 million shares worth more than $36 million.

Just like Microsoft Corporation (NASDAQ:MSFT), Sea Limited (NYSE:SE), and NVIDIA Corporation (NASDAQ:NVDA), SciPlay Corporation (NASDAQ:SCPL) is one of the stocks that growth investors have their eye on.

9. Nintendo Co., Ltd. (OTC:NTDOY)

Number of Hedge Fund Holders: N/A

Percentage Loss in Share Price in 2021: 25.6%

Nintendo Co., Ltd. (OTC:NTDOY) is a Japanese firm that makes and sells electronic entertainment products. In November 2021, Macquarie analyst Yijia Zhai had downgraded Nintendo Co., Ltd. (OTC:NTDOY) stock to Neutral from Outperform and decreased the price target to 48,400 yen from 65,000 yen, noting the weak quarterly results of the firm and a slow start to the holiday season as some of the main reasons behind the downgrade.

Even though it has not lived up to investor expectations in 2021, Nintendo Co., Ltd. (OTC:NTDOY) has still attracted the interest of top growth funds. Among the hedge funds being tracked by Insider Monkey, New York-based investment firm ARK Investment Management is a leading shareholder in Nintendo Co., Ltd. (OTC:NTDOY) with 117,316 shares worth more than $6.9 million.

8. Electronic Arts Inc. (NASDAQ:EA)

Number of Hedge Fund Holders: 53

Percentage Loss in Share Price in 2021: 5.4%

Electronic Arts Inc. (NASDAQ:EA) develops and sells games and entertainment content. Some of the famous games it owns include Battlefield, The Sims, Need for Speed, FIFA, Madden NFL, UFC, NHL, Formula 1, and Star Wars, among others. As the video game industry evolves to take advantage of trends such as subscription services, content downloads, microtransactions, and NFTs, Electronic Arts Inc. (NASDAQ:EA) is well-positioned to benefit. The firm is now one of the largest pure play video gaming stocks on the market.

Electronic Arts Inc. (NASDAQ:EA) has generated lots of buzz on Wall Street as well, even as growth stocks undergo a period of correction. At the end of the third quarter of 2021, 53 hedge funds in the database of Insider Monkey held stakes worth $1 billion in Electronic Arts Inc. (NASDAQ:EA), compared to 56 in the previous quarter worth $2 billion.

7. Take-Two Interactive Software, Inc. (NASDAQ:TTWO)

Number of Hedge Fund Holders: 53

Percentage Loss in Share Price in 2021: 11.9%

Take-Two Interactive Software, Inc. (NASDAQ:TTWO) develops and publishes interactive entertainment content. On January 10, Take-Two Interactive Software, Inc. (NASDAQ:TTWO) had announced that it had bought Zynga, another gaming firm, in a deal worth $12.7 billion. The deal in this regard is expected to be complete by the first quarter of 2023. Take-Two Interactive Software, Inc. (NASDAQ:TTWO) is aiming to expand in the mobile gaming market with the purchase. Mobile gaming is on track to represent over 50% of the gaming market in 2022.

Elite hedge funds hold large stakes in Take-Two Interactive Software, Inc. (NASDAQ:TTWO) as it executes a plan to grow in the mobile gaming sector. Among the hedge funds being tracked by Insider Monkey, Chicago-based investment firm Alyeska Investment Group is a leading shareholder in Take-Two Interactive Software, Inc. (NASDAQ:TTWO) with 885,780 shares worth more than $136 million.

In its Q1 2020 investor letter, Sextant Mutual Funds, an asset management firm, highlighted a few stocks and Take-Two Interactive Software, Inc. (NASDAQ:TTWO) was one of them. Here is what the fund said:

“We mentioned the Xbox, but gamers also need games. We invested in Take-Two last year on the thesis that gaming demonstrates attractive long-term growth opportunities and online distribution would reduce costs and improve margins. With a ready-made excuse to spend eight hours in front of a screen in the basement, such online game delivery must have helped Take-Two.”

6. Activision Blizzard, Inc. (NASDAQ:ATVI)

Number of Hedge Fund Holders: 80

Percentage Loss in Share Price in 2021: 25.8%

Activision Blizzard, Inc. (NASDAQ:ATVI) provides interactive entertainment content and services. On January 18, software giant Microsoft acquired Activision Blizzard, Inc. (NASDAQ:ATVI) in a deal worth $69 billion. Activision Blizzard, Inc. (NASDAQ:ATVI) is the largest pure-play gaming stock on the market with brand names such as Call of Duty, Warcraft, Diablo and Overwatch under its belt. The share price of Activision Blizzard, Inc. (NASDAQ:ATVI) jumped over 30% after the deal was made public.

There is plenty of institutional investor interest in Activision Blizzard, Inc. (NASDAQ:ATVI). At the end of the third quarter of 2021, 80 hedge funds in the database of Insider Monkey held stakes worth $4.2 billion in Activision Blizzard, Inc. (NASDAQ:ATVI), compared to 78 in the preceding quarter worth $3.6 billion.

In addition to Microsoft Corporation (NASDAQ:MSFT), Sea Limited (NYSE:SE), and NVIDIA Corporation (NASDAQ:NVDA), Activision Blizzard, Inc. (NASDAQ:ATVI) is one of the stocks that elite investors are buying.

In its Q1 2021 investor letter, Cooper Investors, an asset management firm, highlighted a few stocks and Activision Blizzard, Inc. (NASDAQ:ATVI) was one of them. Here is what the fund said:

“The portfolio established a position in video game publisher Activision Blizzard. As a watchlist company we have followed Activision for several years. As a reminder the role of the watchlist is to allow us to focus on a select group of companies where we seek to observe important signals around either value latency, industry trends or management behaviour that portend attractive investment propositions.

Technology can often play a disruptive role in content, however video games are a clear beneficiary of technology, both in terms of more immersive and realistic gaming experiences as well as the monetisation opportunities this creates.

In order to benefit from these trends, video game publishers must be owners of unique IP. Activision Blizzard fits this bill perfectly boasting a portfolio which includes franchises such as Call of Duty, World of Warcraft and Diablo just to name a few.

The business is run by CEO Bobby Kotick, who together with Chairman Brian Kelly purchased the foundation assets for the company for US$400k in the early 1990s. Today Activision has a market capitalisation of over US$70bn. Over the last few years Bobby and his management team have refocused resources onto their best IP, with the goal of capitalising on the aforementioned industry tailwinds.

We saw the benefits of this in 2020 with the release of Call of Duty Mobile and Free-to-Play versions (with in game micro transactions) complimenting the traditional core console game. Engagement increased materially and due to the very favourable economics of content publishing, Operating Income more than doubled for the Call of Duty Franchise. Even adjusting for the impact of lockdowns, this is a phenomenal outcome.

Activision has 3-4 key pieces of IP with which they plan to repeat this playbook over the next couple of years. If they can replicate the success of Call of Duty, even in part, we see material upside to the free cash flow power of the business. Further, revenue sources are broadening which will move the profile away from a traditional lumpy annual release cycle of the old video game model towards one of a more recurring nature. This will transition Activision from a publishing to a services business, likely attracting a higher multiple than the current mid-low 20x FCF which is broadly in line with the market. To summarise, we see significant value latency and a pathway to double digit returns over the medium term.”

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