Although Overvalued, It's Far From Game Over for Electronic Arts

We attended the Electronic Entertainment Expo, or E3, in Los Angeles and came away with increased confidence around the overall strength of the video game industry. Not only did all four video game publishers under coverage (

However, some of our discussions at E3 reinforced our skepticism about the hype surrounding virtual reality, or VR, specifically on the revenue opportunity. We also left the show with more questions than answers around eSports and the eventual winners in this rapidly growing space.

We will maintain our fair value estimates and moat ratings for all four video game publishers (Activision-Blizzard, Electronic Arts, Ubisoft, and Take-Two). Despite our positive outlook for the video game industry, we view shares for all four firms as overvalued, to varying degrees. We would be enthusiastic buyers of these names in a sell-off.

While we spotted a number of VR demo booths across the E3 show floor, we continue to believe the relative burdensome nature of the experience and the lack of games will limit the growth of the VR market. Among our four covered publishers, only Ubisoft had allocated serious resources toward creating VR games, and Bethesda is one of the few major third-party publishers that is expected to launch a major title in the near future. The other firms view the sector as having a chicken and egg problem, in which the install base is too small and potential purchasers are waiting for the killer game before investing in the hardware. While Sony has sold over 1 million PSVR units (more than the next two largest non-phone-based platforms combined), that base represents less than 2% penetration of the over 60 million PS4 consoles in households worldwide.

Electronic Arts Planning to Strengthen Connection With Gamers Electronic Arts is one of the world's largest third-party video game publishers and owns some of the most well-known video game franchises including FIFA, Madden, and Battlefield. We believe the firm will consolidate its leading position by developing compelling new versions of its existing franchises and by creating new experiences with its Star Wars license. We expect EA to continue to benefit from the continued growth of the current generation of consoles (Xbox One and PlayStation 4), the ongoing revitalization of PC gaming, and the growth in mobile gaming space.

Like its peers, EA has benefited from the shift within the industry toward a bifurcated market consisting of major AAA blockbuster titles on one side and smaller independent games on the other. EA’s primary competition remains other large third-party publishers, such as Take-Two and Activision, as well as the console manufacturers (and first-party publishers)--Sony, Nintendo, and Microsoft. EA is also a large publisher on mobile platforms, a highly competitive space. We expect the company to continue using its stable of franchises and licenses to create new games, particularly in the free-to-play, or F2P, space. EA now faces additional competition in the mobile space from its console peers that are placing more emphasis on monetizing their franchises on phones. The firm is focused on engaging users beyond the initial game sale via extending the monetization window by expanding the use of multiplayer options and releasing downloadable content, or DLC. Online multiplayer games or game modes lead users to develop social networks, thus encouraging player loyalty via either informal friendship networks or actual teams/clans. DLC can either refresh the multiplayer experience by introducing new maps and increasing the level cap, or prolong single player engagement by extending the storyline. EA has used DLC and in-game transactions via Ultimate Team modes to generate additional income from the FIFA and Madden games. While both games have had multiplayer options, the Ultimate Team modes have deepened the connection with gamers and have rapidly become among the most played modes on both games.

Activision Blizzard Looking to Deal Damage With New Games, Familiar Franchises Activision Blizzard is one of the world's largest third-party video game publishers and owns some of the largest and well-known video game franchises, including Call of Duty and World of Warcraft. We believe the firm is well positioned to consolidate its leading position by developing compelling new versions of its existing franchises and by introducing new experiences, such as Hearthstone and Heroes of the Storm. We expect Activision to continue to benefit from both the upgrade cycle to the current generation of consoles (Xbox One and PlayStation 4), the ongoing revitalization of PC gaming, and the growth in the mobile market via its acquisition of King Digital.

Activision has capitalized on the shift within the industry toward a bifurcated market consisting of major AAA blockbuster titles on one side and smaller indie games on the other side. Activision generally focuses on the higher end of the market, using both its capital to fund the higher budget blockbusters and its marketing advantage to support its titles across multiple advertising platforms. Activision's primary completion remains other large third-party publishers, such as Take-Two and EA, as well as console manufacturers (and first-party publishers) Sony and Microsoft.

Like its peers, the firm is focused on engaging users beyond the initial game sale via extending the monetization window by expanding the use of multiplayer options and releasing downloadable content. Both methods encourage gamers to hold on to the original game longer than in previous generations and provide an income stream from consumers who purchase the game second-hand. Activision has used DLC and multiplayer to extend the life of multibillion-dollar franchises such as Call of Duty, and we believe recent released franchises like Destiny and Heroes of the Storm can also sustain long-term success.

We expect Activision to monetize the user base at the recently acquired King Digital by inserting third-party ads in the company’s mobile games. While we think Activision can generate some additional revenue via this path, we would caution that substantial revenue contribution could take until 2018 and beyond to appear.

Ubisoft Seeks to Get More Wired in With Game Upgrades Ubisoft is the third-largest independent video game publisher and owns some of the largest and well-known video game franchises, including Assassin's Creed, Far Cry, and Rayman. We believe the firm will consolidate its leading position by developing compelling new versions of its existing franchises and by creating new experiences, as it did with Watch Dogs in 2014 and hopes to do with For Honor in 2017. We expect Ubisoft to continue to benefit from the upgrade cycle to the current generation of consoles (Xbox One and PlayStation 4), the ongoing revitalization of PC gaming, and the growth of mobile gaming.

Ubisoft has capitalized on the industry's shift toward a bifurcated market consisting of major AAA blockbuster titles on one side and smaller independent games on the other side. Ubisoft generally focuses on the higher end of the market, using its capital to fund the higher-budget blockbusters and its marketing advantage to support its titles across multiple advertising platforms. Over the past 10 years, the firm has established its blockbuster franchises such as Assassin’s Creed and Far Cry, while creating newer one ones such as Watch Dogs. We expect the company to continue to invest in new intellectual property and to fund the development via sequels and additions to its current core brands.

Like its peers, the firm is focused on engaging users beyond the initial game sale via extending the monetization window by expanding the use of multiplayer options and releasing downloadable content, or DLC. Online multiplayer games or game modes lead users to develop social networks, thus encouraging player loyalty via either informal friendship networks or actual teams/clans. Both methods encourage gamers to hold on to the original game longer than in previous generations and also provide an income stream from consumers who purchased the game secondhand.

Ubisoft is one of the only major video game publishers that is placing a major bet on virtual reality. While we don't expect VR to take off in near future, Ubisoft is the best-situated of the three major publishers to benefit if it takes off more quickly than we expect.

Take-Two Has Tailwind From GTA Franchise Take-Two is one of the larger third-party video game publishers and owns one of the largest and well-known video game franchises in Grand Theft Auto. We believe the firm is well positioned not only to capitalize on the success of GTA, but also to continue diversifying its revenue beyond its signature franchise. We expect Take-Two to continue to benefit from both the upgrade cycle to the current generation of consoles (Xbox One and PlayStation 4) and the ongoing revitalization of PC gaming.

Take-Two has capitalized on the shift within the industry toward a bifurcated market consisting of major AAA blockbuster titles on one side and smaller independent games on the other side. Take-Two generally focuses on the higher end of the market, using both its capital to fund the higher-budget blockbusters and its marketing advantage to support its titles across multiple advertising platforms. Over the past five years, the firm has established new franchises such as Borderlands and Bioshock while reinvigorating older ones such as XCOM. Its largest annual franchise, NBA 2K, had its most popular release with NBA 2K15, which shipped 7 million units, versus an average of over 5 million units for the previous four years. We expect the company to continue to invest in new IP and to fund the development via sequels.

Like its peers, the firm is focused on engaging users beyond the initial game sale via extending the monetization window by expanding the use of multiplayer options and releasing downloadable content, or DLC. Online multiplayer games or game modes lead users to develop social networks thus encouraging player loyalty via either informal friendship networks or actual teams/clans. DLC can either refresh the multiplayer experience by introducing new maps and increasing the level cap or extend single-player engagement by extending the storyline. Both methods encourage gamers to hold on to the original game longer than in previous generations and also provide an income stream from consumers who purchased the game second-hand. With GTA V, the company finally added multiplayer to the franchise, a move that allows the company to benefit from a longer revenue tail.