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Mobile gaming. Under-invested. Under-valued?

The proliferation of mobile phone usage and the move to ‘freemium’ gaming business models has created opportunities for tech investors.

As many market commentators have observed, we are in the latest wave of a computing revolution that really started in the early 1960s with mainframe computing. Since this time each subsequent wave has for a number of self-sustaining reasons happened faster, and at an order of magnitude greater scale with each step. This accelerating development has been driven by a combination of factors – reduced friction driven by increasing processing power, improved UIs, smaller form factors, lower prices and expanded services all contributing to a scaling network effect. Mobile device penetration is expected to exceed 10bn units – more than one for each person on the planet. Mobility is becoming ubiquitous.

Fig 1. Computing growth drivers over time

mobile gaming 1

Source: Morgan Stanley, Mobile Internet Report

This ubiquity is clearly showing through. As figure 2 demonstrates, mobile phone penetration has exploded from just 80m units globally in 1995 (representing 1% of global population) to 5.2bn (or 73% of global population) in under 20 years – an annual compounded growth rate of 25% pa over a 20 year period. In reality, much of this growth has happened substantially in the last 5 years, dominated by smartphone proliferation. Smartphones, giving greater opportunities for mobile data consumption now represent 40% of the total devices. Together with the emergence of the tablet (which are significantly more data hungry) means that over a third of internet traffic is now mobile.

Yet despite all this, there is still potential for significant onward growth in penetration. Still only 22% of the world’s population has a smart phone vs 73% for mobile in general and nearly 80% for TV that other major screen based distributor of content. And the tablet has only just begun in relative terms.

Fig 2: Changing media consumption is creating new market opportunities

mobile gaming 2
Source: Various, including KPCB Internet trends report 2015

This spectacular shift in mobility, together with immediacy of services via the so called “app stores” has lifted gaming from a large, but restricted online audience to a global mobile audience. Overall online and mobile games market has grown at 25% largely as a result of an explosive 45% pa growth of mobile gaming (with online trending more modestly at 10% pa). Mobile gaming now worth in excess of $20bn pa (half of the current $40bn annual digital gaming market) and is set to continue to drive growth and represent 60% of a total $60bn market in 2017. It is this sheer scale that is so compelling.

Fig 3. Mobile & online games sector revenue ($bn)

mobile gaming 3
Source: Digi Capital, Mobile Apps Investment Review, 2014

But in addition to enhanced accessibility this growth has also been facilitated by a wholesale shift in the gaming business model. In 2011 most mobile games were sold for an upfront payment, so that revenues were simply a function of how many people downloaded the games. Games like Angry Birds and Cut the Rope sold at a substantially higher price point to other games, and

In order to capture new convenience based use patterns of mobile users, and to obviate the traditional issues of piracy and theft now that games were globally accessible, the industry required a new commercial model. As a result the “Free To Play” or “Games as a Service” model was born – games delivered to the end customer free of charge, allowing functional game play, but requiring in-app purchases to accelerate progress or enhanced features.

The transition has been abrupt: In 2011 the top 50 grossing games on iOS were over-ridingly premium up front paid apps, whereas they are now hard to find – the table dominated by Free To Play. There are signs that this model may once again be adapting for certain parts of the player universe, but Free To Play is over-ridingly the dominant model, particularly in Eastern gaming markets.

All of these dynamics have created significant opportunities for investors. Firstly, despite overwhelming success of the top mobile game studios there remains a significant value gap between leading mobile and leading console gaming studios. Partly this is reflective of sales and scale – but mobile studios are now reaching far larger engaged and casual gaming audience suggesting that there is significant value appreciation to come.

Multi-franchise success is fundamental to this growth in value. Today’s leading mobile free to play games companies have been successfully generally only in a single franchise. This dynamic leaves the leading studios requiring to acquire capabilities and scale and has led to incredible consolidation. This consolidation has already started – $24bn total deal activity in 2014 according to Digi Capital, an industry authority, with 60% of this activity specifically in the mobile gaming segment.

Notable recent deals such as Softbank recently acquiring control of Supercell (for an undisclosed price), Zynga acquiring Natural Motion for $500m, Facebook acquiring Occulus for $2bn and Microsoft acquiring Mojang for $2.5bn. There is also considerable cross continent interest from Asia, particularly where games show promise for success there – the holy grail for mobile games where revenues per user are 5-6x equivalent Western games.

Fig 4. Nascent mobile valuations lag console – contributing to consolidation

mobile gaming 4
Source: Digi Capital blog, 2014

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