The Decade Gaming Will Tilt (Further) East

The gaming world in the united states has very few large- or medium-capitalization companies that specialize in video games.   Waves of consolidation (Maxis, Broderbund) or bankruptcy (3DO, Acclaim) has swept out many of the historic publicly traded videogame companies as capitalism’s creative destruction did not spare gamers.   Much of the US-based gaming market capitalization is effectively part of Microsoft. But with only 1.9 of Microsoft’s 12.9 billion in revenues coming from the Entertainment and Devices division in the last reported quarter, and an even smaller percentage of operating profit (312 million of 4.48 billion) it is arguable after many earlier years of losses whether this was a worthwhile extension of shareholder capital.   Other sections of the videogame industry are submerged into entertainment conglomerates.  There, alas, they are financially black sheep.   Even occasional large hits such as Beatles Rock Band compete against intellectual property  siblings, “are negative for margins” and Viacom hopes to break-even on it based on the holiday results.   The division-level picture is worse — Disney Interactive is “still in the investment phase”: losing $295 million last quarter.   When the combined results of Disney and Microsoft’s gaming divisions are more or less a wash, there’s a problem in the maturation of the industry.  The occasional frenzy whipped up by bankers that there is about to be a wave of consolidations by the entertainment conglomerates of the game distributors shrivels under the glare of these green eye shades.

Publicly traded gaming boils down to five major US entities: ActivisionBlizzard, Electronic Arts, Take-Two, THQ, and GameStop.  At the close of trading January 11, these five firms had 24.4 billion in market capitalization.  This was already well in the shadow of Japanese gaming firms (Nintendo at nearly 60 billion dwarfs them alone, before one counts Sega, NamcoBandai, Capcom and others.)

Today with EA pre-announcing disappointing holiday results, on the same day as Shanda Games appears to have acquired Mochi Media, the shift in gaming power East is ever more apparent.   The US model of packaged goods distribution as the driver of power within the gaming industry is being rapidly eclipsed by the online-centric Chinese universe.  This is occuring much in the same way as rapidly developing foreign countries immediately skipped the stage of widespread copper-to-the-home development in favor of high speed internet and mobile computing.

The same aggregate market value computation is a little more difficult to arrive at for China: should the best performer in the Hang Seng index in 2009 (Tencent) be counted whose primary revenue driver is not yet gaming?  Does one count Shanda and Sohu after the spinoff of Shanda Games and Sina?   Neverthless, on the close the same day and without Tencent, adding NetEase, Giant, Perfect World, Sohu, Shanda, Changyou, Shanda and SINA together is roughly 17 billion.  Their profit margins collectively put the American firms to shame.  The excitement at GDC China is palpable.

With any reasonable re-valuation of the Yuan the Chinese gaming companies numbers however constituted would quickly surpass the American counterparts.  But with current trends we may not have to wait for that — at current trajectories NetEase, a company few gamers would even pretend to have heard of two years ago may soon have a higher market capitalization than Electronic Arts should the latter experience a big enough drop.   NetEase in part achieved this by winning World of Warcraft distribution rights in China; however that 2.5 billion dollar bump is a lesson in itself.  The Chinese consumer rights to the WoW property are more valuable than all but two standalone American gaming companies!

Niall Ferguson wrote in the Financial Times December 29th the last decade was one “The World Tilted East.” He has started to posit the possibility that in the course of world history western ascendancy of the last five hundred years may not be normative, but an irregular blip.  As with finance so too with gaming.  The Chinese consumer is on the rise – domestic consumption may rise .4 trillion to 2.25 trillion this year, and as the income is increasingly matures over the decade  to be spent on consumer entertainment the multiplying effects on the gaming industry will only accelerate.

The rub on Chinese games currently loudly echos the critique of Japanese consumer goods in the post-war period.  Poor Quality.  One can’t imagine a conference call in China where the virtues of the company are extolled by citing Metacritic scores.  But profit covers a multitude of sins; something that is hard for many American companies to remember.   As the Japanese electronics industry matured and surged in profitability, so too did the quality and it sought foreign markets — leaving unprofitable domestic firms whimpering, then extinct (quick: name the American TV manufacturers.)

This is the future of gaming and its good for us.  No need to call Lou Dobbs or Ross Perot here — there will be a cultural blood transfusion from the rising power the gaming industry sorely needs, not just cheaply outsourced art.   The industry doesn’t need to face the solemn fugues of the TV industry, but the industry that gave Silicon Valley its name.  Without the Japanese chip challenge in the 80s would Intel have evolved to being the great global company it is today, would there have been the intrepid entrepreneurial culture of those companies neighbors?  While threatening to the incumbents change will challenge the sequelitis that afflicts so many American “franchises.”  Through this competition the game industry will be forced to grow as standalone companies with new ideas (look to Zynga’s oft teased IPO to add to the US market cap) to compete and we all will benefit.

It will be an exciting decade to play.