The Case for Early-Stage Investment in Video Games and Esports
Hello, I’m new here.
I’m a recovering founder who recently wound down an esports startup, FanHome, for a variety of reasons I may expound on in a later post. Nonetheless, as I transition to a career in early-stage investing, I maintain a clear-eyed optimism about the potential for early-stage investment in the American esports and video game industry.
I’m excited to tell you why.
For perspective: I’m a casual gamer. Occasionally I’ll play Madden or FIFA with a friend, but I really purchased my Xbox One for consolation after a breakup a few years ago, and it now serves almost exclusively as a vehicle for streaming services. I have never immersed myself in PC gaming with the properties that have brought this industry to the mainstream (Fortnite, Overwatch, League of Legends, etc.), but I have dabbled in order to learn.
In fact, FanHome was not initially an esports startup. But five or six pivots after inception, we realized our best customers were gamers, and it was time to sink our teeth in.
The more traction we got, the more I realized that I was much more like my customer than I initially thought. And herein lies the setting that enables a strong video game investment thesis: as long as huge swaths of America still view gamers as outsiders (e.g. the 33-year-old male covered in Doritos nacho dust who hasn’t left his mother’s basement in 72 hours), there remains an opportunity for venture returns.
There are two pieces to this story:
I. To understand investment optimism, it’s important to understand how the value chain of the $140B global video game market has changed over the past 20 years. I’m going to unpack that — or at least unpack the bits that matter for Part II.
II. Which piece of this industry lends itself to a strong venture investing thesis? This isn’t going to focus on one well-defined category — rather, it will focus on a job-to-be-done that a handful of startups are targeting. And I’ll brief you on those startups!
I: A radical transformation
Mark Goad, an associate at OMERS Ventures, recently authored a comprehensive landscape of the industry as it stands today, and the sheer number of categories he outlined highlights the transformation of video games.
Most of the above chart didn’t exist 20 years ago. Let’s look at one of my childhood-favorite games: Crash Bandicoot. The developer — Naughty Dog — created the game for a platform — PlayStation. The game was published, marketed and distributed by Sony, which owns PlayStation. Around Hanukkah, my mother purchased the game at a retailer — Toys R’ Us (RIP. RIP?). My brother and I played Bandicoot until we beat every level, and then we begged Mom for a new game.
Pretty simple.
Broadcasting. Community. Betting. Superstars. Teams. Services. … These weren’t even words associated with the video game industry, let alone ideas that would become billion-dollar categories within it. ‘Retail’ doesn’t even exist in Goad’s chart, as platforms today go direct to consumers through their online app stores.
Therein lies the keyword that, unsurprisingly, upended the video game market: online. Online gaming has been around since the internet was invented, but Microsoft blew the lid off when it launched Xbox Live in 2002 and made it as simple for me to battle Halo players on another continent as it was to battle my brother sitting next to me.
Fast-forward to 2019, and gaming is a beast the world is still learning how to reckon with.
I’m far from the first to recognize there are potentially attractive venture returns in this industry. Nonetheless, I’ve talked to a lot of investors who either haven’t gotten smart on the industry yet or who have trouble gripping the case for going long on video games.
The former rationale is okay, though a missed opportunity. This post is directed at the latter. It’s time to rid ourselves of any notion that video games are not part of the mainstream consciousness.
Why? Because the young people will win.
The argument against investment sounds like this:
Yes, children are playing more video games, they’re consuming esports, and the industry is profiting. But those children grow up, get jobs, raise families, lose interest, and ultimately churn.
That logic is represented by the red line in my sophisticated chart below, and it ignores obvious trends.
This may seem like a distant parallel, but I view video game investing similarly to how the March for our Lives students view today’s gun control debate: the young people will win. Over time, young people become powerful and change the narrative. If you don’t believe in that concept, you don’t see the full scope of opportunity in video games.
Even if the red line were the real view, I would argue it screams for investment. But this industry will generate true venture returns because of the green area above it. Video games are sticking with young people as they age, and that is fundamentally altering how content is deployed across the industry’s value chain.
More avenues for consumption
In referring to Goad’s landscape of the industry above, I’ll touch on three categories: audience & casual players, broadcasting, and superstars/teams.
Casual players, in their free time, hop on their mobile devices, PCs, or consoles to play games and participate in the community. But I’m particularly excited about the audience segment, as game-viewing represents a relatively new avenue for participation as people age (the green area!).
In case you’ve been living under a rock: yes, people watch other people play video games online. There is no doubt in my mind that you — yes, you — know at least a handful of people who do this in their free time. They probably haven’t told you because of that thing I wrote earlier: the reputation of gaming enthusiasts isn’t great, and a lot of them prefer to keep their hobby close to the vest… for now.
The audience is split into two camps — though, with plenty of overlap: (1) people who watch Twitch and YouTube streamers, and (2) people who watch esport professionals.
(1) Talented independent gamers are streaming their live gameplay to content platforms, the market share of which is dominated by Amazon’s Twitch and Google’s YouTube (this is the broadcasting piece of Goad’s chart). Twitch reported at the end of 2017 that the platform reels in 15 million daily active viewers who spend, on average, 106 minutes on the platform.
Those are the kind of numbers that enable video games to transcend the video game market. Twenty years ago, in the Bandicoot era, developers and publishers would compete against one another to steal share within a set audience of people who typically buy games. Now, content platforms (and the streamers who create the content) are stealing eyeballs from televisions, other streaming services, social media platforms, and anything else that occupies public consciousness.
In Netflix’s latest earnings report, management noted:
“We earn consumer screen time, both mobile and television, away from a very broad set of competitors. We compete with (and lose to) Fortnite more than HBO.”
(2) Esports professionals compete in tournaments and are paid a wage and some portion of tournament winnings. Live tournaments are hosted in major stadiums and arenas all over the world, and the gameplay is broadcast to Twitch and/or YouTube. More recently, some esports content has transcended the content platforms by striking frothy broadcast deals with major networks.
Most of the content consumed on Twitch and YouTube is not professional esports — share is dominated by the streamers discussed in (1). But the major tournament events for League of Legends, Dota 2, Overwatch, and other major titles do drive tremendous concurrent traffic. More importantly, esport professionals set the standard for what young gamers aspire to — these athletes are the best of the best, period. Their accuracy, reflexes and stamina are legitimately unique and require the type of training it takes to be able to connect on a 100mph fastball.
With the professional sport gaining legitimacy through viewership and TV contracts, high schools and colleges have begun to fall in line to help legitimize the sport. This is helpful for the market, as it ensures the pipeline of young video game consumers will continue to grow.
You’re still confused as to why someone wants to watch someone else play a game.
There are three reasons people watch video game content:
(1) Learning. Again, professional gamers a really quite good. A lot of casual players and amateurs want to watch them so they could deploy similar tactics in their own gameplay and improve. This is no different than football teams doing film sessions between games.
(2) Entertainment. Streamers have big personalities that they put on full display during their broadcasts. Oftentimes, the banter is objectively funny.
(3) Access. When you watch content on Twitch, you see a picture-in-picture view of the streamer. You can talk to him/her via the live chat. You can make donations to the streamer, and oftentimes to a cause that he/she cares about. And in extraordinary cases, you could watch the streamer interact with celebrities ranging from Drake to Ben Simmons to Alexandria Ocasio-Cortez.
This form of entertainment doesn’t have to be your cup of tea. But at this point, I hope I’ve at least illustrated that video games have recently penetrated pop culture in ways it has never done before, and they’re here to stay.
II. Ready to put $$$ to work
The reason I care so much about video game audiences is because the connection between watching and playing is strong. As viewership on Twitch increases, so too does the number of streamers providing content.
This is partially because gaming is far more accessible than other activities. When I watch Giannis Antetokounmpo take off from the foul line and dunk a basketball, I wish I could do the same… but there are insurmountable barriers preventing me from achieving that level of athleticism. Conversely, after the first few Ninja streams I watched, I downloaded Fortnite for free, joined the server and got in on the action.
Five minutes, without leaving my couch — that’s how easy it was to enter this community. Granted, mere seconds into my first game I got yelled at by a 13-year-old on my team because I didn’t know what I was doing. But the point remains — as viewership grows, so too does the universe of casual and amateur gamers.
So, here it is…
Investors should place bets on companies that — inadvertently or not — are helping bring the experience of casual & amateur gaming more in line with that of professional gaming.
The startups that position themselves to take advantage of the watch-then-play trend will deliver outsized returns for early-stage investors. There aren’t many other opportunities in which a trend is both incredibly well established and the runway for growth is incredibly long (think about the green area in the chart!!).
Here are three companies that fit the bill. The window for early-stage entry may have closed for these players, but think about how the characteristics described above will enable these businesses to thrive.
(1) smash.gg recognized that as professional esports viewership has increased, so too has the appetite for young people to compete themselves. But organizing amateur competitions is hard, and there wasn’t a dedicated software to help. This company created a platform for amateur esport league and tournament managers to organize, making it seamless to set up brackets, accept registration from gamers, sell merchandise, and much more.
If you’re a Midwest investor, you probably like revenue… so this Reddit post from CEO Shantanu Talapatra might scare you:
Nonetheless, I think smash.gg is tapping into something truly special, and the company has serious customer traction for a Series A venture. The last round of funding in mid-2017 was an $11 million raise at a pre-money valuation of $31 million, led by Spark Capital with participation from Horizon Ventures, Accel, Caffeinated Capital and Lowercase Capital.
(2) Haste is a network optimization platform that reduces lag in gameplay — an issue near and dear to the hearts of all gamers. This company is targeting a problem that touches the most casual gamers and the most well-paid professionals. Last summer, even a high-profile Fortnite tournament in Chicago’s Willis Tower was two-hours delayed due to network issues (this sucked for me as well, as I was hosting a FanHome viewing party, and my customers were bored out of their minds).
“Delay at #RiseTillDawn now nearing one hour. Computers are updating the latest patch. Appears to be like half of the computers are updated with roughly half to go@Ninja and @DrLupoOnTwitch are entertaining the crowd on the main stage”
— The Esports Writer (@FionnOnFire) July 22, 2018
As Goad notes in his write-up, there is risk associated with investments in network tools: there is a chance that broad advancements in network technology will render Haste obsolete in several years.
But after a few conversations with Haste CEO Lynn Perry, I believe that their sales strategy has real potential. The company is aiming to sell through ISPs, with a major opportunity to unlock a robust B2B2C revenue model. If successful, I see big upside at Haste.
(3) Super League Gaming empowers youth competitors to experience video games the way that professionals do. The company has organized the premier amateur gaming league for children, with clubs in 16 cities across the US, and they’ve partnered with movie theaters for hosting their tournaments (much to the joy of theaters).
Importantly, Super League inked multi-year contracts with the publishers of League of Legends and Minecraft. Last fall I met CEO Ann Hand at Super League’s Santa Monica office, and she emphasized that those partnerships provide a distinct competitive advantage in organizing a league. Companies like Riot Games and Microsoft are very protective of their brands, and deal-making with them isn’t easy.
But there is a reason I listed this one last.
On Jan 4th, the company filed for an IPO on the Nasdaq to raise $25 million, without an indication of valuation. The financials in the SEC filing are bleak, and it’s not entirely clear how the company intends to use the funds or what the path to profitability is.
I won’t be buying common shares, but I’m excited to follow from the sidelines. I’m cautiously optimistic that Super League is going to figure out how to monetize the brand equity it’s built with young gamers all over the country.
Summary
I’ve hardly scratched the surface of the video game market. If you want a more comprehensive landscape, I highly recommend reading Goad’s piece linked up top — it’s thorough. I merely focused on the categories that lay the groundwork for a sound early-stage investment thesis.
If it’s not abundantly clear at this point, the video game market excites me, and the ceiling for the industry is very high. If you’ve read this far, either you agree, or you’re just intellectually curious on the subject matter. If you want to keep talking about it, reach out to me — I’d love to chat!
#GGWP
