Games Investing at Atomico
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Part One: Landscape and heritage.
The European games industry is a non-stop unicorn juggernaut: more than a quarter (25.9%) of all the billion dollar-plus games companies founded over the last 15 years were born here. Among them, of course, a slew of Scandinavian household names such as Supercell (Finland), King (Sweden/UK), Rovio (Finland), Mojang (Sweden) and games engine-maker Unity (Denmark). The US, by contrast, has just three.
When you take into account the sheer scale and effervescence of the Chinese market — China overtook the US in 2016 to become the world’s largest market by spend, where gamers now spend over $25bn-a-year on games — it comes as no surprise that the country dominates the sector overall, claiming 11 of the 27 billion dollar-plus games companies founded over that period.
However — tellingly — if you focus on the Top 10 Mobile Games by revenue (2017), the gap narrows considerably, with Europe on 28% to China’s 36%, thanks to Supercell and King. No mean feat when you consider the long tail of the tens of thousands of games the Chinese (not to mention the Americans and Japanese) produce.
Games move the needle.
We have a certain reticence in Europe, when it comes to crowing about our successes. Yet gaming is an area at which we excel, not least as producers of many of the world’s most iconic brands.
As someone who thinks Europe still has a lot to learn from the Valley when it comes to seeking out the limelight, that homegrown success is just one of the reasons why the games sector has excited and appealed to me as an investor over the years.
Another is that although it is already a huge market worth $108.9bn globally in 2017, it continues to grow fast — at a rate of nearly 8% year-on-year.
The ability to exit at all levels is compelling too, for entrepreneurs and investors alike. A successful founder can start a games company, and pick and choose the route they want to take, including whether they take on investment or not, and when they want to sell or go public — if at all.
Within a handful of years of launching their game, they can also be snapped up for anywhere from $5m to $10bn. (And recent experience tells us that we shouldn’t be at all surprised if a $15–20bn European games business lurks just around the corner, as this is a market that’s not only expanding, but constantly evolving.)
The return horizons can be mind-jarringly fast. A startup can go from ‘boutique’ to behemoth in three-to-five years, as opposed to the five or more which are the norm for most venture-backed technology companies. Russia’s Playrix is a case in point: it did <$50m in gross revenue in 2015, and nearly $1bn just two years later. Or indeed Supercell, which went from zero revenue in 2011 to $101m in 2012, to $892m in 2013 and $1.8bn in 2014.
The reality in this sector is that either a game achieves lift off or it attracts little more than tumbleweed. ‘Slow burn’ isn’t really a thing.
Yet what fascinates me most about gaming is the fluidity and dynamism of the space, as well as its almost unlimited potential to create new types of experiences.
Beyond games, by default.
Against a backdrop of the so-called tech-lash, and with Facebook in the dock over the use of personal data, a gaming company could very well seize the moment to build a Tencent-style social network woven around gaming, which it could use as a revenue stream to invest in other social applications such as messaging.
Indeed, I believe the next generation of games companies being developed by a new wave of visionary entrepreneurs will look beyond games by default.
There’s a fluidity around platforms too, which continually develop. Games have shifted from consoles and mobile, to PC and messaging, and flip back and forth between them seemingly at will. Games were one of the first applications on mobile and have since become one of the biggest revenue-spinners for Android and iOS — in fact games accounted for 76% of total iOS and Google Play revenues in 2017.
As VR and AR one day approach a tipping-point, games is the sector to watch for gauging their impact. It’s certain, too, that AI and even Blockchain will drive innovation in gaming in the months ahead — after all, CryptoKitties are already a thing.
Meanwhile as mobile matures, PC is back in vogue. A resurgence of indie game-makers and developers, who grew up playing the first wave of 8-bit PC games are now creating innovative games (often using Steam as a distribution platform) and building highly engaged online communities around them. Worlds Adrift - where you actually get gamers not only creating content within the game in private beta before it launches but also talking about it to their friends and thereby marketing it in advance - is an example.
PC’s comeback is partly driven by the (relative) ease of distribution and the fact that it’s much cheaper to launch a game on the platform due to the array of tools from Twitch to YouTube which can be utilised to spur engagement.
You can be a lot more dynamic and flexible in terms of how you go about your marketing on PC, while it’s a little more tricky on mobile, where the marketing firepower of the most successful mobile games has sucked much of the oxygen out of the room.
Pac-Man @ 40.
The dynamics of games companies are extremely powerful. They are highly cash generative, capital-efficient businesses which reduce the need for multiple funding rounds to prove and scale a company, and therefore minimise dilution of stock.
It’s often claimed that there’s little or no longevity in the games space — when fashions change and the popularity of individual brands start to wane, games tend to vanish without a trace. Or so the argument goes. To the contrary, the evidence suggests that strong games businesses can become long-term cash cows with 10+ year franchises: Lineage was launched in 1998, World of Warcraft in 2004, Minecraft was released in 2009, World of Tanks in 2010, and Clash of Clans in 2012. And so on.
While one group of players may drift away over time, the best games are rediscovered by a new wave of fans. Just as Candy Crush found new audiences, I find myself playing Pac-Man again in my 40s and showing it to my (admittedly somewhat bemused) kids. And Doom, the game I played with my friends in the early 90s, never quite slipped away to that great games arcade in the sky: Doom’s latest incarnation is still doing an estimated low single-digit hundreds of millions of dollars in sales since it (re)-launched in 2016.
A cornered resource.
What Europe has consistently excelled at is creating a group of developers who have had one out-of-the-ballpark smash and then go on to replicate that success.
In my view, a major reason for the continent’s accomplishments in the games space is a combination of a deep-rooted culture that values and cares about style and product — whether we are talking about Italian or Spanish fashion or Scandinavian design — and one which venerates storytelling.
This background enables games developers to create things that have a touch of magic to them. A seductive quality which draws you in. That mix of immersive storytelling, alongside the look and feel of European games — the element of games-building which is non-data-driven — is something we have a unique talent in. It’s what I call a ‘cornered resource’.
Look at the way Bossa Studios do Game jams (i.e. games hackathons) to produce unique games like Surgeon Simulator and I AM BREAD, or the early days of Rovio, or Supercell’s renowned creative model, which today sees a team of just 244, with four games, generates over $2bn of revenue, and became the ‘Dreamworks of games’ in the process.
Similarly our long history of game development - from Acme Software in 1984 (now known as Rockstar North and the original studio behind GTA and Lemmings) to Ubisoft in 1986 and Bullfrog Productions in 1987, to Team17 in 1990, Gameloft and Jagex in 2000, to Gameforge in 2003 and Supercell in 2010 - has spawned a second generation of deep talent across the continent, which in turn is leading to the next wave of innovative games companies coming through.
The compelling characteristics of games.
Among the other factors which in my view set games apart are:
Reach: the incredible range of audiences within reach, whether that’s through games with huge mass-market appeal (it’s worth noting that according to Newzoo’s 2017 Global Games Market Report there are 2.2bn active gamers, of which 1bn spend money while playing) — or more niche high-revenue-per-user genres.
Scalability: founders can launch games at Seed stage, and scale at Series A. They can scale rapidly and globally (East and West), bridging core and casual gamers across multiple platforms as they grow.
Rollout speed: They can roll out fast, with — outside Asia — limited localisation and no fixed local presence.
Engagement potential: games offer 24/7 multiple play patterns with hours spent on games steadily increasing. American online gamers, for example, spent an average of 5.1 hours per week gaming in 2011, rising to 6.5 hours in 2016 — a CAGR of 5%.
Monetisation: there are so many ways to monetise with games: in-app purchasing (IAP), advertising, virtual goods, pre-pay, even out of app brand merchandising and so on. And the monetisation models are becoming ever more sophisticated, ranging from ads for other games where you can actually play a version of that game to the highly controversial ‘loot boxes’.
Margins: with margins of 30%+, small teams can support global audiences (see the 244 ‘Supercellians’ cited above).
Competition: games are an intensely competitive space, particularly on established platforms: it’s estimated that around 1,500 mobile games are launched daily on iOS/Google Play. It’s quite clear that the best games make a lot of revenue and if you want to be a Top 10 mobile game, you need to be generating $1bn-a-year. (Outside the Top 10, revenue soon starts falling off a cliff.) On the upside, distribution models are continually evolving.
Highly data-driven: continuous A/B testing combined with constant performance monitoring ensures the best games are finely tuned.
Science and art.
Yet while data is, as ever, mission critical, what’s so exciting about this sector is that gaming is both a science and an art form. The two need to be blended together to achieve that magical spark, and neither is stronger than the other.
We can say with some conviction that you will not create a hit game today if you are ‘just’ an artist. You need to have the competency to build the best infrastructure when it comes to analysing the game play and how people are behaving — and you are constantly AB testing to optimise performance. But ultimately science alone won’t help you create the next standout game either. That’s down to art.
Read Next: Games investing at Atomico Part 2, the evaluation model we use to find the next Supercell.