The economic fallout brought on by efforts to stop the spread of coronavirus is only just beginning to be felt. Just in the United States, initial jobless claims have quickly surged above 10 million. Businesses are under pressure, either due to mandatory closure or lost business as most potential consumers are confined to home. For others, the sudden increased importance of digital tools has created logistical issues for companies with employees working remotely.
There are a handful of industries that have seen an increase in business related to the COVID-19 disruption. The video game industry is one. According to Verizon CEO Hans Vestberg, video gaming on his company’s mobile network increased 75% week-over-week in mid-March. It’s likely a temporary surge, but it underscores how important games have become — especially to younger, tech-savvy generations.
Of course, higher video game use doesn’t automatically equate to higher share prices for the companies that make them. Nevertheless, three companies well-positioned to attract the growing pool of gamers in the months and years ahead are Zynga (NASDAQ: ZNGA), Take-Two Interactive (NASDAQ: TTWO), and Tencent Holdings (OTC: TCEHY). Let’s take a closer look at these companies and see whether they might be worth investing in.
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1. Zynga: A leader in mobile games
When many think of video games, images of young people holed up in mom and dad’s basement playing on a high-end gaming console come to mind. However, with the advent of the smartphone, video games have become far more mainstream and accessible to a much larger audience.
Zynga is one of the top game developers in this department, known for titles like Words With Friends, FarmVille, Zynga Poker, and CSR Racing. The mobile and social gaming company entered this crisis coming off its best-ever year for revenue and profitability: $1.3 billion in revenue (up 46% year-over-year) and operating cash flow of $263 million (up 57%). The company also completed the sale and leaseback of its San Francisco headquarters, a particularly fortuitous move given the current situation now. As a result, the game studio ended 2019 with $1.4 billion in cash, equivalents, and short-term investments.
Now Zynga won’t be totally immune to the pandemic. Of its revenue last year, 21% of it was derived from advertising sales. Ad spending is sure to take a hit during the coming recession, just as it has in times past. That will be an important metric to watch in the coming quarters.
However, the vast majority of revenue and overall growth came from purchases made by users. Zynga’s live events and the rollout of new titles and features have meant steadily rising in-app and game purchases from a global monthly average user base of 66 million. Trading for 27 times trailing one-year free cash flow (what’s left after operating and capital expenses are paid), this small mobile game stock doesn’t come cheap but could get a huge boost from idle consumers looking to fill up their schedules during the quarantine.
2. Take-Two Interactive: Sports are sidelined, but video game versions certainly aren’t
One of the nasty unforeseen side-effects of COVID-19 has been the shutdown of sporting events — everything from the delay of the 2020 Summer Olympics in Tokyo (rescheduled for summer 2021) to the closure of professional athletics, college sports, and grade school leagues.
Virtual sports are alive and well, though, and Take-Two Interactive could be primed to benefit. The maker of already popular National Basketball Association simulator NBA 2K, wrestling simulator WWE 2K, and The Golf Club Featuring PGA Tour, NFL 2K will be joining the mix as it’s set to return in 2021. After a decade-and-a-half exclusive deal with rival Electronic Arts‘ Madden NFL, the National Football League signed a deal to allow Take-Two to begin making its own American football game. Along the way, Take-Two’s other popular franchises like Bioshock, Borderlands, and XCOM 2 are headed to the Nintendo Switch console.
Take-Two’s revenue tends to be lumpy as growth surges coincide with new title releases. With a slew of new games, 2019 was a record year for the company. However, less cyclical recurring revenue from in-game purchases has been on the rise (37% of the total during the 2019 holiday season). The company also generated record free cash flow of $835 million on sales of $2.9 billion during 2019, and it was forecasting a 22% year-over-year increase in sales during the first quarter of calendar year 2020 (Take-Two’s fiscal 2020 fourth quarter).
With new games and existing titles headed to new platforms coming in the year ahead, Take-Two stock’s 16.5 times trailing free cash flow looks mighty affordable. With a potential bump from shelter-in-place orders waiting in the wings, this could provide a timely purchase for those looking for a growth-at-a-value play.
3. Tencent: The world’s largest video game company
For our last stock we head to China, which had to deal with the pandemic early due to it being the likely origin place of the contagion. In many ways, China’s digital economy is the most advanced in the world, with some of the highest rates of mobile internet use and heavy reliance on e-commerce, delivery services, and digital payment systems.
Enter Tencent, the tech giant responsible for social media platforms WeChat and QQ, which combine for nearly 1.2 billion users, most of whom are in China. But Tencent is also the world’s largest video game company, hauling in $4.2 billion in revenue from that segment alone during the fourth quarter of 2019 (using a Chinese renminbi-to-U.S. dollar conversion rate of 0.14).
As with other video game businesses, revenue from this segment is an up-and-down affair. To combat that, the world’s largest gaming business is in the midst of launching Tencent Start, a cloud-based video game subscription service powered by high-end NVIDIA graphics cards (another top video game buy, but on the hardware side rather than software). Using its deep reach in the industry, Tencent could be a big winner in the up-and-coming game streaming migration that is in the very early innings of evolution.
Until streaming starts generating consistent returns, though, there is plenty to like in Tencent’s portfolio. It owns Riot Games, responsible for League of Legends. It also has a majority stake or large investments in Supercell (Clash of Clans), Epic Games (Fortnite), Bluehole (PUBG), as well as minority stakes in the world’s second-largest video game company Activision Blizzard, and Ubisoft. The stock goes for a premium 36.2 times 12-month free cash flow, but this is a fast-growing tech conglomerate with easy access to the world’s largest base of digital consumers. The COVID-19 outbreak will most certainly cause some near-term disruption, but this video game stock is a long-term buy.
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