#2 Sectors in Brief - The Gaming Sector

Last week I published my 2023 portfolio review. Writing that newsletter allowed me to actively reflect on each company of my portfolio. During that reflection, the company I spent the largest amount of time thinking about it was Evolution Gaming ($EVO). Not because I doubt about its potential but because I felt it weird to have a gaming company (industry I dislike) in my portfolio.

In today’s newsletter I will explore why I don’t like the gaming industry and the reason why Evolution software is the exception.

The Gaming Sector

The gaming industry is one of the most popular and lucrative in the world. Its market size is estimated to be around USD 280 billion, growing at a 8-12% CAGR during the remaining years of the decade according to different sources. Its a fragmented industry where its larger player, Sony Interactive Entertainment, generated USD 25.47 billion in 2022 (<10% market share roughly). Moreover, eGaming competitors have been gaining an professionalizing and gaining in popularity during the last decade.

In addition to the industry tailwinds, many companies have strong competitive advantages in the form of powerful IPs and switching costs. However, from my point of view of a casual gamer, the companies in the industry face significant more potential risks. Here are some:

User Engagement

Gaming its not a new activity. People have played a games, e.g. chess, through history, the only difference introduced by the gaming industry is the change in platform, video supported games. Hence, as you might have already realized, gaming competes against any other activity a person can do on their free time.

Then, a gaming company product not only has to compete against other gaming companies titles but also it has to be the preferred free time activity over board games (Games Workshop), books (Amazon), movies & series (Netflix), music & podcasts (Spotify), sports and even going out for dinner.

Dependence on Hype

Companies’ performance might be very tied to new releases hype - in the case of a company with a great track record of developing video games which become blockbusters - or the release of the latest game of a popular franchise. This hype dependence could potentially last performance by delaying releases due to fear of not meeting the already set expectations or even bad publicity of the early players.

Costly Developments

Video games development can be a time and resource consuming endeavor. Traditional development is based in on the cascading model where a team sets a vision for the new game and after some tests and adjustments of the beta version the game is released and judged by customers.

Hence, most of the feedback of such a large project is received once the product is release to the market, with little possibility to do any further improvement or adjustment, sometimes, until the next title of the franchise. Fortunately, this more of a problem of traditional franchises (Grand Theft Auto, The Elder Scrolls, Call of Duty) and new games have a more dynamic approach (Fortnite).

Churn of Game Titles

The gaming industry is constantly evolving. In order to keep up with the latest trends and consumer preferences, gaming companies need to release new games on a regular basis. This can lead to a rapid churn of game titles, making it difficult for investors to identify long-term growth prospects.

Regulatory Scrutiny

The gaming industry has been under increasing scrutiny from regulators in recent years. This is due to concerns about anti-competitive practices, and the new revenue model implemented during the last decade based in loot boxes and pay-to-win mechanics which promote online gaming addiction. Gaming companies may face fines, legal challenges, and increased compliance costs.

Dependency on Hardware and Platforms

Gaming companies often rely on the availability and success of specific hardware platforms, such as gaming consoles or mobile devices. If a popular platform declines in popularity or faces technical issues, it can significantly impact the sales and profitability of games developed for that platform. Moreover, knowing their advantageous negotiation position over developers, those hardware and platforms also impose them technical limitations, exclusivity agreements and charge by default 30% royalty fee.

The exception which confirms the rule

On the other hand Evolution Gaming is a Swedish iGaming company (not to mix-up with eGaming). The company develops, produces, markets, and licenses fully integrated live casino solutions to gaming operators around the world.

So basically its the software company with not only the skills to digitalizes classic gambling games but also to operate them with a high level of security, trust and great user experience while complying with the existing gambling regulations.

This particular positioning in between the gaming, tech and gambling industry is what makes the difference with the rest of the gaming industry. Let’s see why:

User engagement

We talked about gaming companies competing against any other activity you can do in your free time. In this case of gambling an activity with the potential to change gamer’s behavior, becoming a sticky habit.

The reward obtained when winning a game are monetary. Money is a powerful motivator, and the potential to win a large sum of money can be very enticing. Initially, and inexperienced gambler will release dopamine when they win a gamble and get the monetary prize. As they become more experienced, in the anticipation of prizes during each gamble their body will release dopamine in advance, even though the end result might be a lost gamble.

The combination of the anticipation of a monetary reward and the release of dopamine can be a powerful reinforcement that can promote addictive behaviors. Something similar to trading or scrolling TikToks or Reels (comparable to a slot machine but no money reward involved).

Costly development

Gambling games are simpler than traditional video games. Although, the monitoring to avoid cheating and supervision activities to reduce downtime to the minimum are not. Hence, if a games is not sucessful repurposing the studio and dealers for a new game would be easier than with traditional games. The major problem for Evolution would be the retraining and retention of the dealers.

Regulators Scrutiny

Regulation of online gambling exists in approximately 90 countries. As in any other industry, the restrictions and requirements imposed by regulators impose additional costs to the companies impacted, making more difficult for new players to enter the market due to its incapacity to comply with them.

Moreover, gambling has always being under regulators eye while video games regulation is a new area which future impact is still unknown.

Dependency on Hardware and Platforms

As you might have already sense, Evolution Gaming does not develop games but a digital gambling solution in the form of a fully integrated gambling platform, a one-stop shop where operators can gain access from the generic games to the most customized ones. Evolution revenue comes from fees paid by the customers. Those fees are split between fixed and variables ones in the form of royalties.

Closing remarks

Game developers and also, maybe to a lesser extent, gaming hardware ones faces some inherent risks of the gaming industry which prevent me from investing on what I consider can be a risky proposition. However, I believe many of that risks are not applicable to Evolution Gaming and so I can sleep well at night holding a remarkable share of my portfolio on it.

Hope you enjoyed this newsletter. I think it was time to catch up with the sectors in brief series and at the same time put in writing these thoughts about Evolution Gaming.. Please leave a comment, give it a like and share!

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