Why Video Game Stocks Face Their Worst Year In Two Decades

Video game revenues head for their first decline since 1995

Already beaten-up video game stocks face more downward pressure over the next two years, a key turning point for the industry, as video game revenues head for their first decline since 1995, according to Pelham Smithers, owner of an eponymous London-based research firm.

He blames the slowdown on a myriad of headwinds. including China’s stricter approach to game approvals, a shortage of big console hits, and fatigue among players for battle-royale titles like Fortnite. These accelerated risks should drag on the once red-hit industry until at least 2020, weighing on shares of companies including Activision Blizzard Inc. (ATVI), Electronics Arts Inc. (EA) and Take-Two Interactive Software Inc. (TTWO), according to the market watcher, per Bloomberg

“The various bits of the jigsaw puzzle just don’t add up, so we’re looking for the market to shrink in 2019,” said Smithers. “The sell-off in video game stocks is primarily down to a growing realization of the risk that this view is right.”

Video Game Stocks Are No Longer Fun

% Change From 52-Week High

  • Activision Blizzard; -44.2%
  • Electronics Arts; -40.1%
  • TakeTwo Interactive; -27.5%

Source: Investopedia

Gaming Revenues to Fall by 1% This Year

The surge in the popularity of gaming over the past few decades has been categorized as a social phenomenon, both in the U.S. and abroad. Viral games like Fortnite and the frenzy over e-sports has elevated the industry to compete alongside traditional sports leaders like the NFL, turning games into cash-cows funded by in-game purchases and subscription services.

In light of the gaming industry’s sweeping success, one veteran analyst expects the tables to turn for the first time in 24 years. Smithers, who started covering the industry in the late 1980s, correctly forecast the decline of Nintendo Co., giving it a "sell" rating a decade go, back when that was a contrarian call.

Smithers now forecasts video game revenues to fall by 1% in 2019, to $136.5 billion. He highlights the sell-offs in shares of companies including Tencent Holdings Ltd. and Electronic Arts as supporting his thesis.

Mobile Game Weakness

Smithers views the biggest threat to the gaming industry as a drop off in mobile game sales, representing nearly half of total industry revenues. He attributes the weakness in mobile to the Chinese market, the world’s biggest smartphone market, which he expects to see a 10% contraction due to Beijing’s tighter grip on game approvals. The effect of a Chinese slowdown should be intensified as the U.S. and Japan mobile markets plateau, predicts the analyst. 

Console, PC Gaming Declines

He also expects consoles, which reflect 19% of total gaming sales, to struggle to follow-up a record 2018, while the aging of older consoles should also drag on growth. 

Smith expects revenues from PC gaming, which comprise 25% of total industry revenues, to decline as players lose interest in last-man-standing titles like Fortnite, which have been popular since 2017.

Stocks Too Expensive, Risks High

Apart from China’s crackdown, other negative headwinds facing gaming stocks include disappointing sales of Nintendo’s Switch, regulatory scrutiny over gaming addiction and monetization practices like loot boxes, as well as uncertainty over games pipelines from leading game makers.

“I’m not sure if there’s been enough of a reset in some of the really expensive stocks,” he said. “EA still looks expensive. Capcom still looks expensive." 

Smithers points to two bright spot in the industry, including virtual reality-related sales, which he expects to double from $4 billion in 2018 to $8 billion by 2020, as well as e-sports.

Fortnite’s Impact

The unprecedented success of Fortnite, which stole the spotlight away from Electronic Arts and Activision, has led many market watchers to hone in on the underperforming pipeline of games from older industry leaders. Meanwhile, free-to-play games like Fortnite continue to pick up speed as they generate revenue from add-on content.

In a letter to shareholders, streaming behemoth Netflix Inc. (NFLX) wrote, “we compete with (and lose to) Fortnite more than HBO.”

Shares of Activision fell a whopping 12% on weaker-than-expected earnings guidance, in which the firm admitted that its key Destiny 2 game has missed expectations. Activision plunged again after announcing it would transfer the publishing rights of the game franchise to its developer, Bungie.

In a similar fashion, Electronic Arts’ anticipated Battlefield V game did not spark the enthusiasm the firm hoped for. In November, the game was discounted by 50% just one week after launch. 

Shares of Activision and Electronic Arts have both fallen into bear market territory, down 44% and 40% from their 52-week highs respectively.

Meanwhile, research firm SuperData estimates Fortnite generated $2.4 billion in sale for its published in 2018, the most annual revenue of any game in history.

What’s Everyone Else Saying?

Peter Warman, founder of research firm Newzoo, echoed Smither’s downbeat outlook, trimming his 2018 and 2019 gaming revenue forecasts by 3% to 2%. The IDC recently lowered its outlook for China’s gaming market to grow by just 5% in 2018, compared to the 20% annual growth seen since 2014. 

Not all are so bearish. Analysts at firms including Goldman Sachs, Morgan Stanley and Nomura continue to view the gaming industry as positioned to outperform. 

Moving Forward

Looking ahead, it’s possible that even one blockbuster game could turn things around for the industry, yet that remains an unlikely scenario. Ultimately, falling sales in 2019 are a watershed - and warning - for the industry and investors.

Investors will be keeping a close eye on whether the major gaming companies can re-spark optimism when they report Q3 results, with Activision slated for Feb. 12 and EA set to post on Feb. 5. Investors shouldn’t be surprised to see both firms offer disappointing forecasts.

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