9 janvier 2023
Last year the games sector did not keep pace with its exceptional performance in 2020-21. The industry grappled with varied headwinds ranging from worsening macroeconomic conditions, a post-pandemic softening in demand, ongoing supply issues, changes in the mobile privacy framework and a significantly increased legal and regulatory focus.
Nevertheless, sector fundamentals are solid and medium to long term prospects remain very strong. The industry has matured dramatically in recent years. This has brought the benefits of an ever-growing player base and increasing revenues together with innovation in technology and business models. It has also brought turbo-charged investor interest, especially from big tech majors which increasingly predominate in the sector as part of their long-term strategic plans. By 2025, NewZoo predicts that the industry will grow to 3.5 billion players and generate revenues of USD 211.2 billion, representing a healthy five-year CAGR of +4.2%.
However, as in games, so in the games industry – progression from one stage to another tends to increase the challenge. Post pandemic, we predict that growth, investment and corporate deal activity in the sector will continue to be healthy, albeit potentially at a slower pace and in the face of more opposing forces, as the industry firmly takes its place in the global economy.
The last few years have been an exhilarating time in the video games industry. Following two decades of steady growth since the turn of the century, the industry entered 2020 as the undisputed leader in all forms of entertainment, generating annual revenues greater than the music and film industries combined. The industry's growth rate has been exponential, growing from approximately USD 8 billion in 2006 to almost USD 180 billion at the end of 2020.
In 2020, gaming reaped the benefit of pandemic profits as Covid-19 lockdowns disrupted other forms of socialising and entertainment (see our 2020 predictions piece: "Achievement Unlocked – investment and M&A in the games industry"). The industry grew by over 23% that year alone. Maintaining such stratospheric momentum was bound to prove challenging as lockdowns lifted throughout 2021 and the negative effects of the pandemic began to be felt. Nevertheless, by the end of 2021, the industry had still managed to grow by 7%, topping out at approximately USD 193 billion.
In 2022 the difficulty curve begun to spike. The lockdown benefits which fuelled growth in 2020-21 had passed while the hangover effects, including game delays and supply constraints, remained. A general worsening of macroeconomic conditions and increased interest rates also took its toll on gaming, as it did in other technology sectors. In addition, mobile gaming – for a long time the fastest growing segment and which now accounts for 50% of the global gaming market – also had to contend with changes in advertiser identifier functions by Apple and Google. Their app stores essentially act as gatekeepers to mobile gaming to such an extent that the UK Competition and Markets Authority (CMA) thinks they have an effective duopoly on mobile ecosystems, and launched a market investigation into mobile browsers and the distribution of cloud gaming services through app stores on mobile devices in the UK towards the end of 2022 (as discussed in further detail below). The changes made to the advertiser identifier functions improved privacy for mobile app users but this came at the cost of disrupting the highly targeted ad campaigns which were the lifeblood of the user acquisition strategies used by mobile game developers. According to NewZoo, mobile gaming revenues saw a decline of -6.4% in 2022, while the global games market as a whole generated revenue of USD 184.4 billion in 2022, down -4.3% year on year.
Deal activity in 2022 has followed this wider softening trend as the first three quarters saw lagging results compared to the same period in 2021. In that period, across M&A, private investments and public offerings globally, around 600 closed deals were registered by InvestGame, with an aggregate deal value of USD 51.4 billion, compared to USD 58.8 billion across 700 deals in Q1–Q3 2021. Not a collapse in dealmaker confidence by any measure, but certainly a weakening against recent boom years. When including deals announced in 2022 which have yet to close, the aggregate deal value more than doubled to USD 124.5 billion (however the vast majority of that was attributable to the proposed USD 69 billion acquisition by Microsoft of Activision-Blizzard).
The biggest driver of M&A deal activity was strategic investment, spread across a more concentrated number of larger value transactions, as bigger market players sought to make transformative bets. In a period which saw 600 closed deals, the five largest comprised approximately 65% of aggregate deal value.
Embracer was most active, continuing its rise as a gaming giant on the back of fresh funding from Saudi-backed Savvy Gaming Group. It closed 22 transactions for a total value of USD 4.6 billion (including USD 300 million on the highly-publicised acquisition of three studios from Square Enix, encompassing the totemic Tomb Raider IP). Tencent followed with 14 deals totalling USD 2 billion (including the acquisition of UK-based Sumo Group for USD 1.2 billion), continuing its diversified strategy of taking a mix of minority and majority stakes across all segments of the industry. Sony was third most active with 11 deals totalling USD 5.7 billion (including its USD 3.6 billion acquisition of Bungie, apparently aimed at supporting its push into subscriptions and live-service gaming). By contrast, Take-Two made one big bet on its USD 12.7 billion acquisition of mobile gaming company, Zynga.
Microsoft stole the show with its single announced but as yet uncompleted mega-bid for Activision-Blizzard. The deal is currently subject to anti-trust investigations in the US, the UK and the EU as regulators increasingly turn their focus on the gaming sector. It remains to be seen whether the deal will survive those reviews.
Despite a modest slackening in deal activity in 2022 against the backdrop of more challenging economic headwinds and increasing regulatory intervention, we expect M&A activity to hold-up and for deal values to remain sizeable in 2023. This will be aided by the significant amounts of capital still available in the industry and the strategic imperative to acquire as market players jostle for position in a hyper-competitive space.
The picture for venture capital and private placements in 2022 did not follow the M&A trend towards ever bigger deals. According to NewZoo, there was a clear drop-off in mega round and late-stage investment with these only accounting for 35% of the total USD 9.3 billion total for Q1-Q3 2022 (down from 71% in 2021 and 76% in 2020). Early-stage venture investments predominated, accounting for 41% of total deal value in the period and up substantially from prior years (20% in 2021 and 16% in 2020). Investments in blockchain and crypto-related games companies continued to comprise a significant part of early-stage investments though this has softened compared to prior years, potentially reflecting broader investor scepticism around crypto in 2022.
In our predictions for the games industry last year (see "Back to the future (and into the metaverse)"), we explored how the technology powering games-as-social-platforms – from game engines and cloud streaming infrastructure to virtual reality – would be a crucial component of any future manifestation of the metaverse. While notions of the metaverse are still in their infancy, we predicted that many investors would start to explore the potential of the video games industry as one of the earliest expressions of it.
As we move into 2023, there is widespread scepticism around the metaverse, Web3 and its blockchain and crypto elements, particularly in relation to latter. Last year saw a number of high-profile scandals with the bankruptcy of FTX, the cryptocurrency exchange, and a widespread drop in the value of cryptocurrencies as central bank rates rose rapidly. While a healthy degree of scepticism makes sense as the parameters of the metaverse continue to evolve, in our view, reports of the death of Web3 and crypto have been greatly exaggerated as we discuss in "Tech predictions 2023" and "Web 2023.0 – a sleeping giant?".
Scepticism notwithstanding, 2022 was indeed the year that notions of the metaverse went mainstream and serious metaverse-related investment in the video games industry hit the headlines. We expect this to continue into 2023 and beyond.
Huge bets have been and continue to be made by the likes of Meta and others on metaverse projects. For Meta this has taken the form of multiple acquisitions of game developers and VR-related companies to support its metaverse strategy based around the Oculus headset. However, in line with the broader theme of increasing regulatory attention (discussed in more detail below), its most recent proposed acquisition of virtual reality studio, Within, has been delayed following intervention by the US Federal Trade Commission (FTC) on grounds the deal is anticompetitive. The FTC is concerned that Meta, through its acquisition strategy, is seeking to dominate the emerging market of virtual reality.
Interest in the metaverse and games-as-social-platforms as a new forum for advertising is also thriving. The transition into virtual worlds was turbo-charged by the pandemic and this has accelerated existing trends towards the adoption of digital experiences and products, particularly within a gaming context. Dynamic brands such as Ralph Lauren, Moncler and Balenciaga have all signed commercial partnerships with Epic Games, the maker of Fortnite. Ralph Lauren, in true adoption of the metaverse ethos, has even developed a line of physical fashion pieces designed around digital skins and other items in Fortnite – now gamers can spend money in-game and in-reality to co-ordinate their look in all walks of life!
In the spring of 2022, Epic Games also completed a USD 2 billion funding round (valuing the company at over USD 30 billion) which was led by Sony and the family-owned investment fund which owns the Lego Group. This follows an earlier investment by Sony of over USD 200 million in 2021 (at which point Epic Games was valued around USD 18 billion). Simultaneously with the 2022 investment, Epic Games, Sony and Lego jointly announced a commercial partnership which aims to shape the future of the metaverse to make it safe for children and families.
Perhaps the most high-profile metaverse investment this year was Microsoft's bid for Activision-Blizzard, with the company's CEO publicly stating he views the acquisition as central to their plans in the metaverse. There are reports that Activision-Blizzard had courted a sale to Meta before ultimately signing with Microsoft. Some commentators see Microsoft’s bid as a counter move to the path being forged by Meta in virtual reality, an area where Microsoft has made significant investments of its own. When combined with its existing strengths in gaming via Xbox, cloud services via Azure, and the success of the Xbox Game Pass subscription and cloud gaming services, the potential for Microsoft to steal a march on the metaverse – with or without the Activision-Blizzard deal – looks real.
Another driver behind the rush of high-value dealmaking is the desire among market players to build strong positions in subscription services and cloud gaming. This is an area of the market which has grown rapidly in recent years as innovations in technology and business models have been driven by intense competition. In a year of correction, subscriptions and the cloud have been the feel-good growth story. According to Omdia, global revenues on cloud and subscription gaming in 2022 exceeded USD 5 billion (with almost USD 4 billion being in subscription services). This is projected to rise to USD 12 billion by 2026 (with subscription services again contributing the bulk at around USD 9 billion).
Consumption habits in other forms of entertainment (such as film, TV and music) have dramatically shifted in recent years away from ownership – whether physically or digitally – or adherence to scheduled programming. Subscription services such as Netflix, Amazon Prime, Disney+ and Spotify have transformed those industries with content now, more often than not, being streamed live from the cloud via vast server farms in data centres. While similar impacts are starting to be felt in gaming, given the medium's unique properties it is more likely subscription services and the cloud will supplement traditional gaming hardware than replace it completely.
A distinction can be draw between subscription services and cloud gaming. A subscription service may include several elements across different pricing tiers. This may include cloud gaming but at a minimum it will typically include access to a substantial catalogue of games. These games can be downloaded and played from local hardware for so long as the subscription is maintained. Cloud gaming, on the other hand, involves no local storage or processing of the game and instead streams the game directly to the user's device. Viewing and control inputs are the only local activity, with processing in data centres and delivery via the cloud. Access and flexibility are the key benefit here as cloud gaming can be accessed on devices which are not powerful enough to run the game locally. Crossplay compatibility and cloud save functionality also mean a game which is commenced on a console locally can be continued on a smartphone while the user is on the move.
A key limitation of cloud gaming is latency (time delay between making a button input on your local device, this information being transmitted over the cloud to the data centre server and then re-transmitted back to your device). Acceptable latency is typically measured in low milliseconds, especially for popular online competitive games which demand "twitch" reactions. Latency for cloud gaming is typically higher and this is a key reason it is unlikely completely to displace gaming hardware (such as consoles and PCs). Latency was a contributing factor to the poor performance of Google's pure-play cloud service, Stadia, which was permanently shut down in 2022.
Given the demise of Stadia, it might seem odd to talk of subscriptions and the cloud as a positive development in 2022. However, understanding the role of cloud gaming and the appropriate business model is key. Stadia was cloud-only with no local hardware. It required a monthly subscription for a limited number of games, with additional games needing to be purchased at full price. It was positioned as a wholesale replacement of consoles like Xbox or PlayStation. By contrast, the success being enjoyed by more traditional gaming giants like Microsoft and Sony with their subscription services has been driven by themes of seamless flexibility, excellent value and a central understanding that these services supplement core hardware experiences, rather than replace them.
Microsoft continues to see significant success with its Game Pass subscription service (which now includes Xbox Cloud at no extra cost). Between Xbox, PC and mobile, it is now possible to play Game Pass anywhere at any time, regardless of your available hardware. In the hypercompetitive market of console gaming, Sony has responded with a much-publicised reworking of its own subscription service, combining a back catalogue of games (contemporary and classic) with its own cloud gaming service. Streaming giant, Netflix, has also been making moves in gaming, acquiring multiple gaming studios, and releasing mobile gaming apps which are free to its subscribers. The company has also confirmed its is looking to launch its own cloud gaming platform. It believes it can succeed where Google failed by positioning this as a value add to its current service rather than a console replacement.
We firmly expect the growth of subscription services and cloud gaming to continue into 2023 and beyond. This will be a key battleground as industry players – from established gaming royalty like Sony and Microsoft to intrepid newcomers like Netflix – fight for position in a hyper-competitive sector.
Amid the trends and issues described above, there are growing concerns among some observers that the industry is undergoing a transformation. Some see the relentless deal activity of recent years as giving rise to an increasingly consolidated sector dominated by the gaming empires of existing big tech. Such concerns tend to focus on the following developments.
Microsoft is a key player in console and PC gaming, subscription services and the cloud. With its proposed acquisition of Activision-Blizzard, it looks set to reinforce that position while also making a bold play for the metaverse. Meta has been very active in virtual reality and connected game businesses as part of its metaverse play. Amazon has launched a cloud gaming service (Luna), acquired several game studios and is a leader in gaming live streaming via its Twitch platform. The closest competitor in gaming live streaming is YouTube, owned by Google. As discussed, Netflix has also made inroads with gaming and looks set to continue this strategy. Apple and Google are believed by the CMA to have an effective duopoly over the app stores on their respective mobile operating systems, which act as gatekeepers to mobile gaming. The position is similar in China, where tech giants like Tencent and NetEase dominate the market.
In recent years, regulators have grown increasingly concerned about the power of big tech in all areas of the economy. Many regulators may also harbour regrets about the more permissive approach taken to antitrust oversight when those companies were building their original businesses. The deep experience of tech giants in building massive online and diversified tech businesses together with even deeper reservoirs of the capital now allow them to make the biggest bets in gaming. As the industry continues to grow, and with the tech giants best placed to capitalise, gaming is therefore a growing area of regulatory focus.
The most spectacular example of this happened in China. In August 2021, regulators introduced stringent measures, ostensibly aimed at curbing video game addiction (a serious concern in a country where video games are often referred to as "spiritual opium"), which included capping play time for minors to a maximum of three hours a week and limiting spending to a maximum of USD 60 per month. Regulators also implemented a moratorium on the grant of licences for new games. In China, the law requires that any online game with monetisation requires a licence to operate. The intervening period has been tough for Chinese gaming giants like Tencent and NetEase, with revenues, profits and share prices all falling steeply. Thousands of smaller game studios have closed. The impact has also been felt outside China as no new foreign games were approved in this period.
Towards the end of 2022, however, the situation looked set to improve. Amid a wider relaxation of regulations by Beijing in response to increasing public unrest (in particular, to pandemic-related restrictions), China's gaming regulator announced that the widespread problem of child gaming addiction had been "resolved". This followed an editorial in The People’s Daily, the Communist party’s official newspaper, which noted the cultural and technological benefits flowing from the games industry in economies like the EU and the US. It also extoled the role the industry could play to “support the development of advanced technologies” and “in enhancing the global influence of Chinese culture”. In late December 2022, the regulator surprised the industry with the announcement of more than 120 new publishing licences for games, including 44 foreign games for domestic release. While the future regulatory position in China remains uncertain, there is currently increasing scope for optimism.
In the West, though, the direction of travel appears to be different. A key battleground is likely to be the field of antitrust, especially in the US, the UK and the EU. There have been several recent examples of regulators being more prepared to intervene – whether in announced transactions or in the existing market – to address what they perceive as anticompetitive issues.
As mentioned above, in November 2022, the CMA announced it would launch a market investigation into the distribution of cloud gaming services through app stores on mobile devices. This forms part of a market investigation looking at mobile browsers. The CMA's initial review into UK mobile ecosystems found that Apple effectively blocks cloud gaming apps from its App Store. The CMA is concerned that Apple has an incentive to undermine the ability of cloud gaming providers to access iOS users in order to retain its market power in native app distribution and discovery on iOS. The CMA is also concerned that Apple may have an incentive to delay the take up of cloud gaming services in order to preserve its market power in mobile devices and operating systems.
The CMA review into mobile and cloud gaming follows a class action lawsuit against Sony in the UK Competition Appeal Tribunal in September 2022. That complaint alleges that Sony abuses its dominant position in various markets by not permitting third-party operating systems on PlayStation, and by ensuring games for PlayStation and add-ons can only be sold and purchased through the PlayStation Store, for which Sony takes a commission. The case remains ongoing at the time of writing.
Perhaps the most high-profile example of increased regulatory scrutiny of gaming deals is the proposed Microsoft acquisition of Activision-Blizzard. As mentioned, at the time of writing, this is subject to in-depth second stage reviews by the CMA in the UK and the European Commission in the EU; it is also subject to a lawsuit by the FTC in the US seeking to prevent the deal. This is the boldest example of a trend, particularly for the FTC in the US, of antitrust regulators taking a more aggressive stance. President Biden's appointment of Lina Khan as chair of the FTC has heralded this step change. In the first two years of the Biden presidency, the FTC has attempted to block 22 mergers – this is more than President Obama's first two years and double the amount in President Trump's first two years. This trend has found expression in the gaming space via interventions against Microsoft (on its proposed acquisition of Activision-Blizzard) and Meta (on its proposed acquisition of virtual reality business, Within).
Regulatory opposition to the Activision-Blizzard deal is interesting as this transaction would be a “vertical merger” (involving parties at different stages of the supply chain who are not direct competitors, e.g. a distribution platform buying a content maker). Antitrust cases classically focus on “horizontal mergers” (where the companies are direct competitors).
The concerns expressed by both the FTC and the CMA are that Microsoft will have the incentive and ability to harm competition by foreclosing the access of competitors to Activision-Blizzard content. Regulators are concerned this could give Microsoft an unfair advantage in the emerging market for subscription services and cloud gaming. Such concerns have also been loudly expressed by Sony. Microsoft has rejected this on the grounds it would be economically irrational for them to remove massively popular titles like Call of Duty from other platforms.
Microsoft has sought to assuage concerns by making non-binding commitments to keep games on other platforms for an extended period of time. As part of that effort, they have signed a 10-year deal with Nintendo, but negotiations with Sony for a similar deal have stalled. Regulators have so far seemed reluctant to rely on such non-binding assurances. They recall similar assurances being given to the European Commission as part of Microsoft's acquisition of ZeniMax in 2021, only for Microsoft to announce shortly afterwards that it would indeed make certain games exclusive to its platforms. This saga will continue play out over the course of 2023 and is likely to be hard fought.
2022 was an interesting year for the games industry. A sector used to long-term growth came to the end of two exceptional pandemic years only to encounter a succession of tough boss fights. Rising interest rates and geo-political challenges hit the global economy hard and continue to raise the spectre of economic recession. The games industry was not immune from this. The long-tail of pandemic pains also continued to be felt in the form of game delays and other supply constraints. Changes in mobile privacy settings on iOS and Android hit the established business models of mobile gaming. Regulators across the world entered the game.
Despite all this, however, medium and long-term prospects for the industry remain incredibly strong and growth is projected to return in 2023 and beyond. The small downturn of 2022 should serve as a cautionary note to this dynamic and successful industry. Despite a record-breaking growth rate over the last two decades, which has established gaming as the preeminent form of entertainment and placed it at the crossroads of technological change in our society, the industry cannot become complacent.
The future of the industry remains bright, but we expect the difficulties from an economic downturn, intense competition and increased regulatory scrutiny will begin to separate the casuals from hardcore players. Those who hope to triumph would do well to observe the finest tradition of hardcore gaming – time to git gud!
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