Holiday setup favors stock selection over secular themes - Merrill Lynch
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Interactive Entertainment
Holiday setup favors stock selection over
secular themes
Industry Overview
Moving past the COVID-19 trade; Look for “shots on goal” 02 October 2020
Much, if not all, of the YTD performance of the Big-4 publishers we attribute to COVID- Equity
19. In-game revenues accelerated to +68% Y/Y in 2Q20 from +12% Y/Y in 1Q20 as United States
players used more leisure time playing games and many casual players came back to Interactive Media
gaming. Entering the holiday period, most data suggests the group is now on the
Ryan Gee
backside of that uplift with slower mobile growth, fewer PC players, and less time Research Analyst
streaming. Add to that, 4Q has not been particularly better (or worse) for gaming stocks BofAS
+1 415 676 3548
than the market historically. Our thesis going into 2020 was to favor stocks with “shots ryangee@bofa.com
on goal” to serve as a source of estimate upside and we feel even more strongly now as
restrictions on socializing are likely to ease, not tighten, from here and players will likely
be more, not less, selective with spending on new games. With valuation also at an even-
higher high than it was pre-COVID-19, the near-term setup favors investing in stock-
specific catalysts vs. secular themes.
Event catalyst calendar most positive for UBI then ATVI
Ubisoft (UBI) has as many as seven new games coming by March 2021, more than any
peer, with at least one catalyst in each of the next six months incl. Watch Dogs,
Assassin’s Creed, Far Cry, and Quarantine. Activision (ATVI) has at least five event
catalysts over the next six months incl. World of Warcraft, Call of Duty, and BlizzCon in
February may update the timing of key sequels (Overwatch 2, Diablo 4) for 2021/2022.
These two stocks are the publishers we feel could benefit most from strong pre-order
demand for next-gen consoles. Take-Two (TTWO) does not have a new title over the
next six months (perhaps even longer), but does have an update for GTA Online coming
“soon” that the company says will be its biggest ever.
Secular themes remain, but may take time to play out
The Big-4 are at ~24x FY2 P/E (ex. Cash) vs. the prior cycle peak at ~25x (S&P at 20x
and Mega-Cap tech at 23x), suggesting near-term secular themes around COVID and the
console cycle are already discounted by the market. Growth will moderate ahead against
incredibly high Y/Y comps so getting more constructive on valuation requires line-of-
sight to any of a number of drivers that may improve publisher economics. Next-gen
price increases are happening this year for a handful of games, but seems more of an
industry-wide tailwind next year – benefitting UBI and TTWO most. Elsewhere, growing
adoption of subscription services may gradually shift negotiating leverage back in favor
of publishers as we feel platforms are in need of exclusive content to drive growth.
Gamer survey highlights next-gen interest, UBI, and ATVI
Key takeaways from our recent survey of console gamers include ATVI’s Call of Duty as
the game most players intend to buy when it launches followed by UBI’s Assassin’s
Creed. Cyberpunk was at No. 5. Regarding next-gen demand, more than 50% plan to buy
a PS5 in the next 12 months and about 60% of those that plan to buy have either
already pre-ordered or plan to pre-order by November. In terms of purchase intent,
roughly about 20% of players expect to spend more on games over the next 12 months,
but that figure is about 30% for those that plan to buy a new console. We see potential
for game sales to accelerate in 2021 as more players adopt new consoles. One risk to
monitor from our gamer survey is the impact of higher prices for next-gen games as
more than 60% said it would impact spending on new games and digital budgets could
also take a hit to accommodate the change.
BofA Securities does and seeks to do business with issuers covered in its research reports. As
a result, investors should be aware that the firm may have a conflict of interest that could
affect the objectivity of this report. Investors should consider this report as only a single
factor in making their investment decision.
Refer to important disclosures on page 16 to 20. Analyst Certification on page 15. Price
Objective Basis/Risk on page 14. 12193710
Timestamp: 02 October 2020 12:01AM EDTMoving past the COVID-19 trade
Data shows existing players allocated more leisure time towards playing video games
and more engagement is a leading indicator for more revenue. Data also showed many
casual and/or first time gamers came back to the market and more players is a leading
indicator of more revenue. The result was a sharp, across-the-board uptick in gaming-
related revenue during 2Q20, one that largely persisted into 3Q20. In-game revenue
growth for the Big-4 publishers accelerated to 68% Y/Y in 2Q20 from 12% Y/Y in 1Q20.
Exiting 3Q20, however, several indicators suggest the group is now on the backside of
that COVID-19 driven uplift and the sequential trend might suggest lower overall
revenue from this point relative to the spring and summer months.
Chart 1: Combined Digital In-Game Revenue From The Big-4 Publishers % Y/Y Change
80% 68%
60%
37%
40%
20% 12%
3% 5%
0%
-2% -2%
-20%
1Q19 2Q19 3Q19 4Q19 1Q20 2Q20 3Q20E
Source: BofA Global Research, Company Reports
SensorTower showed US mobile revenue up about 20% Y/Y in September compared to
up about 30-40% Y/Y in early 2Q20 and up high-teens in 1Q20. Data shows a similar
trend for mobile growth in Europe. On the PC, Steam data shows players engagement in
September is off ~25% from where it was in April/May and roughly in-line with early 1Q.
Exhibit 1: Average Daily Mobile Gaming Revenue Y/Y % Change Exhibit 2: Total Players for the Top-25 Games on Steam (in 000s)
60% 3,000
50% 2,500
40% 2,000
30% 1,500
20% 1,000
10% 500
0% 0
US Europe
Source: SensorTower Source: Steamstats
Meanwhile, US retail console sales, a sign players plan for an extended at-home stay,
and Twitch viewership, a signal of leisure time, are each down from 2Q levels.
Exhibit 3: US Retail Sales of Video Game Consoles (in 000) Exhibit 4: Average Concurrent Viewers on Twitch (in 000)
2,000 3,000
1,600 2,500
1,200 2,000
1,500
800 1,000
400 500
0 0
Source: The NPD Group Source: Twitchtracker
2 Interactive Entertainment | 02 October 2020As much as the recent downward trend in some third-party data sources would suggest
otherwise, gaming stocks have outperformed the market in recent weeks (Big-4 up
about 10% since Sept 8 vs. the S&P 500 up about 1%). Perhaps the best explanation for
the relative strength is SuperData’s digital games report showing Y/Y trends for console,
PC, and Mobile ahead of the 2Q20 exit rate. This compares to guidance from the Big-4
publishers, as well as what is baked into our estimates, calling for a deceleration in
digital revenue growth in 3Q20 driven by the easing of restrictions.
Exhibit 5: Worldwide Digital Game Sales Y/Y % Change
40%
29%
30%
17% 14% 16%
20% 11% 9%
10% 2%
7%
2% 5% 2% 5% 8% 3% 4%
0%
-10% -3% -4% -1% -3%
-6%
Source: SuperData; July Growth rate not available, Estimate of $11.6bn based on YTD Revenue through August 2020 of $82.2bn
Interactive Entertainment | 02 October 2020 3Holiday titles calendar and event catalysts
The stock price performance of the Big-4 publishers for much of 2020 was a result of
secular trades around the console transition and exposure to “any” large online business
that capitalizes on the demand to fill leisure time during the lockdowns. The former still
feels like a theme investors with a longer duration can get behind, however, the COVID-
19 trade certainly seems to have less support based on the data previously mentioned.
We see competition for leisure time increasing post-lockdowns and expect players to be
more selective with video game purchases. As such, we think investors should be equally
stock selective – getting behind those with the most new releases and/or the most
highly-anticipated games. Our recent survey of gamers highlighted ATVI’s Call of Duty
Black Ops Cold War, as the game most players intend to buy when it becomes available.
UBI’s Assassin’s Creed Valhalla was No. 2 in our survey followed by Sony’s Spider-Man.
Exhibit 6: Which of the following games do you expect to buy when it becomes available?
Call of Duty Black Ops Cold War 40%
Assassin's Creed Valhalla 32%
Marvel's Spider-Man: Miles Morales 27%
Halo Infinite 24%
Cyberpunk 2077 23%
Final Fantasy XVI 23%
God of War Ragnarok 21%
Star Wars Squadrons 19%
Far Cry 6 19%
FIFA 21 18%
Watch Dogs Legion 16%
Other 15%
None of the Above 8%
Source: BofA Global Research
UBI appears to have the most potential event catalysts ahead with seven new product
launches expected by March 2021 with at least one new game every month for the next
six consecutive months. This includes Watch Dogs in October, Assassin’s Creed in
November, Far Cry in February, and possible Quarantine in March next year.
Exhibit 7: Video Game Release Calendar and Title Catalyst
Seven products from Ubisoft by March 2021
Star Wars - EA Watch Dogs - UBI
Oct-02 Oct-29
Assassin's Creed - UBI Prince of Persia - UBI
Nov-10 Jan-21
Cyberpunk - CDR
Nov-19 Far Cry - UBI
Crash Bandicoot Xbox Series X - Feb-18
Immortals - UBI
- ATVI Microsoft Dec-03 Riders Republic - UBI
Oct-02 Nov-10 Feb-25
October November December 1Q CY21
Call of Duty - ATVI BlizzCon - ATVI
Nov-13 Apex Legends Mobile - Feb -19
FIFA - EA Quarantine - UBI
EA
Oct-09 March 2021
Holiday (?)
PlayStation 5 - Sony World of Warcraft - Diablo Immortals - ATVI
Nov-12 ATVI January 2021
GTA Online - TTWO Dec (?) (soft launch)
October (?)
Five catalysts for ATVI by March 2021
Source: BofA Global Research, Company Reports
ATVI will have at least five event catalysts over the next couple quarters including a new
Call of Duty in November and World of Warcraft later in 4Q. The rescheduled BlizzCon in
February may also be a platform to update timing of new Blizzard sequels (Overwatch 2,
Diablo 4) for 2021 and beyond. Not mentioned in the catalyst calendar below for ATVI
are new mobile titles from King that are expected to launch in 4Q20, as well as potential
for Call of Duty Mobile to launch in China.
4 Interactive Entertainment | 02 October 2020Electronic Arts (EA), by comparison, has three potential event catalysts ahead
including FIFA and a new Star Wars game in October, but timing of Apex Legends on
mobile is very unclear and it is possible the company may not have a new AAA launch
until Battlefield 6 in 2H21.
TTWO does not appear to have any new titles that could serve as stock catalysts over
the next 3-6 months, but we still anticipate an update for GTA Online “soon” that the
company said will be the biggest ever and the company will launch a stand-alone version
of GTA Online sometime in late 2021 that could expose the mode to new players.
Good, though not great, window to trade gaming stocks
The four month holiday window from October to January (before when most publishers
report 4Q results) would seem to be a good time to be owning gaming stocks. After all,
this period accounts for the overwhelming majority of revenue and profits and more
games launch during this window than any other period in the year. However, historical
stock price data suggests that while the holiday window is not necessarily a “bad” time
to be owning gaming stocks, the group has not really outperformed the market either.
Since 2010, the Big-4 publishers traded up about 6% from October to January, in-line
with the S&P.
As for individual stocks, UBI (+8%) and TTWO (up above 15%) have historically
performed better than peers in this window while EA has historically lagged. Over the
most recent five-year period, ATVI has performed in-line to slightly ahead of the market.
Overall, this trend supports our call to be more selective from here.
Exhibit 8: Sector Stock Price Return Sept. To Jan. (since 2010) Exhibit 9: Publisher Stock Price Return Sept. To Jan. (Since 2010
10% 20%
8%
15%
6%
4% 10%
2% 5%
0%
0%
-2%
-4% -5%
15-Oct
22-Oct
29-Oct
15-Oct
22-Oct
29-Oct
7-Jan
7-Jan
14-Jan
21-Jan
14-Jan
1-Oct
8-Oct
5-Nov
3-Dec
1-Oct
8-Oct
5-Nov
3-Dec
12-Nov
19-Nov
26-Nov
10-Dec
17-Dec
24-Dec
31-Dec
12-Nov
19-Nov
26-Nov
10-Dec
17-Dec
24-Dec
31-Dec
The Big-4 SP 500 UBI EA ATVI TTWO
Source: Bloomberg Source: Bloomberg
Interactive Entertainment | 02 October 2020 5Next-gen hardware impact on software
Sentiment among investors we speak to appears mixed on the impact of next-gen
consoles from Sony and Microsoft on the industry this Holiday. On the one hand, the
console transition may be a catalyst for software sales as purchase intent for new
games is higher among buyers of new consoles we surveyed. On the other hand, we do
not see as many new releases this holiday compared to past generations and none of
the upcoming games appear to be made specific to next-gen. Whereas in the past, some
players might hesitate to buy games for legacy consoles and delay buying any new game
until upgrading to new hardware in the months or quarters after launch, we do not see
the same headwind on demand this year as new consoles will support some catalog
games or offer a free upgrade. Overall, we think demand for new games this holiday will
not depend on sales of new consoles as much as it is predicated by the quality of titles.
However, investors should anticipate an acceleration in software sales in 2021 given a)
next year will likely contain more new games from a larger number of publishers and b)
next year is likely when the first next-gen specific games will launch. The exhibit below
shows the launch of Gen-7, Gen-8, and Gen-9 consoles in 2001, 2007, and 2014,
respectively coincided with an inflection in software sales the following year.
Exhibit 11: US Retail Software Sales % Y/Y Change
40% Gen-8
Gen-7 Launch
30% Launch
Gen-9
20% Launch
10%
0%
-10%
-20%
-30%
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: BofA Global Research, The NPD Group
We are encouraged by reports of strong pre-order demand for next-gen consoles as it
suggests a larger base of buyers “intending” to spend more on games in 2021. Our
survey of existing video game console owners found more than 50% plan to buy a PS5 in
the next 12 months and more than 40% plan to buy an Xbox Series X in the next year.
Our survey also found about 60% of those that plan to buy either of the next-gen
console have either already pre-ordered one or plan to pre-order one ahead of the
November launch.
6 Interactive Entertainment | 02 October 2020Exhibit 12: Responses to the question “Do you plan to buy any of Exhibit 13: Responses to the question “Have you pre-ordered a new
following consoles in the next year?” PlayStation 5 or Xbox console to buy when it launches this November?”
35% No but I plan to pre-order before the
30% 21%
console launches if more become…
23%
20% 18% No and I do not plan to pre-order
16% 37%
11% before purchasing
6% Yes but I was not able to reserve a
20%
console to purchase
Xbox Xbox PS5 PS5 Switch PS4 Xbox No Plans Yes and I was able to reserve a
22%
Series S Series X Digital Standard One console to purchase
Source: BofA Global Research Source: BofA Global Research
The average player we surveyed bought three games over the past 12 months (ex. free
to play) and about 20% of players surveyed expect to spend “more” on games over the
next 12 months. However, of those that plan to buy a new console in the next 12
months, about 30% plan to buy more games than over the past year which highlights the
potential for game sales to pick up as more players adopt new consoles. Even if players
are simply upgrading to new hardware and the overall base of game consoles does not
change, we think a larger initial uptake of next-gen consoles will shift more players into
the “buy more” group which increases the market opportunity for publishers. As noted
earlier, ATVI’s Call of Duty Black Ops Cold War and UBI’s Assassin’s Creed Valhalla were
the two games that potential next-gen consoles owners anticipate buying the most.
Exhibit 14: Launch Title Comparison Across PlayStation Generations
No PS1 PS2 PS3 PS4 PS5
1 Air Combat Armored Core 2 Blast Factor Assassin's Creed 4: Black Flag Assassin's Creed: Valhalla
2 Battle Arena Toshinden Dead or Alive 2: Hardcore Call of Duty 3 Battlefield 4 Astro's Playroom
3 ESPN Extreme Games Dynasty Warriors 2 Genji: Days of the Blade Blacklight Retribution Demon's Souls
4 Kileak: The DNA Imperative ESPN International Track and Field Madden NFL 07 Call of Duty: Ghosts Destruction All Stars
5 NBA JAM Tournament Edition ESPN X-Games Snowboarding Marvel Ultimate Alliance Contrast Dirt 5
6 Power Serve 3D Tennis Eternal Ring Mobile Suit Gundam: Crossfire DC Universe Online DmC 5: Special Edition
7 The Raiden Project Evergrace NBA 07 FIFA 14 Godfall
8 Rayman FantaVision NBA 2K7 Flower Madden NFL 21
9 Ridge Racer GunGriffon Blaze Need for Speed Carbon Injustice: Gods Among Us -- Ultimate Edition Marvel's Spider-Man: Miles Morales
10 Street Fighter: The Movie Kessen Resistance: Fall of Man Just Dance 2014 Sackboy: A Big Adventure
11 Total Eclipse Turbo Madden NFL 2001 Ridge Racer 7 Killzone Shadow Fall Watch Dogs: Legion
12 Zero Divide Midnight Club Tony Hawk's Project 8 Knack Call of Duty Black Ops Cold War
13 Moto GP Tiger Woods PGA Tour 07 Lego Marvel Super Heroes Cyberpunk 2077
14 NHL 2001 Untold Legends: Dark Kingdom Madden NFL 25 Fortnite
15 Orphen: Scion of Sorcery NBA 2k14 Destiny 2
16 Q-Ball Billiards Master Need for Speed Rivals FIFA 21
17 Ready 2 Rumble Boxing: Round 2 Resogun NBA 2K21
18 Ridge Racer V Sound Shapes Marvel's Avengers
19 Silent Scope Super Motherload
20 Smuggler's Run Trine 2: Complete Story
21 SSX Warframe
22 Street Fighter EX3
23 Summoner
24 Swing Away
25 Tekken Tag Tournament
26 TimeSplitters
27 Unreal Tournament
28 Wild Wild Racing
29 X-Squad
Source: BofA Global Research, GamesRadar, Shaded region includes PS5 upgrades and titles available post-launch
Next-gen unit outlook remains unchanged
We are still projecting 3.8mn PS5 units in the US and Europe in 4Q20 and 7mn next-gen
units combined including Xbox Series X. However, Bloomberg reports Sony plans to ship
around 11mn PS5 units globally by March 2021, which is well-above the PS4 launch at
around 7.5mn and the PS3 launch at 5.5mn units. Having sold over 110mn PS4 consoles
to-date, the approximate 11mn units ship-in over the launch window suggests an
adoption rate roughly in-line with our current 6% forecast of the percent of PS4 owners
Interactive Entertainment | 02 October 2020 7in the US and Europe that will adopt the PS5 at launch. We think adoption will be
unchanged from the Gen 9 cycle.
Exhibit 15: First Year Adoption of Next Gen Consoles By Install Base Exhibit 16: Console Unit Sales In US and Europe
120 102 117 30 28 28 29
89 24
25 22
90 70
20
60
15
30 6%
5% 4% 6% 10
0 5
Gen 7 Gen 8 Gen 9 Gen 10
0
Initial Launch Sales Existing Install Base 2018 2019 2020 2021 2022
Sony Microsoft Nintendo
Source: BofA Global Research, Company Reports Source: BofA Global Research
Next-gen appeal is better graphics, faster load times
New consoles always promise improved graphics and the Gen 10 consoles are no
exception. A stronger GPU helps, but console makers point to ray tracing, which enables
developers to better simulate light and shadows, as the real driver of more immersive
experiences this generation. Console makers also point to the inclusion of a solid state
hard drive which Sony said will reduce load times by as much as 5x compared to the
hard disc drive found in prior console generations.
Exhibit 17: Spec Comparison By PlayStation Generation
PS2 PS3 PS4 PS5
Price $299 $599 $399 $499 ($399 w/o disc)
GPU 6.2 GFLOPS 400 GFLOPS 1.84 TFLOPS 10.28 TFLOPS
147 MHz 500 MHz 36 Cus at 2.23 GHz
CPU Emotion Engine Cell Broadband AMD Radeon AMD Zen 2
294 MHz 3.2 GHz 8 Cores at 1.6 GHz 8 Cores at 3.5 GHz
Memory 32 MB 256MB GDDR3 8GB GDDR5 16GB GDDR6
Storage 60GB HDD 60GB HDD 500 GB HDD 825GB SSD
Optical DVD Blu Ray/DVD Blu Ray 4K UHD Blu Ray
Native 4K 120Hz; 8K
Visuals 480p 1080p 1080p
compatible
Source: Company Reports
8 Interactive Entertainment | 02 October 2020Secular Themes To Monitor
Publishers “experimenting” with next-gen price increases
The last time either Sony or Microsoft raised the base price of new console games was
in the Gen 7 transition to Xbox One and PS3 when the base price of new games went to
$60 from $50. Since then, development costs for AAA games have only gone up with
improvements in graphics and computing. To illustrate the point, file size of Call of Duty
Modern Warfare in 2019 was over 100GB whereas the original Call of Duty 4 Modern
Warfare in 2007 required less than 10GB. This is not to say that the cost of development
has increased 10x, but does show a lot more goes into making games today than back
two console generations ago. In-game monetization well-beyond the initial sale of a
game has helped to offset the rising cost of development and we note that average
revenue per unit for Call of Duty has increased from less than $10 in 2010 to over $20
in 2019.
Exhibit 18: Estimated File Size of Every Call of Duty Game
No
Campaign
120 Switch to Blu
Ray on PS4
100
80 PS3 Generation
60
40
20
0
Source: BofA Global Research, IGN, Company Reports
Fast-forward to 2020, and several publishers have set the base price of certain games
playable on PS5 at $70 vs. $60 for the same game on PS4. This includes third-party
titles such as ATVI’s Call of Duty Black Ops Cold War and TTWO’s NBA 2K21, as well as
first parties titles such as Sony’s Demon’s Souls and Destruction All Stars. Platforms
would still keep 20-30% of any new game sale so not all of that $10 increase would go
to the publishers. However, we do not think the wholesale margin is likely to change this
cycle as offline retail accounts for a shrinking percent of new game sales. Over 60% of
gamers we surveyed said price increases would impact spending on new games and we
think higher prices could impact overall spending on digital in-game content as well
during a period where players may also be making a big purchase on a new console.
Table 1: Over 60% of gamers indicate the increase to $70 for next-gen console games will lead to
fewer purchases of new games
% What do you think of $70 for Xbox Series X and PS5 Will the higher price lead you to buy fewer
Responses games? games?
20% Fair No
28% Fair Yes
16% Too much No
36% Too much Yes
Source: BofA Global Research
We say “experimenting” because there does not appear to be consensus among third-
parties, or even first party publishers, regarding next-gen price increases. Only ATVI and
TTWO are selling next-gen versions of upcoming games at a premium and are the only
potential beneficiaries we see of price increases. UBI is not raising prices for games
Interactive Entertainment | 02 October 2020 9coming out this holiday, and EA elected not to raise the price for any of its upcoming
games including FIFA 21 on PS5.
Exhibit 19: Next-Gen Version of Select Holiday Games Will Cost More
Retail Price $69.99 Retail Price $59.99 or Below
Call of Duty: Black Ops Cold War Activision FIFA 21 EA
NBA 2K21 Take-Two Madden 21 EA
Demon's Soul Bluepoint Assassin's Creed Valhalla Ubisoft
Destruction All Stars Sony Watch Dog's Legion Ubisoft
Far Cry 6 Ubisoft
Star Wars Squadrons EA
Cyberpunk 2077 CD Projekt
Crash Bandicoot Activision
Immortals Fenyx Rising Ubisoft
Sackboy A Big Adventure Sony
Source: BofA Global Research, Company Reports
Assuming no impact on overall game sales from price increases, UBI would have the
biggest uplift in revenue and EPS from a $10 increase in the base price of a game due to
the company’s above-average exposure to new game sales on consoles. Of the $10
increase, roughly $7 would go to the publisher with no other variable costs to consider
beyond platform royalties.
Exhibit 20: Revenue and EPS impact from an increase in next-gen console prices
80%
62%
60%
45%
40% 34% 36%
25%
21%
20% 13%
6%
0%
Activision EA Take-Two Ubisoft
Game Sales as % Revenue % Impact EPS
Source: BofA Research
10 Interactive Entertainment | 02 October 2020Publishers also warming to game subscription services
A lot has been made recently about Microsoft’s Game Pass subscription service and
similar services such as Amazon’s Luna, Google Stadia, and Sony’s PlayStation Now –
and for good reason. The service is in need of content to satisfy the growing number of
players subscribing to the service (about 15mn). Platforms are becoming commodities
with few clear points of differentiation beyond price. Similarly, eight of the Top-10
publishers now support more than one games subscription services, making it
increasingly difficult to differentiate on content. Price is a factor, but we think new
and/or exclusive content is what will drive subscriber growth and subscriber retention.
More services competing for content gives publishers leverage to negotiate lucrative
exclusive/non-exclusive deals that, all else equal, would ensure gross profit from any deal
at least in-line, if not higher, than what the company would have otherwise generated
from Game Sales alone.
Exhibit 21: Publisher Support For Select Game Subscription Services
Microsoft Sony Google Nvidia Amazon
Game Pass PS Now Stadia Geforce Now Luna
Activision No No No No No
Bethesda Yes Yes Yes No No
Capcom Yes Yes Yes No No
CD Projekt No No Yes Yes No
EA Yes Yes Yes Yes No
Microsoft Yes No No No No
Namco Yes Yes Yes Yes No
Sony No Yes No No No
Square Enix Yes Yes Yes No Yes
Take-Two Yes Yes Yes No No
Ubisoft No Yes Yes Yes Yes
Warner Yes Yes Yes No No
Monthly Subscription $9.99 $9.99 $9.99 $5.99 $5.99
Source: BofA Global Research, Company Reports
Overview of the business consideration for exclusive rights to a top AAA game
Below we illustrate the gross profit potential of a game like TTWO’s Borderlands 3 that
has already sold around 10mn units since launch and could see around 15mn over a
multi-year period. Our Base Case assumes approximately $600mn in gross profit from
distributing the game through traditional retail channels (15mn units x $40 gross profit
per unit).
Scenario 2: If the company were to license exclusive distribution rights to a service, the
gross profit the company would have otherwise been able to generate from Game Sales
(approximately $600mn) is a likely starting point for any negotiations. Here, a
subscription service is the exclusive distributor and the game is not available through
traditional retail channels. The publishers accepts some discount to Base Case gross
profit as the potential for the service’s reach with millions of subs could attract new
players and drive incremental in-game revenue above what it could otherwise.
Exhibit 22: Several Methods for Publishers To Monetize Content Through Licenses
Incremental $700 $700
$650 Engagement License #1
$600 Incremental $100 $100
Engagement $150
15mn Units License #2 $200
Publisher Game
$300
x License Sales
$40 GP Minimum
perUnit License #3
Guarantee $200
$500
Platform
License $300 License #4
$200
Base Case Scenario 2: Exclusive Source Scenario 3: Platform Exclusive Scenario 4: Multiple non-Exclusive
Licenses
Source: BofA Global Research
Interactive Entertainment | 02 October 2020 11Scenario 3: The subscription service is the exclusive cloud provider, but the publisher retains its right to distribute the game through traditional retail channels. The cost for exclusive rights is an even larger discount to Base Case gross profit, but overall gross profit from a) licenses, plus b) Game Sales, plus c) incremental in-game revenues is actually higher than our Base Case. A publisher may be willing to take a fixed discount to gross profit in exchange for additional marketing commitments or payments based on performance (i.e. delivering incremental players and engagement). Scenario 4: Most publishers are using non-exclusive licenses and selling content rights to multiple subscription services. This has the potential for higher aggregate gross profit than Game Sales alone in our Base Case and could prove more lucrative than an exclusive license to a single service. 12 Interactive Entertainment | 02 October 2020
Valuation less likely to drive stock performance from here
The entire year-to-date performance of video game stocks in 2020 is explained by
multiple expansion. The Big-4 publishers are up about 30% while consensus EPS is
virtually unchanged. Meanwhile, the S&P is up 4% YTD with multiple expansion largely
offset by EPS cuts. Despite the COVID-19 uplift, downward revisions for TTWO and UBI
due to title slate changes since the start of the year was offset by upward revisions for
ATVI and EA. We think a decent chunk of the group’s performance vs. the market already
reflects console cycle tailwinds and though demand for gaming still remains elevated
compared to recent history, investors should begin to anticipate slower growth ahead
off very high Y/Y comps and that is likely to keep valuation in check.
Exhibit 23: YTD Multiple Expansion vs. EPS Revision for The Big 4 Exhibit 24: Multiple Expansion vs. EPS Revision for The Big 4 Since 2012
60% 60%
40% 29% 30% 34%
20% 40% 25%
20% 2% 4% 16% 13%
20% 10%
0%
-20% 0%
-14% -2%
-40% -20%
P/E Expansion Estimate Revision Price Performance P/E Expansion Estimate Revision Price Performance
SP 500 Big-4 Publishers SP 500 Big-4 Publishers
Source: Bloomberg Source: Bloomberg
The group is currently trading at about 24x FY2 P/E (ex. Cash) compared to the S&P 500
at 20x. Valuation is limited by the group’s continued reliance on new games sales
(though that reliance is much less than in prior periods) and gaming stocks continue to
see EPS volatility from the timing of “hits” (UBI stock in 2019, ATVI with Diablo 4,
TTWO with GTA 6, EA with Battlefield 6). It is not that we do not think the console
transition could still serve as a catalyst for the space, especially if the strong early
demand is followed up by higher-than-expected software sales this holiday, it is just that
we think the console cycle already explains a chunk of the group’s year-to-date
performance vs. the market.
Exhibit 25: Average 2-Yr Forward P/E (ex. Cash) For The Big 4 Exhibit 26: Average 2-Yr Forward P/E (ex. Cash) For Large Cap Tech
30x 30x
25x 25x
20x 20x
15x
15x
10x
10x
5x
0x 5x
Post-Recession Digitalization Era Streaming Hype Post-Fortnite 0x
(2011-2013) (2014-2016) (2017-2018) (2019-2020) 2011-2013 2014-2016 2017-2018 2019-2020
Source: Bloomberg Source: Bloomberg
We still believe gaming stocks warrant a premium to the market, however, as we see
more upside surprise potential for publishers than the average S&P component. Further,
we think individual gaming stocks could command an even larger premium to the group
based on the shape of the near-term title slate. We see the most upside potential from
new titles from ATVI and UBI while TTWO could see a significant upward revision in
CY21/FY22 estimates based on GTA 5 and the stand-alone launch of GTA Online.
The implied valuation Microsoft recently paid to acquire Bethesda does highlight the
premium placed on content creators and could provide some guideposts for valuation
support or potential premium in an M&A scenario. We estimate Microsoft paid around 6x
forward sales for the company whereas the Big-4 trade at around 5x and we estimate
the deal was also well above the peers on 2021E EBIT (25x vs. 18x). The valuation
premium likely reflects a) strong interest by multiple parties in Bethesda's portfolio, b)
Interactive Entertainment | 02 October 2020 13scarcity of AAA titles, and c) Microsoft (MSFT)'s above-average need for content to
support its Xbox offering.
That Mega-Cap tech stocks (Google, Facebook, Apple, Booking Holdings) and Mega-Cap
tech stocks trade at about 23x GAAP P/E despite higher projected EPS growth may also
limit gaming multiples. The tech group may see more consistent growth, but does not
have the hyper-growth potential of gaming stocks from delivering a hit game. Mega-cap
tech has greater regulatory, media, and business model risks, plus far greater annual
capex requirements. As such, we remain cautious on valuation driving stock price
performance from here.
Re-rating even higher would require direct line-of-sight to other non-stock specific
themes over the near to medium term including improving publisher economics from
platform fee pushback, higher selling prices for next-gen console games, the evolution of
video game subscription services, and the shift towards online competitive gaming.
Exhibit 27: Historical FY2 P/E Trading Range
30x
28x
26x
24x
22x
20x
18x
16x
14x
12x
10x
Big 4 Avg. Lg. Cap Tech SP 500
Source: Bloomberg
Price objective basis & risk
Activision (ATVI; B-1-7; $82.68)
Our $97 price objective is based on 25x our 2021E EPS plus cash per share. This
multiple is in-line with our basis for TTWO and a premium to peers at 23x due to a more
attractive EPS CAGR. We believe this multiple is justified given Activision's growth
opportunity on mobile and PC, the two largest segments of the gaming market globally.
Risks to our price objective are potential lack of compelling new IP that is expected by
the Street, competitive title releases from peers, aging franchises, and franchise
declines at Blizzard and King.
Electronic Arts (EA; B-2-9; $132.78)
Our price objective of $141 is based on 23x our FY22E non-GAAP EPS estimate plus
cash per share. This is a discount to ATVI due to fewer new title catalysts in CY20 and
lower projected EPS growth on a multi-year period.
Risks are: 1) increasing industry competition that impacts EA's unit sales, 2) poor title
quality for EA's new titles, 3) an unsuccessful start for Battlefield V that impacts long-
term franchise potential, 4) Ultimate Team revenue deceleration, and 5) Apex
engagement deceleration.
14 Interactive Entertainment | 02 October 2020Take-Two Interactive (TTWO; B-3-9; $166.11)
Our price objective is $166, based on 25x blended FY21-FY23E EPS plus cash per share.
This is a slight premium to the peer average given above-average digital revenue growth
and potential for significant upside to our current EPS estimates if TTWO's upcoming
title slate contains another new Rockstar title.
Downside (upside) risks to our price objective are: title launch delays (earlier launch),
difficulty in predicting Rockstar title timing or unit sales, uncertainty on Red Dead Online
revenue potential, and potential earnings pressure (boost) if GTA5 revenues start to
decline (grow).
Ubisoft (UBSFF; B-1-9; $79.34)
Our €83 PO is based on 23x blended FY21/FY22 EPS plus cash, which is in-line or
slightly below its direct peers to balance upside from the breadth of new content against
execution risk from delivering a record slate.
Risks to our PO: potential for further delays in upcoming titles, slower growth of in-
game revenues due to lower-than-expected sales of new releases, and lower sales due to
general competition from similar titles in the category.
Analyst Certification
I, Ryan Gee, hereby certify that the views expressed in this research report accurately
reflect my personal views about the subject securities and issuers. I also certify that no
part of my compensation was, is, or will be, directly or indirectly, related to the specific
recommendations or view expressed in this research report.
Interactive Entertainment | 02 October 2020 15US - Internet Coverage Cluster
Investment rating Company BofA Ticker Bloomberg symbol Analyst
BUY
Activision ATVI ATVI US Ryan Gee
Alphabet GOOGL GOOGL US Justin Post
Alphabet GOOG GOOG US Justin Post
Amazon.com AMZN AMZN US Justin Post
Chewy Inc CHWY CHWY US Nat Schindler
Facebook FB FB US Justin Post
Fiverr FVRR FVRR US Nat Schindler
IAC InterActive IAC IAC US Ryan Gee
LendingTree TREE TREE US Nat Schindler
Match Group MTCH MTCH US Nat Schindler
Netflix, Inc. NFLX NFLX US Nat Schindler
Peloton PTON PTON US Justin Post
Quotient Technology Inc QUOT QUOT US Nat Schindler
Shutterstock SSTK SSTK US Nat Schindler
Snap SNAP SNAP US Justin Post
Twitter TWTR TWTR US Justin Post
Uber UBER UBER US Justin Post
Ubisoft UBSFF UBI FP Ryan Gee
Wix.com WIX WIX US Nat Schindler
NEUTRAL
Booking Holdings Inc BKNG BKNG US Justin Post
Carvana Co CVNA CVNA US Nat Schindler
Dropbox DBX DBX US Ryan Gee
eBay EBAY EBAY US Justin Post
Electronic Arts EA EA US Ryan Gee
Expedia EXPE EXPE US Justin Post
Overstock OSTK OSTK US Ryan Gee
Pinterest PINS PINS US Justin Post
Revolve RVLV RVLV US Justin Post
SciPlay SCPL SCPL US Ryan Gee
The RealReal REAL REAL US Justin Post
Wayfair W W US Justin Post
UNDERPERFORM
Everquote EVER EVER US Nat Schindler
Redfin Corp RDFN RDFN US Nat Schindler
Take-Two Interactive TTWO TTWO US Ryan Gee
TripAdvisor TRIP TRIP US Nat Schindler
Trivago NV TRVG TRVG US Nat Schindler
Zillow ZG ZG US Nat Schindler
Zillow Z Z US Nat Schindler
ZYNGA ZNGA ZNGA US Ryan Gee
RSTR
GrubHub GRUB GRUB US Nat Schindler
Vroom Inc. VRM VRM US Nat Schindler
RVW
Cardlytics CDLX CDLX US Nat Schindler
Disclosures
Important Disclosures
16 Interactive Entertainment | 02 October 2020Activision (ATVI) Price Chart
The Investment Opinion System is contained at the end of the report under the heading "Fundamental Equity Opinion Key". Dark grey shading indicates the security is restricted with the opinion suspended. Medium grey
shading indicates the security is under review with the opinion withdrawn. Light grey shading indicates the security is not covered. Chart is current as of a date no more than one trading day prior to the date of the report.
Electronic Arts (EA) Price Chart
The Investment Opinion System is contained at the end of the report under the heading "Fundamental Equity Opinion Key". Dark grey shading indicates the security is restricted with the opinion suspended. Medium grey
shading indicates the security is under review with the opinion withdrawn. Light grey shading indicates the security is not covered. Chart is current as of a date no more than one trading day prior to the date of the report.
Take-Two (TTWO) Price Chart
The Investment Opinion System is contained at the end of the report under the heading "Fundamental Equity Opinion Key". Dark grey shading indicates the security is restricted with the opinion suspended. Medium grey
shading indicates the security is under review with the opinion withdrawn. Light grey shading indicates the security is not covered. Chart is current as of a date no more than one trading day prior to the date of the report.
Interactive Entertainment | 02 October 2020 17Ubisoft (UBSFF) Price Chart
The Investment Opinion System is contained at the end of the report under the heading "Fundamental Equity Opinion Key". Dark grey shading indicates the security is restricted with the opinion suspended. Medium grey
shading indicates the security is under review with the opinion withdrawn. Light grey shading indicates the security is not covered. Chart is current as of a date no more than one trading day prior to the date of the report.
Equity Investment Rating Distribution: Media & Entertainment Group (as of 30 Sep 2020)
Coverage Universe Count Percent Inv. Banking Relationships* Count Percent
Buy 24 38.10% Buy 13 54.17%
Hold 16 25.40% Hold 9 56.25%
Sell 23 36.51% Sell 6 26.09%
Equity Investment Rating Distribution: Global Group (as of 30 Sep 2020)
Coverage Universe Count Percent Inv. Banking Relationships* Count Percent
Buy 1749 54.79% Buy 1114 63.69%
Hold 677 21.21% Hold 415 61.30%
Sell 766 24.00% Sell 386 50.39%
* Issuers that were investment banking clients of BofA Securities or one of its affiliates within the past 12 months. For purposes of this Investment Rating Distribution, the coverage universe includes only stocks. A stock
rated Neutral is included as a Hold, and a stock rated Underperform is included as a Sell.
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price fluctuation, are: A - Low, B - Medium and C - High. INVESTMENT RATINGS reflect the analyst’s assessment of a stock’s: (i) absolute total return potential and (ii)
attractiveness for investment relative to other stocks within its Coverage Cluster (defined below). There are three investment ratings: 1 - Buy stocks are expected to have a total
return of at least 10% and are the most attractive stocks in the coverage cluster; 2 - Neutral stocks are expected to remain flat or increase in value and are less attractive than
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Buy ≥ 10% ≤ 70%
Neutral ≥ 0% ≤ 30%
Underperform N/A ≥ 20%
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18 Interactive Entertainment | 02 October 2020Other Important Disclosures
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