Welcome to the October 2020 newsletter for the Waterhouse VC Fund.
The Fund specialises in gambling assets and businesses that are related to the gambling industry. We aim to leverage our unique expertise and existing assets to generate yield and capital growth for investors over the long-term.
Since inception in August 2019, $100,000 invested in the Waterhouse VC Fund has risen to $370,540, as at 30 September 2020.
Content is (still) king
The video game industry is booming amid the COVID-19 pandemic, and a barrage of new services and major acquisitions suggest the world’s biggest tech companies don’t expect the trend to reverse any time soon.
Microsoft in particular is allocating capital and focus to the industry. Last month, they announced a US$7.5 billion acquisition of ZeniMax Media, parent company to gaming giant Bethesda Softworks. It was Microsoft’s biggest deal ever in the gaming sector and will almost double the number of video game studios under Microsoft’s control. Bethesda published the leading games of the early 2010s, including the Elder Scrolls and Fallout franchises.
In the acquisition announcement, Microsoft made it clear that high-quality, differentiated content is the growth engine behind their Xbox Game Pass subscription, where gamers pay a US$9.99-14.99 monthly fee for unlimited access to a growing library of games. The company has many mainstream franchises that you probably know, including Halo and Minecraft, that Game Pass subscribers can play on their Xbox console, Windows PC and Android device. For gamers who would normally purchase a few Microsoft-published games a year, it’s a no-brainer to instead get a Game Pass subscription.
Subscribers have grown over 50% in the last six months, rising from 10 million in April to over 15 million in September. Microsoft's gaming business now makes up about 9% of revenue and will benefit in the short-term from the release of the next generation of Xbox consoles on November 10.
In for the long haul
Followers of the media industry would be familiar with the ‘content is king’ mantra, but why not just pay licensing fees for exclusive content? Why does Microsoft need to make big acquisitions to own the actual content?
Recently, Sony has dominated the market with a well-executed console-centric strategy. Sony has out-invested Microsoft in landing exclusive games for their Playstation console, paying big licensing fees to publishers. Exclusive games sway gamers to buy one console over the other.
Microsoft is now betting on a more gamer-centric vision, and recent content acquisitions are a necessary part of the business model innovation underway at Microsoft.
After the release of the new Xbox Series X|S, Microsoft’s initial batch of first-party games will also run the last generation Xbox One. Clearly, they are preserving the value of their subscription service at the expense of creating urgency to upgrade consoles. Subscribers to Microsoft’s game streaming service xCloud, included in Game Pass, don’t even need an Xbox at all to play most of the games. Phil Spencer, executive vice president of gaming at Microsoft said “building walls around Xbox, so the only way you can continue the experience you love is to buy a new console ... doesn’t seem in line with the values we have as a team.”
Interestingly, Microsoft is re-introducing the option to own the Xbox console for a monthly fee. However, instead of marketing a simple instalment plan, they’ve framed it as a small US$10-20 increase to the Game Pass subscription fee. Gamers will see a neat bundle that gets them everything they need to start playing.
Previously, Sony and Microsoft sold loss-leading consoles, justified by earning revenue from future sales of high-margin, console-specific games. It’s a very transactional business model. Now, Microsoft is making their subscription service the centre of their relationship with the customer. The Xbox will be merely a specialised device for accessing their game service, which gamers will hopefully be subscribed to for a long time. Of course, by owning the actual content, they can now earn revenue from a much larger pool of gamers who prefer other devices.
With Microsoft building out a fast-growing, high-margin recurring revenue stream that delivers unparalleled value to gamers, we believe their gaming business will have a material impact on Microsoft’s long-term valuation. Subscription models are appreciated by a market hungry for certainty during uncertain times. In Q2 2020, S&P 500 businesses saw sales contract at -10% annualised, while subscription businesses grew revenues by +12%. The subscription model brings their gaming division in line with the rest of the business, with the revenue share generated by services (including LinkedIn, Office 365 and Microsoft Azure) growing from 32% in Q1 2017 to 55% in Q3 2020.
Microsoft hopes to eventually have hundreds of millions of gamers subscribed, which will raise the opportunity cost for publishers considering deals with Sony. It’s a bold, long-term strategy that we’ll be following for the long-term.
For wholesale investors that want to follow gaming’s global growth, please follow us for updates on Twitter @waterhousevc.