The year of WTF games finance

What do companies that farm chickens, make woolly jumpers and develop games have in common? Most sane people would conclude ‘absolutely nothing’ – yet 2014 saw several major acquisitions and investment rounds involving firms as diversified as these.

There’s an investment adage: “if you see a bandwagon, it’s too late”. So with chicken and clothing companies moving into the games industry, has the bandwagon well and truly arrived and if so, how has it happened and what are the implications?

Bandwagon investment happens when investment decisions are made based on other investors’ actions rather than any intrinsic belief or even clear investment logic. Investing in something solely because others are is not in itself a poor investment strategy. Many acquirers and investors prefer to stick with the herd, acquiring companies only in ‘hot’ areas or co-investing besides more experienced and knowledgeable investment partners. Bandwagons can often enjoy strong momentum, delivering solid returns.

However, amongst the dangers is the risk that, as they progress, they tend to attract a growing number of inexperienced investors whose poorly-informed decision-making can drive up valuations to unjustifiable levels and create bubbles. Such bubbles have a tendency to eventually burst (e.g. all things internet in the early 2000s, or Facebook gaming just a few years ago).

I don’t believe there is a bubble for games quite yet, as valuation premiums are not consistently excessive, but games are on a bandwagon and it is picking up momentum.

2014 was another bumper year for games investments and acquisitions with both transaction value and volume increasing materially. There was a marked increase in transactions involving companies well outside the usual sphere of tech and media investment institutions and games firms.

SURPRISING INVESTMENTS

We saw the purchase of a majority stake in Canadian online games developer Digital Extremes by Chinese chicken meat giant Sumpo Food Holdings, and the acquisition of 24 per cent of Chinese online games giant Shanda Games by Ningxia Zhongyin Cashmere, a textiles company. They weren’t all so left field but Amazon’s purchase of Twitch and Facebook’s of Oculus VR also fit into the ‘WTF’ transaction category too, judging by the surprise that their announcements generated.

None of these deals, at first glance, had much immediately obvious business logic to them, but they all share something in common – they are all long-term bets on the growing social and commercial potential of games, gamers and games technology.

The industry emerged from its demographic niche in the mid-1990s but the strong and consistent expansion of mobile and online games markets have delivered new commercial opportunities to exploit games’ wide demographic appeal on a truly mass scale.

Also attractive to external investors, commercial and games design innovations have yielded business models capable of delivering not only strong margins and growth rates but also relatively high degrees of predictability.

Such traits range from rare to non-existent in other sectors.

While the games industry remains highly hits-driven, the hits in online and mobile tend to reach their peak over months and years and rarely suffer the dramatic brevity and concentration of commercial returns that boxed products tend to.

This all makes them considerably more appealing investment and acquisition opportunities, in particular to outsiders unfamiliar with games industry dynamics but capable of analysing financial statements and forecasts.

Games have therefore become a very attractive area for investment these days with their mass global appeal, high growth rates, solid financial fundamentals and excellent exit opportunities.

For anyone involved in games investment a decade ago, when most investors wouldn’t touch a games company with a barge pole, this will represent an incredibly stark contrast.

The games bandwagon is undoubtedly going to carry on rolling and continue attracting a wide array of investors and acquirers. For now, this remains a welcome development as it is funding games innovation and accelerating the growth and diversification of the industry.

I don’t believe a bubble has formed yet but with such ‘alternative’ companies throwing their money in the games ring, the early warning signs are probably here.