13 Comments

Thanks for your thoughts , divergent opinions are what makes a market and I think both of you make some fair points

It's trying to think which is more applicable to each situation I guess

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Thanks so much for an awesome article. Quick edit:

The labels on the market cap chart are actually in units of billions but it's labeled as "units of millions".

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Jun 5, 2023Liked by Aaron Pek

Lovely post. Thanks for sharing the insights mate.

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Jun 4, 2023Liked by Aaron Pek

About the "convergence" of Big Gaming and Big Media, you were coming from the angle of TV series and movie adaptions of original game IPs (even if they were themselves inspired from elsewhere, such as the Witcher series) mutually benefitting the growth of both the game and the media IPs, but really it has always been the case since the beginning, just that people made more video game adaptions of media IPs rather than the other way around. Countless games have been produced this way: from Goldeneye 007, to the numerous Batman and Spiderman games, to Lego Star Wars (Big Media + Big Gaming + Big...Toy?), to Marvel's Avengers. Just curious as to why you are presenting it as something new that's burgeoning in the industry when that was exactly how it was 20+ years ago.

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Hi Toh Nic, thanks for the question. Yes it's definitely true that this has been an ongoing trend for a long time, however the difference this time is that both the Media (i.e. streaming) & Gaming industries have reached a saturation point in terms of growth AND further industry consolidation. Within their respective industries, there is no longer much growth remaining.

Hence, in order for the Media sector to grow/consolidate further, there is suddenly a new more pressing need for this Brand IP spillover across the two sectors to occur. And with the coming convergence between Metaverse and the Media sector (+Gaming), suddenly Big Tech also becomes a new player.

Hope that's an okay answer, and feel free to revert with any other questions!

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Sorry one more thing - the capitalization of R&D which is allowed under IFRS really bugs me given it is generally not allowed under US GAAP

This is not unique to the games business but I've seen some really aggressive capitalization of costs in some European tech names which bugs me a lot

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I see. Without getting too much into the weeds, I think that generally the 5 or 6 recognition criteria for R&D capitalization are fair in intent. No doubt there will be opportunists seeking to push the limits though.

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Ultimately it still remains our job as investors to weed out the chaff from the wheat.

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What do you make of this I think it draws some quite different industry conclusions

https://open.substack.com/pub/turtles/p/almost-longs-1

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Jun 10, 2023·edited Jun 10, 2023Author

Hi, it is a good post, but I think there is just a fundamental difference of opinion here. His position is that AAA gaming franchises can't do well without great high quality titles (i.e. commoditized), while my position is that they can (i.e. not commoditized).

For instance, he says that:

"Big name franchises also do not protect against failure much if the product isn’t good. Take the latest Battlefield 2042 game. A huge budget production, yet it now only has about an average player count of ~8k because it wasn’t a good game."

I would argue that the Assassin's Creed franchise is a counter example to that. It's a bunch of largely mediocre games (by many gamer's admission) which has been milked by Ubisoft for over a decade. Overwatch 2 has also been criticized similarly, but large amounts of people are still playing it. The mobile Diablo received a lot of criticism prior to launch, but iirc it ended up being the most lucrative Diablo title prior to Diablo 4 due to spammy microtransactions.

I've gone to great lengths showing many examples of how AAA gaming titles tend not to be commoditized businesses in nature. Sure a really bad game can sink anything, but they should be the exception rather than the rule. Happy to entertain any constructive feedback.

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Jun 10, 2023·edited Jun 10, 2023Author

Also, he says this:

"What I don’t like though is that EMBRAC depreciates their development spend, instead of just expending it as a cash expense. This makes it so that Free cash flow is lower than earnings because investment in development assets is significantly higher than the amortisation expense. But how does one determine the useful life of a video game? It would seem more honest if they just expensed this, and it makes me question how real their earnings really are. Since this difference is several billion SEK, impact on profits would be significant if the amortisation expense turns out to be too low."

Without meaning any criticism whatsoever, this is just a fundamental misunderstanding of how gaming studios approach their accounting of development spend. You may google the IFRS/GAAP accounting treatment for capitalizing R&D expense, most AAA gaming studios would easily qualify the recognition criteria, and capitalizing development spend represents a true & fair view of the industry's underlying business economics.

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interesting breakdown. Big Gaming also tends to be involved in quite abit of M&A, what do you think of buying up smaller studios as a form of growth?

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Hi thanks for the comment. Yes, this is a valid approach towards M&A in the Big Gaming industry, and is widely practiced by sector incumbents. Perhaps CDPR could attempt something similar once it has grown further in scale.

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