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Around 30 years ago, one of London’s leading tech stocks was Eidos Interactive. This has impoverished video games and their investors. Profit warning followed by profit warning under Eidos management set deadlines that its studios considered unrealistic. Release dates, particularly for its flagship franchise Tomb Raider, have drifted inexorably. Too often, the delivered product was defective and unfinished.
Japan’s Square Enix rescued Eidos from its shareholders’ misery in 2009, with the company first saved from possible bankruptcy four years earlier by its more scrappy British rival, SCI Entertainment.
Gaming has changed a lot since then, although small listed companies like Border developments And CD project have continued the tradition of overhyping and underdelivering headlines. Rent-seeking is the preferred model for big players: Electronic Arts, which this week reported quarterly bookings up 1 percent to $2.37 billion, makes most of its money from content updates and in-game purchases.
The essential problem remains, however: new games take time to develop and only occasionally recoup their costs. Additionally, it is becoming increasingly difficult to break even.
A JPMorgan analysis reveals that the investment costs of developing new AAA titles “have far outpaced revenue growth, particularly in EMEA”:
Three things happen. First, each new flagship title must mobilize an ever-increasing army of developers. JPMorgan calls this a symptom of the “feature inflation” needed to compete:
Second, development costs continue to rise, with the corresponding capex spent per developer increasing by 30% on average compared to 2019. Here’s the data for Ubisoft:
Overall, the cost of developing a AAA game has increased tenfold in 15 years, and the customer probably hasn’t noticed much. Weak pricing power means the standard store price has only increased 17 percent since 2007, from $60 to $70, according to JPMorgan:
“We see that much of the investment growth will not be used to build a larger future pipeline – as is often assumed – but rather is needed simply to support the same pipeline as in the past (in terms of ‘AAA/year) against competition,’ says JPMorgan. This demonstrates a steady decline in returns on new titles over the past few years, shown below with Ubisoft again:
Weak pricing power and ever-higher development costs “are structural productivity problems and not just pandemic-related,” JPMorgan says.
The market has been ineffective in assessing the (video game industry’s) pipeline and investment needs: FCF has underperformed the Bloomberg consensus year-to-date for every stock in our coverage. every year since 2020 (often with significant margins). Investments have doubled on average since 2019, while revenues generally lag far behind. (…)
Competition for talent during the Covid pandemic has driven up wages, and non-US wages have converged as remote work infrastructure built for WFH has made it easier for US studios to hire remotely. ‘stranger. Meanwhile, feature inflation (as represented by number of AAA-credited developers, hours of content, and years of development) implies further cost increases of at least 10%. per year in addition to wage inflation.
Selling more units and in-game purchases may help improve AAA’s economics a bit, but in the latter case, spending has been disproportionately directed toward multiplayer gaming-as-a-service titles like Fortnite and Call of Duty, explains JPMorgan. His team also notes in passing the possibility that generative AI could be a miracle solution for development costs, “but the details remain scarce, as do the legal implications”.
Meanwhile, the bank’s thesis is summarized in a chart of Ubisoft’s consensus forecasts, which, for anyone who remembers Eidos, might bring back unpleasant memories: