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Anser Haider

Hi, and welcome to MediaTalk, a podcast by S&P Global Market Intelligence, where we take a deep dive into issues facing the evolving media landscape. I'm your host Anser Haider. And joining me today once again is our resident gaming analyst, Neil Barbour. In this episode, we'll be talking about some of the most significant issues impacting the video game industry this year.

Despite the record level of M&A activity we've seen in gaming this year, the industry is facing softening growth amid a range of hurdles, including ongoing hardware component shortages, disruptions to game development cycles caused by the pandemic and an increasingly hostile regulatory landscape.

Anser Haider

To start off, Neil, maybe you can talk about some of the declining growth trends you've tracked so far this year within some of the bigger game publishers.

Neil Barbour

Sure. And thanks again for having me Anser. Yes, really interesting Q2 results coming out, a lot of the stalwart game companies seeing some softness in revenue growth or some revenue declines and particularly looking at Activision Blizzard. Their Call of Duty series saw a lower player count year-over-year that they're attributing to Vanguard not meeting expectations. That revenue softness, of course, flows through PlayStation, which is one of the biggest platforms for Call of Duty. So then Sony had a rougher year. And then to a lesser extent, we're seeing some revenue softness coming out of the larger Chinese publishers, namely Tencent. They were down -- for gaming revenue, they were down 2.6% year-over-year when adjusted to U.S. dollars. So there also some ForEx headwinds there because of the stronger dollar over the past quarter.

So it's unclear whether this is just because the software is underperforming or the hardware isn't there, but we're seeing some hollowing out of demand from the pandemic. But we're definitely seeing some reduced demand, reduced revenue flow through some of the larger companies.

Anser Haider

And now we're approaching the crucial fourth quarter holiday season, which, of course, is the period that most top publishers lean heavily on for a substantial chunk of their fiscal year sales. We still have some big releases scheduled such as Overwatch 2, and Modern Warfare 2 from Activision Blizzard. And we have got our Ragnarok coming up from Sony and of course, a new mainline Pokémon from Nintendo. However, several major title releases were delayed until next year, including just about every major game from Microsoft and the next Star Wars Jedi title from EA.

Delays in the industry are very commonplace. It seems we've been seeing a lot more of these recently due to disruptions caused by the pandemic with developers having to work from home. Neil, do you think that the titles that are set to launch this year will suffice in keeping overall software sales competitive to prior years? Or can we expect a dip in growth?

Neil Barbour

So I guess that sort of plays into the prior question as well is that we've seen 2 years of strained developer conditions. We've seen work from home policies or general disruptions and workflow and some -- maybe some strain between publisher-developer relationships. It seems like a lot of that tension is now showing up in the pipeline, and that is to say that there's not much in the pipeline right now. Q2 was fairly bare as far as titles go -- new hit releases go. And Q3 and Q4, as you just mentioned, there is some strength, there's a return to some big name titles coming to market that consumers may or may not be looking forward to. The question is, primarily, will vendors be able to supply the new hardware to gamers that will get them really excited about buying these new titles, maybe spending the $70 for the next-generation version instead of $60 for the first generation version?

There's also some runway for mobile titles released in the second quarter, I'm thinking of Diablo Immortal that released late in the second quarter that may find some runway into the third and fourth quarter as well as Apex Legends from EA. FIFA is still running strong on mobile. Those have -- and it will be a World Cup year, so that will have potential to pop revenues in the third and fourth quarter.

What we're sort of seeing now we're in late August, and we haven't really seen hardware coming to market in a big way yet that you might expect if Sony and Microsoft were able to deliver on promises of increased production. And you're also not seeing a ton of software just yet. We have -- I think Madden just came into the market in the past week or so, the sports games will be happening. And some of them will have onetime uplift or nonannual uplift like World Cup or different sorts of events that come in and out of that market. So yes, I think there's potential, particularly in the fourth quarter to sort of win back some of the losses that are happening right now in the market. But a lot of things have to go the market's way, not the least of which are inflationary pressures and other macroeconomic strains. If consumer discretionary spending is still in a crunch by that time, maybe games take a hit, maybe they don't.

Anser Haider

And like you said, hardware shortages are, of course major concern in the industry. both PlayStation 5 and Xbox Series X consoles are still in short supply, which is pretty unprecedented considering they're both approaching their second year on the market now. And like you said, both Sony and Microsoft have said they are taking measures to improve the production. But now they're having to deal with other factors such as the Russia/Ukraine situation. So assuming that the companies do manage to increase capacity for the holiday quarter, do you think it's safe to assume that demand will continue to outstrip supply.

Neil Barbour

Yes, I still think whatever Sony and Microsoft can make within reason, if they have -- I think, it's somehow fill the year with 20 million consoles each, which is about the best Sony has ever done. I'm not so sure Microsoft has ever had a 20 million, 22 million console a year. But let's say, Sony gets to 17 million, 18 million, 19 million, 20 million consoles, I think the market can digest that much hardware. There's just enough pent-up demand that they would be able to fill those orders.

The question is, if Sony can put the parts together, do they want to put a lot of consoles in the market considering that component costs are up due to inflation and other pressures that they're losing more or not making as much on each console as they would be or maybe they thought they would and maybe they would want to wait until some of that evens out before they really make a big push in consoles. That could be some considerations they're thinking about as they try to wind up if they already have the manufacturing capacity do they fill the components. There's a pretty good chance the components are already bought and they're just waiting for them to be delivered.

But yes, I think the market can digest as many consoles as those vendors put into the market at this point. Now in a year or 2, does that demand carryover? Or is there just 5 million, 10 million, 15 million consumers waiting on a console and need to get that filled and that sort of levels up, that's a different story, but, yes.

Anser Haider

And do you think the lack of current gen hardware is the primary reason a lot of these first-party games that we're seeing from both Sony and Microsoft that they cross gen, like the new God of War that's coming out, it's going to be on the PS4 as well as the PS5.

Neil Barbour

Yes. I think in previous generations, you would see a Call of Duty do 1 or 2 years cross gen. We may be looking at a scenario where they do -- I think this will be the third Call of duty that was cross-gen for this generation. But it's not that -- it's more unlikely to see a first party do that. So yes, I think that is sort of playing into the map a bit. Maybe for Horizon, Forbidden West was always a cross-gen just because of PlayStation 4, installed base was so enormous and hard to ignore. But definitely, at this point, it's rare to see or -- it would be confusing to see in normal times to force a first-party developer to develop for both systems when a platform holder would be actively trying to sell the new hardware.

Since they can't sell the new hardware, it makes more sense to spread that development resources and the potential revenue pool across 2 generations. But I think once Sony gets up to the level that they would like, the supply and demand have evened out, they will shift resources more fully toward the current gen. Microsoft is playing a little bit of a different game since they have the cloud Game Pass in their back pocket. So they can kind of say, whenever we're ready to abandon the previous generations, we can always turn on cloud gaming for the previous generations and just develop on spec, the newest. Whether or not that's really weighing on their current decisions, it's definitely at least floating in the back of their minds.

Anser Haider

You just mentioned Game Pass and obviously, Microsoft is stressing it a lot for their overall gaming strategy. Having said that, there won't be any major releases on the platform this year, any first-party releases because Microsoft has delayed most of those games. Do you think that will impact the services growth rate for the rest of the year?

Neil Barbour

Yes, that's an interesting question. We haven't seen hard numbers for Game Pass coming out of Microsoft for a quarter or 2. So that sort of leaves the question open. Are they still growing? Are they growing not as quickly as they would have wanted to? Why would they be shy with that number? And I think the answer is that maybe growth probably has stagnated a bit just because there aren't a lot of marquee titles that -- gaming is a hit-driven business. In Q4, they had Halo, and they had Forza to send people into the ecosystem. Gamers may have chewed through those already and turned out of the system just because there's not a lot of big name new stuff coming in.

That said, they could reach out to third parties and games on board to make the Game Pass value proposition, look a little more valuable to the average gamer. Does it hurt? Absolutely. Would they rather have a big game that they can really put some marketing might behind and just pull in every hardcore gamer that has the ability to subscribe to Game Pass? Yes. But they'll -- I think they'll be looking for ways to retain subscribers, and they'll probably find a path or 2 to moderate success for the end of the year.

Anser Haider

And meanwhile, Sony has been expanding its own PlayStation Plus service. What are your thoughts on their existing strategy of focusing more on older titles rather than having day in date First Party releases like Microsoft?

Neil Barbour

Yes. Well, it makes more sense this year since, as you said, there's not a lot of day and date stuff coming out from Microsoft. What I do wonder, looking at the quarterly earnings, particularly in Q2 here, as Call of Duty becomes less popular, at least this year's version was less popular. Maybe that is contributing to fewer people keeping their PlayStation Plus subscription for the multiplayer matchmaking benefits. So maybe Sony was looking at that and thinking we need to keep subscribers on the platform and maybe this is a way to offset the losses that we would have gotten from unpopular software or less popular software. I don't mean to say Call of Duty is still a very popular game, but maybe this is less popular than years past.

So viewing it from that lens, maybe it isn't necessarily a direct competitor to Game Pass. It doesn't appear that it moved the needle a ton for them in the most recent quarter. It looks their overall subscription rates were flat, but maybe that staved off a decline in subscriber rates. And that's the way they're looking at this subscription service, then they can turn it on and off as need be. If Q3 comes on and a bunch of people start playing Madden and FIFA again and they decide they need that PS Plus subscription for the multiplayer matchmaking, then maybe they don't need to put as much muscle into the PlayStation now subscription.

If those games go flat, then maybe they move some more interesting titles in the PlayStation Plus Premium and Extra, which is what PlayStation Now became in the past quarter. That was the big transition.

So I think it can be an additive strategy, but they're not looking at having a disruptive strategy like Game Passes. They're just trying to round the edges off.

Anser Haider

And Sony is also planning to launch its new PSVR2 headset next year, which is specifically for the PlayStation 5. Do you think the headset is going to have an uphill battle because of the fact that it's being made for a console that is still in such short supply.

Neil Barbour

Yes, it's a great question. Couple of things working in its favor. The first is that the Quest had to that Meta elected to increase the price of the Quest, they said inflationary pressures were making the $300 price point no longer viable. The entry point is now $400. So now whatever the PlayStation does, it'll look a little better than it would have if there was a $300 Quest sitting in the market right next to it.

What it has working against it? It's not stand-alone. Like the Quest, you still need the console. So the installed base or the addressable audience will be smaller right out of the gate. It's tethered, a cord runs from the headset to the console. So you don't really have as much freedom of movement as you would have with the Quest 2. Things that might be working for it, not only the value proposition that I talked about earlier or the relative value proposition. But it will be working with vastly better hardware. So there's potential for the image quality to look better. PlayStation has a broad pool of developers, which you could leverage. They've had that last time we put out a PlayStation VR headset to mixed results, but maybe those teams have learned some lessons from going through the first time and they could make even more compelling experiences for consumers.

Does that result in a successful headset? You probably have to temper your expectations is what you think are as a successful headset. I think the previous PSVR sold into 5% to 10% of the PS4 installed base, and that's already when the PS4 installed base was at 60 million to 80 million and the PlayStation VR2 won't have that whether it comes out this year or next year. So if they sell something like 5 million to 10 million units, that should probably be considered a pretty big victory for their side. But it'll still be sort of -- it's hard not to look at it as sort of a niche additive feature to a larger ecosystem and not the ecosystem that it is for Meta. So they're more incentivized to build a stronger software library than PlayStation would.

Anser Haider

Right. And then, of course, aside from your consoles and VR headsets, mobile, and you brought it up before, obviously, major game publishers are now aggressively pushing into the space, which has been very lucrative for many companies, especially in Asia. We're now also seen publishers in the U.S. such as Activision Blizzard breaking in more revenue from their mobile divisions. Do you expect this trend to continue in the coming years? Is mobile the space to be to make -- rake in money?

Neil Barbour

Yes, I think so, particularly for publishers or platform holders like Sony or Microsoft that have had some exposure, but not a ton of exposure to mobile. This is a market that they can extend their existing developer pool, their existing franchise intellectual properties. They can pull that over to market and suddenly open up a brand-new revenue stream. And it's interesting to look at some of the major software publishers that really don't have that much exposure to mobile. Take-Two specifically went out and paid $12 billion for Zynga to buy their way into mobile, something they weren't really making happen on their own, so they went the inorganic route. And now that they have that developer resources they can pull across some of the franchise. So maybe that should be a signal to the broader publisher and developer community that just making a mobile game is easier said than done. Maybe it takes a different skill set. I think it's pretty obvious. It takes a different skill set, different kind of strategy and maybe it will be harder to figure out on your own than you think it will be.

Microsoft is buying a little bit of that with Activision. Certainly, they get King, which is a lot of it. But what they also get is Call of Duty Mobile, which is being posted by Tencent and some APAC regions but was developed in tandem with Tencent. So they get that institutional knowledge that they can leverage maybe with some of their other properties.

Yes, I think you're going to see definitely those few publishers looking more and more to extend into mobile. It does seem that some of the larger companies, I mentioned Tencent earlier they're suffering in their home market of China because of a regulatory overhang.

China withholds how many new games can be released by assigning licenses to new games, clamping down on having new games are coming to market, so that's limiting growth potential. They also monitor and limit the amount of time that children can play on game. So that sort of limits how much engagement and revenue can flow through the system. They're seeing a stabilization point of revenue growth in that market, and that's affecting overall loan growth because China is the biggest market.

So I think you're going to see those publishers to try to extend more thoroughly outside of the Chinese market, and they can take a very solid playbook and put it into other franchises and start investing into other markets. NetEase, which is the second biggest Chinese publishers already doing that.

Anser Haider

And finally, let's circle back to the M&A activity that the industry has been experiencing. We, of course, had to back-to-back record M&A deals early this year with Take-Two and Zynga and Microsoft and Activision, which is still pending. And there have been a plethora of other smaller deals as well such as Sony and Bungie. And of course, Sweden's Embracer Group, which doesn't seem to be slowing down its acquisition spree of smaller-sized studios.

And we've also seen other tech players such as Amazon and Netflix expand their own gaming offerings as well. However, keeping the current economic trends in mind, do you think M&A activity may slow down for the rest of the year? How likely are -- will we see another multibillion-dollar deal?

Neil Barbour

Yes, great question. I think if the right deal came along at the right price, of course, it's sort of boilerplate language. It's hard for any major company to pass that up, particularly if they have the -- they can put the funding together or they have the dry powder to strike out on something like that.

What you have to think about, though, is if the -- signs of the economy is slowing, that there could be protracted, I don't want to say recession or bigger word, but there could be a difficult economic climate ahead. And I think some companies will want to at least project austerity and -- sorry, strategic investment managements and making a deal -- making a multibillion dollar deal for a video game company might not project that kind of austerity.

So that's one thing that's standing in the way of probably a very large deal getting done in the second half of the year. Something else to consider is that there's a general sense that the regulatory climate is heightened for deals at this point that particularly among big tech companies, the Feds are looking at those deals a little closer. They would rather foster competition than they would consolidation. So taking those 2 things together, you say what deals can really get done at the size of the Take-Two and the Microsoft deals that happened earlier this year that sent the M&A valuations close to or past $100 billion in the first half of the year, which is head and shoulders above any other year for video game M&A.

And you already saw sort of a few months ago, it seemed that there were reports surfacing that EA was having discussions with different tech companies for different deals to get done, and nothing came of that. I don't know if that's a bellwether or not. But it does seem that the bigger deals have slowed down. And it's entirely possible that we've seen the majority of deal valuation done already.

Anser Haider

All right. And that concludes our discussion for today. Thank you, Neil, for sharing your thoughts with us today.

Neil Barbour

And thank you, Anser.

Anser Haider

And thanks to you, our listeners for tuning in. Stay safe, and goodbye.