The Center of Mass for Mobile Gaming Has Shifted to Asia

As with every content creation industry, I believe that the mature structure of mobile gaming will involve a handful of global giants, and a plethora of indies. There will likely be a constant escalator of start-ups becoming successful indies, ultimately being acquired by larger firms that in turn hope to join 'the majors'. The majors will have multi-genre and multi-geography prowess, and the first 'major' has actually already arrived.

The winning business model in mobile gaming worldwide is 'free-to-play' - it has been unbeatable in its reach and ability to build brand power. No barrier to enjoying the content means user bases can be enormous in popular titles. It is also arguably the most efficient monetization mechanism the gaming world has ever seen - allowing players to create their own demand curve as they trade off time versus expenditure to progress.

Chinese companies began experimenting with this business model a decade ago. Japanese and Korean players were not far behind. They have nurtured and converted this early mover advantage into enduring scale that is now on display through the volume of public mobile gaming companies in the region. Approximately 75% of all public mobile gaming firms were founded and are headquartered in Asia. Largest of them all is arguably Tencent - a c.a. $166 Billion market cap behemoth which has adeptly combined platform and content creation expertise to create a virtuous circle of growth for 15 years.

"I believe that in order to truly turbo-charge power in the value chain for any western gaming business we need to combine content creation with distribution and/or platform dynamics"

Tencent's market cap is vastly larger than any other public gaming company. Its QQ messaging, We Chat and other platform services create an enduring user base from which it has been able to become nearly a 'mega-platform' in China - playing much of the role in the Middle Kingdom that Apple and Google do elsewhere. Its distribution power means it is kingmaker in the China gaming space - a position it leverages to hold onto often the supermajority of revenue from any external game development partner it works with. Tencent also has its own internal game studios and has begun expanding inorganically in a number of territories. To create a business as powerful across the value chain in western markets as Tencent is in China, one would need to imagine Facebook building its own game development division.

I believe that Tencent will be able to leverage its financial muscle as well as distribution might in China to grow leadership positions in other territories. Tencent has already bought control of arguably the largest online MMO company in the West - Riot Games - and also bought a stake in Activision. It owns minority stakes in a wide range of Chinese and international game companies. Over time it is likely to convert some of its minority stakes into majority ones - expanding cautiously but relentlessly in all major gaming markets.

The same game plan is happening to a lesser extent with other Asian internet and gaming leaders. Alibaba has purchased a 10% stake in Kabam. Gung-Ho has bought a majority stake in Supercell. DeNa & Gree have acquired their way to meaningful North American competitive positions.

Alibaba, Softbank, and Tencent are each >$100 Billion Asian businesses which have the wherewithal to become true global gaming behemoths. Alibaba currently has a modest Chinese gaming operating business by comparison to Tencent, but possesses other advantages it can bring to bear. Softbank has clear potential synergies with its carrier subsidiaries in the US and Japan and has significant stakes in Gung-Ho and Alibaba. Others will attempt to follow in their footsteps, and at times need to retrench. But I believe the trend is clear - capital and expansion is flowing predominantly from east to west, not the other way around.

The advantages of scale for mobile gaming players include the same ones enjoyed by traditional content creators other than those tied to physical distribution. Being at 'the top of the barbell' creates value for companies through opportunities to rationalize costs, diversify content, and grow.

Ultimately I believe that there will be a handful of 'majors' in the mobile gaming space - with diversified product portfolios and catalogues. Larger content creation firms can, and I believe likely will, be created through M&A between the public western firms. But I believe that in order to truly turbo-charge power in the value chain for any western gaming business we need to combine content creation with distribution and/or platform dynamics.

At first blush this seems challenging - the mega-platforms in the ecosystem are Apple and Google who leave little room for others in the hardware, software, and billing spheres after all. The narrative of content and distribution being poor bedmates is one that public market analysts have liked to roll out to justify cycles of demergers - after the same firms often advised on the beauty of such marriages only a decade before. Comcast is doing more than fine owning both physical cable and video content creation. So is News Corp with satellite TV and a major film studio. The reality is that success comes down to the precise execution of the combination - no hard and fast rules apply universally to realizable synergies.

I believe there are three firms with relevant network effects that could combine powerfully with content creation scale to rapidly build a western behemoth: Facebook, Yahoo! and Unity. Conflicts of interest would of course need to be managed - but all the large banks manage this after all and at tremendous scale. Tencent has masterfully shown how platform/distribution and content can fit together synergistically. Controlling content I believe is important to making a platform popular rapidly. The reverse is also true - controlling an audience dramatically improves the chances content is discovered and hence increases the probabilities it becomes a breakout hit. A virtuous circle between traffic and content is indeed very possible - in every culture.

"Investor sentiment is currently lukewarm in western mobile gaming - but with leadership we can nevertheless build our own global powerhouse"

Facebook is a company whose revenues have historically been significantly powered by gaming. It has the market cap and global reach to rapidly become a powerful first, second and third party game developer should it ever choose to do so. Such a combination would immediately create a global counterbalance to Tencent and enable it to capture more revenue in the gaming value chain. I would posit that it would be able to very comfortably manage conflicts of interest and provide a significant net boost to its revenues and profitability over all time frames.

Yahoo! has an audience and needs to transition it more aggressively to mobile. I believe that its distribution power is sufficient to potentially build its own gaming portals/stores across all four screens that matter to the 21st century consumer - laptop/desktop, tablet, smartphone, and TV. With its advertising scale and expertise, and its Alibaba-enlarged market cap and balance sheet, it has the financial strength to muscle its way into gaming aggressively. It recently purchased mobile advertising network Flurry and as such has a foundation for making further strides in such directions.

Unity is a software development toolkit used by likely the majority of western top- tier mobile gaming publishers. It allows efficient cross-platform, 2D and 3D development, and is increasingly a de-facto standard for other third party vendors to plug into. The opportunities for expanding Unity to become an analytics and advertising platform are myriad and the company recently appointed former EA CEO John Riccitiello as its chief. In addition, with such a large ecosystem of developers it could be possible to build its own storefront portal and/or regain margin from distributors for Unity and its content creators.

A wide variance in valuations is a significant present barrier to the M&A that would need to happen to create a western-based global behemoth. In the long term valuations harmonize - private companies either go public or get sold; longer operating histories help ensure public companies are valued using similar methodologies. Investor sentiment is currently lukewarm in western mobile gaming - but with leadership we can nevertheless build our own global powerhouse.

We need larger content creators. But more importantly, partnership or combination with either a platform and/or distribution play to drive the virtuous circle that would create a global competitor capable of rivaling - even counterbalancing - Tencent. Without deliberate action, in the long term it is a distinct possibility that most western gaming firms will be partnered with or controlled by giants in the east.