MMORPGs -- the Best Business Model You've Never Heard of

This article is part of our Rising Star portfolio series. Sean is co-manager of the Dada Portfolio.

While I've been a video game player all my life, I haven't always been a video game investor. My trepidation has always stemmed from the fact that to a large extent, the business dynamics in the video game industry are a lot like those in fashion retailing -- one day you've got the hottest thing around and you're the king of the world, but if you stop to celebrate for even half a second, you're already behind. In investing terminology, the best way to express it is that video game companies, on the whole, just don't build a lot of durable moats.

The winds of change
That, at least, was the traditional model. Toward the end of the '90s, a new breed of video games began to emerge called massively multiplayer online role-playing games. These MMORPGs plugged millions of basement-dwelling geeks into alternate realities where nerds like myself could battle each other for digital loot and glory. There, of course, had been multiplayer games before the dawn of the MMORPG, but no other genre connected so many gamers at once, and perhaps no other genre had as much of an influence on shifting the entire video gaming experience from being antisocial to becoming a social one.

The pinnacle of this metamorphosis is no doubt apparent in Activision-Blizzard's (Nasdaq: ATVI  ) World of Warcraft, which as of the end of last year had more than 12 million gamers worldwide. Excuse me, I should say, 12 million subscription-paying gamers worldwide. Because not only has the MMORPG changed the social dynamics of video gaming, it also introduced a completely new business model. The MMORPG is hosted on the company's servers. Customers pay to access the digital game world on a usage-based or time-based system. Yes, that's right, if you're familiar with the latest and trendiest growth and tech buzzwords, then no doubt you are beginning to recognize that this business model is the same cloud-hosted, software-as-a-service model that has rocketed companies such as salesforce.com (NYSE: CRM  ) into triple-digit valuation multiples territory -- as of the most recent market data, 170 times free cash flow. For comparison, Activision-Blizzard sits at a relatively modest nine times.

The power of the MMORPG business model
Despite the vast valuation differential, a lot of the same rules apply. Cloud hosting means more efficient allocation of assets and generally higher returns on capital. As an example, Activision-Blizzard's World of Warcraft subdivision generated an operating margin of about 51% last year, whereas its more traditional, flavor-of-the-month Activision division only pulled in an 18% operating margin. It's like this across the board. In fact, competitors such as Take-Two Interactive (Nasdaq: TTWO  ) and Electronic Arts (Nasdaq: ERTS  ) , both of whom depend on the traditional blockbuster business model, do even worse! Take-Two took in an operating margin of 9% last year and Electronic Arts was at -5%!

On the flipside, you look at some of the Chinese video game companies that specialize in MMORPGs like Perfect World (Nasdaq: PWRD  ) , Shanda Games (Nasdaq: GAME  ) , and NetEase.com (Nasdaq: NTES  ) and you start to see more pleasant numbers: 36%, 30%, and 46%, respectively.

Time to re-evaluate nerdom?
Those are respectable figures any way you look at them -- respectable enough to almost make you feel proud for pulling an all-nighter raiding the night elf capital city, claiming that it's just "market research."

What's your favorite MMORPG? Leave us a comment on our discussion boards. You can also follow the Dada Portfolio on Twitter @TMFDada.

Learn more about Dada
The Dada Portfolio is a part of the Rising Star series of real money portfolios. It is co-managed by Sean Sun and Ilan Moscovitz.

Sean owns shares of Activision-Blizzard. Salesforce.com is a Motley Fool Big Short short-sale choice. Salesforce.com, NetEase.com, and Take-Two Interactive Software are Motley Fool Rule Breakers picks. Activision Blizzard is a Motley Fool Stock Advisor recommendation. Motley Fool Options has recommended a synthetic long position on Activision Blizzard. The Fool owns shares of Activision Blizzard and Take-Two Interactive Software. Alpha Newsletter Account LLC owns shares of Activision Blizzard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (7)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 11, 2011, at 11:53 AM, dales53 wrote:

    MMORPG's: There is soon to be a new KING on the block. If you think the basement nerds have been having fun with WOW, just wait until they can get their hands on Star Wars The Old Republic. If there is one thing that the basement nerds have buried deep in their DNA, it is a love for all things "STAR WARS". ERTS in partnership with Lucas Arts will be releasing SWTOR sometime later this year and the gamers are already drooling to get their hands on it. There have been some "tryouts" of the game, most notably PAC East and it's about ready for release. ERTS shares have already been skyrocketing in the last 4-5 months with other "turnarounds" in the business model and other new releases by the company and it's will go nuclear as SWTOR and also BATTLEFIELD 3 hit the market in the late summer/early fall. Positioned well, there is a chance for life changing wealth to be made here. Remember you heard it here when it happens as 2011 unfolds....... Good luck. dales53

  • Report this Comment On May 11, 2011, at 12:35 PM, Zohl wrote:

    After spending more then two years playing World of Warcraft I decided I had to quit. I did so for several reasons. Activision/Blizzard has the worst customer service when it comes to helping it's subscribers with in-game issues. Also, World of Warcraft is filled with hackers who steal accounts and account information. My account was hacked right after it opened. And after not playing for almost a year I am still getting e-mails from said hackers (who claim to be from Blizzard) asking for account information and/or stating they need me to verify account information by clicking on a provided link.

    While I can agree that the MMORPG market is on the rise, I do know that World of Warcraft does NOT have 12 million players. These 12 million are only accounts, either in limbo, active, or closed like mine.

  • Report this Comment On May 11, 2011, at 5:44 PM, dcgamer wrote:

    I originally posted the comment, below, in the wrong place, so I thought I'd repost it here. @dales53 - agree :

    What you don't see in Activision - Blizzard's quarterlies is the state of the MMORPG biz. ATVI sees a great deal of revenue from WoW. It's a model that's served ATVI very well, but it's an old, tired cash cow.

    Cataclysm might very well have been WoW's last hurrah. If you've played Rift - a new MMO, there are clear indications players are leaving WoW for that game. And with Star Wars: The Old Republic and Guild Wars 2 both expected this year, it's hard to see how WoW will continue to rake in the revenue it once did.

    If WoW gets hit hard, then ATVI is a company with two products - Call of Duty and StarCraft. That's not a good business model.

    I mentioned this briefly in this article. Hope it's okay to post the link.

    http://technorati.com/entertainment/gaming/article/activisio...

  • Report this Comment On May 11, 2011, at 6:00 PM, lution wrote:

    Don't forget the "free" games on Facebook. The more people play those, the less likely they are to play other online games like WoW. I'm also dissapointed in Activision-Blizzard as a stock. It hasn't even been able to keep up with the S&P 500 according to the CAPS page.

  • Report this Comment On May 11, 2011, at 8:04 PM, vidar712 wrote:

    @lution - But isn't a MMORGP a lot like a gym membership? Even if you didn't go to the gym this month, you still have pay your subscription.

    The free games would have to take up so much time that the consumer doesn't play the game at all.

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