The mobile gaming market can be a minefield for investors. Top-heavy business models that rely on a few hit titles and a small group of high-spending "whales" often collapse. Interest in mobile games waxes and wanes quickly as app stores are flooded with new flavors of the month.
That's why Farmville maker Zynga dropped 80% over the past five years, and Glu Mobile, the maker of the Kardashian games, was cut in half during that time. But despite those failures, companies keep launching new titles to tap into the mobile gaming market, which research firm Newzoo claims will generate over $50 billion in annual revenues by 2019.
I'm not a big fan of companies that rely entirely on mobile games. Instead, I'd recommend three well-diversified companies with exposure to mobile games -- Activision Blizzard (NASDAQ:ATVI), Tencent Holdings (OTC:TCEH.Y), and NetEase (NASDAQ:NTES).
Activision Blizzard initially expanded into mobile games at a much slower rate than main rival Electronic Arts. But that all changed after it bought Candy Crush maker King Digital Entertainment for $5.9 billion last February. King's titles had 355 million monthly active users (MAUs) last quarter.
That marked a year-over-year decline, but Activision notes that user engagement was rising. King also had two of the top ten highest-grossing titles in U.S. mobile app stores (Candy Crush Saga and Candy Crush Soda Saga) for 13 straight quarters.
King's mobile games complement Activision's own lineup of mobile games, which include Hearthstone, Skylanders, and Call of Duty. These "mobile and ancillary" titles generated $1.67 billion in revenues in fiscal 2016 and accounted for a fourth of Activision's top line.
Analysts expect Activision's revenue and non-GAAP earnings to respectively dip 3% and 11% this year on unfavorable comparisons to this year's growth drivers like Overwatch and add-on content for Call of Duty: Black Ops III. Despite that near-term headwind, new titles are expected to respectively boost Activision's revenue and earnings by 10% and 21% next year.
Some U.S. investors might not recognize Tencent, but the Chinese tech giant is the biggest video game publisher in the world. It owns Riot Games, the maker of online gaming hit League of Legends, and Supercell, the maker of Clash of Clans and Clash Royale -- two of the highest grossing mobile games in the world. It also holds minority stakes in a wide range of gaming companies, including Activision Blizzard and Glu Mobile.
The growth of that gaming portfolio boosted Tencent's online gaming revenue by 16% annually to 18.47 billion yuan ($2.7 billion) last quarter, which accounted for 42% of its top line.
Tencent also owns two of the largest messaging apps in China -- QQ, which has 868 million MAUs, and WeChat, which has 889 million MAUs. Tencent integrates both platforms into its video games via single sign-ons, which supports the growth of its social and gaming ecosystems.
Tencent is also aggressively expanding WeChat as a monolithic platform which offers ride hailing, payment, delivery, and other services all within a single app. Tencent's growth won't slow down anytime soon -- analysts expect its revenue and earnings to respectively grow 38% and 36% this year.
NetEase is a diversified Chinese tech company that publishes PC and mobile games; licenses titles from Activision Blizzard; develops mobile social, news, and media apps; offers free email, online dictionaries, and note-taking services; and runs the e-commerce site Kaola.com.
NetEase's games target Chinese gamers and aren't as widely recognized as Tencent's top mobile titles. Its top PC games include Fantasy Westward Journey II, New Westward Journey Online II, New Ghost, and Tianxia III.
Its top mobile games include Fantasy Westward Journey mobile, Westward Journey Online Mobile, Tianxia III Mobile, OverOcean, and Invincible. The company launched 40 new mobile games in 2016, expanding its mobile library to over 100 titles.
NetEase's revenues from online games (both PC and mobile) rose 62% to 28 billion yuan ($4 billion) in 2016, which accounted for 73% of its top line. That growth boosted its total revenues by 68% to 38.2 billion ($5.5 billion). Analysts expect NetEase's revenue and earnings to respectively rise 36% and 22% this year on the growth of its gaming portfolio.
But mind the headwinds...
Activision, Tencent, and NetEase all have well-diversified businesses which have healthy exposure to the mobile gaming market. However, two of these stocks aren't cheap -- Activision has a P/E of 38 and Tencent has a P/E of 50. At these prices, NetEase is probably the better buy at 23 times earnings, which is a surprisingly low multiple considering that the stock doubled over the past 12 months.