The COVID-19 pandemic is keeping people indoors and driving gaming usage, which is why top gaming stocks are up year to date even though the broader market is down, but that's not the only reason to like these stocks.
Zynga, Glu Mobile, and Tencent can not only continue to grow revenue in the short term, but also stand to benefit enormously over time as mobile technology advances, making games on smartphones more interesting to play. Here's why investors should consider adding these stocks to their portfolios.
Zynga: Socially connected games are fueling growth
Shares of Zynga are up 211% since April 2016. Zynga has a small share of the $68 billion mobile game market, with trailing-12-month revenue of just $1.32 billion, providing a lot of room for the company to expand over time. The company was founded in 2007 by Mark Pincus, who has a long record of starting small internet software and media companies and made founding investments in Twitter and Facebook. Pincus is no longer CEO of Zynga, instead serving as non-executive chairman. But he still has an incentive to see the company grow, given his sizable stake of 6.8% of Zynga's outstanding shares.
CEO Frank Gibeau stepped in four years ago, and the company has hit its stride under his lead. 2019 was a record year for Zynga, with revenue soaring 46% to reach $1.32 billion.
Zynga's long-term growth strategy is to build games that allow people to compete with other players in games, as in current titles like CSR Racing or Words With Friends, which are two of the company's more popular games. Zynga expects revenue to grow 21% in 2020, driven primarily by CSR Racing, Empires & Puzzles, Merge Dragons!, Merge Magic!, Words With Friends, and Zynga Poker. That guidance was given pre-coronavirus, but the company has not updated that outlook.
There are a few catalysts on the horizon that investors should watch. Gibeau sees opportunities to make acquisitions to fuel growth. Zynga finished 2019 with more than $1.3 billion in cash and short-term investments, and it also generated $239 million in free cash flow. It's got plenty of cash to invest in new games or make acquisitions.
The other catalyst is the arrival of 5G wireless connection speeds. The COVID-19 outbreak could cause a delay in this technology arriving, but whenever 5G does become available, it will be a game changer for mobile game companies. 5G will allow Zynga to make more immersive games with better graphics. It could also open the door to new ways to distribute games through streaming, among other benefits.
Zynga currently sells for 31 times trailing free cash flow. That looks like a good deal, given that free cash flow has climbed 236% over the past three years. Analysts expect Zynga to grow earnings at 19% per year over the next five years.
Glu Mobile: A pipeline of new games should send sales higher
Glu Mobile is the developer of Tap Sports Baseball, Covet Fashion, and Design Home, which are its three top moneymakers, making up 77% of annual bookings (a non-GAAP measure of revenue). In 2019, revenue increased 12%, with revenue up 18% year over year in the fourth quarter. Glu's dependency on three games gives the company a higher risk profile than Zynga, which has a larger roster of popular titles to drive annual revenue growth.
But Glu has an attractive lineup of new titles coming down the pike that should continue to drive growth. The company just released the 2020 edition of Tap Sports Baseball. Glu maintains relationships with Major League Baseball, World Wrestling Entertainment, and Walt Disney to license content for games. Tap Sports Baseball just had a record fourth quarter, while full-year net bookings climbed 21% to $90 million.
Disney Sorcerer's Arena just launched and it should perform very well given the popularity of Disney content right now. Coming later in 2020 is Originals and Deer Hunter Next. Two other games -- TAP Fishing and Crowdstar's P3 -- are scheduled to come out next year.
Glu Mobile is certainly valued like a growth stock, trading at 45 times free cash flow and sporting a forward price-to-earnings ratio of 32.7. But with revenue of just over $400 million in a $68 billion mobile game market, there is tremendous upside potential for this stock over the long term.
Tencent: Set to grow beyond China
Tencent might be a lower-risk way to invest in the growth of mobile games. It owns a 15% stake in Glu Mobile, as well as sizable stakes in other game companies. Tencent is most known in the gaming world for its ownership of Riot Games, the maker of the popular esports title League of Legends and the new team-based shooter Valorant.
Tencent develops in-house and licenses dozens of titles across PC and mobile platforms in China. Online games make up 30% of its annual revenue, with the balance coming from other businesses, such as cloud services, mobile payments, and social networks (e.g., WeChat).
The main risk for Tencent is regulation. China has halted new game approvals before to weed out content that is determined to be too violent or offensive in the view of regulators. Other countries like the U.S. don't have these restrictions, so Tencent has been focused lately on growing its game business internationally to diminish the risk in China and extend its growth runway.
The company just released one of its most popular mobile titles, Arena of Valor (also known as Honor of Kings in China), in the fast-growing markets of Russia and the Middle East/North Africa. The company also has had international success with PUBG Mobile and Call of Duty Mobile, which it developed in partnership with Activision Blizzard. Last year, international revenue more than doubled year over year.
With Tencent's tentacles in so many different games across the industry, it has a very deep development pipeline that it can monetize to grow profits over time. An investment in the stock is basically a bet on the growth of the video game industry, which seems like a good bet given how far the industry has come since the early days of electronic games in the 1970s.
Despite regulatory risk in China, Tencent's stock price has delivered monster returns for investors over the last 10 years and should remain a good investment over the next decade.