In this episode of MarketFoolery, host Chris Hill chats with Motley Fool analyst Aaron Bush about the state of the gaming industry during the pandemic. In this special episode, they talk about all things games, from the latest consoles to gaming apps and subscription services. They also take a look at some gaming stocks and how they have fared. Discover which game could be the next blockbuster, the latest trends to watch in the industry, and much more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on August 3 2020.

Chris Hill: It's Monday, August 3rd. Welcome to MarketFoolery. I'm Chris Hill, and I'm actually off this week, definitely not the summer vacation I was planning back in January, but a little time away after the past few months we've had, I'll take it. So, this is not going to be the usual week of digging into earnings season, but I certainly wasn't going to let the show go dark for a week, so let's kick things off with a conversation I had recently with Aaron Bush.

I don't know anyone who dives into the video gaming industry like he does, so that's what we did. Here's my talk with Aaron.

[...]

Hill: Recently on Motley Fool Money we talked about Microsoft's (NASDAQ:MSFT) latest quarter. One of the headlines was just the gaming segment crushing it, I think it was up 64%. That's the headline. I'm curious, as someone who studies this industry, what was underneath the headline that caught your attention?

Aaron Bush: Yeah. So, I mean, the truth of the matter is just that, people are playing more games at a time when people are stuck at home. People are buying a lot more consoles than before, even if, [laughs] you know, the console generation is coming to a close, people are still trying to find ways to stay entertained. So, it really is as simple as that.

In my opinion, though, what's more interesting than even what Xbox, who presented in this latest quarter is what they're setting up for in the future. So, in the past week, they announced their next-gen showcase, showcasing a lot of their upcoming games, like Halo and a bunch of other games that a dozen of their internal studios have been developing. And the biggest thing that stands out to me about all of that is that every single game that they presented is going to be part of their Game Pass subscription. So, next-gen, for $15/month, you can get access to Xbox Live, Game Pass, which is essentially the closest thing that there is to the Netflix of gaming, and there is not a close second competitor. [laughs] Xbox is just crushing it. So, what they're doing with Game Pass is really interesting.

The third thing that goes under that $15/month umbrella, is that it gives you access to xCloud, which lets you play any of those games from any device. So, if you read between the lines, what Xbox is saying is that, like, hey, yes, Xbox consoles are still the keystone of what they're doing, and if you look at our current business, they're still performing really well, so we don't [laughs] want to screw that up, we still want to play a leading role. But our future is much more about software and services, where at some point down the line you can pay for xCloud or Game Pass and be able to play any of those games on any device without even having an Xbox console.

So, yeah, Xbox they're having a good time right now, but that's not even really what this story is about, it's about what they're setting up for and how, you know, undergoing a pretty complete business model shift is setting them up to innovate really the next-generation of consoles.

Hill: When do you think, and I don't know if Microsoft has tipped their hand on this, when in the future do you think they'll start sharing numbers of subscriptions? I mean, any time you can get someone into an ongoing membership, that generally seems to bode well for business, whether we're talking about Netflix or Costco or anyone else. So, is this something, when you say they're setting this up for, sort of, the next stage for them, is that 2021 or even beyond that?

Bush: So, they have already shared some data, they don't share every quarter. I think the last that they shared, there were 10 million Game Pass subscribers. And so, I forget how many exact Xbox Ones have been sold; it's something like 80 million or 100 million. But the point is, really, only like one-tenth [10%] or one-eighth [12.5%] of people who own Xbox today have [laughs] the subscription. So, they have pretty tremendous room to upsell, and since they're putting in a ton of their top exclusive games into Game Pass, that number is going to go up a lot; [laughs] it's going to go up several tens of millions. And especially, if they could start making it accessible to people beyond who just have the Xbox console, this move dramatically expands Xbox's total addressable market.

And this is something that, you know, it's not going to play out by the end of the year or probably, you know, even the next two, three years, this is much more of, like, the next 5 to 10 years, it's about the next-generation, but it looks pretty strong for Microsoft.

Hill: The first week of August, we're going to get earnings reports from Nintendo and Activision Blizzard, is it reasonable for the investment community to expect more from them because of what just happened with Microsoft's latest quarter?

Bush: Yes, 100%. And I would say, even if you zoom back out a little bit more and just look at Mobile, which is the largest segment of the gaming ecosystem. In the second quarter, the average weekly game downloads rose 20% over the past year. And the time that was spent in all apps, gaming and non-gaming, rose 40% over the prior year. And gaming isn't everything, non-gaming apps represent the majority of downloads. But when you look at the spending that takes place, on the Apple Store, 65% of spending is for gaming; and Google Play is 85%. So, you can bet that that trajectory of really strong growth in people spending time in apps is translating to mobile gaming growth.

And also, like we have seen Ubisoft, which is based in Europe, they reported a really strong quarter too, with much higher engagement, which led to higher bookings. So, yeah, I think it's safe to say that it's going to be a pretty good quarter for gaming companies.

Hill: Yeah, it's nice that Apple and Google [Alphabet] are getting a little slice of those transactions, I'm glad something is working out well for them financially.

Bush: A little tease. And I will say too that, all of the strong results, they can't be extrapolated indefinitely, probably not even the rest of the year. You know, it's really helpful when everyone is stuck at home [laughs] for an elongated period of time, but it is undeniable that certain trends have accelerated in this time. There are more people playing games than before, there are more people watching esports than before.

Digital, as a percent of purchases is [laughs] much higher than before. So, if anything, what's going on has, yes, it has led to an amazing quarter, but more importantly, it's accelerated trends that have already been going, and set a bunch of companies to accelerate in a bunch of different ways in the future.

Hill: So, obviously, the current pandemic is good in terms of the purchasing you're talking about, the consumption of games. What is it doing to the production pipeline? Are those being disrupted in the way that Hollywood movie studios and television studios are being disrupted or is there less disruption because of the nature of the business?

Bush: There still is disruption. It is harder to make games when everyone is away than it is when people can work together, but it's definitely not as disruptive as when you got to be on set and film. There still is some of that in gaming, but not as much. So, for the most part, I would say, at this point, most companies have adapted pretty well to working at home.

And the U.S. is the primary country that's still fully locked down at this point, and a lot of -- like, Europe and the Nordics is a huge gaming hub, and they're starting to get back to normal. So, delays around the world, they definitely have happened, they definitely will continue to happen, but I think, at this point, companies are adapting pretty well.

Hill: In terms of the relationship between Major League Baseball, the NBA, the NHL, the NFL and gaming companies, I'm sure they would never say it out loud, but I'm also sure that the gaming companies are probably happy that we don't really have major league [laughs] sports going on right now in the way that we typically would. Does that cut both ways or is that just -- I'm thinking of a company, like Electronic Arts with their professional game franchises, like maybe it doesn't matter to them or maybe the lack of major sports being played is a drag on them. What do you think?

Bush: I don't think it's going to be a drag, I think, if anything, [laughs] again, like, what's been going on has been accelerating gaming's path to the future. And when sports have been fully locked down, for the first time, you really start to see esports on TV, people playing NBA 2K and Madden, and stuff like that, live. And a lot of times, it's like professional athletes that are looking to set up their own Twitch accounts. So, I think the cross-pollination that has happened just with the big personalities has definitely brought gaming into a bigger cultural moment than in the past. So, that definitely is a tailwind.

So, I'm not really too worried [laughs] about these companies with gaming. Also, we're seeing NBA 2K, which is made by Take-Two, they're raising the price of the base game from $60 to $70, which is the first price increase for a major game like that that we've seen in a really long time. And there's some talk about, you know, does this move indicate that all gaming prices are going to increase. And I think that still is TBD a little bit. But, you know, Take-Two, if they have the confidence to raise prices on their NBA game out of any game at all, they're feeling pretty strong about the demand that's going to be there.

Hill: I say this as someone who is not a gamer, is that a big price increase? I mean, to go from $60 to $70, you know, just on a percentage basis, it's not that big, but it sounds like, within the gaming world, that's seen as kind of a bold move with a little bit of risk attached to it.

Bush: Yeah. I mean, anytime you raise prices -- I would say, $10, when people are buying potentially multiple games a year, like, it does add up and people are sensitive to it. The other big piece is that, that's just the base price, [laughs] games are really good now at selling you lots of digital add-ons and digital tokens and all types of things. NBA 2K has a pretty robust digital economy that gets the most engaged players to spend a lot more money. So, this is totally them just trying to milk the NBA 2K franchise, but they have confidence, so I'm pretty optimistic it will work.

Hill: In terms of the stocks themselves, Activision Blizzard, Take-Two Interactive, Electronic Arts, these are all stocks that, not surprisingly, are up year-to-date anywhere from 25% to 35%, 40% in some cases. When you look at these businesses, and those stock prices, do you think, yeah, that seems reasonable, or do any of them look expensive?

Bush: I think it's all pretty reasonable, to be honest. All four of those companies that you just mentioned are really strong businesses that all have really strong brands and create really high profits. So, thinking out five years or so, I think the prices are pretty reasonable, I do think, though, there is someone lumpiness in video games. It's not always lumpy for every business all the time. But for a business like Take-Two that, you know, they have Grand Theft Auto V, which is like the largest best-selling entertainment piece ever. There's just going to be natural lumpiness in that business. So, if they don't have a huge release coming out the next year or two, it's hard to say what exactly is going to happen to the stock over the next year. Obviously, that's not what we're really about, we're thinking longer-term than that. And some games will come out and outperform expectations, some will underperform it, so that's pretty lumpy. So, what happens in the short-term, who knows, but as a whole, I still feel like the industry is pretty reasonably valued at this point.

Hill: Last thing, and then I'll let you get back to work. What is a game either that you are consuming right now or that is on your radar? I remember before Red Dead Redemption 2 came out, you and David Gardner would talk about that with great anticipation. Is there something on the horizon that you're looking forward to, either from the standpoint of someone eager to play the game or you look at it, and you think, that's going to be a hit for the company that makes it?

Bush: Sure. So, I mean, probably one of the biggest games of the year that's going to come out at some point, I think it might be November now, because it was delayed because of all the COVID stuff, is Cyberpunk 2077. So, this is made by the same people who made The Witcher franchises, and The Witcher 3 was Game of the Year a few years ago. It was a massive open world where people would play dozens and dozens of hours, in the story and in the world. And so, this is like their dystopian sci-fi take that's also going to be pretty intensely open world and super-engaging. There are really high expectations set on that game. I'm sure it'll be good, I don't know [laughs] if it'll -- you know, top expectations, but CD Projekt Red is the company behind that, they trade in Europe. So, I don't know if all of our U.S. listeners will be as interested, but if that goes well for that business, it'll [laughs] do pretty good for the stock, I imagine. So, that's what I'm thinking about.

But I'll throw out one other trend that I'm watching that I think a few games fall into. And that's just the rise of UGC or User Generated Content. And so, if you think about what Minecraft has done or Roblox, which is popular with a lot of kids, or even Fortnite with Fortnite Creative mode. And in a lot of industry's we've seen low-code tools, where people who aren't hardcore developers, and have tons of technical expertise, can come and work with software or work with data at a high level, and the same thing is coming to video games. Where traditionally, and it'll still always kind of be this way, like, professional studios are the ones who make the most popular games and reap the largest rewards, but there are games and platforms coming out and that are further down the horizon that are creating tools and ecosystems where literally anyone can create games and have people play them and build economies within them and get paid for when people engage and spend within it. So, Roblox has been doing a pretty incredible job lately. And Epic Games which owns Fortnite, they own the Unreal Engine, which is the highest end game engine that a bunch of companies use for high fidelity graphics and that type of stuff. And then they have Fortnite Creative mode, which is within Fortnite and is getting more robust. But I think they're definitely going to come out somewhere in the middle with an opportunity that is even more robust, but pretty much everyone can create games. And I think that's going to be a huge wave that's going to create profits for a lot of people. So, there are [laughs] so many trends going on in the game industry, it's hard to just pick one, but that's probably one that a lot of people have their eye on and it's really going to be a much bigger deal over the decade to come.

Hill: I appreciate the time, thanks for being here.

Bush: Thanks, Chris.

Hill: If you want to read more from Aaron on this topic, check out his website, Master the Meta, how to win at the business of gaming. You can find it at MastertheMeta.com. And, yes, I will put that URL in the description of this episode.

As always, people on the show may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.