Microsoft's (MSFT 0.37%) recent $69 billion bid to buy Activision Blizzard (ATVI) highlights the value behind the companies that make video games. With big tech increasingly talking up the metaverse opportunity, companies with talented software engineers are going to be in high demand, and are naturally in the best position to capitalize on the development of these virtual worlds.
Of course, Activision shareholders are probably wondering where to invest next. Here's why I like Unity Software (U 2.04%), Tencent Holdings (TCEHY 3.23%), Electronic Arts (EA 0.79%), and Take-Two Interactive (TTWO 0.78%). Let's find out a bit more about these four gaming stocks.
Image source: Getty Images.
1. Unity Software
While it's still very early days for the metaverse, it's a growth opportunity that investors should pay attention to. In a press release announcing the Microsoft deal, Activision Blizzard stated, "This acquisition will accelerate the growth in Microsoft's gaming business across mobile, PC, console, and cloud and will provide building blocks for the metaverse."
The metaverse will cost billions in technology infrastructure to develop. The need for talented software engineers is one reason Microsoft is paying $68 billion for Activision, and it's also why Unity Software could become an acquisition target as investment in the metaverse ramps up.
Unity doesn't make games. Instead, it provides cross-platform software development tools that it offers as a subscription service. Some of the top game companies in the world use Unity's software engine to build games. Once a studio builds a game with Unity's software, it can launch that game across multiple platforms, such as the various game consoles from Sony, Microsoft, and Nintendo, in addition to mobile and PC platforms.
In December, Unity completed the acquisition of Weta Digital for $1.6 billion, which further bolsters its software development capabilities for real-time 3D content.
"Whatever the word metaverse means, it's going to be built by millions of content creators, and we're on a mission to give them the easy-to-use and high-performance tools that will bring their visions to life," explained Unity's Senior Vice President Marc Whitten during the Q3 earnings call.
Whether Unity is eventually acquired or remains independent, the stock should be a great investment over the long term. Management believes the company can grow revenue at a 30%-plus annualized rate over time.
2. Tencent
Tencent is the largest video game company in the world by revenue, so it stands to benefit from industry consolidation. The China-based company has diverse revenue streams from social media, online advertising, fintech, and video games.
But what I like most about Tencent is that management has a history of acquiring stakes in other compelling companies, including Activision Blizzard, Ubisoft Entertainment, and privately held Epic Games, the studio behind the extremely popular Fortnite esports title.
It also has internal game studios that operate some of the most popular games in the industry, most notably League of Legends. All said, Tencent is a gaming juggernaut, with ownership interests spanning some of the most valuable gaming properties in the industry.
Gaming is Tencent's largest revenue source, comprising 32% of the top line in the third quarter. The stock has fallen recently over concerns about China's regulatory environment targeting large internet platforms, and the possibility that Tencent shares could be delisted on foreign exchanges, so it's not without risk.
But the stock could be significantly undervalued right now, and industry consolidation plays to Tencent's strengths as the Berkshire Hathaway of gaming. Plus, its investments in advanced computing technologies like artificial intelligence make Tencent's case as a key player in the metaverse that much stronger.
Image source: Getty Images.
3. Electronic Arts
Microsoft's proposed acquisition of Activision is not a done deal -- it will have to receive approval from regulatory bodies. But if it's approved, you can bet EA and Take-Two will become potential acquisition targets, possibly by other FAANG stocks, which are all invested in gaming. It's no coincidence that the price of both stocks jumped the day the Microsoft deal was announced, especially on a down day for the stock market.
Regardless of what happens, EA should be worth a lot more in another decade. With over 500 million unique player accounts, EA has a wide global reach across top franchises, like Madden, FIFA, and The Sims. And it's using its excess cash to continue widening that scale, with last year's acquisitions of Codemasters and Glu Mobile.
On a trailing-12-month basis, EA generated $1.26 billion in free cash flow on $6.4 billion in revenue. The stock trades at 6.2 times trailing revenue, which is fair for a high-margin business with recurring revenue from its annual sports releases.
4. Take-Two
In a way, Take-Two already has a massively popular "metaverse" going with Grand Theft Auto Online and Red Dead Online. These are the multiplayer versions of Grand Theft Auto V and Red Dead Redemption 2, which basically turn these games into massive virtual playgrounds where players can almost do anything they want with their gamer buddies.
Take-Two's Rockstar Games is the game development studio behind both franchises. Grand Theft Auto is probably the most valuable video game brand in the industry, considering it has sold a cumulative 270 million copies over the last 20-plus years, and each new release in the series continues to widen its appeal.
Take-Two just announced the acquisition of Zynga, one of the largest mobile game developers. This will bring top mobile titles like Words With Friends and FarmVille under Take-Two's wing, and management looks forward to making mobile versions of some of its console titles.
Take-Two is slightly more attractive than EA, with a lower price-to-sales multiple of 5.6. That lower valuation might be even more attractive considering the growth opportunities on mobile that Zynga brings to the table.
