Everyone seems to be worried about a recession at the moment. With inflation at multidecade highs, energy prices spiking, and first-quarter gross domestic product (GDP) in the United States contracting 1.4%, many prognosticators are saying a recession is imminent. While it is impossible to know for sure, it is always smart to think about how your portfolio companies will hold up during a recessionary period so you can properly calibrate expectations.
One popular sector for investors over the last decade has been video games. Let's see how these businesses are set to fare in a recessionary period.
The evidence says ... probably
To determine how video game spending holds up in a recession, we're going to look at how three large game publishers -- Electronic Arts (EA -0.20%), Activision Blizzard (ATVI), and Take-Two Interactive (TTWO 0.72%) -- did during the Great Recession 15 years ago. Looking at the below chart, both Activision and EA's revenue per share held up well even when the economy collapsed from 2007 to 2009. Activision's performance looks super impressive, but the company did make a large purchase of Blizzard at the time, which gave it an inorganic revenue bump. Without the acquisition, it is likely the business would have grown at a pace closer to EA's.
Still, we can see from the chart that in 2009, both EA and Activision Blizzard took slight hits to their revenue, which some may assume came from a softening economy. But it is hard to determine how much was just from the schedule of game releases versus the broader economy. And even if demand was affected by the recession, we can see the businesses still held up compared to 2007.
But what happened with Take-Two? The company struggled to grow its revenue per share through the Great Recession, which might lead some investors to think its financials are tied to the business cycle. But that was just a small factor at play here compared to what was happening at the individual company level.
What really matters is content cadence and hit rate
Video game companies have lumpy financials, and sometimes, a downturn in sales may correlate with a decline in the broader economy. This happened with Take-Two from 2007 to the end of 2012. But the economy actually had little relevance to its operating results.
So what is the biggest driver of sales? Simply, it is how many games are released and whether one or more turn into hit franchises. For example, in 2008, Take-Two released Grand Theft Auto IV, the latest iteration of its most popular franchise. A year later, without another hit game, revenue per share declined. Then, in 2010, it released the hit game Red Dead Redemption, which drove sales higher before falling back until around the start of 2013.
As you can see in the chart below, 2013 to 2014 was a record period for Take-Two. This was when it first released Grand Theft Auto V, which ended up being a phenomenal success and the most popular individual game of the last decade.
Only a minimum, if any, of Take-Two's sales are determined by the health of the global economy. The same can be said of EA, Activision Blizzard, and other gaming publishers. Of course, the companies need to continue producing great titles for their fans, but this should give investors comfort if we head into another recession in the next 12 to 18 months.
Is it different this time?
Looking through the past financials of EA, Take-Two, and Activision Blizzard, it is clear the Great Recession was not a big factor in their operating results. The main performance drivers were when they released new hit games. However, could that change if we head into a recession over the coming quarters?
There are two reasons I think video games could be more tied to the global economy now compared to 15 years ago. First, the industry is just much larger now, estimated to have $86 billion of spending within the United States in 2021 compared to just $18 billion in 2012.
Second, video game franchises generate revenue over longer periods of time, driven by virtual economies with microtransactions. If purchasing power for discretionary items goes down because of rising food and energy prices, it is possible people will spend less on in-game purchases. This is a different environment than when video game publishers made the bulk of their money from the initial sale of a new game. This industry evolution has been a recent development, so we'll just have to wait and see what happens.
Overall, I don't think investors should be concerned about holding video game stocks during a recession. The industry is still riding a multidecade secular tailwind of adoption. If you take a long-term view, this makes the industry a great hunting ground for potential investments.