Gaming is the gold rush of the digital age
The popularity of gaming has grown immensely. It was not long after the creation of the first computer, that the first computer games were also born. Ever since, the advancements in the gaming industry have been astonishing. Games have evolved from moving around a few clumsy pixels to ultrarealistic experiences involving real-time interaction with other players.
Games have evolved, but so has the entire culture surrounding gaming. It wasn’t long ago that society considered playing video games to be a complete waste of time. However, over time it has become more socially acceptable, and nowadays gaming is popular among all ages.
At the same time gaming has also become increasingly professionalized. Nowadays, talented gamers can potentially earn millions of euros over the span of their careers and E-sports have even surpassed many traditional sports in viewership.
Gaming isn’t going anywhere. We believe it will continue to grow even further. Younger generations are playing more than the previous ones, and nowadays gaming is considered a normal part of life even as we grow older. Young people today will continue to be gamers even in retirement.
Gaming has staggering growth figures. Due to its growth in popularity, we also see increasingly large sums of money in the industry. From an investor’s perspective, this phenomenon is somewhat reminiscent of the gold rush in the 1800s. As an investment, gaming companies are a bit like gold miners, we can’t know for certain whether their future games will be successful, much like how we can’t know whether the miner heading to Klondike will find gold.
Finding enormous success through a single game is comparable to a miner’s pickaxe hitting a gold vein (Rovio’s “Angry Birds”). The risk is high, but so is the potential reward. We can of course reduce this risk through acquiring a larger game company (Nintendo, Tencent, Activision, Blizzard) or through acquiring a handful of different game companies.
However, gold miners weren’t the biggest winners of the goldrush, although some of them got lucky. The ones who actually gained the most were the hardware merchants who sold pans, pickaxes, hammers, and nails to miners with gold fever.
In the HCP Focus Portfolio Management team, we’ve been watching the industry from this perspective. We haven’t been interested in stand-alone game companies, due to their unpredictable nature. Instead, we’ve been searching for the greatest hardware merchant in all of Klondike. Firms like these can benefit more widely from the impact of the gaming megatrend. We’ve considered the hardware merchants to be firms providing gaming infrastructure, widely used game engines, technology, and so on.
After careful consideration, we have decided to invest in China’s leading live game streaming platform: Huya.
Huya was born in 2014 when YY.com’s video streaming service began operating independently. It was listed on the New York Stock Exchange in 2018. Huya is China’s leading live game streaming platform, that allows streamers and viewers to interact during the broadcast. The content provided on Huya consists of mobile, PC, and console games, as well as a few non-gaming-related categories. In South-East Asia and Latin America, Huya’s platform goes by the name Nimo TV, and it covers roughly 4000 games.
In the West, the equivalent market leader of live streaming is Twitch. It was acquired by Amazon in 2014 for 970 million dollars – at the time it had 55 million monthly active users (MAU). From today’s point of view, the price seems extremely cheap. HCP Focus is invested in Amazon, thus by taking a positing in Huya, our game streaming ownership has grown to cover South-East Asia, China, the Americas, and the rest of the West.
Huya’s primary revenue source is its live stream earnings (Q3/2020 94.4% of revenue), which mainly consists of the money that paying users choose to spend on the platform. Over the past three years, the number of monthly average users and the number of paying users per quarter have both doubled. Based on the latest reported quarter, Huya’s MAU was 172.9 million and its number of paying users was 6 million. The remaining portion of Huya’s revenue comes from advertising.
The company’s revenue has grown almost fivefold in the same time span, to 2.8 billion yuan (414.6 million US dollars) quarterly. Huya’s revenue growth was around one hundred percent mark in 2018 and 2019, but it has slowed down since to 24.3% in the latest quarter.
The slowing growth isn’t a cause for concern, as the starting point was quite low and the gross margin has experienced clear growth, now being at 22%. Huya is successfully utilizing its growing user base for improved results. In comparison, their main competitor in the Chinese market: DouYu, has a considerably lower gross margin of 14.5%. Assuming that China’s competition authority will act favorably towards Huya, the company could soon experience new explosive growth, which could easily lead to improved margins as well.
Winner takes all – through a merger or without
Last October Huya announced the plans to merge with its main competitor DouYu. Huya’s largest stakeholder Tencent also owns a part of DouYu. Besides the merger, Tencent would also sell its game streaming service Penguin eSports to DouYu—which is fourth biggest in the Chinese market— for 500 million dollars.
To summarize the Chinese market players: Huya is #1, DouYu #2, and Penguin eSports #4. Huya and DouYu alone have 80% of the market share, so the new Huya would take over the entire Chinese market.
The merger has Tencent’s full support, so internal conflicts are unlikely to come in the way. However, whether the merger will happen, is largely reliant on China’s competition authorities. The deal is expected to be finished during the first half of the year.
It’s clear that there are many synergies that would follow from the merger. Huya’s platform is very scalable, so the addition of new users won’t cause a problem. MAU of the new company would be approximately 400 million, although there are overlaps among the user bases of all three platforms. The larger user base would ease generating more advertising income and allow for improved scalability of servers and bandwidth, as well as better monetization for streamers.
Tencent is the largest video game publisher in the world. China is the largest market for videogames. Gaming is very popular in Asia, far surpassing the West. The merger would allow Tencent great access to streamers and viewers alike, which they would certainly utilize for promoting games and e-sport tournaments.
All of this would improve Huya’s operations and their bottom line. The new company would be an 11 billion dollar giant in the game streaming industry. Currently, Huya’s market cap is around 6.2 billion dollars and DouYu’s around 4.6 billion. The new Huya would be significantly larger, more efficient and it would have almost no competition. Huya’s brand would get even stronger and it would essentially become China’s official video game streaming platform. A natural monopoly with the capabilities to further improve its position in the rest of Asia and Latin America as well.
The merger and its benefits look good, but it is by no means certain. It’s evident that in case the merger fails, Huya’s stock price will fall in the short term, and likewise, if the merger succeeds the stock has a lot of room to grow. We think it is justified for HCP Focus to carry the risk of a potential failed merger, as we consider Huya to be a solid investment in the long term as is. We are not making this investment shortsightedly. Instead, we are following our strategy of looking past cyclical changes and considering the longer-term megatrends at play. Huya is the market leader even without the merger, and it is positioned outstandingly in a high-growth industry.
Game streaming is a part of the platform economy
Most of HCP Focus Fund’s holdings are platform companies. For example, our previous investment Fiverr, Shopify, Etsy, Match Group, Amazon, MercadoLibre and so on. Now Huya joins the list as the latest addition.
We like platform companies. Their businesses scale very well. Arimatti Alhanko discusses the advantages of platform companies compared to more traditional business models in Finnish article Platforms Rule. Platform companies connect the business to the users, which enables the direct exchange of values between them. For a traditional linear business, getting one new customer creates only one new connection, whereas, for a platform company a new customer also creates a new connection with all existing customers. This nature of the business model is highly beneficial for both the company and the end-user.
On Huya’s platform, the connection is created between the streamer and the viewers. A streamer could be an individual or even a e-sports tournament with commentators, like in traditional sports. Streamers get a share of the revenue from paying viewers and advertising. Nowadays, popular streamers are considered celebrities, and their income can be in the millions. This creates a mutually beneficial arrangement, where viewers can consume high-quality content, and Huya gets compensated for enabling everything as a platform.
According to the book Modern Monopolies – How Online Platforms Rule the World by Controlling the Means of Connection by Alex Moazed and Nicholas L. Johnson, in a few decades half of the S&P 500 companies’ output will come from the platform economy. We are seeing that the world is moving in this direction. The world’s largest provider of accommodation (AirBnB) doesn’t own a single hotel room, the largest ride-hailing companies (Uber, Lyft, Bolt) don’t own any taxis and the largest food services (DoorDash, Uber Eats, Grubhub) don’t own any restaurants.
Huya checks all boxes of the HCP Focus investment process. The underlying driving force is the growth of gaming and the subsequent development of the e-sports and game streaming megatrend, which we believe will continue to increase in popularity for a long time.
Huya is a platform company and the clear leader of its own market in China. According to the “winner-takes-it-all” philosophy, the winner will get a disproportionally large share of the market. Huya already has a majority share of the market, and if the merger is successful, it will take over the rest as well. As a platform company, Huya has a significant network effects.
The stock is reasonably priced, although as it is a Chinese company, more conservative valuation multiples are justified. However, considering Huya’s growth metrics, with its forward P/E ratio being around 30, its valuation is very favorable compared to many other holdings in the HCP Focus portfolio.
The primary valuation tool we use for HCP Focus investments is the EVA-method. Using EVA, Huya’s quality and valuation are both very attractive.
HCP Focus Portfolio Manager
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