The inimitable Michael Pachter, research analyst at Wedbush Securities, gave the opening talk at the Digital Game Monetization Summit in San Francisco. Pachter, who follows a number of video game companies as well as other firms like Best Buy and Pandora, is often quoted by media outlets like The New York Times and The Wall Street Journal. He often appears on CNBC to provide more detailed analysis of the companies and industries he follows. Pachter admitted he didn't know much about the mechanics of game monetization, so he updated the audience on the state of the game market and his predictions for the future. As usual, Pachter provided a mix of frank assessments, arguable assertions, and stark predictions.
“We're going to see non-traditional forms of gaming proliferate, as they have been for the last ten years,” said Pachter. He noted that in 2008, the market for packaged games in the US was $22.6 billion with $3 billion in digital revenue. By 2011, packaged goods revenue had fallen to $18.4 billion, and he's projecting a total of about $16 billion for 2012, with $12 billion in digital revenue. “Overall the game industry is really healthy,” Pachter said. He sees the market continuing to expand, both by platforms and in total audience.
Digital distribution will continue to grow, and the day is coming when it will be ubiquitous, according to the analyst. “What I'm waiting for is the day when every single game is offered day and date digitally as well as on disc,” Pachter said. “I think probably within three years every game made will be offered as a digital download.”
Pachter had some harsh words for the Wii U and its future. “I think you're going to see now with the Wii U, notwithstanding its early launch support, nobody's going to support it,” Pachter claimed. “I don't think we're going to see every game on the Wii U next year. I think when next-gen consoles come out they're going to be better than the Wii U. Call of Duty is amazing on the Wii U this year. The problem with playing Call of Duty online is it's a community and if there's only four people playing it on the Wii U it's no fun. Nobody in their right mind would buy a Wii U and say 'I'm going to play Call of Duty.' That's like saying 'I gave up Facebook, and it's Google+ now'.”
While many in the console business are looking to DLC to make up for lower sales of most titles, Pachter threw cold water on the idea. “Everybody loves DLC, but it's tied to packaged goods sales,” Pachter explained. “You can't download something unless you've bought the underlying game. It's between 10-15 percent supplement of revenues to packaged goods, for the games that have it.” That's all well and good; it's an extra $150 million if you sell a billion dollars worth of Call of Duty, but that's not enough to make up for a number of console titles that don't make a profit.
While Pachter is not sanguine about the Wii U's chances, he is more positive about next-gen consoles coming from Sony and Microsoft. He's predicting they will have plenty of storage in order to make it more convenient for users to buy plenty of digital content. “Next-generation consoles are going to have big hard drives, they're also going to have disc drives,” predicted Pachter. “I would guess that the PS4 and the Xbox 720 will have 2 TB hard drives. That pretty much means you can download anything you want and never get rid of anything. You'll have room for a couple of hundred games, no problem.”
Pachter also presented an interesting view of Activision's iconic console franchise. “Call of Duty, I'm calling it a failure,” said Pachter; a surprising statement about a game which generated $500 million on its first day at retail and over $1 billion in just 15 days. “I know the game sells billions of dollars. Activision did a bad thing with Call of Duty from a profit perspective. They trained gamers that you can buy a game and play it all year, ten hours a week, forever, and you never have to pay again. You just wait for the next Call of Duty. I promise you there are plenty of people, numbering in the millions, who play one game, which is Call of Duty, and they never stop. That's just like the people who play World of Warcraft and never stop, yet the World of Warcraft guys are paying $180 a year, and the Call of Duty guys are paying $60. So who's got a better model? This multiplayer thing being free was a mistake. I don't think anybody ever envisioned it would be this big. It's a mistake because it keeps those people from buying and playing other games.”
Activision has already tried to generate recurring revenue for the franchise with Call of Duty Elite, but after running it that way for several months, the company decided to make it free for all Call of Duty players, and return to selling the DLC separately rather than providing it as part of the subscription. That doesn't mean that Activision is done with the idea of recurring revenue for console games, though, according to Pachter. “Prediction: The next Bungie game will be single-player only; the multiplayer aspect of that game will be subscription only,” Pachter asserted. “Activision's going to try it, because they're greedy pigs, and they're bold.”
Pachter also had some zingers for Zynga, shaking his head at the company's rapid fall. “Zynga lacked profitability,” Pachter said by way of explaining the company's share price meltdown. “I have never seen anything like this; like watching a train wreck. The darling of Wall Street, the best company ever, in the course of about two months became the worst company ever, completely hated by Wall Street. Zynga launched at $10, rose to $15, and sank to $2. They have $2 per share in cash. The equity value, the value of the business, is 25 cents per share. The company was worth $12 billion, down to $250 million; that's how far it dropped.”
Pachter compared Zynga's stock to Nintendo's. “Nintendo's trading at about $3 billion of equity value; it was trading at about $80 billion,” he said, noting the huge loss of shareholder value. “The market hates business models that start to show losses, and start to fail. Crappy little Riot Games, doing $150 million in revenue and wildly profitable, is worth a buttload more than Zynga, doing $1.1 billion and not making money.” Pachter said the lesson to draw from that is the market is more concerned now with profitability than just posting great revenue numbers.
Pachter wasn't finished with his assessment of Nintendo's future in the next few years. “I think Nintendo becomes completely irrelevant,” Pachter claimed. “They have their niche, Nintendo's first-party content is great content, and hardcore people will keep buying their consoles, but they're not going to only play with Nintendo consoles.”
Pachter predicted that Activision would be making some acquisitions in the future to expand more into the digital product areas, but the path ahead would not be easy. “Vivendi's going to screw up Activision for the next couple of years, because they're going to cause them to borrow money and buy back stock,” said Pachter. “I think the first thing Activision buys is Take-Two, because that fits in very nicely. Activision should buy Zynga - I just don't think Mark Pincus is a seller. I think Zynga has great assets, they have really good franchises, they have a ton of revenue, and I think run more efficiently they'd make a ton of money.” Is the world really ready for a company containing both Mark Pincus and Bobby Kotick?
Investors have generally abandoned the game industry for now, with most game company stocks not moving much outside of a narrow range for the last several years. When will investors come back to game stocks, and who are they going to buy? Pachter provided some insights. “THQ is not investable. Activision and EA make tons of money, so they are interesting investments. Take-Two doesn't make very much money but they have really great assets, so I think they remain attractive. Ubisoft has great assets and pretty good management. I think those are the four that have a really great shot. The non-traditional guys, Gree and DeNA and Tencent, they have a lot of value; Nexon has a lot of value. All those guys are going to get bid up.”
Pachter gave the technical explanation for his share price prediction. “Game companies used to trade at a premium of about 50 percent to the S&P 500. That just means that the S&P 500 average stock traded at about 16 times earnings, and game companies used to trade at about 25 times. Game companies trade at 8 times earnings now. I think they're all going to trade up around the same as the average stock; they're all going to double. It won't happen until packaged goods come back, or until there's a reliable way to measure digital product revenues. The guys who don't participate in digital have a real problem.”