These days, regardless of whether you are selling video games, streaming services or even office elevators, you are facing consolidation. Aggressive mergers and acquisitions carried out by established incumbents trying to either squelch disruptive innovators by throwing cash at their young founders or negotiating something far more clever when trying to acquire more established players.

COVID no doubt has accelerated this. Many target companies may be struggling financially and are looking to be bought at a discount. Many acquiring companies are looking to de-risk their business lines through diversified acquisitions. There’s plenty of reasons to sell or buy company a company - we’ll get into that.

The global games industry is no exception to this. Whether you are a console manufacturer like Xbox looking to solve their console exclusive game drought through buying Zenimax for $7.5Bn. Whether you are Electronic Arts (EA) who want more mobile game, or racing game exposure through buying Glu Mobile and Codemasters $2.4Bn and $1.2Bn respectively.

It's worth understanding what all this means. Why are people buying? Why are people selling? Let's explore.

Why are companies buying?

Intellectual Property (IP)

Some of the largest acquisitions in the entertainment space are centered around intellectual property. See Disney's 2009 acquisition of Marvel for $4Bn as a the clearest example. An acquisition that unlocked the ability for Disney to use Marvel's heroes, villains, locations and more in their movies, theme parks, merchandise and cruises.

When we think of the OTT streaming world of today. A certain conversation seems to come up:

Person A: Hey, you should check out newest hit show, it's really great.

Person B: Oh cool, where can I watch it?

Content is scattered and content providers like Netflix, Amazon, Apple etc. are in a licensing knife fight, throwing hundreds of millions for the answer to that "where" question to be their platform.

The games industry is no different. For many years, Xbox has been dismissed for its lack of console exclusive games. Sure there's Halo or Fable but compared to Sony's stable of first parties like The Last of Us, God of War, or Uncharted and it’s a tough sell. Xbox had a hard time creating "system-seller" games that got hardware into people's hands. It's one of the reasons why for every Xbox One that Microsoft Sold, Sony sold more than 2.

This may change with Xbox's recent acquisition of Zenimax Media, creators of The Elder Scrolls, Fallout, Doom, Wolfenstein and many other titles. The underlying goal of this $7.5Bn acquisition was to bolster the Xbox Games Pass.

If you want to learn more about how Xbox Game Pass works and its profitability - check out my other post!

A key theme with these acquisitions is genre coverage. Just like Netflix or Prime Video, game publishers want to offer content for many different demographics. For example - racing games. EA's $1.2Bn acquisition of Codemasters in February 2021 has almost cemented their monopoly in the racing genre (and all its subgenres).

Despite all this - I would wager that the premise of Xbox and Sony competing on exclusives has gotten weaker this generation. Xbox is focusing on more omnichannel access, offering Xbox Game Pass on multiple kinds of devices, cloud streaming, and seamless PC + Xbox integration. Low barrier to entry, high lifetime value, Games as a Service done really well. On the other hand PlayStation is doubling down on the premium market, asserting that their games deserve the $70USD price tag and are willing to back it up. How well that strategy works for Sony can only be answered with time.

Proprietary Technology

Sometimes the most valuable assets a company has is under the hood. Some clever stroke of engineering that spawned something so complex, legally protected (or both) that another company simply can't replicate themselves. The only way to acquire this technology is to buy the company that originally created it.

Let's look to Korea for an example where Krafton, the game publisher behind Players Unknown Battlegrounds (PUBG) recently acquired Thingsflow. Thingsflow is the company behind the popular asian chat bot service HelloBot which is built on industry leading artificial intelligence.

“Thingsflow is equipped with deep insights about content consumption trends that we can leverage to create new and innovative experiences for audiences globally, the company has a demonstrated history of successfully applying cutting-edge AI technologies to various services. ”

— Krafton CEO, CH Kim

In this case, Krafton may not be looking to buy Thingsflow for what it offers currently but rather what it could offer when paired with the Krafton games library. It would be no surprise that Krafton had been looking to integrate AI based chat services into their game to increase social engagement and their corporate development team assessed many different AI target companies.

Technology Applications

Extending the earlier point about games companies buying IP for content/genre coverage - buying companies for their technology, whether that be AI models or game engines, expands abilities on two fronts:

Unlocks Market Response Agility

When battle royales burst onto the scene, everyone wanted to make one. However, hosting multiple game instances of 100+ players playing simultaneously with a steady netcode on reliable servers isn't easy. We see this with the user generated content craze that games like Roblox and Minecraft have spurred. It's one thing to make an internal map editor that level designers can tinker with. It's much harder to build a cohesive player facing tool that runs properly.

If you had a publisher who was pressuring you to deliver a battle royale game with user generated capabilities you may look to simply buying another company who's done it before, rather than building all of those capabilities in-house.

Venture into non-gaming lines of business

We see Unity, the game engine company, doing this in the form of Unity Connect, their construction and engineering arm. It is a division that applies the technology they've built from making the Unity engine and expanding their value proposition to include non-gaming work. Unity's recent acquisition of VisualWork, an augmented reality construction technology companies speaks to just that. The stronger that Unity can leverage the already impressive engine they've been building for use cases that demand such fidelity, like engineering modelling, architecture, interior design - they will have a much stronger foothold to stand on when competing with Epic's Unreal Engine.

Epic by the way, has done an exceptional job of broadening their value prop beyond game development tools (Unreal Engine) and game releases (e.g. Fortnite). They've stood up impressive online services and e-commerce divisions in Epic Online Services (EOS) and Epic Games Store.

To learn more about Epic, I highly recommend you check out Matthew Ball's primer on Epic Games and how well they diversified their business lines.

Talent

Acquiring a company means more than just absorbing whatever the company owns, it also means absorbing whoever the company hired. The process of acquiring a company strictly for bringing its team members is colloquially known as "acqu-hiring"

In the games industry this is an effective strategy when looking at two groups of people:

Visionaries & Company Culture Anchors

Whether they be the original founders of the target company or simply culturally prolific people, it's sometimes necessary to buy a company for their expertise. The target company may have thrived because of a strong IP that it has the right to or some clever proprietary technology their R&D team whipped up. However, it's often the leaders at the top who made that all happen, and who could make so much more happen.

They are the spirit of the target company and if they aren't treated correctly upon acquisition the acquiring company loses much of the original value of the target.

Subject Matter Experts

For large companies wanting to expand into entirely new business verticals it pays to bring on people who are just really smart, competent and know more about the vertical than you ever could.

It saves you the time and effort of having to either cultivate the expertise yourself or having to source the required talent who may have a very niche skillset from the labor market

As a blunt, notional example - if you want to get into something complex as artificial intelligence integrations into how game engines render graphics, sometimes you just need to buy a company full of people who can speak that language.

Although this rationale for acquisitions may fly in other industries like finance, telecommunications, or biotech, the games industry is slightly different. Some much of a studios ability to deliver great games or services is the culture. Being a unique blend of high-creativity and hard-STEM worlds, the best games are made when there is a delicately curated balance of culture, experimentation, hard work and of course, people come together. Buying a studio for just its people without proper thought to cultural integration is a recipe for disaster in any acquisition but especially in the games industry.

And then there’s Tencent…

This could be a whole separate post so I’ll keep this brief. Chinese gaming giant Tencent, the largest games company in the world, approaches their aggressive acquisition strategy a little differently than its global counterparts.

In China, the lines between private sector and state backed firms in the technology space are blurry. Tencent for a long time has been a guide to foreign companies looking to enter the lucrative Chinese market. The reason why such a guide like Tencent is needed in the first place is because game publishing in China is vague, complex, bureaucratic - especially when it comes to censorship. It’s never as simple as finding the leading platforms and uploading an app as you would on Google Play or Apple’s App Store. Censors are scrupulous and have made many a game company’s life a living hell to jump through seemingly arbitrary hoops (i.e. your game can not have any character coming up from the ground like a zombie, nor can characters be skeletons).

Tencent has helped many companies such as Activision Blizzard (Call of Duty Mobile), Ubisoft, Epic Games, and Riot Games penetrate this wall all with a caveat. Not a publishing fee or royalty - Tencent wants equity. This initial equity slice that Tencent often takes from companies as a price of admission will eventually blossom into a full blown acquisition if the target company has legs and their titles succeed. If not, their minority equity position doesn’t hurt their pocket books too much.

This strategy has worked immensely well, and even in the past 7 days, we see not one but two acquisition in this vein - Sumo Group and Stunlock However, as China’s tech giants like Tencent grow, their relationship with Chinese anti-trust regulators gets increasingly called into question. The Huya/Douyu mega-merger I wrote my first piece on was shut down by regulators recently because of this.

Take a look at my original piece to understand what this was all about.

So What?

Any of the big ticket acquisitions above were done for a combination of reasons (and others I'm sure I'm missing). But so what? What does such aggressive mergers and acquisitions offer when all of the reasons above are firing on all cylinders?

I believe it generates two immensely powerful boons for acquiring companies

Portfolio Diversification

Just like a portfolio of stocks or bonds or index funds, it's important to have exposure to multiple securities in the case that one of the fails, the others pick up the slack.

Large tech companies are not dissimilar:

Bytedance (parent company of TikTok) is realizing that they can't rely on success of their darling smartphone app if they want to retain profitability and grow. It's why they have been so aggressive to buy mobile gaming studios, for the technological infrastructure (reason 2) but also for the talent that comes along with it (reason 3). If you're curious to learn more, check out my other post about it!
Electronic Arts is buying Glu Mobile to bolster their mobile gaming exposure, a market they already succeed in but relies on a handful of licensed IP (FIFA, Star Wars) not fully EA-owned IP.
Despite facing some recent fire on their work with indies - Sony has been trying to round their out their slate of AAA blockbusters to include more cult hits, as seen by their acquisition of Housemarque, the team behind the recently released Returnal.

Rapid Market Response Capability

When the Battle Royale craze struck the games industry with Players Unknown Battlegrounds and then Fortnite, developers and publishers around the world scrambled to produce their own battle royale. Some succeeded like Activision's Call of Duty Warzone and EA's Apex Legends. Many did not. Much of Activision and EA's success hinged on those companies' ability to mobilize their studios to produce a quality game in a relatively timeframe with a strong post-launch roadmap. Battle Royales were a hot trend that these companies saw, decided to respond, and deployed their resources to meet players needs in a polished and timely manner. The 2021 equivalent is the user generated content craze, pioneered by Roblox. It's why we see a sandbox mode announced for the latest Forza game.

Having many high quality studios under a common umbrella allow you to quickly and strategically deploy resources to make something the industry wants:

If I want a super hero themed battle royale supported user generated content with a live service model, I have the IP to pull off the super hero part (reason 1), I have the technology to support a Battle Royale game with many concurrent players (reason 2), and I have smart teams around the world who can actually build the game (reason 3).

If you've executed your mergers and acquisitions strategy correctly - you should be able to tweak the scenario above 1,000 different ways, depending on which way the way the games industry wind blows and still deliver something great to players.

🔑Key Takeaways

We're seeing unprecedented consolidation in the global video games industry with multiple $1Bn+ acquisitons going through in recent years.
Acquirers are looking at companies for three reasons:
- To buy intellectual property, a precious currency in our content era of TV streaming and console exclusives.
- To plug a technological gap the acquirer has by buying complex proprietary tech
- To bring on visionaries or subject matter experts whose vision or expertise can't be replicated in house
- In Tencent’s case - they geographically gatekeep the Chinese in exchange for equity in the company entering the market.
When the acquiring game company reaps the 3 benefits above it creates additional perks:
- Games companies will de-risk their portfolio from any headwinds, similar to a portfolio of stocks
- It allows companies flexibility to respond to trends and create what the market wants quickly and effectively.

2021 Games Industry Consolidation - Mergers & Acquisitions