2017 has been a stellar year for Activision Blizzard (ATVI).
In the nine months to-date, GAAP revenues were up 8 percent year-on-year and net income 24 percent. Q3 smashed guidance, delivering record revenues and EPS, and resulted in raised annual guidance, again. No wonder its share price has risen a substantial 72 percent.
The reason is all parts of the business are flying. From Activision’s mass market titles such as Call of Duty: WWII, to Blizzard’s core fantasy and sci-fi offerings, and not to forget King’s mobile games, Activision Blizzard has demonstrated it has the brands to attract and retain gamers, as well as the operational abilities to generate increasing amounts of revenues from them.
But what will continue to drive such growth in 2018 and beyond?
Ongoing systematic changes in the games market such as the rising market share of digital downloads, which increases companies’ profitability at the rate of $10 per download, will continue albeit at a decelerating rate. And, despite the current spat triggered by fan backlash in EA’s Star Wars Battlefront 2, so will the ability to better monetize players through micro-transactions.
The launch of Blizzard’s much anticipated esports Overwatch League in early 2018 has great potential too, although requiring heavy investment as its success assumes disruption of the existing esports market.
King opens the door to advertising
A less high profile initiative, but one that could reap significant rewards, particularly in terms of profitability, is King’s decision to start running in-game advertising again.
The reason it doesn’t is due to the success of its match-3 puzzle game Candy Crush Saga, which started making so much money from in-app purchases when it transitioned from a web to a mobile game in 2013, King stopped running ads.
Acquired by Activision Blizzard for $5.9 billion in 2016, following its disastrous 2014 IPO and slowing down of the business in 2015, it’s taken King some time to get up to speed as the third leg of Activision Blizzard’s stool, but 2017 has seen a dramatic turnaround, as evidenced by the return of Candy Crush Saga as the No. 1 top grossing mobile game in the US.
Counter intuitively, King’s player numbers as measured by standard industry metric Monthly Active Players (or Users, MAUs) have continued to decline. The total has dropped from over 500 million in early 2015 to just under 300 million in Q3 2017, although this is a trend most mobile game companies have experienced.
Yet, during this period, the mobile advertising market has matured, moving from mainly low-value, low-quality banner adverts to full-screen interstitials and rewarded video ads, which gift players virtual items when they choose to watch them.
And it’s this ability to generate higher per user revenues, combined with King’s still large audience, that’s seen the company make the decision to re-adopt in-game advertising.
Indeed, aside from the potential size of its inventory, King’s audience, which skews older and more female than industry norms, could be more valuable in terms of attracting brand advertisers. In that context, it’s interesting King recently hired ex-Snapchat executive Brian Ames to be its first president of advertising.
King’s advertising potential
So how much revenue could King generate from advertising?
It’s a complex question but comparisons with other mobile game companies provide us with some rough numbers to play with.
Most obviously, Zynga (ZNGA) and Glu Mobile (GLUU) have in-game advertising as part of their monetization strategies, and as publicly-owned companies, break out its performance on a quarterly basis.
More significantly, French mobile game company Gameloft (now part of Vivendi) re-introduced advertising into its portfolio of titles in 2015, although it’s only released data on a quarterly basis since 2016. However, this does demonstrate the process of how such a transition is made, and how quickly it can impact top line numbers.
The first approach is to consider what percentage of Zynga, Glu Mobile and Gameloft’s overall revenue comes from advertising.
This is a crude comparison because each company has a very different portfolio of games and there’s no reason King will run its advertising business in the same manner. Equally, Zynga’s advertising category is technically “Advertising and other” revenue, which – for example – during FY17 Q3 also included residual sales from its legacy technology licensing business.
Nevertheless, within this caveats, there are some clear trends. Zynga has seen advertising revenue over 30 percent in some quarters, dropping to 25 percent in 2016 as it refocused on in-app purchases, and stabilizing around 20 percent as that strategy gained momentum.
Similarly, Glu Mobile has seen advertising generate over 20 percent of its quarterly revenue, which has fallen to 15 percent as its own turnaround – fuelled by the success of IAPs in its game Design Home – has taken hold.
Most interesting is how advertising has become a substantial part of Gameloft’s revenue mix. Growing from 4 percent at the start of 2016, it now accounts for 16 percent of revenues, although this figure is somewhat inflated as – unlike Zynga and Glu Mobile – Gameloft’s IAPs business is currently experiencing decline.
Millions of eyeballs
Using share of overall revenues gives an overview of how advertising can fit into a company’s monetization strategy but it’s an indirect measure.
More sophisticated, albeit with its own limitations, is to consider the revenue each company is generating in terms of its audience total.
As is clear from the following graph, despite its steady decline, King has by far the largest audience in terms of regular monthly players. Compared to its roughly 300 million total, Gameloft has around 130 million players, Zynga 80 million, although this includes some web players, and Glu Mobile less than 30 million.
(Note: Gameloft’s announcements have become less regular following its acquisition by Vivendi hence its patchy data points.)
In terms of working out how much advertising revenue each company generates from its players, it would be more accurate to use its Daily Average User metric. Neither Gameloft or King publicly reveal this measure of committed players, however.
Similarly, we have no measure of what percentage of each company’s players are exposed to in-game advertising. Nevertheless, what’s clear from the following graph of advertising revenue generated by monthly active players total is the trend is up.
This is most clear in the case of Glu Mobile where it rises from less than $0.25 generated per million MAUs in 2014 to a current figure approaching $0.50 per million.
This reflects the wider change in advertising mix from low value banner ads to higher value video ads. Glu Mobile also runs an inventory of very high value rewarded interactive adverts in some of its more core titles, and more generally runs advertising across the majority of its mobile games.
Given Zynga’s large audience and spread of game genres – from racers to casual word games – the higher volatility of the measure in its case is to be expected, but during 2017 its rate also settled down to around $0.50 per million players.
Gameloft’s low position on this graph is surprising but likely to be a consequence that it doesn’t yet run advertising across the majority of its games, as well as running a lower proportion of the high value rewarded ads formats.
This does demonstrate introducing in-game advertising retrospectively needs to be a gradual and managed process, though. Certainly it would be unrealistic to expect King to generate Zynga-levels of advertising revenue in 2018.
How much and when?
Using these comparative figures, we can consider how much advertising revenue King could generate from its games.
At the lowest level, applying Gameloft’s dollar rate per million players in FY17 Q3 would have generated $26 million of additional revenue for King. Given its quarterly sales were $528 million, up 10 percent quarter-on-quarter and 21 percent year-on-year, this 6 percent boost doesn’t look substantial enough to be worth the effort, even given advertising’s high profit margins.
A Glu Mobile-level of advertising performance would generate over $500 million of additional annual revenue, however, while a Zynga performance would boost King’s annual sales by more than $600 million.
Of course, this is comparing King to mature advertising businesses and hence unrealistic in the short term. More appropriate is a comparison using the growth of advertising for Gameloft as a percentage of overall revenue.
This shows limited upside in the short term but the potential for much quicker growth once internal systems and teams are in place and advertising optimized within products. In this way, Gameloft’s share of advertising went from 4 to 12 percent within four quarters.
On that basis, King could be generating over $200 million annually from its in-game advertising by 2019/2020. This doesn’t really move the needle in terms of Activision Blizzard’s c.$7 billion of annual sales, although in-game advertising could add, perhaps, 10 percent to its c. $1 billion of annual net income, which would be meaningful.
Compared to other initiatives – notably the Overwatch League – adding in-game advertising into King’s mobile games is not going to give Activision Blizzard its next annual billion dollar revenue stream.
But as headline revenue growth starts to decelerate, investors will need to consider how the company is improving its internal efficiencies and maximizing high margin opportunities to maintain the incredible momentum it’s built in 2017.
And this is where initiatives such as King’s reintroduction of in-game advertising could have a disproportionate impact.
Disclosure: I am/we are long ZNGA.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.