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The business of esports

This is an excerpt from Esports Business Management With HKPropel Access by David P. Hedlund,Gil B. Fried & Ronald "Rick" Smith.

By Gil Fried

The rapid expansion of and fast-flowing money into esports have reminded some people of the dot-com bubble of 1997-2000 where the value of many Internet companies shot up . . . and then the market burst, bankrupting many smaller companies and losing almost $5 trillion in market capitalization. The concern is that everyone is trying to jump into the space without really understanding what is going on. The industry is in a position where a new game could come out next week and crush the competition, turning today’s top game into a has-been virtually overnight. One sport example of this type of volatility is mud runs and obstacle course racing. They were all the rage around 2014. In January 2020, Tough Mudder (an endurance race series involving obstacle courses) owed three creditors over $850,000 and its largest lender, event registration company Active Networks, around $18 million. As part of Tough Mudder’s bankruptcy proceedings, rival company Spartan Race offered to pay off the debt and buy the company for a seven-figure amount (Cronin 2020). This story is an example of how a misstep in a market can cause a company to face a harsh economic reality from lenders.

The key to avoiding financial ruin is to understand how economic success is defined. It is not necessarily having the highest total sales. If a company has more expenses than sales, it will lose money, and even a large sales volume cannot keep that company’s doors open for long when it is consistently losing money. The following example of two esports-related companies helps highlight that numbers can tell a variety of stories.

Two publicly traded companies dominate China’s esports market: Huya (NYSE:HUYA) and DouYu International (NASDAQ:DOYU). Huya and DouYu are often compared to Amazon-owned Twitch. Both also are partially owned by Tencent, the largest gaming company in the world. Both companies’ stocks have taken different paths; Huya’s has doubled since its initial public offering (IPO), and DouYu’s shrunk almost 40 percent since its IPO. How could two companies in the same market with the same supposed upside take such different paths?

Huya focuses on hosting live video game streams and other esports content. Its monthly active users (MAUs) grew to 146.1 million in the fourth quarter of 2019 (a 48% annual increase), and total paying users rose to 5.3 million users (an increase of 29%). Approximately 95 percent of Huya’s new revenue comes from selling virtual gifts and items on its livestreaming platform; viewers purchase them for their favorite broadcasters, and Huya takes a cut of the revenue. The remaining 5 percent comes from digital ads.

In the same quarter, DouYu’s total MAUs grew 15 percent annually to 163.6 million. DouYu has a larger overall audience, partly because the company offers more video content beyond esports. DouYu’s audience is not growing as fast as Huya’s and has fewer paid and mobile users. DouYu generates more revenue from ads; its ads generated 11 percent of its revenue, and the remaining 89 percent derived from its livestreaming unit.

If you had $10,000 to invest in either of these companies, which would you choose? In 2019 analysts expected Huya’s revenue to grow 71 percent, with DouYu’s revenue increasing 98 percent. This projection would seem to indicate that DouYu is a better investment. However, a one-year projection usually is not sufficient to determine the wisdom of a long-term investment. In fact, Huya’s revenue was expected to decelerate to 37 percent growth in 2020. These same analysts thought DouYu’s revenue would slow to 38 percent growth in 2020. However, revenue is only one number; profits are a different story. While the bottom lines of both companies were improving as of the start of 2019, DouYu was losing money while Huya was making a profit. Huya’s net income increased 132 million yuan ($17 million) in the third quarter of 2019, which was a 117 percent increase. At the start of 2019, analysts expected Huya’s adjusted earnings to grow 47 percent in 2019 and 80 percent in 2020. In contrast, DouYu’s loss narrowed from 220.5 million yuan to 165 million yuan ($23 million) in the last quarter of 2018 (Sun 2019).

In addition to reviewing trends and growth potential, it is also important to monitor how investors and market analysts view an esports business stock, which can rise significantly when a new title is released or drop significantly when a controversy occurs. In terms of Huya and DouYu, the analysts and stock market provide some interesting perspective. Examining the market on January 15, 2020, Huya was selling for $20.63; the stock had sold for as little as $16.40 and as high as $30.00 per share over the span of a year. With such a valuation, the market value for the company was $4.5 billion. In addition, 48 analysts reviewed the stock; 15 rated the stock as a strong buy, and 25 rated it as a buy. These ratings resulted in a ranking between buy and strong buy. Even though the earnings per share reflected a loss of $2.82 per share, analysts expected that the stock price should increase to $27.45.

On the same day, DouYu was selling for $9.02 per share. The price range was not as wide as Huya; over the previous 52 weeks, DouYu’s shares had ranged from $7.01 to $11.88. Based on the price, DouYu had a market valuation of $2.93 billion, and the anticipated target price was $9.52. Sixteen analysts over several months rated the stock closer to a buy rather than a strong buy. Four had listed the stock as a strong buy, 10 as a buy, and 2 as a hold over the same period. Based in part on the lower share value, DouYu’s board voted in December 2019 to repurchase up to $100 million of their common shares (PR Newswire 2019).

This example helps highlight the importance of examining several different numbers when undertaking a financial analysis. Understanding the critical skill of budgeting is equally important when exploring whether to hold an esports event.

More Excerpts From Esports Business Management With HKPropel Access