ENTERTAINMENT: Gaming Deals Plunge, End of an Era?

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Bottom line: M&A and IPOs by Chinese gaming companies will remain low for the next 2-3 years due to lack of investor interest, but could pick up after that if some players start losing money and have to close or sell themselves to rivals.

Investors shun gaming companies

A new report on global gaming deals in 2015 is shining a spotlight on 2 major trends in China, namely the sector’s high degree of fragmentation and also the near-freeze in IPOs by Chinese companies last year. In fact, 3 Chinese gaming companies actually privatized from New York stock exchanges last year, accounting for more than half of the sector’s global deals last year in terms of total value.

Among the big Chinese deals, the largest saw stalwart Shanda Games finally privatize in a buyout valued at nearly $2 billion, ending a 2-year process. Another big gaming firm to privatize last year was veteran Perfect World, whose buyout was valued at $1 billion. The third was China Mobile Games, whose buyout was worth about $700 million.

The new report notes that those 3 deals alone easily accounted for over half of the $3.7 billion in global M&A involving gaming companies last year. (English article) It adds that global deal value for the sector last year dropped a hefty 81 percent to below $5 billion, as IPO activity and total deal value for gaming firms hit their lowest level for more than a decade.

So, does this mean the demise of the gaming industry, and what’s in store for this year? I’ll return to those questions shortly, but first would point out the answer to the first question is a definite “no”. Games remain one of the most popular functions for smartphone users, and thus it’s highly unlikely they will disappear anytime soon.

The big problem, especially for China, is the market’s fragmentation, which has remained stubbornly high even as most companies see their profits and revenue shrivel. That means that competition is rampant and few companies have the economies of scale to ensure a steady pipeline of popular new titles to replace games that are near the end of their life cycle.

All that said, it’s important to note that last year’s sharp drop in gaming deals was part of 2 broader trends that extended beyond the gaming market. One of those trends saw a huge drop in IPOs by all Chinese companies in New York, following a bumper year in 2014 that saw around $30 billion in new listings. By comparison, last year saw only a handful of Chinese companies list in New Year, with a total deal value worth less than $2 billion.

Privatization Wave

Instead of IPOs, many US-listed Chinese companies spent last year announcing privatization plans, with around 3 dozen companies getting buyout offers, including the ones received by Perfect World and China Mobile Games. Another mobile game company, Sungy Mobile (Nasdaq: GOMO), also received a buyout offer last year, but the broader wave also encompassed many other sectors, ranging from pharmaceuticals to hotels and software.

The privatization wave is now largely finished, though some deals still pending like the one for Sungy could still get completed this year. At the same time, it’s highly unlikely we’ll see anymore offshore IPOs by Chinese gaming companies due to lack of investor interest in the sector. What’s really needed to revive interest in the group is consolidation to create one or more new companies that can compete with current sector leaders Tencent (HKEx: 700) and NetEase (Nasdaq: NTES).

I’ve predicted numerous times in the past that such consolidation was coming, and indeed we’ve seen several smaller purchases announced. But despite that, no major companies have emerged and things look largely as fragmented as ever. At this point I’m not optimistic that consolidation is on the near-term horizon, largely because most companies are still making money even though their profits and revenues are shrinking.

The factor that will finally hasten the necessary consolidation is actual losses, and it’s not clear if and when many of these companies may finally sink into the red. That could still be at least 2 or 3 years away, meaning the next few years could see deal volume for gaming companies stagnate or drop even more as investors avoid the sector.

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