Betting the kingdom
Disney's $1.5 billion push into gaming and the future of entertainment
The SuperJoost Playlist is a weekly take on gaming, tech, and entertainment by business professor and author, Joost van Dreunen.
Disney’s renewed push into interactive is a watershed moment in entertainment with video games at the center. The investment suggests that conventional media and entertainment firms are finally ready to dive into the games industry.
It took a while, though.
Bob Iger, who grew Disney’s market cap from $48 billion to $257 billion during his 15-year tenure that ended in 2020, came out of retirement two years later to navigate the firm’s push into digital. During this week’s earnings report, Disney announced it is taking a $1.5 billion equity stake in Epic Games.
The transition of a media powerhouse like Disney from offering experiences primarily in the physical world into digital environments is not an easy one. For one, it relies on its theme parks for an important part of its success. Its theme park segment reported $9.1 billion of revenues for the quarter, up 7 percent from $8.5 billion, and a profit of $3.1 billion. It trails only behind its declining Entertainment category, which totaled $10 billion (down 7 percent year-over-year), and is double the size of Sports which generated $4.8 billion (up 4 percent y/y).
Growing its Experiences division is promising and bolstered by recent successes. However, its real-world theme parks are not without encroaching risks. Disney recently lost a lawsuit against a local government official. According to the firm, it unfairly had its special tax privileges for its real estate in Florida removed when it opposed legislation limiting how sexual orientation and gender identity are discussed in schools. Regardless of the outcome, it increases its risk profile.
The push into gaming is also a partial answer to concern from activist investors to improve Disney’s presence and relevance across novel distribution platforms, like streaming video, and entertainment categories that resonate with younger audiences. Iger has been cutting costs and increasing the price of Disney+, which lost 1.3 million subscribers over the quarter and continues to struggle to keep pace with Netflix.
But IP-holders like Disney are wise to move slowly into novel spaces. Previously it fell short of delivering on expectations when it built its own online multiplayer universe, Disney Infinity. Falling short of its internal $1 billion revenue target, Disney decided to shut down its gaming operations in 2016. It changed its stance and started expanding its presence in gaming by offering its IP to third-party developers.
Following the success of the LEGO/Fortnite collaboration, Disney has its proof point to re-enter the games industry in a big way and have some skin in the game. A similar collaboration with Epic Games alleviates the stress of also having to provide the engine software and backbone infrastructure to create meaningful online experiences. Where Disney Infinity allowed you to play exclusively as Disney characters, Fortnite promises more agency and expressive experiences for fans of its IP portfolio.
The investment is also a well-timed adrenaline shot in the arm of the games industry, which is facing a tough year as it waits for the start of the next console cycle. Following a strong year with a lot of high-profile releases, 2024 has started with layoffs and a reduced release slate. Combined with the growing cost of doing business with platform holders, adding a novel revenue stream by working with entertainment firms and consumer brands will allow game makers to keep momentum as we inch toward 2025. Now is an excellent time to figure out how to blur the lines between physical and digital theme parks without losing the meaningfulness of the experience.
Disney's move underscores a major strategic shift slowly unfolding in the entertainment industry—the recognition that gaming and interactive experiences are the next frontier for legacy media firms. After past missteps like Disney Infinity, the media giant seems to have learned from experience.
Sometimes it takes a while for technology to catch up to a creative vision. It’s not an exact science. Or, according to Disney’s own Indiana Jones in The Last Crusade:
“Forget any ideas you've got about lost cities, exotic travel, and digging up the world. Do not follow maps to buried treasure and "X" never, ever, marks the spot.”
Looks like Iger would agree.
On to this week’s update.
BIG READ: Xbox porting content to PlayStation
Rumors have emerged that Microsoft is planning to release several first-party titles on rival platforms. Among them are Indiana Jones, Doom Year Zero, Hi-Fi Rush, Sea of Thieves, Microsoft Flight Simulator, Halo Infinite, Grounded, Pentiment and, apparently, Starfield. The suggestion that Xbox would offer its exclusive content elsewhere has a lot of die-hard fans up in arms because they feel the firm is betraying their loyalty.
Among the various bits of alleged evidence, one of the more compelling ones was Xbox CFO Tim Stuart's recent comments at a Wells Fargo TMT Summit in November. It falls just short of stating the Xbox games team is looking to expand its addressable audience. According to Stuart:
“Our mission is to bring our first-party experiences [and] our subscription services to every screen that can play games. That means smart TVs, that means mobile devices, that means what we would have thought of as competitors in the past like PlayStation and Nintendo.”
My expectation is that, yes, Microsoft may be in negotiations with Sony and possibly Nintendo. But both the Japanese console makers are unlikely to greenlight the idea. And even if they do, the underlying economics don’t make sense for Microsoft.
First, Game Pass as a subscription service works well as long as it serves as a discovery tool. Its broad catalog encourages players to spend more time and money on games in the Xbox ecosystem. It is that higher margin that makes Game Pass so valuable to Microsoft. However, as we learned from a data leak last September, the firm still struggles to financially sustain its Game Pass service. By offering it up to Sony, that margin would likely be much lower.
The rumors suggest a largely reactive response from team Xbox to mounting internal pressure. Following several high-profile purchases, its leadership team is now expected to show some results. Specifically, after acquiring Mojang and ZeniMax Media, Xbox is on the hook to deliver on expectations. According to its more recent earnings, Microsoft's gaming revenues rose 49 percent year-over-year while content and services revenue was up 61 percent. But this merely reflects the chance in numbers post-acquisition.
Rolling its premium IP out across different ecosystems, however, goes against past promises. Xbox execs have publicly stated that an important part of the acquisitions centered on providing exclusive content to Xbox players. In 2021, Phil Spencer told the Verge:
“But if you're an Xbox customer, the thing I want you to know is that this is about delivering great exclusive games for you that ship on platforms where Game Pass exists. That's our goal.”
It is possible that following the pitiful release of Redfall, followed by the vast emptiness of Starfield, the ZeniMax purchase doesn’t have much to show for it.
Especially the latter did not yield the results you’d expect from the top-dog game maker. Yes, lots of people *tried* Starfield. It’s beautiful and ambitious. But its many worlds are mostly empty and interactions with non-player characters simply aren’t compelling enough. The long-awaited release enticed millions but I’d have to venture that most were Game Pass subscribers that tried the game for a few minutes and then moved on. Its concurrent player count on Steam shows a considerable drop from a peak of 330,723 players immediately after its release. Its current player count hovers around 4,000. That likely has increased internal pressure to show results.
The net result is a self-fulfilling prophecy. Corporate logic dictates that a large acquisition is first rendered more efficient (e.g., layoffs) and second deployed to maximize the reach and revenue of the established intellectual properties. Two years ago I discussed how consolidation threatens innovation. To whatever degree the current rumor is true, I expect it to follow this same logic.
Despite ultimately completing its landmark acquisition, team Xbox now faces what seems to be a growing amount of internal and external scrutiny on its next moves. In a letter to the 9th US Circuit Court of Appeals, the Federal Trade Commission wrote that Microsoft’s announced layoffs conflict with statements the firm had made during the legal suit around ABK/MSFT. Microsoft previously stated that it would operate Activision Blizzard independently. The FTC argued that the layoffs showed areas of overlap and that the court should have given it a chance to complete its review before allowing the deal to proceed.
Finally, it is remarkable how deep into the Kool-Aid everyone seems to be, considering that Microsoft is one of only two $3 trillion companies. I can’t imagine this level of transparency, deliberate or otherwise, with a firm like Apple, Sony, or Tencent. I’m hoping Microsoft isn’t responding to rumors in the market and fanboy reactions to it. Following its landmark purchase, team Xbox is stumbling out of the gate. It should catch its breath and hammer out a solid plan.
MONEY, MONEY, NUMBERS
This week saw the earnings reports of two firms in transition: Nintendo and Roblox.
Nintendo earned $4 billion in its most recent quarter, down from $4.3 billion a year ago. The firm reported declines for both hardware (-9 percent compared to the same quarter a year ago) and software sales (-6 percent). Digital sales were up 6 percent y/y.
Notably, the Switch is entering its final stage. Industry analysts agree that we’ll soon hear more about its successor. However, Nintendo is currently unperturbed. The success at the box office, now totaling $1.36 billion in ticket sales, and the 12 million (sell-in) units for the recently released Super Mario Bros. Wonder likely contributed to Nintendo’s self-confidence. The firm reported a 93 percent increase to $506 million in its mobile and IP-related business, which it claimed was "bolstered mainly by the generation of revenue related to The Super Mario Bros Movie."
Nintendo increased its full-year Switch sales forecast to 15.5 million units from 15 million. With 139 million units sold, the Switch is Nintendo’s second-biggest seller after the DS, which sold 154 million units.
Roblox reported $1.127 billion in 23Q4 bookings versus an anticipated consensus of $1.072 billion. The firm grew 25 percent year-over-year. It was the first time its quarterly bookings were above $1 billion (up from $899 million for the same quarter a year ago.)
One of the firm’s major strategic initiatives is incentivizing its player base to create in-game content. Like Epic Games, Roblox is looking to transition to a model where its users create a lot of the content (e.g., in-game items and experiences) for its online worlds. The gradual outsourcing of content creation to users is a common revenue strategy.
The rationale is simple: if you make available tools that facilitate user-generated content, you simultaneously strengthen the loyalty of your users and offset development expenses. People have a deeper emotional attachment to worlds where they are free to create and customize the experience to suit their interests. That is true both of Roblox and Dungeons & Dragons. However, Roblox does incur costs. Specifically, it identifies what it calls “four main expense buckets.” (It’s pages 10 through 13 in its most recent supplemental materials.)
Although not an entirely fair comparison, we can see these developer exchange fees, or user-generated content costs, as similar to personnel expenses. It represents the total group of people that makes Roblox possible and engaging, regardless of their precise payroll status.
When asked about developer exchange fees, Roblox CEO David Baszucki stated:
“we want to grow our bookings faster year-on-year than cost of goods, we want to grow our bookings faster than infra and certain other expenses, and we want to grow our bookings faster than personnel costs. That leaves two areas, both our bottom-line as well as our creators. And the more efficient we are with the first three things, the more we can look to possible future expansion on the last two margins, developers and our leverage."
Developer exchange fees have increased from $114 million to $222 million over the three years ending in Q4 2023. But so have personnel costs: from $67 million to $199 million over that same timeframe. User spending seems robust. Average bookings per monthly unique payer were $23.65. Historically, the last quarter of the year shows an increase in average spending. Despite the growth of its overall userbase, the average value of paying players has not dropped dramatically which is an encouraging sign.
Eventually, I’d expect the latter to stabilize and flatten as Roblox reaches an equilibrium in which its users generate enough content on their own for everyone else on the platform. But its current cost structure suggests the two grow alongside for now.
PLAY/PASS
Play. My new favorite thing this week is someone running Doom on bacteria.