Why Video Game Stocks Are Facing Their Toughest Year in Two Decades

Video game industry revenues are poised to experience their first downturn since 1995, signaling a significant shift in the market.

Video game stocks, already under pressure, are expected to face continued declines over the next couple of years. This critical phase for the gaming sector is driven by multiple challenges, including China's stricter regulations on game approvals, a scarcity of major console hits, and player fatigue with popular battle-royale games such as Fortnite. These factors are predicted to suppress growth in the industry until at least 2020, negatively affecting shares of leading companies like Activision Blizzard Inc. (ATVI), Electronic Arts Inc. (EA), and Take-Two Interactive Software Inc. (TTWO), according to London-based market analyst Pelham Smithers, as reported by Bloomberg.

"The pieces of the puzzle simply don't fit together right now, so we're anticipating a contraction in the market in 2019," Smithers stated. "The current sell-off in video game stocks largely reflects increasing awareness of this risk."

Video Game Stocks Are Losing Their Spark

Percentage Decline From 52-Week High:

• Activision Blizzard: -44.2%
• Electronic Arts: -40.1%
• Take-Two Interactive: -27.5%

Source: Investopedia

Gaming Revenue Expected to Decline by 1% in 2019

The rise of gaming as a social phenomenon, both domestically and globally, has been remarkable. Blockbuster titles like Fortnite and the booming e-sports scene have propelled the industry to rival traditional sports giants such as the NFL, with revenues driven by in-game purchases and subscription models.

Despite this success, veteran analyst Pelham Smithers, who has tracked the industry since the late 1980s and accurately predicted Nintendo's decline years ago, forecasts a 1% drop in gaming revenues this year, bringing the total to approximately $136.5 billion. He points to recent stock sell-offs in companies like Tencent Holdings Ltd. and Electronic Arts as evidence supporting his outlook.

Challenges in Mobile Gaming

Smithers identifies the biggest threat as a downturn in mobile game sales, which account for nearly half of the industry's total revenue. He attributes this decline primarily to the Chinese market—the world's largest smartphone base—which is expected to shrink by around 10% due to Beijing's tightened control over game approvals. This slowdown in China is compounded by stagnating mobile markets in the U.S. and Japan.

Declines in Console and PC Gaming

Console gaming, representing 19% of total sales, is also expected to face difficulties following a record-breaking 2018, with aging hardware hindering growth prospects.

Similarly, PC gaming, which makes up 25% of industry revenue, is projected to decline as player interest wanes in popular last-man-standing games like Fortnite, which have dominated since 2017.

High Stock Valuations Amid Rising Risks

Beyond regulatory pressures in China, other headwinds include disappointing sales of Nintendo’s Switch, increased scrutiny over gaming addiction and monetization methods such as loot boxes, and uncertainty surrounding upcoming game releases from major developers.

"Some of the high-priced stocks haven't undergone a sufficient correction yet," Smithers noted. "EA and Capcom still appear overvalued."

However, he highlights two promising sectors within gaming: virtual reality sales, expected to double from $4 billion in 2018 to $8 billion by 2020, and the growing e-sports market.

The Fortnite Effect

Fortnite’s unprecedented success has overshadowed traditional industry leaders like Electronic Arts and Activision, drawing attention to the underwhelming game pipelines of these companies. Free-to-play models like Fortnite continue to thrive by monetizing additional content.

In a shareholder letter, streaming giant Netflix Inc. (NFLX) even admitted, "we compete with (and lose to) Fortnite more than HBO."

Activision’s shares dropped 12% following weaker-than-expected earnings guidance, with the company acknowledging that its flagship game Destiny 2 underperformed. The stock declined further after transferring publishing rights for the franchise to its developer, Bungie.

Similarly, Electronic Arts’ Battlefield V failed to generate anticipated enthusiasm, leading to a 50% price cut just one week after launch.

Both Activision and Electronic Arts have seen their shares fall into bear market territory, down 44% and 40% respectively from their 52-week highs.

Meanwhile, research firm SuperData estimates Fortnite generated $2.4 billion in revenue in 2018, the highest annual earnings ever recorded for a single game.

Industry Perspectives

Peter Warman, founder of Newzoo, aligns with Smithers’ cautious outlook, reducing his 2018 and 2019 gaming revenue growth forecasts by 2-3%. The IDC has also downgraded its forecast for China’s gaming market growth to 5% in 2018, a sharp decrease from the 20% annual growth seen since 2014.

However, some analysts at firms like Goldman Sachs, Morgan Stanley, and Nomura remain optimistic, believing the gaming industry is positioned for continued outperformance.

Looking Ahead

While a single blockbuster release could potentially reverse the downward trend, such an outcome appears unlikely at present. The anticipated revenue decline in 2019 serves as a critical warning signal for both the industry and investors.

Investors will be closely monitoring upcoming Q3 earnings reports from key players, with Activision scheduled for February 12 and Electronic Arts on February 5. It would not be surprising if both companies deliver cautious forecasts amid current market headwinds.

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