Gaming Consoles Part 1: The Thesis - [Business Breakdowns, EP.201]
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This is Matt Russell, and today's episode is the first in a multi-part series on the video game market, more specifically, the video game console market. Our guest is Sia Kamali, the founder and fund manager at Skycatcher.

Now, Skycatcher describes themselves as focused on capturing asymmetry at the internet frontier. And SIA has very strong conviction, which you'll hear, that the video game console market is entering a major paradigm shift with an App Store model set to hit its inflection point. For this episode, we start with an overview of the video game console market itself, laying out the size and where it stands today.

And admittedly, I did not appreciate it has been a growing market over the past decade. It's just been massively overshadowed by mobile. We get into why now could represent the shift or the catalyst in terms of both the return profile for the businesses and this specific economic model and the potential inflection in earnings. We get into even more depth in episode two and three when we cover the names most exposed to this theme with Sony and Nintendo.

I think that the shift from hardware to a more software-like revenue stream is obviously a positive for these businesses. But CLAs out numbers around how big of an impact this could be. Now, on these episodes, we always recommend you do your own research.

This particular episode is definitely laid out as an investment thesis, so it's even more important to message that today. And while I wouldn't insult your intelligence and suggest that on our other episodes they don't come across as bullish, we invited Sia Ahn to lay out his thesis, so this one is particularly geared towards that investment opportunity. I hope you enjoy this first episode, and make sure to stick around for the detailed analysis on Sony and Nintendo in Episodes 2 and 3. ♪

All right, so we're doing a bit of a new format here. And it was a great opportunity to try this out because we have a very interesting theme that's playing out within an industry. It's a really interesting industry, I think, to a lot of people. That is the video game market. And I think you've come at this with a creative observation approach.

something very interesting around specifically video game consoles. So in this introductory episode, we're going to cover a lot about that market, a lot about your thesis. And to kick things off, video game consoles, when I think of the market for video games today, there's been so much talk about the shift to mobile. There is this console market, but it felt to me at least like I'm hearing less and less about it. So maybe you could just give us a state of the world sketch of where we stand today with

with video game consoles, and then we can get into the juice and the meat from there. Absolutely. And also super excited to be here, Matt. It's the first time we've had an opportunity to really publicly share what we do at Skycatcher, and it's coming on 10 years. I think it's about time we share some of our hopefully interesting ideas. Yeah, so state of affair of where the video game console market is today.

You're looking at a market that's roughly $50 billion across the world, and it's three players, being Nintendo with their Switch franchise, Sony with the PlayStation franchise, and Microsoft with Xbox. Now, the clear leader in this, in terms of how you divide inside this, actually gets quite interesting. So Nintendo and Switch dominates that family category, and PlayStation dominates, really, the mature audience globally. So you could say...

If you had to stack rank this, I'd probably put PlayStation at the top of the list in terms of just spend of across the console. They're roughly 50% of that spend. And then Nintendo, who's going to catch up, most of their purchases are first party and third party is catching up on the side. And then Microsoft is, I wouldn't say a distant third because on a global basis, they may be, but in terms of US and Europe, they have strong footholds on that front.

Now, let's think about where this market in terms of size. So there's about 330 million monthly active users across this entire ecosystem. And if you went back and looked at this 10 years ago, we estimate called 150 to 180 million people. So markets kind of doubled in the last 10 years. It's been very steady growth. And in terms of revenue, similarly, you've seen revenues for industry double.

Now, the last few years has actually been quite challenging for the market because you've seen PC do really well and console now we think is going to have its moment on that front.

You mentioned that $50 billion number. I assume, is it an annual metric that you're measuring there just for the context to get a sense of size? When I think about what incorporates $50 billion, is that the console sales or is there a lot more going on just beyond that? The way that number is just focusing on software. So first party, third party, and then additional subscription services on that front. And so...

Of that number, you can say a little less than half of that is actually dominated by PlayStation. They're the most advanced in terms of that aspect of it. Yeah. Just hearing the size of the market, the active users that have grown, it brings the Mark Twain reports of my death are greatly exaggerated quote to mind.

I had imagined that you had seen more of a shift towards mobile at the detriment of the video game consoles. But can you just talk a little bit about the dynamic and set the record on what has been happening with mobile and whether that's impacted market share at all for the video game consoles? Yes. So I think mobile really took off from 2010, 2011 onwards and represents, and let's just call total gaming, $220 billion.

Total, right? Mobile is almost half that. And mobile has, for the last 10 years, been the place to be. And that changed in the last two, three years. Coast changes to IDFA and other challenges around just mobile game ROIs in terms of ad spend.

Now, during this entire period, you can see that core gaming, which is console gaming, PC, continued to grow steady-eddy. And I think when you think about that core gamer versus the mobile gamer, the core gamer, they're willing to shelf, they're willing to spend a couple hundred bucks for a device that plays a game versus a mobile gamer is just playing something to pass time on his phone and it's very quick session versus you look at the console gamer, they'll play for hours in

And so I think you have to look at these two chords and say, most gamers are both. They do both mobile gaming and they do console gaming. But where the spin power is in terms of time for money is much better value in console gaming because how much time you can spend on a big screen on your couch versus mobile gaming obviously has made more money, but

If you look at how mobile gaming makes money, it's through gotcha mechanics. It's definitely a lot of these high dopamine type hits

Yeah, the mobile gaming economies are fascinating ones to get an appreciation for just how insulated they are in terms of feeding one another inside that business. But I think the console market has obviously changed a lot since then. You mentioned software as a piece of the revenue equation. That's something that I don't really think existed 20 years ago, if I'm thinking about software correctly in this context.

So maybe you could just bring us up to speed in terms of the shifts that the video game console market has had over the past 10 to 20 years. What has changed? What has made them a more interesting business line versus the old buy it once, use it forever type model?

So this gets to the crux of our thesis is we view video game consoles as generational platforms and it's because of change that we think people are mispricing. So you think about 10 years ago, the console was a device that you bought a disc from a Walmart or GameStop, put it in there, played it, and that whole console was just this thing that plays games. Did nothing much more than that. But then you look today...

These devices are now devices where you buy the game digitally, so you're not going to retail shop to buy anymore.

And then two, you're also playing games online with your friends and the live services part, you're making money on either the online subscription or just microtransactions. And then third, which is really where this comes to lock in, once you download the game, obviously this becomes the content library. And the content library means that, okay, I'm stuck in PlayStation ecosystem or I'm stuck in Switch or I'm stuck in Xbox. So

I think this control or let's say the moat that the console has of the user is far more powerful than I think people have come to realize. And for us, that wake up moment, this trend started in 2015, but COVID really had fuel to the fire to our thesis when we look at the numbers behind that. Go back to 2015 and you look at Nintendo, you look at PlayStation,

Digital purchases of sales, meaning buying a game through the console, 10% less. Most people back in 2015 were still buying physical disc. Fast forward to today, Sony's at almost 70%. Nintendo's closer to 60%.

And that tipping point has happened. And so for us, when you think about the margin that now gets collected to Sony's PlayStation and Nintendo Switch, well, they're acting as the App Store. And if we take even a step back further, I'd argue that one of the best business models of all time has been the App Store business model. And so...

When we look at the total net earnings power of console app store versus Apple's app store today, you're capturing Apple's app store around 2015, 2016. And if we'd gone back and said, look, let's buy Apple in 2016, led to a massive return because today's Apple's app store net earnings are, we estimate, close to $23, $24 billion a year. And you're now at that point where you're halfway through

But the next half is actually going to be the real profitable part where we get to 100%. And we already see consoles today are coming without disc already. And can you spell that out a little bit? Because I think you mentioned the shift for the video game industry really started taking place around 2015, 2016. It's many years later. So why is now the time where you really see that shift? And...

And if there's an analog to point to, that's really helpful as well in terms of why you see it gradual and then sudden, it sounds like based on your description. Let's also look back again from 2015 to today. What was the other major thing that happened here for consoles and for gamers for the console thesis that happened?

you had the major of life service games come out such as Fortnite, Players Unknown Battleground. These were titles that really brought the idea of games lasting forever in a whole different level of scale that didn't exist. Okay, so let's fast forward to today.

We're at this interesting tipping point where we estimate the lifetime value of a PlayStation customer is around $600. And we think that's going to triple from here. And respectively for Nintendo, it's around $300, but we think it's going to 5X from here to over $1,400. And we think for both of these consoles, both these ecosystems...

There are two different drivers happening. So let's just break down one by one what's happening. First, for Nintendo, you are now eight years into the Switch 1 cycle. And we know the successor to Switch, the Switch 2, comes out, or at least is announced, by March of 2025.

And with the Switch 2, it's a massive hardware upgrade where we think it will not just support the current Nintendo games, but also really support third-party titles that weren't there before. And now when we look at on the other side for Sony's PlayStation,

We're actually a different stage. We're at a stage where the PS5 has been out for four or five years. The PS5 Pro just came out, and we know the next four years, the second half of the PlayStation console is typically the most profitable. But it's also we're entering a phase where PlayStation has come out and says, we're going to really focus on live service games in a way that they never did before.

Historically, Sony and PlayStation, they've always been the king at single-player games. And now they're really putting more of the resources, especially for their own IP, on live service games. So essentially, to sum it up for you, from 2015 to today, spending for gamers on both platforms has increased.

But we're at a point where spending for the PlayStation user just on software side is around $180. And for Nintendo, we estimate is a little under $100. And for both of these platforms, we see continued growth. But a lot of it is going to depend on life service spending, playing with your friends.

And the Nintendo thesis with the Switch release makes a lot of sense. Are there any catalysts from the Sony side? I think what you referenced there, just in terms of being in this cycle on the PlayStation side of things, but are there milestones or catalysts that you've seen that represent something important in terms of them also partaking in this? Absolutely. So this PS5 cycle that's come out,

I would argue and say that it hasn't really had its console selling title since the Grand Theft Auto series. So the last time you had the new iteration of Grand Theft Auto, that caused a massive upgrade of PlayStation from PS3 to PS4. And right now, we're at an interesting moment for PlayStation where the PS4 to PS5 translation is only 50%.

Now, what's really interesting when you get into the data, and this is what Sonia shared with us, is that even though it split the ecosystem of 120 gamers between the two platforms, we know that the gamers on PS5 spend a billion hours more than the PS4 gamers playing.

from an engagement perspective. And now you say, okay, what's going to cause people to go from PS4 to PS5? Well, I think the answer is simple. GTA 6 comes out. It's supposed to come out next year. That is a console selling title. And I think it's going to really drive

massive sales of PS5s and it won't be surprising we see sellouts across the board on that front. But remember, when you're spending more time in a game, which we see PS5 users are, you're also probably likely to spend more money in the game. So I think first and foremost, you have to look at this as a broad stroke

to the health of this ecosystem. And when we look at that, there are really two metrics we're looking at in terms of just a very simple LTV analysis. We're looking at the average revenue per user, and then we're looking at, on the denominator side, how many are churning and how many stay long. So when you think about this math, let's just take, for example, let's start with Sony's PlayStation. So I mentioned to you the big jump that happened from

2015 to 2020 for PlayStation, our estimate was the lifetime value of a user went from a little under $200 to $500. And what drove that was one, the spending for users almost doubled, but also more importantly was the fact that the users are staying in the ecosystem longer and there's less and less churn. When I think about that upgrade, you're going to see...

basically customers transition from one to the next which

which is going to provide that initial revenue bump for the new console. Do you see a material change then beyond that? Because let's say the customer was on a PS4, there theoretically should have been some revenue base. They're stepping into PS5, you're going to get that one-time impact. Is there other knock-on effects beyond that where the value of that customer increases just from the upgrade beyond the initial purchase?

Yeah, there's two parts to this thesis around console. One is App Store. So you collect a 30% toll road on every digital purchase, both first-party and third-party.

The second piece is around subscription. And what you need to understand, both Nintendo Switch subscriptions offering and PlayStation's offering, it allows you to connect online and play with your friends. But with it also comes a catalog of free games. Now, PlayStation catalog is way far more advanced than what Nintendo's offering today.

But part of the thinking is that as you upgrade from PS4 to PS5, one is a bigger hard drive so you can download more games.

But also, there's about 50 million users who are paying the monthly subscription, and there's over 110 million PlayStation. So half of them are not playing online. To me, that's the opportunity is saying, can we get that up to 70, 80, 90% where they want to play online with their friends? And with that, they'll now get the PlayStation subscription back.

And then with that comes obviously online play, but also a catalog of games that PlayStation rotates out and offers to you. So you look at where the consoles are and they're basically the key distribution channels now or the becoming more important. And I think what they're doing in the subscription side really changes the game because if your content, you're wondering, do I participate in the subscription? Do I don't? It's a really interesting dynamic on that front in terms of

the spending increasing for gamers today. Now, you touched on just what that means. So we think the lifetime value of a PlayStation customer is around $600. And we think the next three, four, five years, that's going to go to almost $2,000. And that's going to be on the back of two things. One, content just moves towards live service. And with that, more spending in terms of microtransactions. And then two,

I think the subscription part is a key part because gaming's longevity comes from the social aspect. You asked me earlier about what gaming was 10 years ago. And look, I've grown up playing games and it was a single player experience. You bought a game, you played it for two weekends and you were done. That was it. Move on to the next thing.

That's not the case anymore. And I think that's what makes this next bump and what we think lifetime value of customers will be for both the PlayStation ecosystem and the Switch ecosystem really interesting next four or five years.

Yeah, it's fascinating. And then those numbers in terms of lifetime value of a customer are staggering. When you think about the components, I think you've outlined you have the first party dynamic, and then you have the third party dynamic. And a lot of what I think led to the iPhone app store success was just the emergence of these third party apps, where there was this new economy that was fruitful, that the

that they could go after. Until very recently, you didn't hear nearly as much about that 30% toll road fee. In the early days, it was just a new opportunity that never previously existed that offered very interesting ways to make money. Where do we stand just in terms of the third party side of the equation? I think you mentioned in terms of being the walled garden versus overpassing.

open to these third parties. But how much development is going on there? How key is that to the thesis just more broadly? Where do we stand? So for a Switch ecosystem, from our estimates, close to 70% of spend is first party. And essentially what that tells you is I'm buying a Switch to play Mario, to play Pokemon, to play Zelda. And that pool is super, super powerful because there's over 120 million plus players

Maximum users on the Switch and growing. Now, when we look at Sony, a little bit different dynamic. We'd actually flip that because third party is almost 70% of the spend.

And for the PlayStation ecosystem, they're able to support the latest and greatest because it's the latest hardware and graphics and it appeals to a much older audience. I think the way we look at what's going to happen with these different ecosystem is the Switch is going to catch up. I think they've given us enough in terms of what we've seen in terms of the leaked data on the Switch successor is third party will be something that they start really supporting.

And then for the PlayStation ecosystem, look, you just saw the biggest acquisition ever in Microsoft buying Activision. And Sony now recently has been rumored on buying a Japanese game company called Katakawa. But I don't think the industry stopped consolidating and they're going to keep buying content. And with that, that's going to be a key pool to their ecosystem in due time. It's also a way to hedge the potential risk. I want to talk about the risk of

to our console thesis in, let's say, 10 years from now. But content is a key pool to these ecosystems, and I think Sony recognizes that and how they've been behaving on the M&A front.

Yeah, it's so interesting to have two different players that dominate a market that have taken two different approaches to the third party opportunity. Obviously, Nintendo seems to be slightly adjusting their tune, but certainly interesting to see. When you split out the economic opportunities, one thing that always gets talked about

an increasing amount is the in-game purchases. And that's a new thing that certainly wasn't around when I was most active with video games. How big of a market is that? And is that a portion that you expect to continue to grow over time? It feels like one of those things where there's obviously a lot of value in it. It can also be one of those areas where you can get a little bit greedy with it. But where do we stand just in terms of the size of that economy, so to speak, and where it's going?

to let's talk Switch first. Essentially, for first-party titles, there's almost next to no in-game purchases, and Nintendo's been very conservative on that. But I think from our recent conversations with the company, that is going to change, and they're more flexible to that. And partly because

They know from the third-party titles that Nintendo supports, and for Nintendo Switch's ecosystem, it's a lot of single-A, double-A indie games. They're building those tools in the Switch store to allow for in-game purchases. And I think the Switch 2, you'll see potentially Nintendo IP now start to leverage that in a way that they never did before. Now let's look at, for a moment, kind of on the PlayStation side,

I think they're well in advance into leveraging it and they understand the power of it. But maybe the right way to look at this is, is this close to what we're seeing in mobile? Because mobile gaming is pretty much dominated by this behavior.

But in mobile gaming, this behavior of in-game purchases is below single-digit percent make up mass joy of revenue, very low paying ratios. There's only a handful of games out there that have paying ratios that are close to 15%, 20%, and those are titles that you've heard of, such as Fortnite or Roblox. I think in console, it'll be interesting to see, does that shift for PlayStation ecosystem change?

They've come out and said, we'll focus more on live service games, but can they do more than what we've seen on mobile? And that's something that I'm looking at and always thinking through what is the unit level economic? Because as a gamer, I've been trained to just buy gotcha packs and it works. It's powerful. There's a dopamine hit when you get something that you really like.

But it also can create pretty bad behaviors and also create situations that doesn't really allow gaming to get to mainstream audiences in a big way. This is early days, but just on this point is you're starting to see in-game ads in console games. So as example, I play a lot of formerly called FIFA, but now called FC25.

I'm seeing ads in my game. Well, remember, I already bought this game. I paid 70 bucks to buy the game. I'm also doing in-game purchases and I'm seeing ads. I think there's a long room for console, but they also have a lot of space. And in-game ad is something that's really nascent for consoles in general.

Yeah. Well, it's interesting to see how many levers there are to pull to get that customer value up. If we just go back to that one more time, breaking out the 600 to the 2000, do you have... It doesn't have to be...

super precise measurement in terms of what drives the majority of that. But any loose math on where you expect that to be just in terms of whether it is the upfront purchases versus the subscriptions versus anything else? So let's look at Nintendo for a moment. Nintendo is not as far along as PlayStation. Back in 2015, we estimate the lifetime value was $90. 2020, 3X to $260. $260.

Now, for both Nintendo and Sony, you can see that it is growing. But if you just actually overlay the stock price and said, I bought and hold from 2015 to 2020, both of them, their stock price nearly tripled for both on the back of this becoming a much more stickier, higher quality user. Now let's get to our bold predictions. So we think Nintendo today...

the lifetime value is going to go 5x, go from $300 to $1,400. Broad stroke. Let's look at the math of what's driving it. Well,

What we're looking at when we say revenue per user, we're not looking at hardware for both sides. We're actually leaving the hardware out of it. We want to keep it apples for apples. We're just looking at the software side of spin for the users. And we know from the math is it's roughly a little under $100 for Nintendo users today. Now, what's interesting is because this is the first time Nintendo will go to an iterative cycle, meaning Switch 1, Switch 2, Switch 3,

We're taking our lifetime value, the churn part, and we're saying instead of users churning every five, six years, the churn is now only 10 years or 11 years. And the further you go out, that means the lifetime value of that user is, of course, worth more and more and more. Now, this is a pretty monumental moment for a company like Nintendo, who has never done an iterative cycle. And every set, we set the player base.

It was always hard for the market to say your lifetime value is high because I don't know if people will continue to the next device you bring out. That risk is off the table. And I think that is what gives us so much excitement around this generational consult thesis. Let's now look at Sony for a moment. Sony obviously is further along in this process. We shared that the lifetime value is around $600 today. We think this gets to almost $2,000.

But if we look at the spin power, it's around $180 per user today. And we think this is only going to grow to maybe $280, $270. But similarly, the user, instead of being around for seven, eight years, is going to stay around for 11, 12, 13 years. Because one of the things that Sony's working on and we know is that

There is less and less gaps between consoles and the titles because of live service games. If you're playing a PS5 today, let's say the next edition of PS6,

It's going to continue on. You'll go from Fortnite here to Fortnite there. And you didn't have that in the last cycle. And I think this is that broad stroke of what we're saying is that really the console cycle, this cyclicality that you saw in the past, really it's gone. And in that, the churn rates are going to come down lower on that front.

Yeah, there's a certain stickiness there and seeing how they evolve that stickiness and what leads to stickiness will be interesting as well.

On the point of profitability, so to speak, margin profile of these businesses, just the shift away from hardware makes a material difference. The cost of selling something through a retail location, having to ship all those titles, having to produce all the boxes and whatnot, looks drastically different than just granting, through a couple of clicks, access to these games online.

What does that show up in the numbers themselves for these businesses? And you could walk through to the extent that it's available for Nintendo and Sony, but just some snapshot of how much of a difference it makes. Yeah, no. So if you looked at Nintendo today, it's almost a 50-50% split between hardware and software. But if you really get down to the bottom line and earnings, it's majority software driven. Now, Nintendo and the Switch...

They were never devices that they stole, that losses. There was always small margin in it. But obviously the software margin is where you want to be. For PlayStation, very different. So margins have oscillated quite a bit between, let's say, low single digits to as high as 20%. We're at that point where right now the margins are around 10% and should be much higher. One of the things that we're looking forward to is a margin expansion story at the PlayStation ecosystem level. But...

With each of these businesses, I think the hardware is part of this, you know, if you take a step back and say, the hardware is part of this vertically integrated mode that I have, and then how these devices evolve and behavior of gamers, it will be interesting because, you know, not to get too out there, but is there a scenario where in the next generation of Switch, it becomes a phone because it's a

quite a big phone, but these things are all quite feasible to do and cost-effectively. And then when you look at the PlayStation ecosystem, obviously one of the risks to the thesis could be around people streaming games and playing from their TV. But then you think about part of this moat of why you play the Switch is you want to play the IP. And so Sony's got a treasure trove of IPs and they're requiring more.

There's a lot going on around kind of the makeup of these businesses where hardware isn't necessarily a bad thing. It's part of that moat. And the part that I think people are, when we look at the numbers in the next four or five years is we think people or market when I say people is they're sleeping on the fact that the bottom line could accelerate because of third party and software sales. And we think

That's going to be showing up in the numbers the next few quarters, but also really a question of like, hey, I have a business that

Historically, and if I take a step back, what did the PlayStation ecosystem do from a recurring operating profit perspective? So prior to PS4, PlayStation's operating profit was very volatile. It was all over the place. And hence, yeah, this is not a great business because no one likes cyclicalness. But since PS4 to today, you've had a new norm where the PlayStation ecosystem has been churning out

a couple billion dollars in profit annually. And we think this is going to accelerate and double from here, basically. When I look at Switch, same concept. So just looking at operating profits, they've always been okay, but they had that one little blip called the Wii, where they, for four or five years, operating profit went negative.

And I think markets, they look at that and say, okay, what if this happens again? And our whole argument is that that's not going to happen again because you're building off the success of the most successful device that Nintendo did in Switch, going to Switch 2. And then with that, you're also saying, look, this is a whole different market where you're making money in live service and software. So yeah, I think that touched on many points there, but...

I think that's the right way to look at it is this recurring nature and offering profit for both companies is going to be higher and then really less cyclical is the way that I would think about it.

It was just an interesting market to think about prior to the shift. You had essentially five-year DCFs for whatever the new console was and all the games associated with it. But you were going to see some cyclicality in there and then from one to the next. So it's interesting to see how it shifted. And I think that just the point on the $2 billion of operating profit from PlayStation and then the change for Nintendo makes a lot of sense. Getting back to the hardware point that you were referencing earlier,

When you think about an alternative risk just being mobile, what are the hurdles from a technology perspective for mobile to capture more of this opportunity? And what I'm basically getting at is, are there just graphical constraints that will never be reached? What are the other things that stop an iPhone or an Android from being able to carry these titles? When you look at some of the best IPs out there,

Some of them are on mobile. Some of them are on console. And it's split between these experiences. But there will always be titles that you're not going to be able to play on your phone because of just how you use the controller. And those titles don't make sense to be on a mobile device that's super tiny. I think...

It's going to come down to really the type of game you want to play and type of session you want to play. So I'm speaking out loud for a moment here, but if I were looking at Fortnite, I'm pretty sure my engagement sessions on console versus mobile are very different. Each IP will do what it makes sense because you'll have some IPs that are crossover and some that won't.

but not a big factor in my mind in terms of how the future evolves against mobile versus console. I don't think of them as fighting each other. If you wanted to get into kind of, okay, what are the things that are potentially battling each other? I would say it's console versus PC. Yeah, I wanted to get into the PC market. It's a very interesting one.

And I've probably referenced the making of Prince of Persia book on this podcast several times, but it really is fascinating. It gets you into the earlier days of this market, specifically around PCs and just how unique it was at that moment in time. But after the days of doom in the late 90s, early 2000s, when my dad brought home a copy, it felt like PC just fell off and to the benefit of the console market where all the games shifted that way.

I could be just not the right person, the end of one anecdote. But what happened to the PC market? Where does it stand today? And it sounds like there's a risk of it regaining life or being stiffer competition. So where do we stand there with that market? So the PC market, called the ballpark, it's around $40 billion. So it's slightly smaller than console in terms of spend. Still very respectable, though, in terms of relative size.

But in terms of reach and user base, so it's hard to come up with monthly active user numbers. But I think if we looked at the top platform for digital spend, it's a platform called Steam. Steam has 130 million monthly active users. So it's bigger than PlayStation, bigger than Switch, bigger than Xbox. And we know, for at least what's been out there, is that it's about 9 billion in sales. Now, what I think is interesting about the PC market is that

Of that 130 million users, about 50 million of them will get a controller and plug it into their PC to play. Now let's unpack that a little bit further.

One of that behaviors is because if I'm playing an online game on PC, I don't have to pay the subscription. Versus when you look at console, to play online, you need a subscription. You have to pay that additional five, 10 bucks a month. So if in a scenario where console says we'll get rid of the subscription online play, then I think PC is going to have a hard time. There's 50 million users who want to come over. Yeah.

Then when you unpack and you go back to the titles part, because the PC market, there's 14,000 games annually that get released on there versus consoles. There's a couple hundred, 300 games. So you're looking at AAA games versus the single A, double A indie games, very different markets. In that sense, there's just a lot of IPs that are not on PC that are console exclusives.

So myself as a gamer, I have a Switch, I have an Xbox, I have a PlayStation, I have a gaming PC. And if I'm being honest, I play my PlayStation the most and my Switch the second and the gaming PC and Xbox are the number three and four. But it's very much title driven for me.

And does PC have obviously just given by the number of titles released each year, there are going to be some that are released only on PC. But does it have major titles, major IP that are only released on PC?

They do. But I think one of the more interesting things about PC is that there's a lot of innovative tiles that come out of PC because the budgets are a lot less than console. So let me give you an example. One of our most noble investments that we were successful with is a Korean company called Krafton.

Krafton created the battle royale genre with a game called Players on a Battleground. They were the first to really invent this. And then later on, Fortnite and Free Fire came and mimicked their gameplay. But what's interesting about this game, Players on a Battleground, or PUBG, is that it was built with a budget of less than $10 million and ended up being a massive hit worldwide.

because it expanded the shooter genre in a way that shooter genre hadn't before, because it introduced a new win condition. And so when you think about PC IPs, there's a lot of innovative stuff that comes there. And since PUBG, it came out from PC. But then once successful, they immediately go into mobile. They immediately go into console because they know the bigger markets are there in terms of profit pool on that side.

And when you think about the third-party market, just game developers, new games, where they're coming from, are there any new entrants or interesting catalysts for that market to potentially grow on console? Absolutely. In fact, I think one of the most interesting things that we've seen since we've been investing in video games going back to 2017 was the flood of venture capital that went into the space of

on this metaverse thesis and COVID hype. And so on the back of that, you've just seen a bunch of venture funding that before COVID never really happened. And so we think there's already a handful of venture game studios that have looked at console as a way to explore that before would never look at it. Do you remember console? There's only a couple hundred games that launch each year. And then the second piece is...

How do we reach this audience to the store in terms of advertising on there? And because we know that the console gamer is a high value customer, that's one that's much more valuable than just the mobile gaming user. It's a market where I'm always impressed. You referenced the leaks earlier. There's something to be said for how big an industry is and how niche and obsessive the customers are based on the number of leaks that come out.

You can have industries where nobody cares if there's a leak about the next apparel line from the GAC. But if there's a leak about a video game, people are lined up at their computers looking at every pixel. So there's something very interesting about the customer base and the obsessiveness of it. One of the things that we've never talked about in our conversations has been esports, which was a very popular theme. And there's the whole idea of streaming and that being something that's major. Does that play any...

any role in the economy of these games, these consoles in the future? Just what's your thought process around esports? Because it felt so thematic in the moment, say five years ago, and I just haven't followed it nearly as much recently. So esports, when it first got a bunch of momentum, people were investing in teams and it was

really wild back then. But I think when you take a step back and you look at really what it is, it's a marketing function and the value is really accumulating to the game itself because people are playing your game all over and they're playing it competitively. But we're potentially maybe getting into an area where esports might be something more than just marketing. And why I say that is because

Up until this year, esports has been run in Asia that's run by different channels. And now we have the first Olympic sport event happening next year in Saudi. And

I think that's a big deal because now countries are going to win Olympic medals in esports in a situation that they never happened before. And you have countries like Japan that have come out and said, we're building teams. And Korea is a powerhouse in this category. So I think the esport category, if I look at it, I think it's a soft power aspect. From a business model perspective, it's a media company. You're trying to get eyeballs and

You're getting to an audience that is the next generation of consumers. You're building brand awareness from that front. But it definitely has its own challenges when you look at what's the lifetime of an esport player. It's only a couple of years. Is your brand the player? Is it the team? They're global. They're not really city-based.

It's a very fascinating case study, I think, of just real... But also you think about how many people want to make this work and think about where the consumer is today. So I mentioned to you earlier, I play a lot of FC25. Every footballer today looks at their FC25 rating and complains about it. And they care a lot because they're the first generation of footballers who are probably playing a lot of games themselves too when not on the pitch training. Yeah.

So discoverability, brand awareness, esports is, I think, a channel for creating that awareness. And then thinking about generational dynamics and consumer preferences, how does that play into this? I am certainly of a generation where consoles were a major theme. But as you think about different generations, their preferences, are there any unique dynamics there that play a role in this thesis? Yeah.

In fact, one of the most exciting parts to the thesis is that there is this massive sector growth and what is known as Gen Z. And so myself, I'm a millennial, but when I think about investing, I think about investing into what Gen Z wants to do. And the reason is simple.

They are the most important incremental spender in a decade ahead. And if you think about markets, pricing change is very hard. And I'm always thinking about where does incremental spend happen? So back to Gen Z. So the oldest Gen Z-er is around 25, 26 years old. They're just starting to enter the workforce.

In terms of estimates, the spin power today is roughly $400 billion, and it's expected to grow to $2 trillion. And so when you think about that kind of spin at a global level, that is what gets me really excited about the video game industry on a whole. But then specifically when I think about the mid to hardcore gaming of console, where you're spending hours on your couch playing with your friends,

And now let's get into the social aspects of Gen Z. This is really the first generation that grew up playing games with both guys and girls. And that has led to huge implications of why microtransactions are working versus in my generation, you didn't have that dynamic and microtransactions really didn't exist as a concept. So there is essentially a scenario here where I think in the next 10, 15 years,

Gaming surprises a lot of people and goes from an overall $200 billion to a trillion dollar industry. But it's because the paying ratios are going up, not just in mobile, but people are going to spend money in games overall because this is now the activity to hang out. And now that you have both genders playing games, it introduces all the social dynamics of why we spend money in the real world.

So that is truly what makes this next decade unique and what makes us so excited to be going all in into this thesis. When I put this all together and just think about the signposts or the milestones to watch for, for the thesis to play out, I think you outlined switch to being successful.

a major one, and then on the PlayStation side, the next Grand Theft Auto release. Obviously, if there's delays around those, that moves things around a little bit. But is the main thing that you're watching for just the adoption and the sale of those titles? What else are you monitoring the most to maintain confidence in this thesis playing out? Yeah, so let's first touch on Nintendo first.

Nintendo historically has been viewed through this lens of how many units you sell this year. And the most they ever sold was 21 million units. That was the first with the Switch 1. And that was in year 3. And Wall Street will continue to focus on that, a number of units sold, number of units sold. But remember, there was a time when everyone looked at Apple the same way, how many units you sell.

Nintendo in the last few years has been disclosing active annual players, and they're going to continue to reinforce disclosing KPIs as they stop focusing on how many YouTube sell, how many active players in our ecosystem is that number growing. So to me, that's the key KPI from that front.

PlayStation, much further along in that sense. But I think for us, what we're going to spend more time thinking about is how much is around the subscription side. Can you grow from the 50? Can you grow that to 60, 70, 80 million on that front? And then when you think about the console market overall, something that kind of doesn't get discussed enough that I think really deserves a flashlight because it's the 10-year vision of how big consoles can get is

is we're not seeing huge player-based growth in these markets in terms of Western. But think about a market like India. Think about a market like China. Console gaming is actually growing. So I'll give you a fun fact. In India, PlayStation is dominating, but it's dominating with maybe $200 million in revenue. But this grew 50% last year. Now, obviously, you think about a PlayStation device and the price point and the TV, right?

But if you want to play the middle class of India, that is a 10-year vision. And the console gaming markets for it to grow will have to go in a market like India. Now, it was interesting, early this year in August, there was an IP called Black Myth Wukong that came from China, six years in development, used Chinese historical IP, and that caused PS5s to sell out in China.

And today, the console gaming market in China is called 20 million people. And this is out of a market at 600 million people. So China is the biggest single gaming market in the world. But console gaming has really got a long way to go to catch up. But again, it goes back to what's going to pull a lot of people to consoles. I think it's going to be the IPs itself, the titles, if you want to play it. So that was a really good example of, I think, people potentially sleeping on the fact that

You have China and its rules of regulation, but console gaming is growing market there. Then you have India, which is super early. It's less than a million users, a couple hundred million in sales. But this last year we saw 50% growth and PlayStation and Sony has come out and said, we're going to really focus on India. So they've actually recently set up a division to go and invest in Indian content and help support building that on that front.

So that's, I think about 10 years from now, I'm thinking about emerging markets and I'm thinking about their adoption of consoles on that front in terms of just new users coming in.

And then just to bring this to a wrap, when you think about the market's appreciation for this, what's reflected in the businesses themselves, the stocks themselves, how do you go about approaching that? Whether it's just the growth potential from the actual earnings or the multiple itself and a potential rewriting based on the back of a business model shift, how would you even begin to frame that and think through it?

So let's break this down one by one. Nintendo first. If you think about where Nintendo is going and its operating profit, it has margins of 35 plus percent. It's been doing that for many years. It's highly profitable. 12 billion plus in cash. It's in a great place. And I think the next step is saying, well, why do you trade at this multiple of 13, 14 times EBITDA? Why can't this be much higher? Why can't this be maybe more like a Netflix? And I say Netflix because...

When I think about Netflix, close to $300 billion and Nintendo at $60 billion market cap. Nintendo could be at Netflix's earnings power today in the next few years. But that's going to take some time. It's going to take not just having first party, but really having third party titles come in and say, let's leverage the in-game purchases that create these massive economies. So one thing that gets us excited is you think about

there's titles I've never before been on the Switch. So the Call of Duty title from Microsoft, that's coming on the Switch, that's announced. And I think there's more of that title on that front. So I always think about when it comes to valuation, both these companies, both Nintendo and Sony, they're going to have strong earnings growth the next few years, but what multiple will you pay? And to me, in the case of Nintendo, it just has to keep doing what it's doing. Margins could expand, but

I think it warrants higher multiple because of its just quality of the business. Now let's take a look at Sony. Sony, I think, will be a lot clearer story of this evolution because margins are lower than they need to be. They should be much higher at both the PlayStation level and at the group level. And I think if we see that really materialize, margin expansion stories are well received by the market.

Because bear in mind, Sony trades at eight times EBITDA. Should this be at 15 times or 20 times? Honestly, I would say yes for a company that is a global leader in entertainment and both video games, but you can talk about music and anime and other categories. So the margin expansion story is a tried and true approach to multiple expansion. And I think for Sony, that would be the next step for it.

Excellent. Well, this has been a fun kickoff to the rest of these conversations where we'll dive deeper into the individual businesses, but appreciate you sharing the knowledge. My pleasure. Thank you for your time. To find more episodes of Breakdowns ranging from Costco to Visa to Moderna, or to sign up for our weekly summary, check out JoinColossus.com. That's J-O-I-N-C-O-L-O-S-S-U-S dot com.