游戏主机（第1部分）：投资论点——[Business Breakdowns，第201期]

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This is Business Breakdowns. Business Breakdowns is a series of conversations with investors and operators diving deep into a single business. For each business, we explore its history, its business model, its competitive advantages, and what makes it tick. We believe every business has lessons and secrets that investors and operators can learn from, and we are here to bring them to you. To find more episodes of Breakdowns, check out joincolossus.com. All opinions expressed by hosts and podcast guests are solely their own opinions. Hosts, podcast guests, their employers, or affiliates may maintain positions in the securities discussed in this podcast. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions.

This is Matt Russell, and today's episode is the first in a multipart series on the video game market, more specifically, the video game console market. Our guest is Sia Kamalie, the founder and fund manager at Skycatcher. Skycatcher describes itself as focused on capturing asymmetry at the internet frontier, and Sia has 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 its size and where it stands today. Admittedly, I did not appreciate that 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 catalyst in terms of both the return profile for these businesses and this specific economic model, as well as the potential inflection in earnings.

We get into even more depth in Episodes 2 and 3, when we cover the names most exposed to this theme, Sony and Nintendo. I think the shift from hardware to a more software-like revenue stream is obviously a positive for these businesses, but Sia lays out the numbers around how big of an impact this could be. 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 emphasize that today. I wouldn't insult your intelligence and suggest that our other episodes don't come across as bullish, but we invited Sia to lay out his thesis, so this one is particularly geared toward 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, Sia, 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 playing out within an industry that's really interesting to a lot of people: the video game market. You've come at this with a creative observation and something very interesting around video game consoles specifically. In this introductory episode, we're going to cover a lot about that market and a lot about your thesis.

To kick things off, when I think of the video game market 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. Maybe you could just give us a state-of-the-world sketch of where we stand today with video game consoles, and then we can get into the juice and the meat from there.

Absolutely. I'm also super excited to be here. 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.

As for the state of affairs, you're looking at a market that's roughly $50 billion across the world. There are 3 players: Nintendo, with its Switch franchise; Sony, with the PlayStation franchise; and Microsoft, with Xbox. The clear leader, in terms of how you divide this up, is actually quite interesting. Nintendo and Switch dominate the family category, while PlayStation dominates the mature audience globally.

You could say, if you had to stack-rank them, I'd probably put PlayStation at the top of the list in terms of overall spending across the consoles. They're roughly 50% of that spend. Then there's Nintendo, which is going to catch up. Most of Nintendo's purchases are first-party, and third-party is catching up on the side. Microsoft is not a distant third because, on a global basis, it may be, but in terms of the U.S. and Europe, it has strong footholds there for now.

Let's think about where this market stands in terms of size. There are about 330 million monthly active users across this entire ecosystem. If you went back and looked at this 10 years ago, we estimate there were 150 million to 180 million people. The market has roughly doubled in the last 10 years. It's been very steady growth, and in terms of revenue, you've seen revenues roughly double over that period as well.

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

You mentioned that $50 billion number. I assume that's an annual metric, just for context, to get a sense of size. When I think about what incorporates $50 billion, is that console sales, or is there a lot more going on beyond that?

That number is just focusing on software: first-party, third-party, and additional subscription services. A little less than half of that is dominated by PlayStation. They're the most advanced in terms of that aspect of the business.

Just hearing the size of the market and the active users that have grown brings Mark Twain's “The reports of my death are greatly exaggerated” quote to mind. I had imagined that you had seen more of a shift toward mobile at the detriment of video game consoles. Can you talk a little bit about that dynamic and set the record straight on what has been happening with mobile, and whether that's impacted market share at all for video game consoles?

Mobile really took off from 2010 and 2011 onward, and represents—let's just call total gaming $220 billion in total—almost half of that. Mobile has been the place to be for the last 10 years, but that changed in the last 2 or 3 years after changes to IDFA and other challenges around mobile-game ROI in terms of ad spend.

During this entire period, you can see that core gaming—console gaming and PC—continued to grow steadily. When you think about the core gamer versus the mobile gamer, the core gamer is willing to shell out a couple hundred dollars for a device that plays a game. A mobile gamer is just playing something to pass the time on their phone, usually in very short sessions. You look at the console gamer, and they'll play for hours.

I think you have to look at these 2 cohorts and say that most gamers are both. They do mobile gaming and console gaming. But where the spending power is, in terms of time for money, there's much better value in console gaming because of how much time you can spend on a big screen on your couch. Mobile gaming has obviously made more money, but if you look at how mobile games make money, it's through gacha mechanics and a lot of these high-dopamine types of hits.

The mobile gaming economies are fascinating, just to get an appreciation for 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. Maybe you could 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 model?

This gets to the crux of our thesis. We view video game consoles as generational platforms, and it's because of this change that we think people are mispricing them.

You think about 10 years ago: the console was a device that you bought on disc from Walmart or GameStop, put the disc in, and played. That whole console was just this thing that played games. It didn't do much more than that. But today, these devices are where you buy the game digitally, so you're not going to a retail shop to buy it anymore.

You're also playing games online with your friends, and the live-services part is making money through either the online subscription or microtransactions. Third, and this is really where the lock-in comes from, once you download the game, it becomes part of your content library. That means you're stuck in the PlayStation ecosystem, or stuck in Switch, or stuck in Xbox.

I think this control—or the moat—that the console has over the user is far more powerful than people have come to realize. For us, that wake-up moment started in 2015, but COVID really added fuel to the fire of our thesis when we looked at the numbers behind it.

Go back to 2015 and look at Nintendo and PlayStation digital purchases of sales, meaning buying a game through the console. They were less than 10%; most people back in 2015 were still buying physical discs. Fast-forward to today, and Sony is at almost 70%, while Nintendo is closer to 60%. That tipping point has happened.

For us, when you think about the margin that now gets collected by Sony's PlayStation and Nintendo Switch, they're acting as the App Store. If we take even one step further back, I'd argue that one of the best business models of all time has been the App Store business model.

When we look at the total net earnings power of the console App Stores versus Apple's App Store today, you're capturing Apple's App Store around 2015 or 2016. If we had gone back and said, “Let's buy Apple in 2016,” that led to a massive return because today's Apple App Store net earnings are, we estimate, close to $23 billion or $24 billion a year.

You're now at that point where you're halfway through, but the next half is actually going to be the really profitable part, where we get to 100%. We already see consoles today coming without discs.

Can you spell that out a little bit? You mentioned that the shift for the video game industry really started taking place around 2015 or 2016, and it's many years later. Why is now the time when you really see that shift? If there's an analog to point to, that's helpful as well, in terms of why you see it as gradual and then sudden. It sounds like that's your description.

Let's look back again from 2015 to today. What was the other major thing that happened here for consoles and gamers? For the console, you had the major live-service games come out, such as Fortnite and PlayerUnknown's Battlegrounds. These were titles that really brought the idea of games lasting forever to a completely different level of scale that didn't exist before.

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 roughly triple from here. For Nintendo, it's around $300, but we think it's going to 5 times from here, to over $1,400.

For both of these consoles and ecosystems, there are 2 different drivers happening. Let's break them down one by one. For Nintendo, you are now 8 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 2025.

With the Switch 2, it's a massive hardware upgrade. We think it will not just support the current Nintendo games, but also really support third-party titles that weren't there before.

On the other side, for Sony's PlayStation, we're at a different stage. The PS5 has been out for 4 or 5 years, and the PS5 Pro just came out. We know the next 4 years—the second half of the PlayStation console cycle—is typically the most profitable. But we're also entering a phase where PlayStation has come out and said it's going to really focus on live-service games in a way that it never did before.

Historically, Sony and PlayStation have always been the king of single-player games. Now they're really putting more resources, especially for their own IP, into live-service games.

To sum it up, from 2015 to today, spending for gamers on both platforms has increased. We're at a point where spending for the PlayStation user just on the software side is around $180, and for Nintendo we estimate it's a little under $100. For both platforms, we see continued growth, but a lot of it is going to depend on live-service spending.

The claim around Nintendo with the Switch release makes a lot of sense. Are there any catalysts from the Sony side? I think what you referenced there, in terms of being in this cycle on the PlayStation side, is important. Are there milestones or catalysts that you've seen that represent something important in terms of Sony also partaking in this?

Absolutely. With this PS5 cycle, I would argue that it hasn't really had its console-selling title yet, aside from the Grand Theft Auto series. The last time you had a new iteration of Grand Theft Auto, it caused a massive upgrade from PlayStation 3 to PlayStation 4.

Right now, we're at an interesting moment for PlayStation where the PS4-to-PS5 transition is only 50%. What's really interesting when you get into the data—and this is what Sony shared with us—is that even though the user base is split between the 2 platforms, with roughly 120 million gamers across the 2, we know that PS5 gamers spend 1 billion more hours playing than PS4 gamers. That's from an engagement perspective.

You then ask, “What's going to cause people to go from PS4 to PS5?” 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 drive massive sales of PS5s. I wouldn't be surprised if we see sellouts across the board on that front.

Remember, when you're spending more time in a game, as we see PS5 users doing, you're also probably likely to spend more money in the game. First and foremost, you have to look at this as a broad stroke toward the health of the ecosystem.

When we look at that, there are really 2 metrics we're looking at in terms of a very simple LTV analysis. We're looking at average revenue per user, and then, on the denominator side, how many are churning and how many stay around.

When you think about this math, let's take Sony's PlayStation as an example. I mentioned the big jump that happened from 2015 to 2020 for PlayStation. Our estimate was that the lifetime value of a user went from a little under $200 to $500.

What drove that? First, user spending almost doubled. But, more importantly, users are staying in the ecosystem longer and there's less and less churn.

When I think about the upgrade, you're going to see customers transition from one console to the next, which is going to provide that initial revenue bump for the new console. Do you see a material change beyond that? Let's say the customer was on a PS4. There theoretically should have been some revenue base they're stepping into with the PS5, so you're going to get that one-time impact. Are there other knock-on effects beyond that, where the value of that customer increases just from the upgrade beyond the initial purchase?

There are 2 parts to this thesis. One is the App Store, where you collect a 30% toll road on every digital purchase, both first-party and third-party. The second piece is subscriptions.

What you need to understand is that both Nintendo Switch's subscription offering and PlayStation's offering allow you to connect online and play with your friends. They also come with a catalog of free games. The PlayStation catalog is far more advanced than what Nintendo offers today.

Part of the thinking is that as you upgrade from PS4 to PS5, you have a bigger hard drive, so you can download more games. But there are also about 50 million users who are paying for the monthly subscription, while there are over 110 million PlayStation users. Half of them are not playing online.

To me, that's the opportunity. Can we get that up to 70%, 80%, or 90% of users who want to play online with their friends? With that, they'll get the PlayStation subscription. That gives them online play, but it also gives them a catalog of games that PlayStation rotates and offers to them.

You look at where the consoles are, and they're basically the key distribution channels now, or they're becoming more important. What they're doing on the subscription side really changes the game. If you're a content creator, you're wondering whether you should participate in the subscription. It's a really interesting dynamic on that front.

In terms of spending increasing for gamers today, we think the lifetime value of a PlayStation customer is around $600, and over the next 3, 4, or 5 years, we think that's going to go to almost $2,000. That's going to be on the back of 2 things.

First, content is moving toward live services, and with that comes more spending in terms of microtransactions. Second, the subscription part is key because gaming's longevity comes from the social aspect.

You asked me earlier about what gaming was 10 years ago. I grew up playing games, and it was a single-player experience. You bought a game, played it for 2 weekends, and when you were done, you moved on to the next thing. That's not the case anymore.

I think that's what makes this next bump—and what we think lifetime value will be for both the PlayStation ecosystem and the Switch ecosystem—really interesting over the next 4 or 5 years.

It's fascinating, and those numbers in terms of lifetime value are staggering when you think about the components you outlined. You have the first-party dynamic, and then you have the third-party dynamic. A lot of what led to the iPhone App Store's success was the emergence of these third-party apps, where there was a new, fruitful economy 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 had never previously existed and offered very interesting ways to make money. Where do we stand on the third-party side of the equation?

You mentioned the console as a walled garden versus being open to these third parties. How much development is going on there, and how key is that to the thesis more broadly?

For the Switch ecosystem, our estimate is that close to 70% of spending is first-party. Essentially, what that tells you is that people are buying a Switch to play Mario, Pokémon, and Zelda. That pool is extremely powerful because there are over 120 million active users on the Switch, and that number is growing.

When we look at Sony, there's a different dynamic. It could actually flip that, because third-party is almost 70% of spending. The PlayStation ecosystem is able to support the latest and greatest in terms of hardware and graphics, and it appeals to a much older audience.

The way we look at what's going to happen with these different ecosystems is that the Switch is going to catch up. I think they've given us enough, in terms of what we've seen in the leaked data on the Switch successor, to suggest that third-party titles will be something they start really supporting.

For the PlayStation ecosystem, you just saw the biggest acquisition ever in Microsoft buying Activision Blizzard. Sony has also recently been rumored to be buying a Japanese game company called Kadokawa.

I think the industry is still consolidating, and they're going to keep buying content. That will be a key pull to their ecosystems in due time. It's also a way to hedge the potential risk. We can talk about the risks to our console thesis in, let's say, 10 years from now, but content is a key pull to these ecosystems. I think Sony recognizes that, based on how it has been behaving on many fronts.

It's interesting to have 2 different players that dominate a market taking 2 different approaches to the third-party opportunity. Nintendo seems to be slightly adjusting its tune, but it's certainly interesting to see how you split out the economic opportunities.

One thing that always gets talked about an increasing amount is in-game purchases. 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 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, but it can also be an area where you get a little bit greedy. Where do we stand in terms of the size of that economy, so to speak, and where it's going?

Let's talk about the Switch first. For first-party titles, there's almost no in-game purchasing. Nintendo has been very conservative on that, but I think, based on our recent conversations with the company, that's going to change. They're more flexible about it, partly because of the third-party titles that Nintendo supports.

For the Nintendo Switch ecosystem, there's a lot of single-A, double-A, and indie games. Nintendo is building tools in the Nintendo eShop to allow for in-game purchases. With the Switch 2, you'll potentially see Nintendo IP start to leverage that in a way it never did before.

Let's look at the PlayStation side. I think PlayStation is well advanced in leveraging in-game purchases, and it understands their power. But perhaps the right way to look at this is to ask whether it's close to what we're seeing in mobile.

Mobile gaming is pretty much dominated by this behavior, but in mobile gaming, this behavior has below-single-digit paying ratios and makes up massive revenue. There are only a handful of games with paying ratios close to 15% or 20%, and those are titles you've heard of, such as Fortnite or Roblox.

I think it will be interesting to see whether that changes on PlayStation. The company has come out and said it will focus more on live-service games, but can it do more than we've seen on mobile? That's something I'm looking at and always thinking through: what are the unit-level economics?

As a gamer, I've been trained to buy gacha packs, and it works. There's a dopamine hit when you get something you really like, but it can also create pretty bad behaviors and situations that don't really allow gaming to reach mainstream audiences in a big way.

This is early days, but you're starting to see in-game ads in console games. As an example, I play a lot of EA Sports FC 25, formerly called FIFA. I'm seeing ads in my game. Remember, I already bought this game. I paid $70 to buy it, I'm also making in-game purchases, and I'm seeing ads.

I think there's a long runway for consoles, but they also have a lot of room to grow. In-game ads are something that's really new for consoles in general.

It's interesting to see how many levers there are to pull to get that customer value up. If we go back to the $600-to-$2,000 figure one more time, do you have to be super precise about the measurement? Any loose math on what drives the majority of that? Is it the upfront purchases, subscriptions, or something else?

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. In 2020, it had tripled to $260.

For both Nintendo and Sony, you can see that lifetime value is growing. If you overlay the stock price, you can say that if you bought and held from 2015 to 2020, both stocks nearly tripled. That was on the back of the user becoming much stickier and higher quality.

Now let's get to our broader predictions. We think Nintendo's lifetime value today can grow 5 times, from $300 to $1,400. Let's look at the math driving it.

When we say revenue per user, we're not looking at hardware for either side. We're leaving hardware out of it because we want to keep it apples-to-apples. We're just looking at software spending by users, and we know from the math that it's a little under $100 for a Nintendo user today.

What's interesting is that this is the first time Nintendo will go through an iterative cycle—Switch 1, Switch 2, Switch 3. We're taking our lifetime value and churn assumptions, and we're saying that instead of users churning every 5 or 6 years, the churn period is now 10 or 11 years. The further you go out, the more that user's lifetime value is worth.

This is a monumental moment for a company like Nintendo, which has never gone through an iterative cycle and has historically reset the player base with every new device. It was always hard for the market to say, “Your lifetime value is high,” because people might not continue to the next device you release.

That risk is off the table, and I think that's what gives us so much excitement around this generational console thesis.

Let's look at Sony for a moment. Sony is further along in this process. We shared that the lifetime value is around $600 today, and we think this gets to almost $2,000. If we look at spending power, it's around $180 per user today, and we think that's only going to grow to perhaps $270 or $280.

Similarly, instead of users being around for 7 or 8 years, they're going to stay around for 11, 12, or 13 years. One of the things Sony is working on, as we know, is reducing the gaps between consoles and titles through live-service games.

If you're playing a PS5 today and the next edition, the PS6, comes out, the experience will continue. You'll go from Fortnite here to Fortnite there. You didn't have that in the last cycle.

I think that's the broad stroke of what we're saying: the console cycle's cyclicality is really gone, and churn rates are going to come down as a result.

There's a certain stickiness there, and seeing how they evolve that stickiness and what leads to it will be interesting as well. On profitability, or the margin profile of these businesses, the shift away from hardware makes a material difference.

The cost of selling something through a retail location, shipping all those titles, and producing all the boxes looks drastically different from granting access to these games through a couple of clicks. What does that show up as in the numbers themselves for these businesses?

You can walk through what's available for Nintendo and Sony, but just give us a snapshot of how much of a difference it makes.

If you look at Nintendo today, it's almost a 50/50 split between hardware and software. But if you get down to the bottom line and earnings, it's majority software-driven.

Nintendo and the Switch were never devices that they sold at a loss. There was always a small margin in the hardware, but obviously the software margin is where you want to be.

For PlayStation, it's very different. Margins have oscillated quite a bit, from the low single digits to as high as 20%. We're at a point where margins are currently around 10%, but they should be much higher. One of the things we're looking forward to is a margin-expansion story at the PlayStation ecosystem level.

With each of these businesses, I think hardware is part of the moat. If you take a step back, hardware is part of this vertically integrated moat. It's about how these devices evolve and how gamers behave.

Not to get too far out there, but is there a scenario where the next generation of Switch becomes a phone? It's a fairly large phone, but these things are quite feasible to do cost-effectively.

When you look at the PlayStation ecosystem, one risk to the thesis could be people streaming games and playing them from their television. But part of the moat is why you play the Switch: you want to play the IP. Sony has a treasure trove of IP and is acquiring more.

There's a lot going on around the makeup of these businesses. Hardware isn't necessarily a bad thing; it's part of the moat. The point people are missing when we look at the next 4 or 5 years is that the bottom line could accelerate because of third-party software sales.

We think that's going to show up in the numbers over the next few quarters. But it's also a question of saying, “Historically, what did the PlayStation ecosystem do from a recurring operating-profit perspective?”

Before the PS4, PlayStation's operating profit was very volatile. It was all over the place. You could say, “This is not a great business because no one likes cyclical businesses.” But from the PS4 to today, you've had a new norm where the PlayStation ecosystem has generated a couple of billion dollars in profit annually.

We think this is going to accelerate and double from here. When you look at Switch, it's the same concept. Its operating profits have always been okay, but there was one little blip called the Wii U, where operating profit went negative for 4 or 5 years.

Markets look at that and say, “What if this happens again?” Our whole argument is that it's not going to happen again because Nintendo is building off the success of its most successful device ever, going from the Switch to the Switch 2. It's also a completely different market, where you're making money from live services and software.

I think that's the right way to look at it. This recurring nature of operating profit for both companies is going to be higher, and the businesses are going to be less cyclical.

It's an interesting market to think about. Before the shift, you essentially had 5-year DCFs for whatever the new console was and all the games associated with it. You would see some cyclicality in there and then move from one cycle to the next.

It's interesting to see how that has shifted. Getting back to the hardware point you referenced, when you think about an alternative risk from mobile, what are the hurdles from a technology perspective for mobile to capture more of this opportunity?

What I'm getting at is whether there are graphical constraints that will never be reached, or what else stops an iPhone or an Android device from being able to carry these titles.

When you look at some of the best IP out there, some of it is on mobile, some of it is on console, and it's split between those experiences. But there will always be titles that you're not going to be able to play on your phone because of how you use the controller and because those titles don't make sense on a tiny mobile device.

I think it's going to come down to the type of game you want to play and the type of session you want to have. 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 would be very different.

Each IP will do what makes sense. Some IP will cross over, and some won't. But it's not a big factor in my mind in terms of how the future evolves between mobile and console. I don't think of them as fighting each other.

If you wanted to identify the things that are potentially battling each other, I would say it's console versus PC.

I wanted to get into the PC market. I've probably referenced The Making of Prince of Persia book on this podcast several times, but it's fascinating. It gets you into the earlier days of this market, specifically around PCs, and how unique it was at that moment in time.

But after the days of Doom in the late 1990s and early 2000s, when my dad brought home a copy, it felt like PC just fell off, to the benefit of the console market, where all the games shifted that way. I could be the wrong person—the n-of-1 anecdote—but what happened to the PC market? Where does it stand today?

It sounds like there's a risk of it regaining momentum or becoming stiffer competition. Where do we stand with that market?

The PC market, to use a ballpark figure, is around $40 billion. It's slightly smaller than console in terms of spending, but still very respectable in terms of relative size.

In terms of reach and user base, it's hard to come up with monthly active user numbers. But if we look at the top platform for digital spending, it's a platform called Steam. Steam has 130 million monthly active users, so it's bigger than PlayStation, Switch, or Xbox. We know from what has been publicly reported that it's close to $9 billion in sales.

What's interesting about the PC market is that, of those 130 million users, about 50 million will get a controller and plug it into their PC to play. Let's unpack that behavior a little further.

Part of it is because if I'm playing an online game on PC, I don't have to pay a subscription. When you look at console, you need a subscription to play online. You have to pay that additional $5 or $10 a month.

In a scenario where console says it will get rid of the subscription for online play, I think PC is going to have a hard time. There are 50 million users who want to come over.

When you unpack the titles and go back to the number of games released, the PC market has around 14,000 games released annually, versus a couple hundred or 300 games on consoles. You're looking at triple-A games versus single-A, double-A, and indie games. They're very different markets in that sense.

There are a lot of IP that aren't on PC and are console exclusives. I have a Switch, an Xbox, a PlayStation, and a gaming PC. If I'm being honest, I play my PlayStation the most and my Switch second. The gaming PC and Xbox are third and fourth, but it's very much title-driven for me.

Given the number of titles released each year, there are obviously going to be some games released only on PC. Does PC have major titles and major IP that are only released there?

It does, but I think one of the more interesting things about PC is that a lot of innovative titles come out of it because the budgets are much lower than on console.

Let me give you an example. One of our most notable successful investments is a Korean company called Krafton. Krafton created the battle royale genre with a game called PlayerUnknown's Battlegrounds, or PUBG. They were the first to really invent this, and later Fortnite and Free Fire came along and mimicked their gameplay.

What's interesting about PUBG is that it was built with a budget of less than $10 million and ended up being a massive hit. It expanded the shooter genre in a way that hadn't happened before because it introduced a new win condition.

When you think about PC IP, there's a lot of innovative material that comes from there. Since PUBG came out of PC, once it became successful, they immediately went into mobile and immediately went into console because they knew the bigger markets were there in terms of the profit pool.

When you think about the third-party market—game developers and new games—where are they coming from? Are there new entrants or interesting catalysts for that market to potentially grow on console?

Absolutely. In fact, one of the most interesting things we've seen since we've been investing in video games, going back to 2017, was the flood of venture capital into the space on the metaverse thesis and the COVID hype.

On the back of that, you've seen a bunch of venture funding that never really happened before COVID. We think there are already a handful of venture-funded game studios looking at console as a way to expand that previously would never have considered it.

Remember, on console there are only a couple hundred games launched each year. The second piece is how you reach this audience in the store in terms of advertising there. We know that the console gamer is a high-value customer, much more valuable than the mobile-gaming user.

I'm always impressed by the leaks. 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 product line from the Gap. But if there's a leak about a video game, people are lined up at their computers looking at every pixel. There's something very interesting about the customer base and its obsessiveness.

One of the things we've never talked about in our conversations is esports, which was a very popular theme. There's also the whole idea of streaming and that being something major. Does that play any role in the economy of these games and consoles in the future?

What's your thought process around esports? It felt so thematic about 5 years ago, and I just haven't followed it nearly as much recently.

When esports first got a lot of momentum, people were investing in teams, and it was really wild back then. But I think when you take a step back and look at what it really is, it's a marketing function. The value is really accumulating to the game itself because people are playing your game all over the world and playing it competitively.

We're potentially getting into an area where esports might be something more than just marketing. I say that because, until this year, esports had been run in Asia through different channels. Now we have the first Olympic esports event happening next year in Saudi Arabia, and I think that's a big deal.

Countries are now going to win Olympic medals in a sports situation that had never happened before. Japan has come out and said it's building teams, and Korea is a powerhouse in this category.

If I look at esports, 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 reach an audience that represents the next generation of consumers. You're building brand awareness through that channel.

It definitely has its own challenges. When you look at the lifetime of an esports player, it's only a couple of years. Is your brand the player, or is it the team? They're global; they're not really city-based. It's a fascinating case study.

But think about how many people want to make this work, and think about where the consumer is today. I mentioned earlier that I play a lot of EA Sports FC 25. Every footballer today looks at their FC 25 rating and complains about it. They care a lot because they're the first generation of footballers who are probably playing a lot of games themselves when they're not on the pitch training.

Discoverability and brand awareness—esports is a channel for creating that awareness.

Thinking about generational dynamics and consumer preferences, how does that play into this? I'm certainly of a generation where consoles were a major theme. As you think about different generations and their preferences, are there any unique dynamics that play a role in this thesis?

One of the most exciting parts of the thesis is the massive secular growth in what's known as Gen Z. I'm a millennial, but when I think about investing, I think about what Gen Z wants to do. The reason is simple: they're the most important incremental spender in the decade ahead.

If you think about markets, pricing in change is very hard. I'm always thinking about where incremental spending happens.

The oldest members of Gen Z are around 25 or 26 years old, and they're just starting to enter the workforce. In terms of the estimates, their spending power today is roughly $400 billion, and it's expected to grow to $2 trillion.

When you think about that kind of spending at a global level, that's what gets me really excited about the video game industry as a whole. Specifically, I think about midcore to hardcore gaming on console, where you're spending hours on your couch playing with your friends.

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. That has led to huge implications for why microtransactions are working. In my generation, we didn't have that dynamic, and microtransactions really didn't exist as a concept.

There is essentially a scenario where I think that, in the next 10 or 15 years, gaming surprises a lot of people and goes from an overall $200 billion to a $1 trillion industry. That's because the payer ratios are going up. It's not just mobile; people are going to spend money in games overall because this is now the activity where they hang out.

Now that you have both genders playing games, it introduces all the social dynamics of why we spend money in the real world. That is truly what makes this next decade unique and what makes us so excited to be going all-in on this thesis.

When I put this all together and think about the signposts or milestones to watch for as the thesis plays out, I think you outlined the Switch 2 as a major one. On the PlayStation side, the next Grand Theft Auto release is obviously important. If there are delays around those, that moves things around a little bit.

Is the main thing you're watching for the adoption and sales of those titles? What else are you monitoring most closely to maintain confidence in this thesis playing out?

Let's touch on Nintendo first. Historically, Nintendo has been viewed through the lens of how many units it sells each year. The most it ever sold was 21 million units, during year 3 of the original Switch cycle.

While the market continues to focus on the number of units sold, remember there was a time when everyone looked at Apple the same way: how many units are you selling? In the last few years, Nintendo has been disclosing annual playing users, and it's going to continue reinforcing the disclosure of key performance indicators as it stops focusing on how many units it sells and starts focusing on how many active players are in its ecosystem.

To me, that's the key KPI for Nintendo.

PlayStation is much further along in that sense, but I think we're going to spend more time thinking about the subscription side. Can Sony grow the subscriber base from 50 million to 60 million, 70 million, or 80 million?

When you think about the console market overall, something that doesn't get discussed enough—and that deserves a spotlight because it's part of the 10-year vision for how big consoles can get—is that we haven't seen huge user-base growth in Western markets. But think about a market like India or China. Console gaming is actually growing there.

I'll give you a fun fact. In India, PlayStation is dominating, but it's dominating with perhaps $200 million in revenue. That grew 50% last year. Obviously, you think about the price point of a PlayStation device and a TV, but if you want to reach the middle class of India, that's a 10-year vision. For the console-gaming market to grow, it will have to expand into a market like India.

What's interesting is that, early this year in August, an IP called Black Myth: Wukong came out of China. It was 6 years in development, used Chinese historical IP, and caused the PS5 to sell out in China.

Today, the console-gaming market in China is about 20 million people, out of a market of 600 million people. China is the biggest single gaming market in the world, but console gaming still has a long way to go to catch up.

Again, it goes back to what's going to pull people to consoles. I think it's going to be the IP itself and the titles. If you want to play a particular title, that will bring you over.

That was a really good example of people potentially sleeping on the fact that China is a huge opportunity, despite its rules and regulations. Console gaming is a growing market there.

Then you have India, which is super early. It's less than 1 million users and a couple hundred million dollars in sales, but last year we saw 50% growth. PlayStation and Sony have come out and said they're going to focus on India. Sony has recently set up a division to invest in Indian content and help support its development.

That's how I'm thinking about the next 10 years. I'm thinking about emerging markets and their adoption of consoles—new users coming in.

To bring this to a close, when you think about the market's appreciation for this, what's reflected in the businesses themselves and in the stocks? How do you approach that, whether it's the growth potential from the actual earnings or the multiple itself and a potential re-rating based on the business-model shift?

How would you begin to frame that and think through it?

Let's break it down one by one, starting with Nintendo. If you think about where Nintendo is going and its operating profit, it has margins of 35% or more. It's been doing that for many years, it's highly profitable, and it has more than $12 billion in cash.

It's in a great place. I think the next step is asking, “Why do you trade at a multiple of 13 or 14 times EBITDA? Why can't this be much higher? Why can't it be more like Netflix?”

I mention Netflix because when I think about Netflix at close to a $300 billion valuation and Nintendo at a $60 billion market cap, Nintendo could have Netflix's earnings power today within the next few years. But that's going to take some time.

It will require not just first-party titles, but also third-party titles coming in and leveraging in-game purchases to create these massive economies. One thing that gets us excited is that there are titles that have never been on the Switch before.

The Call of Duty title from Microsoft is coming to the Switch. That's been announced, and I think there will be more titles like that.

When it comes to valuation, both Nintendo and Sony are going to have strong earnings growth over the next few years. The question is what multiple you're willing to pay. In the case of Nintendo, it just has to keep doing what it's doing. Margins could expand, but I think it warrants a higher multiple because of the quality of the business.

Now let's look at Sony. Sony will be a much clearer story of this evolution because margins are lower than they need to be. They should be much higher, both at the PlayStation level and at the company level.

If we see that margin expansion really materialize, margin-expansion stories are well received by the market. Sony trades at around 8 times EV. Should it trade at 15 or 20 times? Honestly, I would say yes, for a company that's a global leader in entertainment—not just video games, but also music, anime, and other categories.

The margin-expansion story is a tried-and-true approach to multiple expansion. I think for Sony, that would be the next step.

Excellent. This has been a fun kickoff to the rest of these conversations, where we'll dive deeper into the individual businesses. I appreciate you sharing your knowledge.

My pleasure. Thank you for your time.