Is this the biggest growth opportunity in the world today?

For many investors, esports and gaming conjure up images of teenagers playing computer games in their basement against their friends. But this tired caricature has long been left behind in what is now one of the fastest-growing industries in the world.

Gamers no longer compete for free merchandise and extra pocket money. This is big business, and the prizes on offer are often larger than traditional sports. In 2019, The International, a Dota 2 tournament, saw over US $15 million awarded to the winning team.

If esports is big, then the gaming ecosystem that feeds it is enormous. As Clayton Larcombe from PAC Capital explains below, the gaming industry is bigger than the film, music, and TV industries combined.

After immersing himself in the esports industry for several years, Clayton recently decided to launch a dedicated esports and gaming fund to capitalize on the opportunity. Given the lack of coverage for this exciting sector, I seized the opportunity to learn more about it.

Key stats and facts:

• Esports is the competitive side of gaming, where players compete for huge prizes.
  
• The global gaming industry produced annual revenues of $159 billion in 2020 - more than the movie, TV, and music industries combined.
  
• In 2021 the global esports audience is predicted to be 474 million people, up from 398 million in 2019. By 2024, this is expected to grow to 577 million. (Source: NewZoo)
• 60% of Tencent's revenue comes from esports and gaming. Tencent is the seventh largest company in the world. Microsoft, the second largest company, earns 33% of its revenue from gaming.
  
• 'The International', a Dota 2 tournament, had a prize pool of US $34.3 million in 2019. The vast majority of this prize pool is 'crowd sourced', with sales of special in-game items contributing to the pool.
  

Could you tell me a little bit about how you first developed an interest in esports?

My interest in esports started about two and a half years ago. My background was in global listed markets. I was in Hong Kong for a long time with the big US banks, trading for Morgan Stanley and JP Morgan. But I made a decision to move back to Australia and create my own fund management company. My specialty is finding investment opportunities around the world. That's why I wanted to set up my own funds-managing business. That led me to interact with two of the founders of an esports company in Brisbane, which I ended up investing in as an angel investor.

It was a few years ago that my interest in esports started, but I really dived in hard about two years ago. There’s been a big new wave of interest in the sector and a new industry is forming. My love of esports started then, as did my passion and desire to understand the sector more. It takes time to really dive into each sector and know how big it is. There are so many moving parts in the industry, from marketing to production, teams, leagues, and even hardware. It's a very big funnel that I've had to work hard to understand, but which led me to form the PAC Global Esports Fund.

Could you explain at a high level, the size and scope of the opportunity in esports?

I came from a traditional Australian sporting background where I liked my cricket, rugby, and golf. In 2019 Tiger Woods won the Augusta Masters, his prize money was US$2 million. The same year, the Fortnite World Cup was on, and a 16-year-old called ‘Bugha’ won over $3 million in front of 120,000 people in a stadium. I thought to myself, "wow, there's a huge amount of money going to the sector," and that was the catalyst that started to open my eyes.

Globally, the film, music, and TV industries combined produce less revenue than esports and gaming. That is mind-blowing. In 2000, the gaming industry was generating $20 billion of gross revenue. Now it’s $150 billion. Those numbers are eye-watering and something you must take note of.

What are some of the challenges in trying to invest in this industry using kind of passive vehicles such as ETFs?

My business, PAC Capital, is a funds management business that manages wealth and diversifies across of many industries around the world. I use passive ETFs in a lot of part of my business. They're an essential product.

In recent years, a range of different esports and gaming index have been created. There's an ETF that's just come on the market around the world from VanEck, it became available in Australia mid last year. I use a lot of VanEck's products and I'm all for the company, but I find a passive product challenging in an industry that is so dynamic. The industry is still forming, there are mergers and acquisitions going on, with so many moving parts, how can a relatively static index represent this evolving sector?

I can't stress enough how important it is to be active and have the ability to make money on the long and short side in this sector. Valuation can get crazy, and many companies trade on momentum.

Could you tell us about how investing in esports companies and gaming companies might be different or similar to investing in global equities more broadly?

All I could think about when I was living in Hong Kong and around Asia and the world was moving back to Australia. I missed it so much and it's so good to be home, but we're a pretty conservative nation that has a very different tolerance to risk and new ideas. But once we get a hold of something, we move quickly. I think that Australians are a bit behind on what's happening around the world with esports and gaming. What I've heard around from people that I'm speaking to about esports and gaming, they feel that it's a speculative industry that's made up of little gaming companies. They don't understand the size or magnitude of what's happening.

Let's look at a few companies. Tencent is the seventh biggest company in the world. 60% of Tencent's revenue comes from gaming, and esports. 33% of Microsoft revenue comes from gaming. These are some of the biggest companies in the world.

We have certain limits on market-cap. We can only invest in companies with over a billion dollars market cap. There are a lot of parameters that we set. But just like we spend the time to research a bank or a commodity producer in Australia, it's the same fundamental analysis that goes into breaking down their ratios, their forward projections, their balance sheet, and everything like that.

It's the same mechanics that go into it. So, everything that we do around the screening process, the research we do for the Esports Fund is very similar to what we do for the headline fund. The only difference is because this sector is such a growth industry, you can almost throw valuations out the door for a lot of these companies, at least when it comes to things like PE multiples. It’s got to be a forward projection looking at momentum, and you must consider M&A activity, which again highlights the need for active management in this sector.

Could you tell us about an unlisted esports company that you think has the potential to be a leader in the industry?

This is a topic that's close to my heart. I'll tell you about a company that I got involved in a long time ago, which led me to my interest in esports. I got involved with a company out of Brisbane. Essentially, they set up a wagering system that was competing with companies like Points Bet or SportsBet. Their wagering system was purely tailored to online games, and the company was called Picklebet.

This was a startup when I first got involved, but I believed in the founders, Nick Heaney and Damon Oudejans. At PAC Capital, we've got a VC arm that can act as a feeder fund into our bigger portfolios. We invested at the seed stage a few years ago, and they were doing around $50,000 worth of wagers a month at a margin of about 10%.

Fast forward to now, and they're now doing $4 million a month. They've just gone to the Australian Gaming Commission for an international license, so now they can go into Canada and Asia, North America. They’ve just taken significant investment from some big funds around Australia, including Tribeca Investment Partners. The company will have a pre-IPO round soon, and it looks like that could come onto the ASX or maybe the Nasdaq after that.

But they're not just a wagering platform. They've also now about to build out a content channel. They will own the content. They’ll be setting up live games around the world. They'll be like Barstool in America, or LADbible. It's not just about wagering, it’s a place where you come and have fun with your friends. It's more of a community feel. It's not about having a bet for physical money. It's a place where you can come in, interact with each other and have a fantasy play. That's what they're trying to create.

Could you tell us about a listed company or companies which offer the best exposure to the growth in esports?

Nintendo is a pure gaming play. Esports and gaming are very overlapped and linked. To clarify, esports is the competitive side of gaming. Nintendo has been under fire for a few years now for building up such a large cash position on their balance sheet. Nintendo is currently the most cash-rich company in Japan. Why? They've now started to launch some different Nintendo systems, which are now are Asia's top hardware system. Why would they be doing that? Because there has been an influx of M&A activity around the world.

Nintendo, I feel, are building a war chest up to acquire companies, like Tencent have done around China and Asia. Electronic Arts all of a sudden has $5 billion of cash on their balance sheet over the course of last year. Everyone missed that. Then they came out at the start of this year and acquired CodeMasters for £1.2 billion.

These big companies are building up a cash war chest for M&A. You've seen Tencent do it over the course of the last couple of years. They are buying anything gaming that moves in Asia. Hewlett Packard bought a massive gaming accessory brand recently called HyperX for $425 million. M&A activity is rampant at the moment. And it's only going to grow as new ideas and new products come to market.