The economics of esports are unlike those of traditional sports in a few major ways. In all, it means we don’t quite know what the future holds for the booming industry.
Can a competitive video game team really be worth a billion dollars?
The world will soon find out, as investment into such teams continues in the wake of LA-based esports organization FaZe Clan‘s announcement that it would go public via a SPAC (Special Purpose Acquisition Company) at a valuation of $1 billion. This, despite Forbes pegging their value at a modest $305 million only months earlier.
Where’s the delta coming from? What does the market see that the rest of us don’t? And, most importantly, is this a sign of things to come or just a proverbial “flash in the pan?”
To answer these questions, we need to zoom out briefly to understand the mechanics of the esports industry and define some terms.
What Do We Mean By Esports?
For the uninitiated, “esports” are video games that are played competitively with something at stake.
That’s usually a non-trivial amount of prize money, but dating back to the nascent days of video games, the stakes were normally bragging rights at your local arcade or a year’s subscription to Rolling Stone magazine. While there are tens of thousands of video game titles, there are only a few that garner enough popularity and players to evolve into the spectator sport known as esports. In other words, every esport is a video game but not every video game is an esport.
There are several popular titles across different genres of games that have emerged as popular esports, including League of Legends, Defense of the Ancients 2 (“DOTA2”), Counterstrike GO, and Fortnite. Tournaments and leagues have become increasingly more mature and sustainable since DirectTV’s ill-fated Championship Gaming Series closed shop in 2008 amid the financial crisis. Today, teams compete in various titles for millions of dollars in front of sold-out in-person audiences in major arenas like Madison Square Garden, with viewing audiences that, at their peak, can rival the Super Bowl.
The mainstream sports investing class began to pay serious attention to esports around 2013, at the same time the League of Legends World Championship Final sold out LA’s Staples Center despite the title being barely four years old. In the coming years, a wave of investments into esports teams ensued in hopes that they would serve as a profitable vehicle to capitalize on the rising tide of esports popularity across the globe. However, at the time, the space was akin to the Wild West as it lacked any real organizational infrastructure or standards in key areas such as player wellness or competition structures.
The Price of Admission
Esports differ from traditional sports in several key ways. The first and most obvious is that unlike basketball or football, someone (the publishers) actually owns the games in esports.
Given that these games are the intellectual property of the publishers, they control all aspects of the game, including who can and cannot use it to host competitions. Some publishers, like Valve, have a more liberal stance when it comes to allowing independent organizers to host competitions or create leagues using their games. Activision/Blizzard opted to create the first two franchised leagues in esports with the Call of Duty and Overwatch Leagues, and they maintain a more tight-fisted grip on how or who can use their games in an esports context.
Given the sheer volume of titles and the barriers to entry to fielding a team for certain games, esports teams can compete across titles and leagues. Many teams have multiple sub-teams that compete across different titles under the same roof. Team Liquid, which is the highest earning team in esports history, fields teams in 14 different titles, which is like the New York Yankees having a team that plays in the NHL, NBA, NFL, EPL, and 10 other leagues at the same time. Due to the still-maturing infrastructure across esports, the costs of participation for certain titles is low, whereas the costs of participation for titles like Call of Duty or Overwatch is incredibly high. Purchasers of franchises in those leagues reportedly shell out in excess of $20 million for a slot.
When you take into account the increase in the operational costs of fielding a winning team, which has been spurred by increases in player salaries and competition among teams to secure the best support infrastructure, the proposition of owning and operating an esports team is only becoming more expensive.
Chasing the Dollar
While most sports team investments are made on the basis of the asset’s value increasing as opposed to the expectation of robust cashflows, unlike traditional sports, the revenue streams of esports teams are basically two-fold: prize money and sponsorship. The latter disproportionately accounts for the lion’s share of revenue, but both are extremely fickle.
Though prize money is increasing, any meaningful money is usually reserved for the winner of a tournament and winning consistently in any sport is difficult. Sponsorship dollars are really what’s keeping teams and the industry afloat as they account for roughly 60% of all revenue generated in an industry that just cracked $1 billion in annual revenue.
It’s a scary proposition because it can be extremely fickle and often dependent upon the performance of the team. Brands and advertisers are ultimately betting on the massive global viewing audience for esports, which tends to skew toward the younger male demographic. But sponsors can only buoy the sport for so long as the real bet for most team owners and stakeholders is the inevitability of lucrative media rights deals.
Many believe such deals are inevitable, but it’s unlikely that linear distributors will take the plunge, and so it will likely be digital-native distribution platforms like YouTube or Twitch that esports teams and leagues will bank on to distribute their competitions. However, with so many titles, leagues, and competitions, it’s likely that there are going to be many suitors for a finite amount of dollars, which means that the game might ultimately end up being zero sum where some survive and others do not.
The real inevitability appears to be a consolidation of teams, leagues, and publishers. We have already seen the consolidation of publishers, especially on the heels of Microsoft’s announcement that it is purchasing Activision/Blizzard for $68.7 billion, but we are likely to see the same phenomenon play out with esports teams and leagues for the purposes of both efficiency and long-term survival.
So in a sport with so many different games, teams, and leagues, and without sustainable long-term revenue streams and global annual revenue barely touching $1 billion, are the FaZe Clans the rising tide that lifts all boats or the outlier?
The economics of the industry and the teams belie the valuations at this stage, but where teams like FaZe Clan and 100Thieves differentiate themselves is in their ability to build brands and businesses that transcend their performance on stage.
If you look at esports teams more like media organizations, you can begin to make a case to justify their seemingly inflated valuations. These organizations drive audiences and engagement, which are increasingly coveted in a time when there are so many entities vying for the consuming public’s entertainment dollar. The interesting thing to watch about FaZe Clan in particular will be how the public markets react to them over the long term. It’s easy for privately held sports teams to justify their valuations to private buyers — the sheer scarcity of assets is enough to justify the cost. It is much harder for public markets to reckon with a company that has yet to turn a profit while only generating $50 million in annual revenue.
In some sense, team valuations are immaterial at this point because so few are actually changing hands, but if a few prominent teams fold or see valuations dip in any meaningful way, it could prompt investors to pull back capital and force these organizations to stand on their own two feet. It seems that the industry is in the midst of a big game of musical chairs, where in this instance the music is sponsorship revenue and continued investor support, but what happens if the music slows or even stops? Esports valuations have all of the hallmarks of a bubble and all eyes will be on organizations like FaZe Clan to see if their unicorn status moves the entire market up or provides just enough air to burst the bubble.