As esports enjoy tremendous growth, investors are perking up their ears and beginning to look for opportunities to tap into the young industry.

At the same time, 2018 is shaping up to be a landmark year for the esports efforts of some of the biggest video game companies out there, including Activision Blizzard (ATVI), Electronic Arts (EA -0.64%), and Take-Two Interactive (TTWO -0.39%).

In this episode of Industry Focus: Consumer Goods, Vincent Shen and Motley Fool contributor John Ballard talk about the history of competitive gaming, the biggest professional leagues, and the outlook for this industry and its hundreds of millions of fans.

A full transcript follows the video.

This video was recorded on May 22, 2018.

Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day.

We're pre-recording in the Fool HQ studio for this episode, which will go live on Tuesday, May 22nd. I'm your host, Vincent Shen, and today I have two different reasons to be extra pumped for this show. First, we're busting out the mailbag to cover a listener question that has us revisiting a relatively young industry, one that's made quite a bit of progress since we covered it last summer. Not only that, I'm also excited to introduce a new guest to the show. Joining us via Skype is Motley Fool contributor, John Ballard. Welcome to Industry Focus, John!

John Ballard: Thanks for having me!

Shen: This is your first time appearing on a podcast, right?

Ballard: Yes, that's right.

Shen: Awesome. I think you chose the right show. We have a great listener base, dozens of open-minded and eager investors. John, I was checking out your Fool.com profile, too. How long have you been following The Motley Fool?

Ballard: Probably since about 2005.

Shen: Wow. Longtime Fool, that's great to hear. Based on our conversation the past few days, I really think we chose the perfect episode for you to make your Industry Focus debut. Let's get down to business with the mailbag question. This one comes from David in Cleveland, Ohio. Fools, remember, you can always reach the Industry Focus crew by sending an email to [email protected] or by connecting with us on Twitter. Just look for MFIndustryFocus. 

David had this to say:

I myself am not a gamer, but I do think esports is only going to get more and more mainstream. I'd like to put together a basket of esports stocks and would be interested to know what you all recommend. It seems there's a few obvious players, but there must be other ancillary companies that are benefiting from the sport's growing popularity.

I first heard of esports a few years ago when a younger colleague of mine went to New York City for a weekend tournament. He and his girlfriend spent considerable money to sit in Madison Square Garden for a day or two and watch their favorite players. At the time, I thought they were a little nuts. Now, I think they were on the leading edge of something big.

John, I think you and I are both inclined to agree with the last part of David's message, that esports is on the verge of really taking off. Depending on who you ask, some would say it already has.

We're going to take the time to walk through some of the history of esports and the drivers that have lifted the industry to its current status and popularity. Then, we'll dig into the main companies targeting esports before talking about important recent developments, getting a handle on some of the actual financial opportunity, and then, what investors can expect going forward. 

John, you've been closely covering the video game business. You have personal experience with some popular esports titles, too. Competitive gaming has been around for a long time in different forms. Would you agree that esports in their current form are really the product of a gradual evolution, rather than something really new to the world?

Ballard: Yeah. You could trace it all the way back to the 1970s with small tournaments and arcade competitions. Gradually, with the faster internet speeds, it started coming on. It started to take off, really, in the last 20 years, and then the momentum just kept building with social media and Twitch. The first big esport game was probably StarCraft in the late 90s. It was really the first game that emphasized talent and skill and de-emphasized the button-smashing of the arcade days. It was a very, very thoughtful game that required players to make a lot of decisions and strategize.

Shen: Something with the arcade games, too, that I'd like to jump in with, it's a kind of fun story. It's important to keep in mind that just because there weren't these multi-million dollar contracts and city-based teams five, ten, or even 30 years ago, doesn't mean there weren't already a lot of video gamers looking for ways to compete against each other. 

I remember seeing a documentary from 2007 called The King of Kong, a really awesome movie. The documentary follows a rivalry, essentially, between these two experts who are fighting, angling for the world record high score in the 1980s arcade version of Donkey Kong. For something as harmless sounding as an arcade game competition, there's a surprising amount of intrigue and controversy there. A great movie I recommend to any Fools who have yet to see it. 

From my personal experience, too, around 2002, 2003, I was playing a ton of Counter-Strike. That's a first-person shooter game that's popular to this day. My friends had a clan and everything, we'd set up low-level matches against other teams, but there were leagues, rankings. Even then, the best players were already competing in pretty big tournaments with cash prizes and [sponsorships], so this has been building up over years and years. 

But the big thing you mentioned, with faster internet speeds, more and more robust multiplayer experiences, and larger and larger player bases, it's raising the bar for competition and turning into something that people are really interested in seeing, in terms of a spectator event.

Ballard: Yeah. It's Twitch, it's social media, YouTube, all those elements have come together in the last ten years, and it's made esports make headlines. Companies are seeing a game like League of Legends -- that started getting popular around five to seven years ago. There's tens of millions of people tuning in to watch that annual championship event. Companies are recognizing that. They're seeing, "Hey, we can take our popular franchises, launch that into esports, too, and sell advertising." Companies are starting to invest their own money into this, and that's something that's never really happened before. That's really why this is starting to take off.

Shen: Yeah. With that in mind, now that you've mentioned those companies, I want to stop there before we go any further. I do want to get some of the actual companies and stocks into the mix. Investors are pretty fortunate with video games in that there are quite a few publicly traded companies targeting the esports opportunity. They also happen to be some of the leading names in the industry.

A lot of our listeners have probably heard of Activision Blizzard, ticker ATVI; Electronic Arts, ticker EA; Take-Two Interactive, ticker TTWO. Across the board, we're seeing esports come up more and more in these companies' press releases and their earnings calls. I'm going to share a few quotes from management teams. It's not like I had to go digging to find these examples -- these are all from the most recent quarterly investor calls. 

From Activision Blizzard's CEO Bobby Kotick, he says:

The inaugural regular season of the Overwatch League is progressing well with millions of viewers each week, an average viewing time of over an hour, which provides our multiple global broadcast partners and sponsors with access to a highly engaged and hard-to-reach audience.

The Overwatch League continues to thrive, and our players are getting even broader recognition of their incredible talents in mainstream media. We see even greater opportunity with the playoffs and grand finals still to come, and we've begun sales of our next round of Overwatch League teams.

Over time, we believe our esports initiatives could rival traditional sports for audience interest, advertiser interest, sponsors, ticket sales, and merchandise sales, both virtual and physical.

That's really impressive. And then, as part of those efforts, the company's also increasing their hiring of people with experience in sports and marketing and broadcasting.

I have another quote here from Electronic Arts CEO Andrew Wilson. He says:

In terms of esports, we've talked about this a little bit less this quarter. I mean, we saw tremendous engagement in both our Madden League and our FIFA League, up significantly year over year and breaking records in both broadcast television and on digital channels. We're going to continue to double down there. We have an entire competitive gaming group that are pushing to grow that and really think about the ongoing evolution.

Those comments, again, are just from this month. I don't think it gets any clearer that the leading industry players are taking the esports opportunity really seriously. And that doesn't include other major video game publishers that are just not public companies. 

So that everyone listening can keep track of what titles go with these companies as we discuss more recent progress and developments, for Electronic Arts, they have a lot of popular sports franchises forming the bedrock of their esports division. Across their esports franchises, they have over 100 million players with almost 20 million of them getting involved in their FIFA and Madden competitions. On top of that, they're hoping to branch out from sports titles to some of their action games like Battlefield later this year. 

For Activision, its major esports title is Overwatch, with 40 million registered players. A Call of Duty-based league is also in the works, and there we're talking about an even bigger fan base with hundreds of millions of players. The company delivered a record Q1 2018, with almost $2 billion of revenue and double-digit growth for both the top and bottom lines.

We'll take a deeper look at numbers, financial contributions from esports in a bit. But I'd like to offer some updates from the notable achievements in esports that we covered last summer. At the time, we talked about multi-million dollar cash prizes, growth in attendance at live esports events. John, what's the latest news? I feel like the industry is constantly hitting new milestones at this point.

Ballard: Overwatch League started in January. Of course, there was a big buildup with it last year. The company just kept talking about it on conference calls, and a lot of investors had high expectations. The league pretty much exceeded expectations. They had 10 million total viewers opening weekend. They've been averaging 200,000 to 300,000 average viewers per day. That's the one making headlines, but they also have Call of Duty World League launching this year, and there could be other esport leagues coming in the future. 

Then, you have EA, Electronic Arts, they have their FIFA, Madden, Battlefield franchises coming into esports this year. The viewership I've seen, those leagues aren't probably doing, maybe, quite as well as Overwatch League. From the data I've gathered, they're probably doing around 100,000, maybe a little less, in viewership. 

Then, we have Take-Two Interactive. They've launched NBA 2K League this month in May. That game doesn't have quite the wide viewership of Overwatch and FIFA. Some comments of people I've seen on Twitter mentioned it only got maybe around 10,000 viewers. But you have to understand, it's also a game that doesn't really rank very high on Twitch. Casual people tuning into Twitch to watch other people play it, there's maybe 1,000 viewers a day, so it got a bump. Management, though, they say they're happy about it, they're still very enthusiastic about it. 

But I think the heavyweights among the companies is the Overwatch League and probably FIFA and Madden after that, and you can see it in the way the companies talk about it. I found something interesting, EA and Take-Two aren't being as proactive in releasing press releases giving information about what's going on with their esports. Activision releases a lot of information. They're telling you how much money they're making on advertising, sponsorships. They're telling you how many viewers they're getting. They really speak a lot about it in conference calls. EA has mentioned some viewers, and they're happy with it. But those companies aren't really talking up their esports as much as Overwatch and Activision. Usually, as investors, when you see that, you think, maybe those companies aren't doing so well, they're not meeting expectations. 

I think all eyes right now are on Overwatch League, because it just has an unprecedented structure in how it's set up. The management is really ambitious about turning that into an NBA-scale type league. 2018 is the first year ever that all three of these publicly traded companies -- Activision, EA, and Take-Two -- have professional leagues launching, so this is really a big year for esports. It's a real milestone.

Shen: Kind of a watershed moment, sure. Even for Electronic Arts, they've mentioned some things. They actually had the No. 1 esports program on television in 2017 with their Madden Challenge special. They talked about their road to the eWorld Cup, that had 17 million digital views, so still some impressive numbers on that side, even if they're not potentially touting it as much as some of the competition.

Just a couple of more minutes here. You shared some notes with me that had really impressive details about what professional gamers are getting from these contracts, partnerships with professional sports leagues. Could you share some of the developments there really quick?

Ballard: That's one of the interesting things about esports. These players are getting signed to these contracts, and I think, in a lot of ways, as we monitor the progression of esports going forward, this is going to be a good way to monitor the magnitude of esports. 

The minimum salary of Overwatch League is $50,000. These players are given health insurance and retirement savings plans over that. Each player gets 50% of their team performance bonuses on top of that for achieving certain things through the season, like winning little playoffs that happen in between stages of the season. The total of all of that is $3.5 million in team performance bonuses. Then, the champion of the whole season will get a $1 million reward on top of that, so there's some money at stake. 

Overwatch pros spend a lot of time practicing these games, and they're being recruited for their skill, and they're being put on these contracts so that they have the support from the company to spend all their time year-round playing these games.

Shen: These are people who are spending like 12 hours a day practicing, very much true to what an athlete would experience trying to reach the top of their game. Something else that I thought was really interesting and important to the big developments for this industry was something that you wrote about on Fool.com recently. That was a partnership that one of these companies had with Nielsen trying to get some legitimacy in terms of esports ratings and how important that is for advertisers. Could you talk a little bit about that?

Ballard: In order to attract advertisers, that's going to be the big revenue driver for these professional esport leagues, along with sponsorships. That's estimated to make up 77% of the esports market this year, so it's a big thing. In order to get that advertising, there has to be verifiable data about who's watching and for how long. Nielsen TV ratings, of course, those are the authority when it comes to this. 

Very recently, Activision announced that Nielsen will provide its TV rating expertise to provide that data for the company's esport events for specifically Overwatch and Call of Duty World League. This could really get the momentum going for esports' ability to attract advertisers, which it's going to need if it wants to reach that scale of the NBA. What Nielsen ratings measure is a percentage of the people watching between 18 to 49 years of age. 

Activision, by doing this, is essentially putting those events against the biggest entertainment channels in the world. If you look at TV shows like The Walking Dead and Game of Thrones, the most popular TV shows, they generate millions and millions of viewers a week. Overwatch league is generating 200,000 to 300,000 average per day. That's for matches held Wednesday through Saturday. 

So we think, "Well, that's nothing, why would advertisers be interested in 200,000 viewers?" That brings up another interesting angle about this. Activision executives have released all this information about what they're seeing in engagement and viewership and the money they're generating so far from this. They know they have something very valuable, and they wouldn't risk doing this if Nielsen was going to put out a weak report. They knew there was a good chance that that would totally stop Overwatch League in its tracks, and it would probably ruin the growth opportunity for a lot of other esport events as well.

Shen: Yeah. I think a big part of that is the confidence that they have with getting into this partnership to show that, right now, it's still in the early stages. They might not have those mega audiences that some of the traditional television networks might be able to command. But in the end, this is building up toward something that really can rival, maybe not the biggest shows, necessarily but a common series, maybe one or two million viewers, definitely reaching that point, so very impressive stuff there. 

I know a lot of our listeners are also, at this point, going to be wondering about monetization, looking for numbers to crunch. Next up, we're going to share our thoughts on just how sizable the esports contribution can be to revenue and profits.

We've managed to set the stage a little bit for how big esports is getting. A few years ago, companies were more tight-lipped about how profitable or lucrative some of these events and leagues could be. But now, the viewership and engagement are exceeding a lot of expectations, the companies are sharing much more detail. 

Activision, for example, they're managing to sell teams in its esports league for $20 million each or more, and that number seems to be going up. Can you tell us a little bit about some of the actual contributions that these opportunities are making?

Ballard: Activision recently revealed that they've sold, so far, 12 teams for $20 million each. That comes out to about $240 million. They sold more than $100 million of broadcast rights and sponsorship sales, and that's just for a handful so far. This is why the Nielsen news can be big. If Nielsen reports strong data and gets that accelerating, brings in more advertisers to have interest in this, that'll increase that even more.

Activision wants to expand Overwatch League to 28 teams. That gives us a clue as to where the scale of this is going to be. Management has said the price of teams, so far, is going up because there's such demand they're seeing because of the strong viewership from the beginning of the year. Let's say teams sell for $25 million. That'd be an additional $400 million. ESPN has already reported from their sources that that could fetch between $30 million to $60 million each. You do the math, 16 teams for as much as $60 million, that could be another $1 billion in revenue.

Shen: Or getting really close to that point very quickly.

Ballard: Yeah. Now, we have to keep in mind, though, that's just one-time team sales. That's not recurring revenue. But obviously, these are smart business people. These are entrepreneurs. You have Robert Kraft at the New England Patriots who's bought one of these teams. His track record speaks for itself in the NFL, growing the New England Patriots. These are well-informed business people buying these teams, and they obviously expect this to be a good investment and to recover that cost of these teams and profit over the next several years. That's something interesting to keep in mind about these team sales. 

In a way, these teams' values give us an indicator as to what potentially could be the annual recurring value of Overwatch League, if you want to think about it in terms of revenue or whatever. It's pretty obvious that this is probably going to be, conservatively, at least a $1 billion business segment for Activision when you look at all that. You add up the team sales, you add up the sponsorships, you anticipate there's going to be more advertisers coming in at some point spending money annually on this --

Shen: I would go beyond that, really, beyond the direct contributions from things that you mentioned like sponsorships, advertising, ticket sales, franchise deals. Management at these companies also recognize that their bread and butter here is also from the increased interest that they generate in their esports titles. This ends up creating a virtuous cycle. Esports popularity draws in more viewers, more potential players. And while most of these games do cost money to purchase, so companies get revenue from that initial sale, they want to extend the tail of revenue generation from each title. That happens thanks to greater engagement, because most of these games have in-game purchases, downloadable content. 

And some popular titles, like Fortnite, which Tencent has its fingers in as part-owner of the game's developer, that costs no money upfront and it's free to play. But even then, the latest estimates for that game put monthly revenue at over $200 million, s really, really impressive.

We have a few more minutes. I want to address that part of David's question that asked about the non-obvious players to include in an esports basket. When we were talking about this before the show, several names came to mind that we ended up disqualifying. Those included Amazon, thanks to its ownership of Twitch, and Alphabet because of its YouTube platform. The problem with both of these companies is that gaming makes up a very small part of their businesses. As quickly as Twitch is growing its audiences and affiliates, Amazon investors know that the earnings engine at the company is Amazon Web Services. Then, Alphabet does not break out results for YouTube specifically, but it's safe to say that it's still a pretty small portion of the top line. YouTube gaming, specifically, is still a relatively young effort. 

But beyond the media side of things, I think there's also a way to tap into esports growth through certain hardware providers, the big ones being NVIDIA (NVDA -2.09%) and AMD (AMD 0.10%). A lot of people want top-of-the-line gaming PCs to be as competitive as possible. They want the latest graphics card, or GPU. That's a big part of that. I remember, personally, spending more money on my GPU than any other component when I built my computer a few years ago. Average selling prices for these products are going up. Both NVIDIA and AMD reported 70% and 95% growth, respectively, in their gaming segments in their latest quarters. 

On the latest earnings call, a really telling quote from NVIDIA's CEO, Jensen Huang. He said this: "Fortnite and PUBG are global phenomena. The success of Fortnite and PUBG are just beyond comprehension, really. Those two games are a combination of Hunger Games and Survivor. They've captured the imagination of gamers all over the world, and we saw the uptick and we saw the demand on GPUs from all over the world." That is in reference to a $6 billion segment at that company, so more than half of their revenue. 

I consider that closely tied enough to the esports opportunity that both they and AMD are solid options to include in any kind of esports basket that David or any other listeners want to create beyond the pure players in terms of companies like Activision and Electronic Arts.

The last thing before we close out our episode here, I'd like to spend a few more minutes talking about the outlook. John, when you and I were chatting before the show, you brought up some points I thought were really interesting about how esports are going to impact game development going forward, and also how they might change the content of games to be more appealing to wider audiences. Can you speak to that really quickly?

Ballard: One thing benefiting the esports multiplayer growth right now is how games like Overwatch and Fortnite can bring in more female gamers into the shooter genre. I think this is a really important thing to understand about where esports has been and where it's going. It's historically been small and not very relevant to the industry, not to mention the wider world of entertainment. Part of that reason is that, typically, video games have been associated primarily with men. And you see this in esport tournaments, where finding a female gamer playing on a team is very rare, it's almost non-existent. And it's because shooters like Counter-Strike and Call of Duty, like we talked about earlier, they're realistic military shooters. That tends to limit their base and audience to primarily males. 

Overwatch has this colorful, bright presentation with a balance of female and male in-game characters that you can play. I think that's really attracting more women to the shooter genre. It's also happening with Fortnite. I saw a study recently where twice as many female players play Overwatch than the average shooter. I think it's about 16% of the player base, and I can attest to this from my own experience playing the game and watching people play it on Twitch. 

This is a really important thing for Overwatch League's ability to attract advertisers. Obviously, with more women in the game, there will clearly be more women viewers watching esports matches. I've seen this on Overwatch teams so far, there's at least one woman who's actually on an Overwatch League team. This kind of opens the door for women viewers and more women getting involved in esports. 

Activision just came out with their press release for their new Call of Duty coming out this fall. It's mostly being aimed at the multiplayer segment of the gaming community. They're really playing down their single-player and playing up more the multiplayer. It's about positioning the game more for esports, especially with Call of Duty World League ramping up this year. 

It just shows where the industry is. It's all about multiplayer games, it's about what's going to keep players spending the most time in games. And right now, that's games like Fortnite. NVIDIA, the graphics maker, they've been crediting these games for driving their demand in GPUs recently.

Shen: That's going to influence the way these games are developed, and color how the companies think about where they put their priorities, where they place their focus for the actual format for these games. But that's all the time we have for today. Thanks a lot, John, for joining us today! I hope you enjoyed your experience on your first podcast!

Ballard: Yeah, thanks for having me! It was fun!

Shen: Fools, thanks a lot for tuning in. I'm sure we're going to be touching base again later this year on developments with the video game industry, with esports.

Thanks again for listening! I'll be back again next week. People on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. Fool on!