The video game industry is one of the largest entertainment markets, but the recent sluggish sales performance of the leading players means investors can buy some of the industry's cream-of-the-crop at attractive valuations.
Here's why France-based Ubisoft Entertainment (UBSFF 1.85%) (UBSFY 1.90%) and China's Netease (NTES -0.90%) are two undervalued video game stocks worth buying in 2023.
1. Ubisoft Entertainment
Ubisoft is one of the top video game producers in the world, with best-selling franchises like Assassin's Creed and Rainbow Six under its wing. Profitable growth from the shift to digital distribution of games over the last decade was a boon for Ubisoft, as it was for all the leading game companies. Before a sharp sell-off last year, the stock was up over 500% in 2021 from 2013 share prices.
The reopening of the economy and high inflation have dragged down Ubisoft's revenue growth over the last year, but this is a great buying opportunity before the company's upcoming release slate.
Bookings (a non-GAAP measure of revenue) fell 18% in fiscal 2023 ending in March. This was driven by weak sales from back catalog titles, but Ubisoft's top franchises continued to perform well. The company reported record active users for the Assassin's Creed franchise, while popular shooters Rainbow Six Siege and The Division 2 saw key player-engagement metrics strengthen. Meanwhile, there are several releases planned in fiscal 2024, including a new Assassin's Creed game, that management expects to return the company to growth mode.
A new Assassin's Creed game is always a big catalyst for Ubisoft, given the franchise's popularity. All the releases in the long-running series have sold an estimated 200 million copies, according to Statista. Currently, the company has a large player base of 133 million across all its franchises, which provides opportunities for further monetization over the long term.
Meanwhile, the stock is selling at a deep discount to pre-pandemic valuation levels. Its price-to-sales multiple of 1.50 is dirt cheap for a top video game company. Most of Ubisoft's biggest competitors sell at sales multiples above 4. Microsoft appears close to receiving the regulatory approval to acquire Activision Blizzard, which would value the Call of Duty maker at nearly 9 times trailing revenue.
If Ubisoft was an unproven game company without a long operating history, the stock's low valuation would make more sense. But investors can count on Ubisoft because it has been around a long time making blockbuster games that attract millions of players.
Over the last 10 years, revenue grew about 5% per year, which isn't much. But it doesn't have to grow at high rates for investors to earn a great return over the next five years. The company is in the process of improving margins through better cost discipline. After a year where adjusted operating profit fell, management expects lower costs to boost the bottom line.
If Ubisoft's new releases can keep the top line growing consistent with the previous record of growth, a lower cost structure in the business should allow earnings to grow much faster, which could cause Wall Street to revalue the stock at a much higher valuation that is closer to the price-to-sales multiple of its industry competitors.
Ubisoft might be the best bargain in the industry right now.
2. Netease
Netease is a leading game maker in China, the largest gaming market in the world. China's gaming market is expected to reach $57 billion by 2027, according to Niko Partners. This is up from $45 billion in 2022 and remains a major growth opportunity for Netease.
However, Netease stock sells for a discounted valuation of 18.9 times expected earnings this year. As the company executes against its long-term objectives, the market could award this leading game company with a valuation closer to the S&P 500 average of 25.
The company saw strong performance from its flagship title Fantasy Westward Journey Online in the first quarter. Netease is also seeing strong early results from its newest title, Eggy Party, which was the most-downloaded game on iOS in China.
Upcoming titles, such as the international debut of Harry Potter: Magic Awakened, in partnership with Warner Bros. Discovery, are near-term catalysts for Netease. The game was originally launched in select Asian markets a few years ago and generated nearly $200 million within two months of release. The company has other releases with promising prospects, including Badlanders, a next-generation shooter that debuted last month with 20 million preregistered users.
With video game stocks, there is always the risk that a new release doesn't sell up to its potential. With Netease, it operates in China, which is known for tighter regulation over its entertainment providers than in the U.S. However, this has been going on for years. Last year, Netease failed to get some games approved for release, which caused near-term uncertainty for sales. But these droughts can be great buying opportunities, since Netease can make adjustments to satisfy the strict standards of regulators that are closely monitoring games for violent content.
Despite the risks of investing in China, Netease might actually be a safer bet than Ubisoft. The Chinese game maker grew revenue by 26% per year over the last 10 years, partly boosted by acquiring other game studios. The company is also very profitable and pays a dividend to shareholders, with the yield currently at a market average of 1.45%.
Ultimately, from a long-term perspective, buying leading game stocks like Ubisoft or Netease when they are trading at discounted valuations can be a rewarding strategy. These companies have great resources to invest in the biggest games and take advantage of the growth opportunities available as more players pick up the hobby.
