Holly Black: Welcome to Morningstar. I'm Holly Black. With me is Neil Macker. He is an equity analyst at Morningstar Chicago. Hello.

Neil Macker: Hi. How are you today, Holly?

Black: I'm good. Thank you. Neil, you've been looking at the video games sector and this is an industry that would have been close to people's hearts over the last 12 months. Can you tell us a bit about how it's evolved over the recent years?

Macker: Yeah, the video game industry, if we're looking the last 20 years, has changed quite a bit. And one of the biggest changes we've seen is the rise of what we call micro transaction, player recurring revenue. And these are transactions that happen after you either buy the game or downloaded the game itself that are added on additional revenue. And what we've seen is this has helped returns in terms of returns on investment, margins, for companies like Take-Two, EA, Activision Blizzard, and Ubisoft as well. And this has helped sort of the margins across the space increase and returns as well, basically.

Black: And what does that do to brand loyalty? Because when I was growing up, you know, you're either a PlayStation person or a Nintendo person or an Xbox person and you couldn't switch between them.

Macker: Yeah. So, we're still seeing some of that brand loyalty, some of that fanboyism as we like to call it within the space here. But we're also seeing people are also becoming sort of fans or lifetime players over a specific game itself. So, there are players that every year buy Call of Duty, whatever platform they happen to be on and play that game continuously for a year. Another change of the last 20 years is sports games like FIFA or Madden or NBA 2K you may have only played for two or three months 20 years ago. Now people are playing that 9 to 10 months around the year basically. And so, you're seeing a longer tail and longer amounts of revenue streams here for these companies as well.

Black: Okay. So, why was this sector such a big winner during the covid-19 pandemic?

Macker: Well, we're all stuck at home and we all need entertainment options. And now, we have more and more free time. One of our general theories around media and video games is that as people get more and more free times, what we do is find ourselves another screen to put ourselves in front of and video games became one of those screens to some extent over the last year here. And so, I think we've seen not only people necessarily playing more, but also people, let's say, who are in their 20s or 30s who may have not had as much free time as they did in their teens, come back to video games as well. And so, we've seen quite an uptick in terms of just number of hours played and players itself over the last year here.

Black: So, with that uptick in mind, is there more growth to come? Or have we reached peak video game?

Macker: I don't think we've necessarily reached peak video games, but we do think that like as the pandemic sort of slows down here, as we get more people vaccinated and people start going out more, we will see a pullback here in the next year or so in terms of usage and things like that. Over the long term, we still think it's a long-term secular growth in terms of the amount of time and money that people are willing to spend on video games, particularly in markets outside of, let's call it, the more developed video game markets like the US, China, Japan, looking at places like India or Latin America, things like that. We expect further growth down the road. Mobile obviously has helped that space as well.

Black: So, having delved into this sector, what are some of your top picks?

Macker: Well, so, as you know, the pandemic has helped valuations sort of rise quite rapidly over the last year. We have started seeing a little bit of a pullback. And with that pullback right now Ubisoft is of the four companies recover, the only one that's 4 Stars right now. We do think it's right now a good entry point for the company in terms of long-term value.

Other names that we're seeing a little bit of pullback and that investors should keep their eyes on include Take-Two. The company is most famous, of course, for Grand Theft Auto, but also NBA 2K, Civilization, BioShock, Borderlands, there are number of franchises there along with the strong management team. So, if that stock pulls back a little bit further from our fair value estimate, we think that investors should keep an eye on that name as well.

Black: Neil, thank you so much for your time. For Morningstar, I'm Holly Black.