In 1997, the now blissfully defunct investment bank Dresdner Kleinwort Benson organized a conference with video game companies. Interest in the industry had been piqued by the company Eidos's success with the game Lara Croft. The bank's chief analyst began the conference by welcoming everyone and shared how he had to overcome level after level in a sort of video game to reach the position of chief analyst. Sadly, he hadn't completed the final level – hosting a video game conference the day after the entire analyst team within the sector resigned. With his rhetorical skill and sense of humor, it's not at all surprising that he earned the trust.

This was during the bad old days, when game development wasn't a particularly lucrative industry. All distribution was physical, and publishers, but especially retailers, had all the customer contact and thus most of the power. In this way, everyone except the game developers captured most of the cash flow. Eidos was a temporary exception, having broken through the glass ceiling with large volumes and for a moment created really good growth and profitability. Unfortunately, Eidos couldn't follow up on the success, and there were no opportunities to build a real franchise out of Lara Croft. The stock became a big disappointment and "cured" many investors from enthusiasm for video games. For a very long time.

Video game companies, even the major publishers, were seen for a long time as a real trash sector. Volatile profits were given single-digit PE ratios. Piracy added to the misery. Despite this, many creative souls kept fighting, not least in Sweden. Sadly, Electronic Arts could buy out DICE far too cheaply in 2006. The ice age for the industry lasted almost until the beginning of the 2010s. Digital distribution and the Steam platform made it possible for developers to reach a larger audience, and increased digitalization enabled direct contact with the developers' fans. It became possible to build a smaller base game and follow up with so-called DLC (downloadable content) over time. Consumers' search costs decreased, and physical retail significantly reduced its importance. Thus, the industry could spread its costs over time, drastically increase revenues, and multiply cash flow.

The last decade has meant an expansive, beneficial environment for the industry, especially for those developers who could take control over the rights to the content they create, their IP. The digital sea rose and lifted many boats. Ten years ago, 10 – 20 games were launched every month on Steam. In 2023, there are over 1000 games per month.

A transformed industry, with companies growing rapidly and displaying cash flows never seen before, gradually softened investors' previously critical attitude towards video games. Strengthened by their successes and with the support of investors, some companies in the industry were able to acquire even stronger positions. Ever-lower interest rates acted as an additional strong lamp in the greenhouse world of video games.

All above is history, seen from a perfectly clear hindsight position. We now also see that the Covid pandemic disrupted the balance in the industry and gave an artificial "boost" to consumer demand during 2020. After the end of the pandemic, consumer behavior has normalized, and all else being equal, fewer games become successful. Another effect of the pandemic was that costs rose and more new games were delayed compared to the original plan. With a larger supply, higher budgets, and a more discerning consumer, the risks for any given game increase. At the same time, capital costs have risen with higher interest rates. Investors' enthusiasm has turned to skepticism. Many investors who were late to enter the industry got burned, further affecting the sentiment.

With this background, we traveled to Cologne in August for this year's Gamescom, probably the world's largest video game fair, with up to half a million visitors. Have we had an almost biblical cycle of seven fat years, and are we now in seven years of misery? Should we once again think of video games as a "trash sector," or is it time to think constructively and look for green shoots in the industry? Of particular interest to us was to get a better picture of some of our holdings' pipeline of upcoming games. Not least Embracer, which has several important games to be launched in the reasonably near future, especially PayDay 3 and Space Marines. Our impression of both games was unequivocally good. Especially PayDay 3 looks well-crafted on a new platform (Unreal 4), and the developer Starbreeze is relatively alone in its genre.

On the theme of genre, we could see that space games and RTS (real-time strategy) look heavily competitive, with several big games on the way out. Budgets seem in several cases still to be very ambitious, not least from Asian game developers trying to break into the Western world. At the same time, both Fatshark and Paradox Interactive noted that a large portion of the most popular games on Steam are produced by smaller teams of around 10 people. Indie publisher Devolver also sees great opportunities. A big and strong IP or not, the important thing is to make good games! It sounds simplistic, but ultimately it means that we must assess the creative power of the game developer and the depth of what they have created.

The stock market's attitude to previously expansive companies like Embracer and Stillfront is very much "show me". Both companies have a balancing act in generating cash flows to reduce their net debt while continuing to invest in making games that consumers like. A similar balancing act applies to companies operating with net cash. Frontier Developments is extremely good at creating engaging, high-quality games. Unfortunately, they have disappointed investors by being overambitious and putting too much effort into the latest games they released. The return on those investments will not meet reasonable expectations. They are open that it will take a couple of years before the numbers will turn for the better, even if they do the right things from now on.

As investors in the video game sector, we have had to play through several levels: avoiding mayflies like the 90s' Lara Croft, the frustration of watching Swedish quality developers like DICE, Mojang, and King disappear abroad, learning the beauty of live ops that allow games to live much longer than we have seen before, acting as anchor investors in Stillfront, Paradox Interactive, and Embracer, and supporting these companies in their expansion. The last level, to correctly navigate an environment of higher interest rates and overly ambitious expansion, we did not play in the best way. With that said, we do not believe the industry should permanently enter a new ice age. It's more likely time to constructively look at more of the companies in the sector.