Few could have predicted how popular it would be to watch other people play video games online. Yet it has become one of the most popular things to do on YouTube. Canadian based company, Enthusiast Gaming (EGLX - $634.47M), aims to capture this trend by becoming the number one community for video games and eSports fans. The company does not create or even host video games. Instead it provides the community that fans flock to after the gaming is done with.

Over the last few years the company has been buying up swathes of assets in the form of websites, YouTube channels and social media. The company now owns 1000+ YouTube channels, 100+ websites and reaches over 300 million gamers every month. The company also owns popular eSports team Luminosity Gaming, some subscription sites and a couple of gaming expos.

In Q1, the company reported revenues of $30 million, 90% of which came from its media and content segment. Meanwhile, 70% of that can be directly attributed to its acquisition of multi channel network Omnia Media. That gives the company $73 million on a TTM basis and a runway to $120 million for the rest of 2021.

Tailwinds

The global market for video games and eSports is burgeoning. According to NewZoo, the video games market was worth an estimated $175 billion in 2020 and is compounding at a rate of 10.3% per year. Meanwhile, eSports is worth $500M and growing at 11.6% annually. Enthusiast Gaming’s web properties allow it to tap into this trend and connect with millions of highly sought after users.

Gen Z are coveted by advertisers but are becoming increasingly difficult to reach. According to Enthusiast, 48 per cent of its users don’t use Facebook. That means brands are struggling to find them.

In 2020, the Biden-Harris Presidential Campaign collaborated with Enthusiast Gaming to target this young segment of the population in the run up to the US election. The goal was to drive voter turnout and engagement by targeting voters through key gaming properties like Fortnite. Enthusiast now works with numerous big name brands across its online channels where it can charge higher advertising rates due to its direct advertising model.

Every day more and more Gen Z and millennials are leaving traditional social media like Facebook. Where are they going? They're flocking to our video game communities to maintain social connections with friends, to make new friends. They are also consuming more and more hours of content on YouTube and Twitch. Enthusiasts Gaming's fan flywheel provides Gen Zs and millennials with the content, the eSports and the entertainment that they crave.

Adrian Montgomery, CEO.

Not only do young people love gaming, some see it as part of their identity. According to Enthusiast Gaming CEO Adrian Montgomery, two thirds of Gen Z males say that gaming is a core part of who they are. Hence, Enthusiast Gaming’s long-term vision to become the social network for gamers.

Competitive Advantage

A key question is whether Enthusiast Gaming has any significant competitive advantages or moat?

According to Montgomery, owning thousands of YouTube channels and hundreds of websites provides the company with a moat that other companies will find hard to emulate. Interconnected assets bring with it synergistic qualities and network effects. The company is attempting to own the whole ecosystem from expos to eSports to online communities.

That may be so. However, it wouldn’t be that difficult for a company with large pockets to embark on a similar strategy. Enthusiast does own a significant number of online assets but not all of them are high quality. Muselk, for example, is one of Enthusiasts top ranked influencers. But with 9.4M subscribers, Muselk is only the 80th most popular gaming channel on YouTube. Online channel W2S is better, ranked number 30 on the list. Luminosity Gaming, whilst one of the most watched eSports teams on Twitch, is not even in the top 30 teams when ranked by competition earnings.

In other words, there are many more popular gaming channels and teams out there that Enthusiast doesn’t own. If Enthusiast wants to truly dominate this niche then it may need to seek out higher performing assets.

One potential source of advantage for Enthusiast is Project GG. This is the code name given for the social network that Enthusiast is rolling out for gamers. The platform aims to unify all of the company’s online channels and charge a premium subscription. This would become an additional revenue driver for the business.

Numbers

A bet on Enthusiast comes down to whether or not the company can maintain engagement among its network of 300 million gamers while lifting its average revenue per user (ARPU). Current ARPU at $0.40 has plenty of room for growth especially when compared to other networks. Facebook, for example, has an ARPU of $32. Meanwhile Snapchat is $9.6 and Pinterest is $4.9.

If Enthusiast Gaming can increase their ARPU to $1, total revenue would likely double to over $300 million. That would give the company a valuation of only two times sales. More importantly, it would confirm the growth narrative that investors need to see.

The fact that Enthusiast is ramping up its salesforce and embarking on Project GG indicates that the company is moving into the second stage of its flywheel where it focuses primarily on driving revenue. Enthusiast will continue to make acquisitions but it will also focus on increasing ARPU.

I want to reiterate that M&A has and will continue to be a very important part of our go-forward growth strategy. Do we need to acquire to grow? No, we're just getting started and believe very much in our organic growth strategy built around our proprietary monetization flywheel. And with 300 million gamers connecting with our content and influencers each month, we have the scale to deliver significant revenue and margin growth.

Adrian Montgomery, CEO.

Risk Factors

There are risks, of course. The pandemic has resulted in a flood of new YouTubers who are all competing for traffic and ad dollars. Large companies like Netflix and Peloton have signaled a move into video games which adds to competition in the sector.

Enthusiast’s growth, so far, has come almost entirely from acquisitions. This may be in keeping with the company’s business model but those acquisitions have been funded by share dilution. Long term debt is only $10.9 million but the number of shares outstanding has increased from 20 million in 2018 to 116 million in 2021.

What’s Going On Here?

Enthusiast CEO Adrian Montgomery recently discussed how the online video game space is ripe for consolidation. He compared the opportunity to buying Miami beachfront real estate in 2009.

Maybe he is right. There are plenty of popular online channels (on YouTube and elsewhere) that could be bought and put to good use. Doing so creates network effects and builds a stronger moat. However, acquisitions are not cheap and online consumers can be fickle. With only a few years of financial results, we don’t have much to go on.

For Enthusiast to succeed, the company must continue to grow their community of users and get their average revenue per user into single digits. Considering the strong tailwinds in the sector and the previous skill shown in acquiring assets, that seems like a low bar. The company has multiple routes to increasing ARPU and the risk:reward seems reasonable. I have bought a small position.

Thank you for reading Unexpected Value.

Disclosure: I/we are long EGLX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This post expresses the opinions of the writer and is for information, entertainment purposes only. Joe Marwood is not a registered financial advisor or certified analyst and does not purport to tell or suggest which securities customers should buy or sell for themselves. The reader agrees to assume all risk resulting from the application of any of the information provided. We strive to provide accurate data and analysis, however, mistakes and errors do occur. Financial investing is risky and not for everyone. You should not bet more than you can afford to lose. Past performance is not indicative of future results.