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Gaming M&A faces mega-deal slowdown as investors move downstream

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Gaming M&A faces mega-deal slowdown as investors move downstream

As the number of remaining independent targets of scale in the games industry is limited, high-profile mergers and acquisitions are set to decline in the year ahead. Most M&A activity is likely to take place at mid-market level and may largely evolve around mobile assets.

Established gaming companies looking to improve their portfolios with new genres, or to expand their geographical market footprint, should not expect a repeat from 2016, when blockbuster deals such as Tencent Holdings Ltd.'s $8.6 billion acquisition of a majority stake in the Finnish "Clash of Clans developer" Supercell, and the closing of Activision Blizzard's $5.9 billion purchase of London-based "Candy Crush" developer King Digital Entertainment plc, made it a prolific year for the games M&A space.

"This hunger is still out there but… who is there left to buy?" questioned Keith Katz, co-founder of Execution Labs, a Montreal-based games investor.

Slim pickings in the mid-size mobile and PC markets mean the mega-deals of 2016 are unlikely to be replicated.

"There are a handful of midsize studios throwing off some good revenue, but how many of those are doing this sustainably over several games and without the benefit of licensed IP?" Katz explained.

Last year, gaming M&A rebounded strongly, amounting to $30.3 billion-worth of deals in 2016 with an average deal value of $300 million, according to data from technology M&A adviser Digi-Capital. This follows an 81% drop in deals the prior year.

Other headline transactions included the $4.4 billion acquisition of Israel-based social casino game company Playtika, by a Chinese consortium that included Shanghai-based Giant Interactive and Yunfeng Capital, a private equity firm launched by Alibaba founder Jack Ma.

"The year 2016 was clearly an outlier year," according to Serkan Toto, CEO of game industry consultancy Kantan Games.

With last year's total transaction value boosted to "absurd" levels by a handful of large acquirers, Toto said in an interview that it remains highly "questionable" whether deal activity in the year ahead would reach the same dizzying heights.

Instead, further M&A is firmly on the cards in the middle market, which is increasingly being squeezed by much larger companies consolidating the space, he added.

But even as investors anticipate smaller-ticket deals, the appetite for mobile assets to boost exposure to the fast-growing market for games played on handheld devices is likely to persist this year.

"Mobile will play an even bigger role in M&A this year," said Tero Kuittinen, chief strategist at mobile app investment firm Kuuhubb, adding that "Pokémon GO's explosive launch demonstrated there are still a lot of breakthroughs to come."

The breakout augmented reality hit, developed by San Francisco-based Niantic, is estimated to have accrued more than 550 million installs and $470 million in revenues in its first 80 days, attracting more than 20 million new mobile gamers across the U.S., U.K., Germany and France alone, according to figures released by research firm Newzoo.

However, Pokemon's success does not necessarily mean a breakthrough for virtual reality and augmented reality in gaming.

"Both segments are over-hyped at the moment," Toto noted. He is convinced that "it is way too early for significant deal sizes in these segments."

Nevertheless, the success of Pokémon GO, as well as the upcoming Snap Inc. IPO, are likely to revive interest in mobile assets, said Kuittinen.

The growing mobile app segment recorded 40% growth in revenue last year, according to a report published by intelligence firm App Annie. The report also shows global downloads were up 15% year on year with time spent on apps up by 25%.

As mobile gaming continues to gain momentum, industry observers expect mobile assets to attract further M&A interest from major Chinese, Japanese and Korean game developers seeking global expansion, as well as traditional PC and console game developers.

Kuittinen said Asian companies such as SEGA, a Japanese video game developer, would become more active acquirers as they may attempt to duplicate the success of Pokémon GO, while Toto suggested that Activision Blizzard, another traditional player, could make a play for mid-size, mobile studios this year.

At the same time, hyper competition and the sector's approach to maturity may mean lower valuations as investors target more profitable studios, according to Olli Oksman, partner at Helsinki-based law firm Kalliolaw.

Oksman pointed out that even Finnish developer Rovio, one of few remaining targets of scale in the industry, has struggled as new games continue to overtake the once-popular "Angry Birds," launched in 2009. In 2014, Rovio's profits fell 73% to €10 million.