The smart thing about “stupid” investments

I’d like to preface this article by saying that I am by no means a financial expert. My knowledge on economics and finance is limited to what I’ve learned working in this industry and what can be deduced by common sense; so take what I say with a grain of salt. I merely hope to spark conversation and learn, as well as give people a fresh perspective on what’s going on.

It’s top of mind whenever someone speaks about recent developments in the US esports world — questions we all hate to answer, but always get:

What do you think about recent investments in esports teams? Do you believe esports team valuations are warranted?

No. No, they’re not warranted. They’re stupid, and so are you if you think Cloud 9 is going to be a billion dollar company anytime soon. But that doesn’t mean the investments are necessarily stupid, and it doesn’t mean that they’re bad either — not all of them, anyway.

First, let me give you some context. Here’s a list of large companies that you should be well aware of, and their latest reported valuation:

Discord — $2B.
Deliveroo — $2B.
Reddit — $3B.
Intercom — $1.3B.
Lime — $2.4B.

In contrast, Cloud 9 raised money at a $310M valuation. For more context: that’s a tenth of Bayern Munich’s $3B valuation in 2019; a world-renowned top football team with $751M in annual revenues.

C9’s estimated annual revenue is $22M. They’re not a tech company, and they’re not a brand with nearly the reach or revenue opportunities of a Bayern Munich. Even if they managed to magically grow their revenue alongside esports’ impressive 40% YOY growth, it’ll take them until 2025 to reach $165M in revenues, which would still likely leave you in doubts of a $1B valuation — and that’s a highly optimistic forecast for their expected revenue, given that they’re actively involved in highly volatile projects that are likely to crash and burn in the coming 2 years. A topic I’ve addressed in the past.

But regardless of how much I disagree with their high valuation, and the similarly outrageous valuations of other teams like Cloud 9, there is some method in this madness, and a reason that some of these firms have been willing to spend as much as they have.

Knowledge. Desperation. And a wild ride.

Esports is the wild west, no less in 2019 than it was in 2014. There’s a lot of things going wrong, a lot of things to be figured out, but also a lot of growth. Ridiculous growth, in fact, in what is unarguably an exciting industry: esports is the next generation of entertainment, and the convergence of two of the worlds largest entertainment industries — gaming and sports.

There are three key motivators that individuals, companies and VC firms have committed to investments in the space, and whilst I could go on long tangents on why exactly, I’ll summarize:

The Wild Ride

Esports teams are to millionaires what basketball, racing and football teams are to billionaires, and esports events have reached a level of prestige that can easily be compared to the biggest sporting events. In other words: there’s a relatively low barrier of entry to being a part of the wild ride that is esports, with all the bells and whistles, the VIP experiences, and the excitement, that would come with owning a sports team. People will spend money on what excites them and brings them enjoyment. Some people can and will spend more than others; to this type of investor, buying into this experience is like buying a movie ticket.

Desperation

This part will sound a lot more pessimistic than my usual outlook on things. A large motivator for esports investments, especially coming from the sports angle, is desperation. The sports industry, whilst still obviously enormous in size, is stagnating. They need to find ways to address the young audience that isn’t watching and spending on sports — or they’ll be a dying industry soon. Esports, especially in the form of sports simulations like EA SPORTS’ FIFA, is their salvation — or so many of them seem to think.

Knowledge

VCs, private equity firms, other financial institutions, they rarely do things just for the ride. They don’t have anything to gain from trying to save a dying industry either — that’s a high risk play, and they’ll be more likely to wait for it to die and salvage the scraps; especially the private equity bunch.

No, there’s a much bigger motivator at play for these players to have invested in teams like Cloud 9: knowledge.

There’s only so much you can find out analyzing an industry from the outside. Knowing concrete numbers allows you to figure out unit economics, it allows you to put actual numbers against your potential investments, as opposed to wild guesses. That knowledge is invaluable, and it’s only getting more expensive to buy into it. In the age of freedom of information, ironically, information comes at a price, and these guys are willing to pay for it.

In the end, whilst few of the teams in the space are likely to ever really achieve the ridiculous valuations at which they’ve received investment in the last years, an esports team, especially if it is already break-even, is a relatively safe bet: there’s not all too much new to figure out and monetizing a team is a largely solved problem. They’re in the business of selling content, entertainment and fandom, to sponsors and their audiences; it doesn’t take a genius to understand and make the model work.

But learning about the industry from this perspective is going to be an invaluable resource to investors when they make choices on which services providers, broadcasters or tech companies they’ll invest in in the future.

The multi-billion dollar industry

In summary, whilst some people are just in it for the ride, or in it because they’re trying to save face; there are many smart people out there that made a choice to buy into what is soon to be a multi-billion dollar industry, and in the long-term — even if their current million-dollar investments don’t pay off — they’ll make those investments count in other ways.

You’d be surprised how much money is out there, just waiting for the right opportunity to jump in and buy up or invest in companies in the space. When those opportunities arise, today’s investors will be able to capitalize on the knowledge, the data and the connections they’ve bought into in a big way.

What does that mean for the real valuation of esports teams? I don’t know, in fact — I don’t think anyone out there is capable of making correct estimations today. Much of their valuation will depend on how well they build up their content teams, work on their longevity and diversification, and tap into current and upcoming revenue opportunities. Most of them probably aren’t going anywhere, and many of them will stabilize at a significant value, but team owners out there should have no illusions of joining the “three-comma-club” anytime soon.