After publishing our report on eSports two weeks ago, we got a fantastic response with a very large number of people asking for the full report and signing up for our newsletter. Thank you for all the interest.

One interesting learning from the past couple of weeks is the number of people and groups looking at investing in eSports. There are clearly a lot of people interested in participating in the eSports industry. So in this piece we want to take a closer look at the practicalities of investing in an eSports team. We are also working on follow-up pieces looking at what we know about the franchise opportunities currently being marketed to investors; as well as a piece looking at eSports investment opportunities beyond buying a team.

First, we have had gathered several datapoints confirming that revenue opportunities for eSports team are still fairly limited. While the prize pools for tournaments are significant, these are not reliable enough to build a business around. That really leaves three sources for team revenue:

• Sponsorships – brand advertisers are increasingly willing to sponsor teams. This includes the usual eSports ‘native’ brands – gaming hardware, games and energy drinks. We think there are many other brands coming into the fold. For instance, Bud Light renewed its eSports sponsorship two weeks ago, and our sense is that many other non-native brands are evaluating the best path forward.
• Merchandise sales – this includes sales of both physical and digital goods. This analysis was reinforced by Riot’s update on its new league structure (plus our analysis of that announcement here).Of these, the digital goods are probably the larger opportunity for now.
• Revenue share – this is really two items. First, there is revenue share from participation in leagues and championship events. This revenue consists of ticket sales, merchandise sales and some sponsorship. The second, larger pool is a share of revenue from broadcast rights. This is likely going to emerge as the largest source of eSports revenue, and is part of the ongoing dance between the teams and the game publishers.

Beyond these three buckets there are a number of other potential revenue streams, but these should are all small currently and probably best labeled as experimental.

That is not a long list, or are any of the revenue streams particularly deep at this stage. And set against this are considerable costs. Again, Riot’s post has a good list of these. They include the costs of participating in live events and video production for streams, coaching and staff salaries, business overheads, marketing, a game house or other facilities, and most importantly player salaries.

Despite this seeming imbalance, there are a few hundred professional or semi-pro teams competing. However, the industry is moving quickly. As the large games make moves towards franchise models, the upfront cost of participating in the major leagues and events are increasing. For instance, Riot is reportedly asking for $10 million to join its North American league, and Activision is reportedly asking for $20 million to participate in its Overwatch League. This is likely going to push a number of teams out of the fold, at least on the franchised game titles.

So let’s examine this from the perspective of an investor new to eSports. The first choice is whether to participate in one of the franchised games or invest in other games. The franchised games will come with a fair amount of stability and the support of the game company selling franchise rights, but they come with a big upfront payment. We have not modeled out a full team P&L yet, but it is hard to see a team being able to recoup the upfront costs in under three years, and quite possibly stretching to a five year payback. By contrast, investing in the other titles upfront costs much lower, but at this point an investor probably has to have budget of a few million dollars to support a team structure large enough to compete seriously. This path also allow teams to invest in newer titles which do not yet have established championship dynasties. However, all of this comes with a serious risk that a year or two from now those games may themselves go down the franchising path. Riot pointed out that they are going to provide some compensation for endemic teams which do not join the new franchise system. The point being there is serious downside risk for all titles as the move to franchising expands to other titles.

We will close this analysis with a summary of the risk categories that team investors have to prepare for:

• Player risk – team-building is always hard for a new organization. This is especially true when the players are largely comprised of teenagers with expectations of only a 3 to 5 year career. If you want a sample of this, check out YouTube videos which document some of the team houses and their tense dynamics. There is good reason to believe that reality TV could be a viable business model for many teams.
• Execution risk – whether building a new team from scratch or reinvigorating an existing team that has been purchased, new owners face considerable risk that the team structure will not work, that teams will lose tournaments and viewership, and all sorts of other business risks associated with a media business.
• eSports risks – eSports is still very new and unfamiliar to many potential fans. Teams will need to spend considerable energy and resources educating and attracting fans. This is particularly true of the franchised teams which appear to be structured around geographic territories. The game companies want to encourage the teams to build a local fan base, by hosting events and other local activities. There are plenty of successful examples of this (Hint: look at what they do in South Korea), but the model is still largely unknown in the US and Europe.
• Game risk – teams have to choose wisely which games they compete in. The game may not become popular enough to gather an eSports audience, or it may lose popularity to some other title. Consumer game playing and viewership habits can be fickle. Having a championship team in a game with only a few thousand viewers likely a money-losing proposition.
• Platform risk – one interesting eSports theme is mobile. There is a huge audience for playing mobile games, but it is not clear how this will convert to eSports viewership. Many mobile games show promise for becoming big eSports hits – Clash Royale from Supercell and Vainglory from Super Evil Megacorp are two prime examples. But this promise has yet to fully materialize. The Twitch viewership for the last Vainglory championship series was still dwarfed by viewership of a half dozen average League of Legends streamers playing routine matches. Personally, we are very bullish on Vainglory, but that is still based more on hope than hard data.
• Publisher risk – we view the tension between the teams and the game companies as one of the key dynamics in eSports. Most of the game companies recognize the importance of a having a healthy eSports ecosystem around their games, but ultimately their commercial interests will trump any goodwill. Imagine investing in a franchised league, with big upfront payments, and then a few years down the road, the same game publisher launches a franchise system for a different title and directs their marketing emphasis there. If franchising becomes widespread this will happen to someone at some point.
• Bad apples – finally there is the real risk that some league or game title is tainted by a scandal of some sort – cheating and gambling are top of mind here. We would argue that this is both likely to happen and unlikely to dampen the overall momentum for the eSports industry. However, a scandal could wreck a particular, specific game or league. It is hard to gauge how bad such an occurrence would impact any team, but it is highly likely to significantly delay the return on any team investment.

Put simply,  investing in a team is going to get more expensive and payback periods are going to cover many years. This does not mean a team investment is a bad idea. But such investments will require increasing patience and extended time horizons. That is going to require deep pocketed investors.