A few weeks ago, you may have heard about Travis Scott's concert on Fortnite. On the surface, this may have seemed like an interesting COVID-19 experiment.
Some of us may have gotten flashbacks to Ready Player One.
Not everyone loved it, but plenty showed up: over 27.7 million individuals attended the five pre-recorded Fortnite experiences made available by Epic Games (Fortnite and Scott).
The concert helped promote The Scotts - an album that racked up 7.45 million plays in its first 24 hours on Spotify, where it remains the worlds Number One hit.
To me, this was one of the first signs of the intersection between digital entertainment and gaming.
In order to better understand this intersection, we need to look into:
- Tencent Holdings, one of the largest tech companies in China and early-stage investor in over 46 unicorns.
- Epic Games, the creator behind Fortnite.
The Story of Tencent
It's a publicly-traded company ($TCEHY) with a $500B enterprise value. Tencent is literally a conglomerate that dominates a number of internet-related products/services, is the largest social media company in China and one of the world's largest investment portfolios.
The company was started by Pony Ma (the current CEO), Zhang Zhidong, Xu Chenye, Chen Yidan and Zeng Liqing in 1999.
After seeing limited traction with a couple of products, Tencent took off in the early 2000s by mimicking the business model of ICQ, an early version of MSN, in China (later branded as QQ). Using QQ, Tencent was able to ride the wave of PC adoption in China. During that time, they found interesting ways to monetize the QQ platform including advertising, selling virtual goods and building a social network.
Instead of letting the competition go after the QQ platform, Tencent developed Weixin (now known as WeChat). The app was introduced at a time when the majority of the Chinese population was getting access to cell phones. Today, the app is one of the world's most powerful social media and commerce apps, having over 1 billion monthly active users.
Using the success of QQ and WeChat, Tencent built products and services in a number of other verticals including gaming, media, fintech, cloud and internet utilities.
Here's a look at where Tencent ranks today.
To enable the success above, Tencent is organized into six different groups.
Corporate Development Group
As the platform for the company's new business incubation and new business exploration, CDG is responsible for promoting development and innovation for important areas such as financial technology and advertising, as well as marketing services, including payment and financial applications. As a professional support platform, CDG also supports the company and various business groups in strategic planning, investments and mergers, investor relations and corporate global communications, marketing and public relations, and more.
Cloud & Smart Industries Group
Responsible for promoting the company's cloud and industry Internet strategy, CSIG explores the interactions between users and industries to create innovative solutions for smart industries via technological advancements such as cloud, AI, and network security. While driving the digitalization of retail, medical, education, transportation and other industries, CSIG helps companies serve users in smarter ways, building a new ecosystem of intelligent industries that connect users and businesses.
Interactive Entertainment Group
Responsible for the R&D, operation, and development of the company's interactive entertainment business including games and eSports. Through online gaming, live broadcasts, and offline eSports, IEG assists the company in leading the global interactive entertainment market to create better interactive entertainment content experiences for users.
This team in particular is responsible for developing some of the most popular games in market today including Call of Duty Mobile and PUBG.
Platform & Content Group
Responsible for the company's Internet platform and the integrated development of the content and culture ecosystem. PCG integrates social platforms such as QQ and QZone with traffic platforms such as Tencent's App Store and browsers, as well as content platforms including news, videos, sports, live broadcasts, animes and movies to develop a better growth environment for Tencent's content ecosystem. PCG promotes the cross-platform and multi-modal development of IP, with the overall goal of creating more diversified premium digital content experiences for more users.
Technology Engineering Group
Responsible for supporting the company and its business groups on technology and operational platforms, as well as the construction and operation of R&D management and data centers, TEG provides users with a full range of customer services. As the operator of the largest networking, devices, and data center in Asia, TEG also leads the Tencent Technology Committee in strengthening infrastructure R&D through internal and distributed open source collaboration, constructing new platforms and supporting business innovation.
Weixin (WeChat) Group
Responsible for the construction and operation of the WeChat ecosystem and leveraging WeChat's open platforms such as Official Accounts, Mini Programs, WeChat Pay, WeChat Work and search function, WXG provides solutions and connectivity for intelligent upgrades across all industries. WXG is also responsible for the development and operation of QQ Mail, WeRead and other products.
It's clear that over time Tencent has built an entire web of platforms that feed off of each other. If this wasn't enough, Pony Ma made it a point to invest in his competitors and companies around the world (with over 1000+ investments in 2008). Some recognizable ownership stakes include 5% of Tesla, 40% of Epic Games (the company behind Fortnite) and 7.5% of Spotify.
This doesn't even include investments made in 2019 and 2020, which would also include positions in Universal Music, Byju, Reddit and many more.
I'll also make an honorable mention for Tencent Music Entertainment Group (TME). TME is a joint venture between Tencent and Spotify (also traded on the NYSE as TME) and develops music streaming services for the Chinese market. Their apps, including QQ Music, Kugou, and Kuwo, have more than 700 million active users and 120 million paying subscribers.
The Transformation of Epic Games
Epic Games is an American video game, software developer and publisher based in Cary, North Carolina. The company was founded by Tim Sweeney in 1991. For a long time, the company was just like any other gaming company creating games for the PC market and the console market (Gears of War, Gears of War 2).
While the company achieved moderate success, Tim was seeing a shift in the market and did not believe in the sustainability of the game publisher model. The market at the time was shifting toward a 'Games as a Service' model. This is where Tencent's investment in Epic Games came in, where the company accepted $330M in exchange for a 40% ownership in the company. Tencent was seen as an expert in this space given its investments and success in the gaming space.
During the period of 2012 to 2018, the company went through two major developments.
I won't go into too much detail as I expect most of you would be familiar with the game. Fortnite was first launched as a paid game and later a free to play game with over 250 million players as of 2019. There are three main modes:
- Fortnite: Save the World is a player-versus-environment cooperative game, with four players collaborating towards a common objective on various missions.
- Fortnite Battle Royale is a player-versus-player game for up to 100 players, allowing one to play alone, in a duo, or in a squad (usually consisting of three or four players). Over the course of a round, the safe area of the map shrinks down in size due to an incoming toxic storm; players outside that threshold take damage and can be eliminated if they fail to quickly evacuate. This forces remaining players into tighter spaces and encourages player encounters. The last player, duo, or squad remaining is the winner.
- Fortnite Creative is a sandbox game mode, similar to Minecraft in that players are given complete freedom to spawn everything that is within the game on an island, and can create games such as battle arenas, race courses, platforming challenges, and more.
Fortnite Creative is by far the most interesting mode from a growth standpoint as there's massive opportunity to expand the use cases of different modes.
The Unreal Engine
Unreal Engine is the world’s most open and advanced real-time 3D creation tool. Continuously evolving to serve not only its original purpose as a state-of-the-art game engine, today it gives creators across industries the freedom and control to deliver cutting-edge content, interactive experiences, and immersive virtual worlds.
It essentially acts as a platform that allows developers to build games and other interactive experiences. Think of it as the back-end system for Fortnite, except now it's open sourced so anyone can create a game off of the platform.
The success of Fortnite and the Unreal Engine catapulted Epic Games to the upper echelon of game platforms - leading to a partnership with Disney, a $1.25 billion investment round and the makings of an extremely profitable business.
To further solidify it's foothold in the gaming market, Epic launched its own digital games store, both for its own titles and those of third party developers.
In December 2018, Epic Games Store was created to challenge the incumbent king of digital PC games retail, Steam. The most important element of Epics transition from content creator to content retailer was its decision to reward the artists of the video games world i.e. games developers via a generous 88%-12% revenue split. This was a significant challenge to a raft of other online game retailers, Steam included, which had traditionally charged a 30% commission on digital sales.
On top of that, the storefront built a mechanism that ensures influencers for example, bloggers, YouTube hosts or Twitch live-streamers get a monetary reward if they successfully convince a consumer to buy a game. When an approved Epic influencer (Creator) shares a referral link to any game, they earn a revenue share of any consequent sales on Epic Games Store, at a minimum rate of 5%
The combination of the Unreal Engine, Epic Games Store and Fortnite makes Epic Games a lot more than your average gaming company.
Now when you combine Epic Games with Tencent, you can create something that's truly transformational.
Tencent's Next Opportunity: Digital Entertainment x Gaming
Circling back to my first point, I believe that Tencent is uniquely positioned to own the intersection of digital entertainment and gaming around the world.
What could Tencent want with music, gaming, and AI?
In January 2019, Epic Games acquired Serbia-based 3Lateral, which is, in Epic’s words, “the leading developer of digital humans technology”. And is, in other, even more shudder-worthy words, a company that uses “data to create once unthinkable humans.”
Here's a video to prove his point.
If there ever was a company that could build a non-human, human pop star, 3Lateral is it — which means, by association, Epic Games is also it.
Here's a hypothetical scenario: Let's take the top hits from Universal Music (courtesy of Tencent), the technology of 3Lateral, the platform of Fortnite and the distribution of WeChat. All of a sudden, you can have massive virtual events, featuring classics from the past, presented by non-humans.
Given the recent Travis Scott concert, I don't think we're that far away.
In Tim Sweeney's words, “we can go a lot further with the creation tools built into games. Where this is ultimately headed is games becoming more open platforms for creators to build their own stuff… In the future, we’d like for any musician to hold their concert of that sort without having to coordinate with us.”
Tencent even alluded to this possibility during their Q4 earnings call in 2019.
Here's the question that was asked:
It seems like some leading video traffic platforms are entering more and more digital entertainment services. We have seen news about games, literature, music, live broadcast etc. So just wonder how would that offset your strategy and perhaps that industry’s our cost structure in running digital entertainment?
Here's the answer that Martin Lau, Chief Strategy Officer of Tencent gave.
- We have a very strong franchise over some of the most important genres. For example, in mobile gaming, if you look at tactical tournament as an example, these are game genres in which we have an absolute leadership position in and they have essentially become both genre-defining as well as smart social networks for gamers.
- It's about development capability, which rests both within creativity as well as technical know-how. Over the years by being successful in different genres, I think we have demonstrated our creativity and I think those are the things that we have to continue to do well and do better on.
- The relationship that we have with game, IP and game companies around the world. A lot of the leading game companies are our partners or our investee companies. As a result, we can actually work with the other game companies and bring exciting new games in different formats to the market. I would say we also have a very strong presence in social network and that has a strong synergy with our game business because games by nature -- especially online games, and mobile online games by nature are social networks. So you want to play with your friends or you want to play with your game mate, right? So by having a social network that actually can connect with all your friends as well as new friends from the games, it actually give us a very specific advantage.
- We actually have a very strong ancillary ecosystem around games. If you look at eSports, if you look at streaming platforms, all these are places where people discover games and engage with KOLs on games, as well as with their friends. So I would say these are all the advantages that we have invested for a long time in this vertical to be the leader and we'll continue to do better.
- Even with the SARS crisis, which was on a much lesser scale, there was clearly a structural change in consumer behavior where pre-SARS compared to post-SARS people spent more time on digital entertainment. And that may again be the case here.
Notice how Martin points to the strength of the ecosystem that Tencent has built when describing the opportunity with digital entertainment, gaming and social network.
While it may have been difficult to predict this at the time, Tencent has amassed a combination of assets that can pull the world toward a virtual reality that can rival the likes of Ready Player One.