Loot Box Legislation: Three Video Game Stocks That Could Lose a Level

Loot boxes have proven to be a huge cash cow for Electronic Arts Inc. (NASDAQ:EA), being prominently featured in the company’s iconic sports franchises Madden, FIFA, and NHL. In those games’ Ultimate Team modes, players can purchase packs of cards with real money that reward them with current or past players for their dynasty teams.

EA’s Ultimate Team revenue had exploded to $800 million annually by 2016, pushing the company’s gross margins up from the low 50% mark to the low 70% mark. That was only the tip of the iceberg, as EA knew that the real money was to be found by implementing loot boxes in its Battlefield and Star Wars games, which it did to disastrous acclaim last year in Star Wars Battlefront II.

Activision Blizzard, Inc. (NASDAQ:ATVI) is very serious about microtransactions, as evidenced by the fact that they have a patented system “for driving microtransactions in multiplayer video games”, though it hasn’t yet been added to any of the company’s games. That system would attempt to convince players to purchase better items in games through targeted manipulation of its matchmaking system. Activision’s microtransactions sales more than doubled in 2016 to $3.6 billion, with loot boxes being a massive source of revenue in games like Overwatch.

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TAKE-TWO INTERACTIVE SOFTWARE, INC Common Stock (NASDAQ:TTWO) has also fully bought into microtransactions, with CEO Strauss Zelnick saying on a conference call last November that the company will only release games that include “recurrent consumer spending hooks” in the future. While Zelnick noted that the models used to capture that persistent consumer spending will not always be the same, there’s little doubt that loot boxes will be one of them. Take-Two’s revenue from such digital transactions jumped by 66% in the third-quarter of last year to account for nearly 50% of the company’s total revenue, being lead by Grand Theft Auto V/Online.

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Microtransactions, and specifically loot boxes, are clearly a force powering revenue and earnings growth for gaming companies right now. Yet it’s a force that could be threatened in a meaningful way by government legislation in the near-to-medium term. While gaming companies would adapt to and work around any legislation in a way that would mitigate some of the potential damage, investors should nonetheless approach video game stocks with a modicum of caution in the near-term.

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