How a seasoned venture capitalist at IDG Ventures views game investments (interview)

Venture capitalists have had a hot and cold view of gaming. When the sector is hot, they invest in games by the hundreds of millions of dollars. But when it cools down, like it did in 2012, when social-game company Zynga’s stock price crashed, venture investors fled. Game developers are so wary of VCs that they have turned to crowdfunding site Kickstarter and angel investors for sources of income.

But Phil Sanderson, a game-savvy partner at IDG Ventures, has been investing in games for a long time. He has invested in companies such as Telltale Games, the maker of the acclaimed The Walking Dead episodic adventure game series; Hammer & Chisel, the developer of an upcoming tablet multiplayer online battle arena game (MOBA); game-discovery firm Iddiction; and mobile developer Funzio, the creator of titles like action role-playing game Crime City.

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He also invested in Next Games, which is working on a mobile version of The Walking Dead, and he put money into Plain Vanilla Games, the maker of the wildly popular trivia app QuizUp. Some of these investments have paid off nicely. Funzio was acquired by Japan’s mobile-social gaming network Gree for $210 million.

Sanderson has stayed with games through thick and thin. He looks at lots of potential game deals but invests in just a few every year.

Here’s an edited transcript of our interview with Sanderson.

GamesBeat: Why don’t we start with your investments in game companies and why you’ve been attracted to that sector?

Phil Sanderson: I made eight new game investments in the last 24 months. We’re about to announce another investment tomorrow morning. I see the game industry as at an inflection point right now. The market is large, $60 billion and growing quickly. That’s just in software. These companies are earning a lot of revenue and making a lot of exits as well.

I looked at some of the statistics on M&A transactions. Prior to 2008, I could only find six companies that sold for more than $200 million, not including public companies. After 2008, I found 20 companies that sold for more than $200 million. In fact, the median valuation on those transactions was $500 million. I recently did a blog post on that. So it’s a huge market with a lot of exits.

I also believe the King initial public offering is going to be a seminal transaction in the gaming space. It’ll lift that Zynga effect, which has kept a lot of investment down.

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GamesBeat: Can you explain what you mean by the Zynga effect?

Sanderson: The expectations were so great as far as Zynga’s performance that when their stock went down significantly, people felt like, “OK, the gaming industry is a one-hit wonder. They did well and had some hits, but they can’t replicate it. They have a lot of cash, but where’s the future of Zynga? Where’s the future of the gaming industry?”

GamesBeat: That was at the end of 2011. It seems like it had a big effect on VCs who were new to game investments. They started to shy away from anything game-related. As long as Zynga’s value was closer to $9 billion, they could see big payouts coming, but if it dropped to somewhere around $2 billion, the potential payout for game startups was crushed down. [Now Zynga’s market value is back above $4 billion.]

Sanderson: That’s right. We started to see a lot of VCs exit the market. When I talked to entrepreneurs, they complained that very few people were making game investments, and that’s still the case. But in venture, it’s often beneficial to be counter-cyclical, to be a contrarian. We know that markets wax and wane. I see a trend happening in gaming that’s starting to wax.

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Supercell’s revenue is significant. If you look at World of Tanks, it’s reported that they’re doing more than a billion in revenue. Candy Crush, within King, has 93 million daily active users. It’s massive. But if you look at King, they have a platform to make mobile games. Pet Rescue Saga is a real game. There are 15 million DAUs. It’s casual, but it makes a lot of money. Even though King’s revenue declined last quarter, they still did $1.9 billion in revenue.

King will be a successful IPO, I think, and it will change people’s views of the market. People will realize that you can make a lot of money in gaming. At that point, valuations will be a lot higher. It may be too late for some people to make as much money, but we’ve been doubling down on our investments in the gaming sector with really good teams, following certain themes that we feel are going to be strong this year.

GamesBeat: In this case, it seems like it pays to be one of the VCs that studies the game market and knows it well. You can be much more discerning than someone who’s more of a generalist.

Sanderson: I think so. I’ve focused heavily on gaming. I’ve been involved with game finance since 1993. I worked at Robertson Stevens in the entertainment software group, working on M&A transactions and IPOs for companies like Electronic Arts, Broderbund, and Microprose. I kept with it. There have been more opportunities for investors, though, in the last five years, than at any point in the last two decades. Mostly because of the higher bandwidth, more platforms, and as a result, more gamers around the world.

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A billion people play mobile games on a monthly basis. That’s a big market. I see a lot of opportunities there within different sub-sectors. One of the big areas that we’re focusing on is mobile gaming and tablet gaming. I’ve seen traditional console games, or traditional web-based games, move to tablets in a very big way.

GamesBeat: You have your own blog, and you did a post recently on four gaming trends to watch. Mobile and tablet gaming was one of them. How have you decided that these are the four that you want to pay attention to?

Sanderson: The areas I like to focus on are really a combination of just my own personal experience and what I’m hearing from entrepreneurs. They’re out there building great games, seeing opportunities. When I see smart people, many of whom have made money in games before, focus on certain areas, it’s a call to action.

I’ve spent a lot of time, for example, on storytelling within games, which is one of those themes. A lot of that is based around existing IP. We’ve not seen a lot of great IP-related games on the mobile platforms yet. It’s mostly been Electronic Arts licensing some great titles for the Xbox and PlayStation and so forth. We’re starting to see it with Kabam’s Hobbit game, for example. I’m seeing more and more companies that are able to license great titles from the studios.

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We’ve been very successful in the past with Telltale Games. I invested five years ago and I’ve been on the board since then. They’ve made incredible games out of The Walking Dead. They’re coming out with Game of Thrones this year. They have some other titles that they haven’t announced as well. The audiences love those games.

We just invested in another mobile game company that we haven’t announced yet. They have licenses for great IP, and I’m very focused on looking at other companies that have been able to acquire the rights to these games and are continuing to make good games out of them.

One of the other themes that I’ve looked at is trivia games. Trivia has always been very popular, going back to Trivial Pursuit and board games, as well as Name That Tune and other types of popular TV shows. I looked at all the opportunities that were out there and chose to work with Plain Vanilla Games and Fresh Planet. Plain Vanilla Games came out with QuizUp, which is an award-winning game that continues to perform incredibly well. Fresh Planet came out with SongPop and MoviePop, which are both incredible games as well. These are the two top games in the category. We’re looking for other games like them in the trivia space. Trivia can be around other areas – pop culture, brand-related, other types of things – but we really like the category. We’re interested in doing more.

Another category is MOBA, like League of Legends or DOTA 2. DOTA 2 has more than six million monthly active players. League of Legends I believe has more than 12 million. These are very popular games online. I would say that the new platforms, such as tablets, are getting to a level today where they can create great experiences for MOBA players. We invested in Hammer & Chisel for that reason.

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GamesBeat: That’s Jason Citron’s new company, right?

Sanderson: Exactly. Jason is an experienced CEO who has done very well in the mobile gaming space. There are other companies too, like Super Evil Mega Corp and so forth. There will be more. I feel that what’s great about iPad gaming, for example, is it’s a third device. If you own an iPad, if you have enough money to pay for it, you have enough money to pay for virtual goods or downloadable games. The demographics are strong, and the capabilities of the iPad and other tablets are getting so good, that it’s going to encroach upon the console market. We’re already seeing that. I’m talking to a number of game companies that just produce games for tablets. They’re not doing Android phone or iOS phone versions.

The other trend I talked about was eSports. I like the area of eSports, where people watch celebrity players compete. I’ve talked to some platform companies in the eSports area. I’ve not figured out where to invest yet, but I see it as such a large trend that it’s something we all should be watching closely. What’s interesting about eSports is that, unlike watching an NFL game, people can watch computer games and then actually play them themselves. They can interact on that level. There’s a potential to get a lot of these hardcore players involved with eSports. Now my job is to figure out how to make money as an investor in that category.

GamesBeat: It seems like Twitch has been a runaway success there. It showed that people are finally enjoying spectating on games.

Sanderson: Absolutely. Twitch is a great success story. There will be others like it. You’ll also see different business models, like QQ in China, coming to the United States. It’s not just around video content, but also other forms of subscription services or ways to interact. There are different models we’ve yet to see.

GamesBeat: Speaking of overseas developments, Newzoo came out with an interesting report on China. They noted that Tencent can now be classified as the world’s biggest gaming company as far as revenues. They had $5 billion in revenues related to games last year. It’s an eye-opener. What do you think about gaming in other territories?

Sanderson: The gaming market is absolutely global. Tencent has done an incredible job of partnering with other game publishers, and also working through WeChat, to use the mobile category to push games out. That’s where gaming is going, especially in Asia. We see WeChat, Kakao Talk, and Line not only doing one-to-one communication in a social networking way, but integrating gaming within those platforms for consumers. We’re going to see that in the United States, absolutely. I’m surprised we haven’t seen as much of it yet.

Global gaming is massive. A lot of our companies are interested in working in Asia as well, and that’s why we’ve partnered with IDG China, which is a sister fund of ours. We’ve co-invested with them four different times. They have very deep connections. They were the first investor in Tencent, back in the day.

There are some differences as well, comparing eastern to western gaming. Puzzle & Dragons is very popular in Asia and Japan particularly, but it’s very different from a traditional role-playing game or something like a Clash of Clans. Gung Ho surpassed Nintendo’s market cap at one point in Q4, though. It was well north of $12 or $13 billion, and it’s a very young company. There’s a lot of money to be made in Asia, but most companies are thinking about gaming globally now, not just about individual territories.

GamesBeat: Some other VCs are active in games. Rick Thompson’s Signia is one of them. They did about eight investments in 2012. They felt that was the right cadence for keeping track of a fast-moving game industry. I wonder what your own view is on how often you’re interested in investing in games. And when you’re not, what are you doing besides game investments?

Sanderson: We do see a number of the same investors out there. I’ve co-invested with Benchmark, Greycroft, and Signia quite a bit. Those three, and IDG Ventures, tend to be the more active VCs in this category across the board. I invested in Funzio with Rick Thompson. We sold the company to Gree, which was a great sale, $210 million. I know they’ve been very successful within Gree as well. I’m proud of those guys.

I would like to four or five game investments per year. That seems like the right level. I don’t want to do too many in any given category because of conflicts, but that’s probably where I would like to be in 2014. As far as other investments, I’ve also made search-related investments. I’m on the board of Simply Hired, which is one of the leading job search online companies out there. I’ve made some e-commerce investments lately. I made a SAS investment toward the end of last year called GuideSpark, which recently raised $15 million from the NEA. They just announced that last month. It’s been a successful company so far.

I’m interested in gaming, but our fund is very focused on consumer internet and enterprise IT companies. I’ve been a venture capitalist for about 17 years. I’ve invested in about 50 companies across that spectrum. As a venture capitalist, you need to look at where the trends are going and invest early in those trends. I believe gaming is one of the biggest trends we see out there today, which is why I’m so aggressive as far as investing in this category.

GamesBeat: Do you hear any particular criticism of that view from other venture capitalists? Do any other investors have various reasons to believe that gaming isn’t going to live up to some of these expectations?

Sanderson: Absolutely, I do. I talk to a number of investors who have made game investments in the past, even successfully, and they say, “We’re not doing as much gaming.” Part of it’s the high-profile nature of Zynga, and also that perception that gaming is a one-hit wonder space, that it’s a hit-driven business like running a movie studio.

I don’t believe that’s necessarily the case. When you create a movie, it needs to be a hit, and you’re not sure it’s going to be a hit. You know you have expensive actors that people will want to go see, but that doesn’t mean it’s going to be a popular movie. In the case of a lot of the investments I’m making in games, I do see it as a hit-driven model. If you create a business model that works and a technology that works, and then you layer on the genres, such as fantasy or war or crime or space, the genres that have worked in the past—If you layer that on to the model, in many cases they will work really well.

Going back to King, because they’re on file to go public and so forth, they’ve got more than 100 million daily active users of their games. If they come out with a new game, they’re going to cross-promote that game. Hopefully they can do it effectively. They’ve been the mobile game space almost 10 years, so for a company like King to create a new game, they have an advantage. It’s not all based on luck. It may be based on luck initially, like with Angry Birds and Rovio at first, but today, Rovio can continue to make great products and great games.

Zynga was one of the largest hiring companies of MBAs, because that was their culture, to create as much revenue per user as they could. It was not necessarily a culture of creativity. In fact, there’s a common practice within Zynga to stand up in front of your peers and explain why you made a mistake that you made. That works well for certain types of people, and it doesn’t necessarily work well for creative people. It quells creativity. Many of Zynga’s games, initially, they had purchased or copied.

It’s a very different culture that I see in most of the game companies that I talk to, who are very creative, who create platforms that are scalable, who are not just throwing darts at the wall and hoping to hit the bull’s-eye. That’s a common perception that will go away eventually. I see it as a wide-open market for me and a few of my peers to make great game investments.

GamesBeat: The year of the story, or storytelling in games, has been talked about in a variety of places. A lot of it was spurred by the success of The Last of Us and BioShock Infinite last year. But you invested in Telltale five years ago. There was no year of the story on the radar at the time. That’s an interesting perspective. As a VC, I guess you do want to jump on trends before they become real, but you were way ahead of the curve on that one. If people are investing now, is it too late to invest in that kind of trend?

Sanderson: I don’t think this is a one-horse race. Telltale’s business model and focus has been unchanged from their very beginning, which is impressive. Most startups end up changing their business model a few times along the way. They have not, which has been great. With Walking Dead, they won 90 game of the year awards. They’re doing incredibly well with Fables. They’re working on Tales from the Borderlands now. They released Walking Dead season two. I see them as one of the leaders, if not the leader, in the storytelling category.

There will be multiple winners here, though. One thing that Telltale has shown is that people love this form of interaction. In many cases, the line between games and media consumption has been blurred. Just as you would sit down and watch a TV show or a movie, or read a book, when you interact with a game like Telltale’s and you follow the storyline and make decisions that change the outcome, it’s sort of like watching an episode of Breaking Bad, or some other TV show. It’s a pretty broad market. People like to interact with content. They like to follow storylines. There will be a lot of other storytelling types of games and interactive media companies that evolve.

A lot of it will be around existing IP. For a license holder, like a movie studio, these types of games offer really lucrative incremental revenue. They’re willing to license to great game companies.

GamesBeat: It would probably not be a great thing if there were 100 storytelling-game startups tomorrow, though.

Sanderson: Yeah, that’d be tough. But I’m already seeing some new ones that are very interesting. When you have an engaging device, like an iPad or another tablet, it’s a great medium, to be able to enjoy a storytelling game. It’s a very rich experience.

GamesBeat: Are you still seeing a lot of console game developers give up and try to form new online and mobile studios?

Sanderson: I see a lot of console developers, who’ve created very successful games in the past, move to mobile. It’s a bit of an issue for me, because I believe you need the mobile experience to be successful, or else you’re going to go through some trials and tribulations along the way. You’ll spend a lot of money to be able to learn about that.

One of the big differences is that the development cycle for a great console game may be one or two years. For a mobile game, it’s four to six months. Then you continue to build on that. I talk to companies who say, “Yeah, we’re going to launch in mid-2015.” You can’t do that in the mobile space. It doesn’t work.

So I see a lot of movement from the consoles to mobile. I don’t see a lot of people continuing to produce for the console category. That’s just the big guys — Activision, EA, Microsoft and so forth. There has been a big shift away. Plus, it’s hard to make money as a pure development studio for the big publishers in the console space. It’s going to be a challenge for the publishers.

GamesBeat: What do you think of the big game publishers right now and the platform owners like Nintendo, Microsoft, and Sony?

Sanderson: Microsoft is doing a pretty good job with the Xbox, as is Sony with the PS4. I’m challenged to figure out where Nintendo is going. A lot of people are. They have a lot of cash, but they don’t have a historical model of buying companies, so they need to develop something that works. I can’t see where they’re going.

The Xbox would be better if it weren’t part of Microsoft, I think, if it were spun out. But who knows what’ll happen there? They’re still great platforms, both Xbox and PlayStation. I love what they’ve done with Xbox Live and PSN, with the online communities. Those will continue to grow and people will continue to spend money on those. Those are powerful platforms.

Amazon has done an incredible job with the Kindle. They’re becoming more relevant. We’ll see them as more of a major player. Google has likewise done incredibly well with Android, especially with Google Play. I’m seeing more startups focus only on Android, which is very interesting. The open nature of Android makes it a lot easier to work with as a publisher. Their platform is so large that it’ll remain one of the major players.

GamesBeat: I wonder if Google, Apple, and Amazon are the ones that might move further into the home and try to disrupt console gaming with mobile technology.

Sanderson: Their move into the home probably won’t happen through a set-top box. It’ll happen on the tablet. If you have a tablet in your hands and you connect it to Apple TV and play an incredible game on your screen, that’s a great experience.

I would rather see them do that through Apple TV than try to come out with another console, which I don’t think they would do anyway. They’ve done that in the past. Microsoft has done that in the past. It hasn’t really worked. But the tablets are getting better and stronger. They’ll definitely take away market share from the set-top boxes.

When you think about Activision and Electronic Arts, they have great legacy products and great legacy IP. They’ll continue to produce great games there. But I don’t see them as innovators within the mobile gaming world. Again, mobile gaming, the revenues aren’t that big today. It’s under $2 billion. But it’s growing very quickly. It’s where the market is going. They need to play in those categories in a much bigger way.

It’ll take them a while. They’ll probably look at some major acquisitions – not in the next year, or even two, but beyond that. And when they do a major acquisition, it’ll probably be with a large company like a Gree or a DeNA or a Gung Ho.

GamesBeat: What do you think of the newer technologies that are coming in and affecting games in some way, like virtual reality with Oculus or Steam Machines from Valve — or the Ouya?

Sanderson: I’m rooting for those guys, but it’s hard to see how the virtual reality area will make a large impact. I would love it if they did. I’ve seen it not really get any traction over the last 20 years. Ouya has its challenges as well. I would love for those guys to take off, but there are major players in this category that are hard to disrupt on the platform side. It’s a hard investment case to make when I look at them. I would love to see more of a fragmented marketplace, but like many markets, it consolidates over time. I don’t know how they’ll do in the long run.

In general, though, I’m bullish on the gaming market. We’re doing seed investments, very early stage. We do about seven or eight of these per year, and four to five series A or B investments per year. We look at some late stage investments as well, but that’s our sweet spot.

There might be some activity, again—When eBay went public, for example, there was a rash of IPOs afterward. When Google went public, there was a rash of IPOs afterward. They followed big droughts in the market. King could be that. We could see other companies start to look at IPOs in the U.S. If you look at the big players today, it’s Kabam, Kixeye, Telltale, and some others in the private markets. I would like to see some liquidity for some of these private companies, possibly in the IPO category. It may take a King or someone else like that to get the ball rolling.