The following is a redacted version of GS Research’s report “The World of Games: eSports: From Wild West to Mainstream” originally published June 26, 2018 (59 pages). All company references in this note are for illustrative purposes only and should not be interpreted as investment recommendations.

As defined by the Oxford English Dictionary, a sport is “an activity involving physical exertion and skill in which an individual or team competes against another or others for entertainment.” Under this definition, we believe eSports are as much of a sport as any other, and one that at the highest levels requires intense training and focus. Professional eSports teams train for up to 8 hours a day, have coaches, trainers, and nutritionists on staff, and players receive base salaries, just like any pro sports league. In the U.S., there are roughly 50 colleges that have varsity eSports teams, and eSports are under discussion for inclusion in the 2024 Paris Olympics, according to the BBC.

To play a traditional sport, one typically needs access to an appropriate venue (field, court, etc.), and to be successful, it almost always helps to be big, fast, strong, or coordinated - or better yet some combination of all four. To play multiplayer video games, all that is necessary is the requisite hardware and an internet connection — and there is a community of millions of players online that are ready to play at any hour of the day. Also, to become successful at eSports, physical stature is not as important, in our view, as reaction time, focus, and strategic thinking. Therefore, we believe professional video game play can be appealing to a massive global audience of people who can watch and learn from pros and try to improve their own gameplay — something that we believe isn’t as possible for most traditional sports fans. And because the distribution of eSports are nearly 100% digital, fans can stream eSports content for free anywhere in the world, unencumbered by traditional TV rights that for most Western-based pro sports leagues have been segmented by geography and are often lumped into an expensive cable subscription.

In short, we believe eSports are at the cross-section of some powerful trends: social connections being formed and maintained online, digital consumption of video, and global growth in the gaming audience. Looking ahead, we see numerous public and private investment opportunities that we believe will benefit from the structural growth of eSports, both in terms of audience and, increasingly, monetization, as the requisite infrastructure is built to transition eSports from the “Wild West” of sports to a full-fledged professional sport. We summarize our key takeaways below.

The audience opportunity. In 2018, we estimate the global monthly audience for eSports will reach 167mn people, based on data from NewZoo, larger than that of Major League Baseball and the National Hockey League. We estimate the total online population is over 3.65bn people globally, to go along with 2.2bn gamers, but eSports viewers represent just 5% of the online population TAM, which suggests that there should be plenty more runway for audience growth. By 2022, we estimate the eSports audience will reach 276mn, similar in size to the NFL today.

Due to the growing popularity of survival-based games Fortnite and PUBG, we believe eSports viewership is moving more into the mainstream, which should support a 14% audience growth CAGR for the next 5 years. Recently, Epic games announced that it would set aside $100mn in prize pool for the first year of Fortnite eSports tournaments, nearly the size of the entire eSports prize pool in 2017. With growing incentives for eSports players, and by extension more interest from the casual observer, we believe the eSports audience should continue to outpace the growth of traditional leagues.

League infrastructure is creating meaningful opportunities for direct monetization. In the early years of eSports, there was little organization or infrastructure, and as a result, the massive audience of eSports did not translate into meaningful revenue streams for players, team owners, etc. But in 2017, Riot Games created the North American and EU League of Legends leagues, while in January of 2018, Blizzard launched the Overwatch League. We believe these leagues created the requisite infrastructure that will allow eSports to finally start to close the monetization gap relative to other established sports leagues.

In 2017, we estimate eSports generated $655mn in annual revenue, including 38% from sponsorships, 14% from media rights, and 9% from ticket revenue. But by 2022, we expect media rights to reach 40% of total eSports revenue - comparable to the average of the four major Western sports leagues today - as massive audiences and associated revenue for established online video platforms like Twitch, YouTube, Douyu, and Huya will be able to support a growing pool of media rights fees paid to top publishers for their content. As media rights and sponsorship continue to grow, along with the formalization of pro sports leagues, we expect total eSports monetization will reach $3bn by 2022.

Fortnite and the “Moneymaker” effect. In 2003, Chris Moneymaker, an accountant and amateur poker player from Tennessee, outlasted a field of 839 players to win the World Series of Poker. His victory sparked a meteoric rise in the popularity of online and tournament poker. Just 3 years after his victory, the first place prize money for the WSOP increased to $12mn in 2006, up from $2.5mn in 2003. The relevant lesson here is that Moneymaker elevated poker’s profile as a sport to the mainstream — and we believe Fortnite is doing the same thing for video games and eSports.

The Fortnite phenomenon has been well-documented, but by way of background, the title has reached more than 125mn players on across console, PC, and mobile. According to SuperData, as of April the game generated $296mn of revenue across platforms, an annual run rate of $3.6bn — more annual revenue than any major console or PC game today. As Fortnite brings more new gamers to the ecosystem, particularly those in younger demographics, we believe the eSports audience - and associated revenue streams - will benefit over time.

A new paradigm for distribution. Unlike traditional sports, the vast majority of eSports viewership is online, the same medium where multiplayer game play takes place and through which the eSports audience consumes media content. In the coming years, we believe eSports content (particularly live) will continue to grow in value, not only due to its audience reach but also the engagement it commands, creating an opportunity for advertisers to target a captive and young demographic.

In the West, we believe Twitch and YouTube Gaming are the primary distribution channels for live and recorded eSports content. Because Twitch captures 84% of live-streaming viewership in North America, we currently estimate that it over-indexes on revenue relative to YouTube, with 54% of gaming content gross revenue market share in 2017 relative to 22% for YouTube. There are three major monetization channels: advertising, tipping, and sponsorship. By 2022, we model eSports industry advertising revenue of $429mn (25% 5-year CAGR), tipping revenue of $372mn (24% 5-year CAGR), and sponsorship revenue of $1.1bn (34% 5-year CAGR).

Asia is leading the way for eSports globally. China’s eSports market is built upon the largest gamer base in the world, with approximately 442 million gamers as of 2017, a 57% penetration rate of Chinese internet users, according to CNNIC. By 2018, China will contribute one third of the global game industry’s total revenue, according to NewZoo. For Asia more broadly, there are 89 million eSports viewers, according to NewZoo, roughly half of global audience in 2018E. We believe the popularity of eSports in this region could be a leading indicator of what is to come in Western markets, as markets like China and Korea already outpace the North America in some measures of technological change like smartphone penetration.

Venture investment in eSports has stepped up meaningfully this year. Since 2013, there has been $3.3bn of venture capital investment in eSports-related start-ups. In 2018 YTD, we have already seen $1.4bn of investment, a nearly 90% y/y increase from from the total amount of funding in 2017. The uptick was largely driven by two outsized investments made by Tencent in Chinese online video platforms Douyu and Huya of $630mn and $461mn, respectively. We believe these investments in particular underscore two key trends: 1) the opportunity for live-streaming to monetize the growth in eSports in a way that few other eSports-related businesses can, and 2) the popularity of eSports in Asia in particular.

China - The Largest eSports market in the world

China’s booming eSports market is built upon the largest gamer base in the world, with approximately 442 million gamers by the end of 2017 and a 57.2% penetration rate of China internet users, according to CNNIC. According to NewZoo, China by 2018 will contribute one third of global game industry’s total revenue, and will remain the number one gaming market by revenues and by players. A robust user base has contributed to the rise of eSports in China. With mobile gaming popularity growing rapidly, more mobile eSports titles (e.g Honor of Kings) have emerged in China, driving a step-up of in eSport market size with a 2015 to 2017 CAGR of 40.6%.

China’s online gaming and eSport sector has moved from a niche market into the mainstream due to the range of games and the engagement. As the gaming industry has matured, perceptions towards online gaming and eSports has gradually changed. In 2016, China’s NDRC (National Development and Reform Commission) issued a policy to “encourage national and international eSport tournaments, on the premise of protection over IP and minors.” The Ministry of Education has also recognized eSports as a major of study for higher education. Under this benign policy environment, more capital has flowed into the Chinese eSport ecosystem, yielding more professional leagues, tournament producers, content distributors and specialized stadiums. The postive investment thesis is further backed by local governments’ support by way of infrastructure (e.g. providing real estate) and has resulted in multiple brick-and-mortar hubs across China and even an “eSport town.”

Chinese professional eSports leagues have also gained recognition in the global arena: most recently, Chinese team RNG won the 2018 LoL MSI world championship, with 60mn unique viewers watching the final between RNG and a Korean team. Korea helped to create the eSports industry 16 years ago and it has since evolved into a national pastime - but China’s eSports industry is still nascent. We expect further growth of China’s eSports industry driven by more tournament IPs, enhanced distribution channels (e.g. live-streaming platforms), infrastructure development and inbound capital across the eSports ecosystem. The industry in China is expected to grow at 23% CAGR during 2017-22E according to Frost & Sullivan.