Who Will Benefit From Cloud Gaming?

by: Dzhafer Medzhakhed

Status of cloud gaming

Cloud computing is a recent shift, that is occurring in the IT industry where more and more IT functions are transferred to remote servers, which are held by third parties. The development of the cloud is strongly related to the generalization of broadband internet, since to have an acceptable user experience, a high speed of data exchange between local machine and server is mandatory. Cloud gaming is just the part of the cloud that is related to the video game industry. Two pioneers in the field of cloud gaming are Onlive and Gaikai, both privately held. These two companies allow any person to connect to their servers and play the games that they have in store. The benefits of such services are obvious: people having cheap netbooks or old notebooks/PCs that cannot handle the graphics of more recent games, just need a high speed connection to play. No need to invest in expansive hardware and no need to buy discs or spend hours downloading the game. You only need high speed internet, and a credit card. Another advantage of cloud gaming is platform independence as for example you can play on your android or iOS powered tablet plenty of PC/console games.

Gaming console manufacturers such as Sony (NYSE:SNE), Microsoft (NASDAQ:MSFT) and Nintendo are still very strong. But as the services of cloud gaming companies continue to improve, and their game libraries to expand, we will probably see a migration of customers at some point. Two technical hurdles that are slowing the mass adoption of cloud gaming currently are internet latency and graphics. Many very popular games are centered around multi-player experience, and thus require low latency/lag to make the gaming experience as fluid as possible. With the improvement of internet infrastructure and the installation of additional cloud gaming servers that will reduce the average distance user-server, this issue will start to progressively fade. The graphic side of the equation is mostly a matter of internet speed and compression settings. If you would need to transfer good quality HD signal, you need at least 10Mbit/s connection. This is still far from being universal. In addition, Full HD graphics are not yet available on the cloud gaming platforms (Onlive supports ~720p, and has 1080p in the works). whereas this is a standard feature of many console or PC games. Innovative accessories such as the Kinect or MEMS based joysticks give console manufacturers another edge. However, the price of these accessories is relatively cheap when compared to the price of the console itself (powerful processors, memory). Which means cloud gaming could easily add such accessories to their platforms. Altogether, we probably will need another 2-3 years to see cloud gaming become a mass phenomena. One key accelerating factor for cloud gaming will be its integration with the internet enabled TV or smart TV. This will make cloud gaming accessible to a much larger audience.

Tablets - a cloud gaming killer?

The processing power of tablets is growing extremely fast, and will soon be comparable to the processing power of current gaming consoles. Features such as Apple's airplay which allows to mirror your tablet game to your LCD panel through Wifi makes tablets even handier than console and PCs. This might lead us to think that cloud gaming will become irrelevant and be replaced by mobile devices gaming. However, one of the nice features of cloud gaming is that you don't need to download the game: you can play it immediately. Today, many of the tablet and smartphone games are still small in memory size. But to reach the level of entertainment of console and PC games, mobile devices games would need to increase drastically in memory size, and therefore become slow to download. In addition, most of the games on the servers of Onlive and Gaikai have a free trial version. That means that you can instantly have a good taste of the game before you buy it. No need to spend hours downloading the demo. But the main reason why tablets will not harm cloud gaming is a new trend that will emerge in the coming quarters: smartphones and tablets feature saturation. How many users need a quad core processor in their smartphone? What will you do with an 8 core processor in your tablet? Read your emails, browse web pages and watch photos and videos? Most of the tasks that are handled by the current tablets do not require more processing power than Nvidia's (NASDAQ:NVDA) Tegra3 or Apple's (NASDAQ:AAPL) A5X. This is to say, that this trend of increasing processing and graphical power in tablets will soon hit a wall of low customer demand. And parameters such as battery life, price, and weight will become more critical. This is why we think that cloud gaming has a strong future on tablets as well.

The winner and losers

At first sight, one would think that cloud gaming would benefit chip manufacturers that are focused on servers such as Intel, AMD or Nvidia (graphical compression). However, since servers can be more efficient than standalone PCs or consoles, the increase from server sales might not be sufficient to compensate for the losses in CPU and GPU sales of gaming consoles and GPUs for gaming enthusiasts. In other terms, cloud gaming could be slightly bearish for these companies.

In the cloud model, telecommunication companies and other utility providers such as Cisco (NASDAQ:CSCO), Qualcomm (NASDAQ:QCOM), Teliasonera, Akamai (NASDAQ:AKAM), Teradata (NYSE:TDC), Amazon (NASDAQ:AMZN), etc are the first winners. But their growth is not specific to cloud gaming, it is related to the overall growth of the cloud. And you might notice that stocks of many of these companies have already priced in this paradigm shift.

In our opinion, to understand who will really benefit from cloud gaming you need to look at another adjacent trend. It's been more than a decade that IT engineered characters have started to appear in movie theaters. And every year, more and more computer animated movies are being released. The huge success of Avatar is a perfect example of this new virtual entertainment trend. On the other hand, there is the opposite process where in video games, small movie clips with real actors are used. This hybridization process of gaming/movie industry is far from over. Thanks to progresses made in hardware and software, today's games have become very realistic. Moreover, within a few years, the graphical realism of games will start to reach movie-like quality. When compared to films, video games offer more than one story: RPG games such as Mass Effect offer thousands of story lines in one game and universe you can explore at wish. This interactivity feature gives video games a much greater creativity potential than TV/movies. And with the gap of graphical realism quickly closing, we expect video games to start to take a predominant place in household life. The Kubricks, Spielbergs and Coppolas of tomorrow will be game directors/creators!

Therefore, our conclusion is that video game developer companies such as Activision Blizzard (NASDAQ:ATVI), Electronic Arts (NASDAQ:EA), etc will be the real long term winners from the cloud gaming trend. And all the movie/TV studios that won't adapt to this trend will become the losers.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: The company names in this article are provided as examples, not as investing recommendations.