New eSports ETF Belongs In Your Portfolio: NERD Analysis And Interview – Listed Funds Trust – Roundhill BITKRAFT Esports & Digital Entertainment ETF (NYSEARCA:NERD)

The growth of eSports continues to be one of the biggest themes in the world of both sports and video games. Advertisers, celebrities, and sports team owners are flocking to eSports in hopes of investing in new teams and leagues thanks to massive growth in audience figures and prize winnings. Many gaming companies are involved in the eSports market, but many remain far from pure play options to see the gains from growth in eSports. Recently, a new ETF hit the public markets that offers investors the right exposure to the growing industry and the right mix of stocks that will benefit along the way.

(Photo Credit: NERD Investor Deck)

The NERD ETF (NERD) will hold companies that earn revenue from electronic sports-related business activities. This includes video game publishers, streaming platforms, video game tournament organizers, gaming hardware companies, technology companies, and companies ownings eSports teams.

The fund (prospectus) will look at three main categories to determine its holdings:

• Pure-Play companies: primary business model and growth are directly linked to eSports
• Core Companies: company has substantial operations linked to eSports
• Non-Core Companies: linked to eSports, but is not the major revenue driver for the company

Each holding must have a minimum market capitalization of $100 million or $150 million if it is considered a non-core company. Six-month daily average volume of each holding should be $1 million or above. The fund will rebalance quarterly after the third Friday of March, June, September, and December.

The NERD ETF creates a thematic relevant score given several items. Those scores then determine which stocks are included in the fund and which of the three categories listed above they fall into. Scores are created using key word searches, regulatory filings, analysts reports, and industry publications. Scores of 125 and above put the companies into the pure-play category. Scores of 75 to 125 put them in the core company category. A score of 25 to 75 places companies in the non-core company category, and a score of under 25 keeps the company from being added to the fund.

I had the opportunity to ask some questions about the NERD ETF and eSports in general to Will Hershey. Mr. Hershey is the co-founder and CEO of Roundhill Investments, the company behind the NERD ETF. His commentary is mixed in with this analysis of NERD.

The current holdings of the NERD eSports ETF are (as of 08/28):

It shouldn’t come as a huge surprise to see Activision Blizzard as the largest holding in the ETF. The large US gaming company has been able to monetize its intellectual property quite well by creating eSports leagues for several of its properties. Mr. Hershey points out that, in terms of Activision’s Overwatch League, “management has taken US esports to the next level, both in terms of monetization and mainstream acceptance”. He cites over $200 million in sponsorships and broadcast rights as a prime example of the value of the Overwatch League to ATVI. Franchise slots for Overwatch League teams continue to rise in value and initial fees paid to the company.

As a perfect example of wealthy individuals wanting to get involved in eSports, check out this piece on two NFL owners (Robert Kraft – Patriots, Stanley Kroenke – Rams) paying $20 million to secure franchises in the initial Overwatch League of 12 teams. Eight additional teams were added with franchise fees of $35 million paid. Plans call for the league to hit 28 teams and new members to pay $60 million for the rights to a franchise. This is a great business model ATVI has created. The company is attempting to replicate that success with its Call of Duty brand, which will launch an eSports league. Franchises, which will include the Korenkes, will start at $25 million.

I was surprised to see Tencent placed lower in the NERD ETF. The company is the largest gaming company in the world and owns League of Legends and is a partial owner in Epic Games, the owner of Fortnite. Hershey said he likes to call “Tencent a mini gaming ETF because it has exposure to so many different players in the space. Tencent’s gaming-related portfolio includes stakes in (see picture).” Hershey did say the main reason Tencent was lower in the weighting was its diversification outside of gaming.

(Photo from Will Hershey interview email)

Unlike the Van Eck Video Game and eSports ETF (ESPO), the NERD ETF has huge holdings in companies that stream video games and tournaments. Afreecatv, Huya, Sea, Bilibili, and DouYu are all heavily involved in the streaming business. ESPO has 26 holdings, but is heavily weighted in the video game publishers themselves and also hardware makers.

(Photo Credit: NERD Investor Deck)

Here is a comparative look at the two ETFs that include eSports in their name:

As you can see from the chart, there are some major differences between these two ETFs. Besides the general makeup of video game companies versus including streaming companies as well, ESPO contains much larger companies. The heavy weighting of large-cap companies in ESPO is more of a negative to me, as the smaller companies using eSports to grow seem like they have the bigger opportunity to be long-term winners. I also love the larger international exposure that NERD has compared to ESPO.

When asked for differences between NERD and ESPO, Hershey pointed to the primary differences of exposure and theme. He called the inclusion of NVDA and AMD “picks and shovels” way of getting involved in eSports. He also pointed out that gaming represents only 50% of NVDA revenue. Hershey highlighted the scoring system used by NERD saying, “that we will assign higher weights to companies more exposed to esports and lower weights to holdings that are less exposed. The end result is higher weightings in companies like HUYA and DOYU (0% in the other ETF) and lower weightings in NVDA and AMD (currently 0% in NERD).”

The rationale behind investing in the eSports market is pretty simple. The industry is seeing explosive growth thanks to a massive population of people that play and watch others play video games. More than 2.3 billion people worldwide play video games. In the United States, two out of three people play video games. The number of people who watch video game streams continues to grow. Worldwide, 454 million people watch video game streams. That figure is expected to grow to 645 million by the year 2022. More people watch video game streams than Netflix, HBO, ESPN, and Hulu combined. The video game market is expected to grow 10% annually through 20201 after hitting $138 billion in 2018.

Investing in this ETF and getting exposure to a basket of video game and streaming stocks is the way to go. Take the Chinese streaming market for example. There is a much larger population in China and higher interest in watching and playing video games. There are also two main players in the streaming market (HUYA, DOYU), and other smaller players BILI. This ETF has exposure to all three of these names. Hershey tells us “a diversified approach to Chinese livestreaming makes sense. We have exposure via Huya, DouYu and Bilibili.

I was happy to get the opportunity to ask Mr. Hershey about the recent DouYu IPO, which I recommended in an article right here on Seeking Alpha. I asked Hershey first why DOYU was so much lower in its weighting compared to rival HUYA. Mr. Hershey told me that “our methodology calls for new IPOs to replace low scored (low weighted) companies. This strategy is meant to limit the impact of potentially volatile IPOs while still providing exposure to key components in the esports ecosystem. It is very likely that DouYu receives a higher weighting upon our next regularly scheduled rebalance in September.”

Mr. Hershey went on to talk about the poor performance of the Douyu IPO. Like me, he was surprised to see the stock fall in its opening day and continue to trade lower than its IPO price. He cites the trade-war volatility and geopolitical concerns as a possible reason why the stock is down. “Douyu reported what appeared to be strong quarterly results, yet the stock continues to remain under pressure,” Hershey said. He remains bullish with this advice, “We think that a combined market capitalization of US $8 billion for Douyu and sister Huya will likely prove to be attractive for a Chinese game-streaming market that is nearly 5 times the size of the US equivalent market in terms of users.”

Investing in this ETF also gets investors exposure to individual eSports teams. Hershey pointed out to me that BILI, HUYA, NetEase (NASDAQ:NTES), and GameWith all own teams in major eSports leagues. “Huya owns the Chegdu Hunters of the Overwatch Leagues and LPL team Royal Never Give Up, while BILI has Bilibili Gaming. NTES also owns a team in the Overwatch League; GameWith owns a Clash Royale team,” he said. Hershey went on to say, “For some, this may be the best way to get exposure, but that exposure comes with several unknowns. Quite honestly, we are too early to be able to tell if the OWL will more closely resemble the XFL or the NFL.” While he remains cautious, I continue to think team values will be one of the fastest risers in the eSports market. Take a look at the values of professional sports teams and you can see how sponsorships and broadcast deals have dramatically increased valuations.

Hershey leaves us with this baseball analogy, saying “we are still in the bottom half of the first inning for esports.” He says anyone who tells you exactly who the winners and losers will be is lying as it is too early to tell. He reminds investors to “take a long-term approach to the industry”. In terms of picking individual stocks for esports, Hershey says, “Esports organizations (teams) are probably the sexiest way to get involved, but also come with risks. We see our ETF, which holds public companies at various stages in their lifecycle, and across sub-segments, as a smart way for most investors to get involved for the long term.”

The eSports market continues to grow and should have no problem producing many winners over the short and long term. Who those winners are is the million dollar question. Investors should consider a small exposure to eSports in their portfolio via individual stocks or an ETF like NERD. This is a hot growth market that you don’t want to miss out on.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NERD, HUYA, DOYU over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Interview with Will Hershey was conducted via email with questions sent and answers sent back. All opinions are my own. All questions were provided by the author.