Amazon (AMZN) recently announced Luna – a cloud-based gaming service that operates much like Alphabet’s (GOOG) Stadia. Luna is interesting in that it appears to compete directly with Stadia yet has a few important differences. Let’s discuss them.
Barrier of Entry
By “barrier of entry,” I mean two different things. The first is the barrier of entry for Amazon to enter the gaming market. The second is the barrier of entry for users to employ Luna. For the sake of simplicity, let’s combine the former barrier with our discussion of Luna vs. Stadia because Amazon’s entry to the market will be played under the same paradigm as its competition with Stadia.
Luna vs. Stadia
The barrier of entry to the gaming market is somewhat negligible for Amazon. Amazon will find its entry into this market a smoother transition than Google’s due to its ownership of Twitch and its ability to advertise its own products in a much more efficient way than Google.
First, Amazon already has the eyeballs of many potential users of Luna. Twitch is to Luna what YouTube Gaming was to be for Stadia. In the gaming streaming community, Twitch emerged as a clear winner over YouTube due to fewer restrictions on content. Streamers on Twitch can stream without concerns of copyright restrictions or region-specific locks, and this is the very fact that led to Twitch’s absolute domination here. Clearly Twitch is a powerful asset for Luna and gives Amazon an edge over Google despite Stadia being the first service to launch.
Second, Amazon has the eyeballs of many potential buyers of Luna. Compare this with the former statement: The users and buyers of Luna will likely see some bifurcation due to the demographics to which Luna appeals. While the end users are likely casual gamers, the buyers will also include mom/dad/grandma/grandpa – essentially non-gamers looking to purchase gifts or upgrade their home entertainment systems – with some overlap, of course. These eyeballs will be on Amazon.com, not on Twitch.tv. Amazon will be pushing Luna on Amazon.com much in the way it pushes Kindle, Alexa, and its other products. This is an important fact for understanding the future of Amazon: With each new product or service release, Amazon decreases the visibility and increases the marketing spend of rival products. Roku (ROKU) and Facebook (FB) are currently experiencing this phenomenon, and the release of Luna implies Alphabet is next.
So, not only does Luna have an advantage over Stadia during its release period (compared with Stadia’s release period) but it also has an advantage in the long game. Amazon will almost certainly leverage its web traffic with ads for Luna at the top of Amazon.com, but this is an impossibility for Stadia on Google.com. The same goes for Twitch.tv (vs. Youtube.com). Amazon has certainly cultivated the right environment for marketing Luna.
But marketing, selling, and being well-received are three different concepts. Amazon will have no problems in the marketing area, for sure. For understanding the other two concepts, we must first understand the market.
The Gaming Market
The gaming market is changing. Gamers see it. Developers are leading it. And Amazon seems to be molding itself to it.
The change to which I’m referring is that of games as a service (GaaS). In the past few years, we’ve seen a gradual transition from the $60-per-game to a subscription economy. Luna and Twitch are both subscription services, and clearly Amazon is not interested in selling individual games. In fact, you cannot buy individual games through Luna – a significant difference between it and Stadia. Currently, the plan is to sell subscriptions to the games of specific developers (e.g., Ubisoft) or a general subscription that gives users access to a number of specifically chosen games. Luna, with Twitch, is clearly focused on the subscription-based model to which the gaming industry is transitioning, while Stadia is seemingly applying more of a shotgun approach with both individual sales and subscriptions.
One part of this industry change is a lower barrier of entry to actually playing a game. An increasing number of modern games are free-to-play (F2P). Gamers gain free access to these games, which are usually designed with clear incentives to spend money within the game. These design features include difficulty plateaus, tradeoffs between spending money vs. spending time – aka “grinding” – and/or in-game status symbols such as cosmetics. Examples include Let It Die, Magic Arena, and Rainbow Six Siege, respectively.
Amazon is taking the subscription-based model to a more macro level. Developers found that they could get gamers hooked to their games by reducing the barrier of entry that could be described as buyer’s remorse of software; gamers now can try a game without dropping $60 on the software. Amazon is mirroring this by reducing the barrier of entry that could be called buyer’s remorse of hardware; gamers need not drop hundreds or thousands of dollars on a console or gaming PC.
Granted, Stadia is playing the same “hardware buyer’s remorse” reduction game, but Amazon is dropping the barrier of entry even more here, with lower costs to game through Luna. At the cheapest, you only need $40 worth of hardware (the cost of the cheapest Fire TV stick and a cheap Bluetooth controller) to get started using Luna. The service cost of Luna, too, is cheaper at $6, roughly half the price of a Stadia subscription.
For the intended demographic of buyers – casual gamers and non-gamers – the lower cost is a clear competitive edge.
The Demographic Problem
The main difference between Amazon’s endeavor and that of gaming developers lies in the market. While gaming developers are primarily targeting gamers – those serious about playing and (usually) winning – Amazon is targeting casual gamers. No serious gamer will be playing through a streaming platform such as Luna due to latency and other issues. Especially in eSports, hardware is often the bottleneck for skill and enjoyment.
That non-casual gamers spend more time and money on games is unquestionable. Amazon’s business with Luna, if it remains targeted at casual gamers, will be one of wide but shallow sales. We are talking low price-per-customers, which implies that marketing ROI will also be low. I cannot imagine Luna’s release making a significant impact on Amazon’s balance sheet even in Luna’s most successful quarter. The most significant impacts Luna can make in a single quarter – in its current implementation – are the side-effect of squeezing out competitors on Amazon.com to drive more sales to Luna (as opposed to Stadia, for example) and the few possible upsells, such as the $60 Amazon controller. Subscription sales might be pretty over the long term but are unlikely to drive Amazon stock in the same way Netflix (NFLX) subscriptions drive its stock.
In short, the release of Luna is interesting but is not important for an investor’s thesis on Amazon. Likewise, Luna seems a bearish catalyst for Stadia – but just as Luna is to Amazon, Stadia’s business is such a small drop in Google’s business and unlikely to be significantly impacted once you consider the entire balance sheet of the company. If anything, the Luna release news is most bullish for other gaming companies, as the reduced barrier of entry to gaming could convert casual gamers to serious gamers, driving sales for Nvidia (NVDA), and Sony (SNE), among others.
Conclusion and Trade Idea
I’ve said mostly good things about Luna above. But now we have to be realistic with regard to Amazon stock. At present, Amazon stock is highly overpriced. The potential for a correction to a more fairly valued price represents a high risk that is not compensated by the release of Luna or any other recent news.
Compared to Stadia, Luna is impressive, but in light of Amazon’s stock run-up this year and its valuation metrics, this new product is by no means a reason to invest in Amazon – especially now. If you like this stock, buy it on a pullback, not on this news. I am not an Amazon bear by any means, but I do care about risk/reward. If you are going to play Amazon, play the risk/reward curve, which highly favors the downside.
Here’s my suggested pullback play.
Buy Oct16 $3,050 puts
These puts are the closest to Amazon’s earnings date without surpassing it. While expensive, they will be rising in value into mid-October due to the volatility rush that occurs before earnings. The main concerns here will be the speed of movement – Amazon’s pullback must exceed its time decay, which is currently $3 per day, $7 below the average daily downward movement for Amazon; if Amazon’s price action remains as such, this put should prove profitable at expiration, though I recommend closing once this option’s theta hits $7.
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