Epic’s Mega Deal

The Past, Present, and Future of Epic Games

Earlier this week, Epic Games announced a $2b funding round from Sony and KIRKBI (the family-owned investment company of The Lego Group) that valued Epic at $31.5b. Each group put in $1b, which is a significant investment for each party. For Sony, this represents a large tripling down as the company had already invested $450m across two prior rounds. To put this in context of the broader industry, Epic’s valuation is slightly lower than the market cap of Electronic Arts ($34.7b), and exceeds Unity ($27.7b), Roblox ($26.5b), and Take-Two ($16.0b).

Epic became a household name following its release of Fortnite Battle Royale in September 2017, and the valuation has skyrocketed since. Consider the timeline of the company’s last five major raises:

• June 2012: Tencent acquires 40% of shares for $330m (valuation of $825m)
• October 2018: Raised $1.25b at a valuation of $15.0b
• August 2020: Raised $1.78b at a valuation of $17.3b
• April 2021: Raised $1b at a valuation of $28.7b
• April 2022: Raised $2b at a valuation of $31.5b
  

While the velocity of growth can make Epic seem like a relatively new entrant to the gaming industry, knowing the company’s extensive history is important to understanding its current position and future ambitions.

Brief History of Epic

The origins of Epic date back to 1991 when Tim Sweeney started Potomac Computer Systems in his parents’ house while he studied at University of Maryland. Initially intended to be a computer consulting business, the company quickly pivoted to video game development after Sweeney found moderate success selling a few thousand copies of an action-adventure puzzle game called ZZT.

Fast forward to 1998, Sweeney brought on Mark Rein as a business partner, changed the name of the company to Epic MegaGames, and expanded the team to over 50 employees. The pillars of modern Epic were established that same year with the initial release of the Unreal FPS game series. As the name suggests, this game was built using the Unreal Engine, which was also being licensed out to other game developers.

Between 1998 and 2006 (23 games), Epic continued building out their portfolio of PC games. This continued until software piracy / copyright infringement pushed the company to focus on console games. Epic found quick success in the console space with the release of Gears of War on the Xbox 360. This achievement ($100m in revenue on a $12m budget) kicked off several years of content development and studio acquisitions. Six Gears of War titles have been developed by Epic since 2006.

Jumping ahead to 2012, Tencent’s 40% equity investment in the company represented a substantial strategic shift that is still core to Epic’s identity today: games-as-a-service. In line with this, Fortnite survival mode was unveiled as a free-to-play title in 2014 (originally announced in 2011). The company’s ability to embrace the live ops model, constantly adapt gameplay, and create new experiences has been critical to building and maintaining one of the most notable IPs and brands in gaming.

Another core component of Epic’s identity is its focus on enabling anyone to become a creator. Epic has done this in 3 ways within the past 8 years:

1. Increasing access to its engine by releasing Unreal 4 under a new licensing plan in March 2014 and charging a $19 monthly subscription alongside a 5% royalty on revenues. Soon after, the company made it free to schools. Tim Sweeney has stated that the user base for the engine grew by 10x before March 2015, when the engine was made free for all users (Epic only asked developers for 5% of revenue for products that earn >$3k in revenue per quarter) (Fortune).
2. Establishing a 12% revenue share for the Epic Games Store and denouncing other publishing platforms who charge more (Variety)
3. Going toe-to-toe with Apple to fight against their monopoly of the mobile publishing market (The Verge)

This brings us to Epic today. While the company has a deep portfolio of content (primarily Fortnite), an industry leading game engine (Unreal), a robust game distribution platform (Epic Games Store), and back-end services (Epic Online Services), the most popular theme communicated from the leadership team is the desire to build into the “metaverse”. We have previously written about how the definition of this term is incredibly vague. However, this latest fundraise and the messaging around what the company hopes to achieve is starting to provide more clarity.

Epic Today (and going forward)

Looking at Epic’s strategy today and going forward, we believe Epic’s vision of the metaverse is not about Fortnite, transmedia IP, or digital events. It is about owning a user’s entire digital experience. This means controlling the content they consume, the platform that houses the content, the tools used to build the content, and the online services that allows users to communicate, collaborate, and cooperate. Such a strategy is directly aligned to the existing portfolio that has been built over the course of decades.

One of the most interesting aspects of the latest raise is the emphasis on creating a safe space for children to play (age-ing down vs Roblox who are trying to age-up). The partnership with Lego is key to establishing a trusted brand that continues to solidify Epic as the de facto digital entertainment brand for young people.

With this in mind, one line in particular stuck out in Epic’s recent announcement: “This investment will accelerate our work to build the metaverse and create spaces where players can have fun with friends, brands can build creative and immersive experiences, and creators can build a community and thrive.”

If this strategy sounds familiar, it is probably because these three pillars of engaged social communities, brand integration, and user creation replicate the high-level model of the most successful kids play platform in the world: Roblox, a $26.5b “metaverse”. Epic’s fight with Apple over their 30% revenue share may be a warm up for stealing market share from their next key competitor (Roblox), who take an aggregate 47.5% from developers (Roblox Developer Economics).

Although we do not believe there is going to be any one platform that can call itself “the” metaverse, Epic has demonstrated a clear willingness to take on its competitors in the battle for users’ time and attention (as highlighted by the hundreds of millions of dollars in losses realized by the Epic Games Store to secure top content). It seems the next big step is engaging these audiences earlier and creating an ecosystem they never want to leave.

Takeaway: While Epic’s exponential growth and unbridled ambition may seem like the result of a few favorable bets, the business is rooted in decades of calculated strategic decisions that have continually paid off. The company is now well positioned to leverage the synergies across their various assets to create the go-to platform for digital experiences across age groups. While the latest target appears to be a younger audience, we believe the company is setting itself up to engage and grow with a user throughout their entire digital life.