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Hi everyone — welcome to another issue of Naavik Digest. If you missed our last one, be sure to check out our dive into the portable game console market. In this issue, we’re reviewing Square Enix’s Q1 FY2024 earnings and discussing to what extent PlayStation exclusivity for Final Fantasy XVI hurt both the game’s initial launch sales and potentially its long-term prospects, too.

We're also excited to announce that Naavik will be attending this year's Gamescom later this month. Naavik Co-founder Abhimanyu Kumar and Consulting Partner Jordan Phang will be in Cologne, Germany on August 23rd (Day 1) and available to discuss consulting relationships, content contributions, Naavik’s new Open Gaming Research Initiative, and broader partnerships. They'll also be free if you just want to catch up and hear what Naavik has been up to lately. Submit a meeting request by clicking on the link below, and we look forward to seeing you at the business area!

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Inworld AI Raise / Playtika Acquires Youda / EA Earnings / BattleBit Remastered

In this week’s Roundtable, the squad discusses Inworld AI raising more than $50 million for AI NPCs in games, plus Playtika's acquisition of Youda Games. Then after a short discussion on EA’s earnings report, we discuss the demise of physical games and retail outlets like GameStop. Finally, we peel apart the success of BattleBit Remastered to figure out what other game developers can learn from this surprise hit and discuss how much graphic fidelity really matters for success. Join us for all the latest games business news with Aaron Bush, Tammy Levy, and host Devin Becker.

As always, you can find the Naavik Gaming Podcast on YouTube, Spotify, Apple Podcasts, Google Podcasts, our website, or anywhere else you listen to podcasts. Also, remember to shoot us any questions here.

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#1 Square Enix’s Exclusivity Gamble May Have Backfired

By Nick Statt, Naavik Managing Editor

Square Enix is no stranger to exclusivity deals, and the Japanese publisher has made it a point to approach this console gaming distribution strategy with pragmatism. It has chosen to side with its longtime partner Sony when it makes sense, but it’s also gone multiplatform when it feels a wider release will give it a bigger bang for its buck. Yet, in the case of Final Fantasy XVI, Square Enix’s decision to go exclusive with the PlayStation 5 may have ultimately backfired.

A new report from Bloomberg revealed that the company’s disappointing Q1 FY 2024 earnings released on Friday led to the company’s worst intraday stock decline in almost three years when markets opened in Tokyo on Monday morning. One of the primary culprits: Final Fantasy XVI not meeting “the high end of the company’s expectations,” Square Enix President Takashi Kiryu said on a post-earnings call last week. According to the report, the PS5’s more limited install base was a factor in the game’s sales performance.

Let’s review the company’s Q1 earnings, discuss Final Fantasy XVI, and also examine the broader console exclusivity landscape in 2023.

Square Enix’s Disappointing Q1

Square Enix’s financial performance for the three months ended June 30th, 2023, had several bright spots, but it also revealed the company’s dragging profitability.

The company saw a 76% year-over-year growth in game sales to 7.54 million units and revenue of ¥85.6 billion ($602 million), which is up 14% compared to this time last year. The HD Games unit also saw a 142% increase in sales to ¥29 billion ($204 million), thanks mostly to the Final Fantasy franchise, with the release of both FFXVI and the Final Fantasy Pixel Remaster collection arriving on PlayStation and fthe Nintendo Switch.
But both its mobile and MMO segments are down 18% and 22%, respectively, due to a lack of new content for Final Fantasy XIV and Dragon Quest 10, and only a single new release for smartphones with the launch of the free-to-play Dragon Quest Champions. FFXIV’s Growing Flight patch launches this October, so that segment will certainly rebound in Q3, but the mobile segment appears to be struggling of late with a combination of macro effects, game cancellations, and Square Enix’s hesitancy to port Japan-only mobile games to the West.
With the aforementioned failure of FFXVI to hit the higher end of the company’s estimates to help make up for these other declines, Square Enix suffered a 66% year-on-year drop in operating profit to ¥6.3 billion ($44.3 million).
Square Enix still forecasts a 4.9% increase in year-over-year net sales to ¥360 billion ($2.5 billion), with new releases in the Dragon Quest franchise and the much anticipated Final Fantasy VII: Rebirth (the second installment in the FFVII remake series) due out in spring 2024 and an Xbox release for FFXVI.

FFXVI Might Have Needed Xbox to Break Through

While there was a fair amount of buzz around FFXVI thanks to a savvy pre-release demo and a heavy marketing campaign in the run-up to launch, the game still failed to meet the “high end” of Square Enix’s expectations, though we don’t exactly know what that high might have been.

What we do know is Square Enix said the game sold 3 million copies (shipped to retailers and digitally sold) one week after launch. While that may sound like an impressive milestone, it’s clear the company was hoping for a slightly better result considering FFXVII Remake sold 3.5 million copies in its first 10 days to the admittedly much larger PS4 install base.
A much more telling data point might be the success of FFXV, which launched in 2016 at roughly the same point in the life cycle of the PS4 and Xbox One as we are now for the PS5 and Xbox Series line. The difference, of course, is that FFXV was a multiplatform release, and understandably it became the fastest-selling entry in franchise history with 5 million copies shipped and digitally sold in its first 24 hours.
The PS4 was also not as supply-constrained as the PS5. But it’s worth noting there were only roughly a million or so more PS4s in the wild during the launch of FFXV than there are PS5s today, so that’s less of an excuse for Square Enix than it might have been a year ago.
It seems clear now that despite whatever exclusivity arrangement Square Enix brokered with Sony to make FFXVI a console exclusive, the game’s launch didn’t quite hit the bar. Lower sales than FXV is expected, but perhaps Square Enix leadership hoped for something more in the 4-5 million range after its first week to two weeks given Sony’s current console market lead and the apparent strength of the Final Fantasy brand name for PlayStation owners.
To be clear, an attach rate of somewhere between 8 to 10% of PS5 owners, combined with whatever financial and marketing incentives Sony promised as part of its exclusivity contract, is not at all a bad outcome by any means and does appear in line with even Sony’s own first-party portfolio. That suggests either Square Enix’s internal targets may have been too ambitious or the company’s data might be forecasting poor longevity for the game given its early sales performance.
Still, we know FFXVI has experienced a dramatic falloff in retail performance, with retail sales of the game in Japan plummeting more than 90% in its second week after release. The central question now is whether the game will maintain a decent attach rate as more PS5s enter consumers’ homes.
The major franchise departure in FFXVI’s combat system (and to a lesser extent its more gritty, Game of Thrones-inspired tone) may ultimately affect whether it becomes a classic like prior entries, which would ensure more sustainable long-term success, or if it sputters and fails to surpass 10 million units sold. But either way, Square Enix seems a bit tepid on the game’s early performance and we may have to wait until more sales data is available to cast a more sound judgment on whether the game is underperforming.

Rethinking Console Exclusivity

Console exclusives clearly aren’t disappearing any time soon. Just look at Starfield, which is poised to be the biggest Xbox exclusive in years and may be the first real system seller of the Xbox Series generation. But for third-party publishers and developers, console exclusives come with risk, and Square Enix has dabbled enough on both sides of the strategy to see exactly where those risks lie.

Square Enix still plans to make FFVII Rebirth a PS5 exclusive next year. But beyond that, the company appears done with cutting Xbox out of the equation. At the FFXIV Fan Fest in Las Vegas last month, Square Enix and Microsoft announced a partnership to bring the MMO to Xbox devices at long last in 2024.
The partnership also included Square Enix CEO Takashi Kiryu saying the company would “whenever possible … bring our games to Xbox for players around the world to enjoy.” The “whenever possible” is a nice euphemism for “whenever Sony doesn’t pay for console exclusivity.”
Many of Square Enix’s most recent games, including Forsaken and Octopath Traveler II, have skipped the Xbox platform in favor of exclusivity deals with other platform holders, which says as much about the company’s working relationship with Microsoft as it does about the viability of console exclusivity.
Still, now that Microsoft Gaming CEO Phil Spencer has actively repaired that relationship, and with Square Enix leadership publicly announcing less-than-expected sales for FFXVI, it seems likely the Final Fantasy maker may become a more multiplatform publisher after next year.
This might also make Square Enix a more attractive acquisition target. Thanks to the FTC v. Microsoft hearings, we now know Microsoft was eyeing a purchase of Square Enix just a few years ago as part of its Game Pass and first-party expansion plans.
A more multiplatform company would certainly be in line with Microsoft’s Activision Blizzard acquisition strategy and would still boost Xbox’s profile in Asia while helping drive Game Pass growth. But it seems doubtful Microsoft will want to go through more acquisition scrutiny in the short term, so such a deal may be much farther on the horizon.

#2 Gaming Market Update: July 28th - August 4th

By Mario Stefanidis, CFA, Naavik Contributor

For the week ending August 4th, 2023: The average return for gaming companies tracked by Naavik with a market capitalization exceeding $500 million was -1.6%. The S&P 500 returned -2.3% and the Nasdaq-100 returned -3.0%. Full access to the Naavik Gaming Company universe is available here.
Keywords Studios (LSE: KWS) fell -13.0% after delivering their 1H 2023 trading update, for the six months ending June 30th. Overall revenue increased by 19% from the same period last year, from €321 million to approximately €383 million. However, on an organic basis without the impact of acquisitions, revenue grew by only 10%, less than half the rate of 2022’s 1H growth of 22%. Adjusted operating profit is expected to be €59 million, a 5% increase from €56 million in the comparative period in the prior year. While Create, the company’s development services segment, has been performing well against challenging comparables, Globalize, which is responsible for localization services, is experiencing a pronounced slowdown. Keywords expects to report its formal half-year results on September 12th.
Unity (NYSE: U) declined -11.5% after releasing its financial results for Q2 FY2023, which exceeded the company’s top and bottom line expectations. Adjusted EBITDA rose to $98.8 million, up more than three times from the previous quarter and marking the fourth consecutive quarter of EBITDA growth. Free cash flow was $33.5 million, the first FCF-positive quarter since Q1 2022. Revenue of $533 million rose 80% year-over-year, ahead of the company’s midpoint revenue guidance of $515 million. This includes the acquisition of ironSource, which is now a part of the Grow Solutions segment. On a pro-forma basis, this segment rose 7% year-over-year, while the unimpacted Create Solutions segment rose 17%. Customers contributing over $100,000 in TTM revenue grew from 1,085 in Q2 2022 to 1,330 in Q2 2023. Some undisclosed portion of this growth was due to the ironSource merger. Unity projects Q3 2023 will generate revenue between $540 million to $550 million, up 1% to 3% from Q2. Despite the relatively positive results, the stock price declined markedly last week.
Electronic Arts (NDAQ: EA) fell -11.1% after reporting earnings for Q1 FY2024, which showed net bookings of $1.578 billion (up 21% year-over-year) and net revenue of $1.924 billion (up 9% year-over-year). The growth was driven by momentum in EA Sports and Star Wars Jedi: Survivor, with 75% of net bookings coming from live services and other net bookings. This figure was 83% last quarter, as live services net bookings were down 27% from Q4 FY2023. EA's expectations for FY 2024 project net revenue and bookings between $7.3 billion and $7.7 billion, a midpoint of $7.5 billion, while analysts expected north of $7.6 billion.

Notable Venture Financing Deals

Square Enix Inworld — *Source: Intel Capital*

Inworld AI raised more than $50 million in venture funding in a round led by Lightspeed Venture Partners (LSVP) that values the company at over $500 million. Additional investors include Stanford University, Samsung Next, Microsoft’s M12 fund, First Spark Ventures, and LG Technology Ventures. This follows the company’s Series A last August, which also raised $50 million. Joining the board of directors is LSVP partner and head of gaming Moritz Baier-Lentz, who previously invested in Inworld’s March 2022 seed round while at BITKRAFT. According to Kylan Gibbs, Inworld's co-founder and chief product officer, the company is now the most funded startup at the intersection of AI and gaming.
- Inworld is focused on creating non-player characters that promise to be as intelligent as humans. The goal is to make characters and interactions central to the gaming experience, enabling more immersive and interactive narratives. Inworld aims to be a creator tool, not a game studio or production house. It wants to have technology easily adapted by AAA game studios, which can save time and money by not having to build such tech from scratch. Developers can fine-tune these interactions via a no-code menu, where elements such as the relationships between characters, NPC dialogue tone, and speaking priority can be managed. Inworld plans on launching an open source version of its engine in the coming months, allowing developers to draw insights on character interactions from a shared pool.
Venture capital firm a16z initiated a second “Speedrun” accelerator for pre-seed startups within gaming and technology, with plans to invest up to $75 million. The first Speedrun was a product of the firm’s presence at GDC 2023 back in March, when it received more than 1,600 applications for funding. This led to 32 investments in startups and culminated in a four-week accelerator program. Furthermore, 80% of those startups received additional funding from other investors following a demo day in June.
- This new class will participate in a 10-week program beginning next January and ending in March during next year’s GDC. Chosen startups will receive $500,000 in funding, and be paired with industry mentors from companies like Riot, Take-Two Interactive, Twitch, Unity, and Zynga. This new round is focused on providing support to various types of founders, with an emphasis on passion and product shipping capabilities rather than specific industry categories like “esports” or “VR.”
Google has opened applications for its $2 million Indie Games Fund to support small games studios in Latin America. Eligibility for the fund is restricted to independent developers with 50 or fewer employees, and those working with publishers must meet additional requirements. Studios are required to use the investment to build or grow their games on Google Play, including on the company’s Google Play Pass subscription service. Priority will be given to those porting their games to Android or building from scratch on the platform. Around 10 studios will be selected, each receiving between $150,000 and $200,000.

Notable Strategic Investments

Square Enix Techland — *Source: Shacknews*

Playtika, an Israeli gaming company specializing in social casino and casual mobile games, has agreed to acquire Youda Games' portfolio from Azerion. The initial acquisition amount is €81.3 million, but includes an earnout based on the performance of the acquired titles, which could boost the total consideration for the deal to a maximum of €150 million. Youda is primarily known for its social card game Governor of Poker 3, which is available on the App Store and Google Play.
- According to data.ai, the app has been downloaded 15 million times and generated $108 million in net microtransaction revenue since its August 2014 launch. Azerion is disposing of its Youda Games assets due to a focus on digital advertising in the last few years. Chief Revenue Officer Sebastiaan Moesman has said “social card games have become less strategic for Azerion” since then. For Playtika, the acquisition aligns with its strategy of leveraging its live ops expertise and technology to scale and optimize games, according to Playtika's president and CFO Craig Abrahams. Compared to Playtika’s previous purchases, Youda is relatively small. The acquisition is expected to close by Q3 of the current calendar year.

Notable Studio Updates & Partnerships

Square Enix Version — *Source: DayFR Euro*

Microsoft Gaming CEO Phil Spencer made a surprise appearance at Final Fantasy XIV Fan Fest in Las Vegas alongside Square Enix game director Naoki Yohida. The two, later joined by CEO Takashi Kiryu, announced that Xbox and Square Enix would ”look to partner more closely together in the future,” beginning with the release of MMORPG Final Fantasy XIV on Xbox Series X and Series S in spring 2024.
- Kiryu and Yohida affirmed this intention and expressed Square Enix's desire to bring more games to Xbox. This announcement is a major blow to Sony, which is still reeling from its failure to prevent Microsoft from purchasing Activision Blizzard. In June, Sony and Square Enix held a pre-release celebration event for Final Fantasy XVI, where Sony Interactive President Jim Ryan said the partnership between the two companies has “never been stronger.”
Krafton’s Striking Distance Studios, the developer behind the survival horror game The Callisto Protocol, laid off 32 employees as part of an internal restructuring process. The layoffs were first noticed through LinkedIn updates by former staff members, including development personnel like VFX artists and level designers. Striking Distance confirmed the layoffs and stated that strategic changes were implemented to realign the studio's priorities to better position current and future projects. The company also emphasized its commitment to supporting departing employees with outplacement services and severance packages. The news comes amid other restructuring efforts in the gaming industry, including layoffs at CD Projekt Red and Niantic. Reports also suggest that publisher Krafton was dissatisfied with the sales figures of The Callisto Protocol.
Yuka Kitamura, the renowned composer behind the music of popular FromSoftware titles such as Elden Ring, Sekiro: Shadows Die Twice, and Bloodborne, announced her departure from the company to pursue a career as a freelance composer. Kitamura began her tenure with FromSoftware in 2013, composing the soundtrack for Armored Core: Verdict Day. Since then, she has been responsible for some of the most memorable soundtracks in gaming. Elden Ring’s soundtrack received nominations for best music at various award shows, including The Game Awards, BAFTA Games Awards, and New York Game Awards. Kitamura confirmed her intention to continue working within the game industry and launched a new website promoting her previous work.

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