Esports insiders are increasingly convinced that many team organizations are overvalued and a market correction is coming.

In the two years since traditional sports teams started acquiring esports organizations, faith in the long-term potential of video games has grown stronger. But pessimism about the short- and medium-term prospects of esports teams is also growing, as spending pressures grow faster than revenue. The terms at which some leading teams have raised additional investment capital appear divorced from standard business metrics.

All of this will lead to some shaking out in the coming months, experts predict, likely in the form of layoffs at less popular game titles and organizations’ ancillary businesses. Seeking to remain viable with negative cash flow, some likely will be forced to return to the capital markets at a lower valuation, costing founders and early investors money, control, and pride.

Organizations, the esports lingo for companies that operate one or more competition teams under a single brand, are where the majority of sports and entertainment investors have put their money to date. While the esports boom has included a range of businesses, team organizations like Cloud9 , TSM , and OpTic Gaming are the best-known brands in gaming outside the game titles themselves.

But organizations face multiple headwinds.

[perfectpullquote align=”right” cite=”” link=”” color=”” class=”” size=””]”When you’re seeing teams right now raising over $300M valuations on revenues under $25 [M], you’re kind of like, what?”[/perfectpullquote]

Sponsorship revenue isn’t growing as quickly as hoped, and organizations lack the hard assets and control of intellectual property that sponsors want. Twitch viewership in the games that have drawn the most investment, League of Legends and Overwatch , tracked over the course of 2018 more like established properties than early-stage growth plays, with OWL actually losing some audience from its launch, according to The Esports Observer Audience Insights. And teams continue to be concerned that the game publishers aren’t giving them enough help to build their companies.

Simply put, there’s not nearly enough revenue in the system. Though public data is scant, sources say the annual top line at most teams is in the mid-seven figures, except for high-end outliers such as Cloud9, Team Liquid, and TSM, which are well into the eight figures.

“When you’re seeing teams right now raising over $300M valuations on revenues under $25 [million], you’re kind of like, what?” said Jason Lake, the founder of compLexity Gaming , an organization acquired by Jerry Jones and John Goff in 2017. “I try to choose my words carefully, because no one’s more bullish about esports than I am. I just think good, old-fashioned common sense would go a long way here, because the revenue has still not caught up to the size of the demographic and eyeballs.”

Credit: Christopher Ott / ESPAT Media

Also, the combination of a non-unionized workforce and a sudden influx of investment dollars have forced labor costs to skyrocket in the past four years, forcing some teams to choose between competitive excellence and investing in other business lines that might yield more long-term growth, like elite sales teams and advanced merchandising operations.

The strongest organizations are the ones least dependent on the actual competitive teams to make money — for instance, Team Liquid , whose investors include Ted Leonsis and Peter Guber, runs gaming community websites, a Wikipedia-style site called Liquipedia, the video production arm 1UP Studios and an influencer talent agency, Liquid Media. Separately, NRG Esports recently launched a joint venture with a group of noncompetitive gaming personalities in Australia who are collectively “significantly bigger” than any esports team, NRG co-founder Andy Miller said.

[perfectpullquote align=”left” cite=”” link=”” color=”” class=”” size=””]”These are not structural long-term problems, just from a valuation perspective, some teams grew way too fast.”[/perfectpullquote]

Esports evangelists say it’s far too early to draw conclusions. But privately, some investors and advisers agree that a serious return on esports team organizations looks farther away than it did just two years ago. Estimates vary, but most believe it’s at least a five- to 10-year horizon.

Obviously, traditional sports owners are well-acquainted with money-losing properties that nevertheless appreciate greatly over the long term. And to be sure, some investors are in the game precisely because they think their property will emerge at some unknown future date as part of a small handful of powerful global team brands, a la Manchester United, not because they’ll spin off cash any time soon.

“Long term, if you’re David Blitzer, or Wes Edens, or the Lacobs, and you don’t care what happens in the next three years, you care what happens in the next 30 years, you’re going to be fine and not worried about short-term market fluctuations,” said Josh Swartz, president and co-founder of Catalyst Sports & Media , an agency that advises investors and brands on their entry into esports. “These are not structural long-term problems, just from a valuation perspective, some teams grew way too fast.”

The valuation issue is one of expectations: Can an esports team build value at a pace far quicker than any traditional sports team can? The market believes they can, but there’s little hard evidence of that right now.

According to a recent attempt by Forbes magazine to estimate the value of the top-12 esports organizations, those teams on average trade at values 14 times their annual revenue. To put that into context: That’s more than double the NBA average valuation of 6.5 times annual revenue, according to Forbes, and even eclipses the 11.3 revenue multiple that drove a major funding round in 2017 for the home-rental platform Airbnb, which can scale much faster than an analog sports team.

[perfectpullquote align=”right” cite=”” link=”” color=”” class=”” size=””]”Are valuations out of control? Undoubtedly some of them are…” [/perfectpullquote]

The theory is that esports organizations have the best of both sports and technology, said Mike Sepso, an esports consultant and founder of Major League Gaming , which sold to Activision Blizzard in 2016.

“The optimistic point of view is you’re combining both the long-term value accretion of sports franchises with high-growth, early-stage tech multiples,” Sepso said.

Steven Cohen, chief strategy officer at AEG and a board member of Immortals , says esports teams are more traditional than it might appear. Yes, theoretically they have a global fan base and some aspects of the company can be replicated like software or social media companies. But fundamentally, the work of building a distinctive brand, a deep emotional bond with fans and long-term relationships with sponsors can’t happen quickly. “It’s going to take some time to solve, and it’s much more analog than digital,” Cohen said.

A key variable is how many esports organizations can become a Manchester United-style global brand: One? Five? Thirty? Investors are willing to pay a premium to get in, if they’re convinced the property is on that track.

“High valuations are an indication of limited franchise opportunities and scarcity of high-quality management teams in esports,” Sepso said. [perfectpullquote align=”left” cite=”” link=”” color=”” class=”” size=””]”There is always urgency to monetize, but at this stage in esports, it’s definitely not panic.”[/perfectpullquote] Cohen added: “Are valuations out of control? Undoubtedly some of them are. And some of them we don’t think are overvalued at all. The question is, are people prepared to play the long game? Because it’s very early.”

One high-profile team organization already retrenched. Infinite Esports , the holding company formed by Texas Rangers investor Neil Leibman to hold OpTic Gaming after he acquired it in 2017, made deep cuts to staff this fall.

Also, Echo Fox , the team owned by former NBA star Rick Fox, cut fighting game players and teams in Gears of War and Call of Duty . An ambitious league in the game “H1Z1,” operated in part by Twin Galaxies, a sister to Echo Fox under the holding company Vision Esports (whose investors include the Yankees), collapsed amid reports of deep losses. Sources say other organizations are reconsidering their breadth as well heading into 2019.

[perfectpullquote align=”right” cite=”” link=”” color=”” class=”” size=””]”It’s OK, corrections are good, things don’t go up and to the right forever.”[/perfectpullquote]

Sepso says the revenue pressure is not yet a crisis, and investors believe sponsor and ad dollars will come around. “There is always urgency to monetize, but at this stage in esports, it’s definitely not panic,” Sepso said.

Investors insist this is not a “bubble.” There is a proven, sticky audience for esports on some level, and there’s no doubt that gaming culture in general will continue to claim a larger part of the American entertainment landscape. But there’s a difference between saying video gaming culture is a rocket ship and esports organizations as currently constructed are a sure bet.

“The sky’s not falling, just that the pricing grew really fast, and really quickly,” Swartz said. “It’s OK, corrections are good, things don’t go up and to the right forever. It’s good to have kind of a retrenchment. Further, it’s important to separate esports valuations from the global gaming marketplace, which shows no signs of slowing down any time soon.”

Ben Fischer is a staff writer for Sports Business Daily, which this article was originally written for. You can read the original article here.