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The waiting game trips game makers
Video-game players won't buy new games until they get their new consoles. The game makers' stocks are sliding, but investors should buy now, before the gamers return.
By Robert Walberg
For video game makers, there will be no cheer this holiday season. It turns out that, as feared, consumers put off buying new video games until the arrival of new consoles from Microsoft (MSFT, news, msgs), Sony Corp. (SNE, news, msgs) and Nintendo.
The evidence: First, the NPD group, a game-sales researcher, said sales for the month of November were down 21% from the same month last year. A few days later Activision (ATVI, news, msgs) warned that its third- and fourth-quarter sales and earnings numbers would be below guidance the company gave in early November.
While the news certainly wasnt good, it also wasnt a big surprise -- at least not to anyone that follows the game industry. Earnings and sales have been declining throughout the industry over the past several months amid growing concern over rising licensing and development costs, increased price competition and waning demand. Stock prices have reflected the unsettled environment, as shares of Activision, Electronic Arts (ERTS, news, msgs) and Take-Two Interactive Software (TTWO, news, msgs) have declined by an average of 31% from their 52-week highs.
Waiting for the hardware
One of the industry's biggest concerns is that consumers are waiting for the new systems before buying new software. In the case of the Xbox, the new system is already out, but demand has been so great and supply so limited that many consumers cant get their hands on the new system ahead of the holiday. No hardware, no software purchases. (Xbox maker Microsoft is the publisher of this Web site.)
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That's bad news for the industry, as Sonys new Playstation system isnt due out until spring, while Nintendos new system, called Revolution, wont debut until the fall. The software makers could be looking at another six to nine months of sluggish sales.
With slow sales comes more intense price competition. Over the past few weeks alone, industry leader Electronic Arts slashed prices on many of its leading titles, including Madden 2006, NCAA Basketball and FIFA 2006.
The slimmer margins those cuts create couldnt come at a worse time for the industry, as its licensing and development costs are escalating at an alarming pace. Whether it's increased licensing fees demanded by professional sports leagues, or the higher costs of developing more sophisticated games, costs are on the way up across the industry.
This might not be a big problem if the companies were in position to jack up prices, but they don't have that luxury. Dont be surprised to see operating margins declining when the companies report their results over the next couple of quarters.
Small-screen gaming
Not all the news is bad, however. There are new frontiers offering exciting growth prospects going forward, especially in cell-phone gaming. Though small compared to the video gaming business, the growth in cell gaming is explosive. According to the London consulting firm of Informa Telecoms & Media, the cell-phone game industry has grown by 342% over the last two years alone.
The cell industrys tremendous potential explains why Electronic Arts didnt mind using its financial muscle in its bid for Jamdat Mobile (JMDT, news, msgs). While some on the Street think the $680 million price tag for Jamdat was too high, it was a small price to pay to acquire a leadership position in the fast growing space. Look for Activision, Take-Two and THQ Interactive (THQI, news, msgs) to try and make similar forays into cell gaming.
Electronic Arts is also beginning to develop games in Asia exclusively for the local market. The company, smartly, hopes to better exploit the regions intense demand for video games.
More good news: By this time next year, consumers will be plunking down their dollars to buy titles for the three new gaming systems in what could be a record year for sales. Compared to this year's sales, next year's results will look very good indeed.
Unfortunately, there is nothing on the immediate horizon but negative sales news, lower earnings guidance and ratings downgrades. Consequently, expect shares of Electronic Arts, Activision and Take-Two Interactive to fall by 10% to 20%. The negative news cycle should also drag down better performers like THQ and Midway Games (MWY, news, msgs).
Long-term investors will want to take advantage of these declines to add shares in front of next years rebound. Due to strong management teams, solid financials and decent product mixes, my two favorites are Electronic Arts and Activision.
At the time of publication, Robert Walberg did not own or control shares of companies mentioned in this column.
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