Tuesday, November 08, 2011

Activision To Hit Gaming Target, EA Could Miss

The electronic gaming industry is in a shooting war between traditional console gamers and social network gaming. With Activision (NYSE: ATVI) reporting its earnings Tuesday, investors can see just how well it's doing. But should you invest in Activision or would Electronic Arts (NASDAQ: ERTS) be a better bet?

And these two companies are in a shooting war. That's because Activision's Call of Duty controls 90% of the so-called shooter segment. and EA wants to take that down to 70%. It’s no secret that EA are directly going after Call of Duty, mainly because the company mentions it at any given opportunity. This latest episode sees EA claiming they want to take Activison’s 90% share of the shooter market down to at least 70%.

As EA's Jens Uwe Intat told ButtonCombo in September, “We will give Activison a hard time in the space. And we have done it when we won back the football category from PES. That’s what we are doing in the shooter space. One of my favourite sayings is ‘Rome wasn’t built in a day’. We might not do it Day One, but we are going to take a decent amount share from Activision. In broad numbers, Activision has 90 per cent of the shooter market, and we want to see that go down to 70. I would be even happier if they were left with 60 per cent.”

Experts agree with EA's assessment of Activision's market position. As Jesse Divnich, an industry expert, told IndustryGamers, the "Call of Duty franchise is outperforming the category's growth, and since release counts have been similar over the year the data would conclude that Call of Duty is both growing the Shooter category while growing its share."

And that category has been growing rapidly. Since 2008, the number of Shooter games sold has been growing at an 8.5% annual rate from 68 million in 2008 to 80 million in 2010. That amounts to $5 billion in revenue -- up from $3 billion in 2006 -- a 13.6% annual rate, according to IndustryGamers.

With all this good news on Activision, you might expect it to be reporting outstanding results for the third quarter. If so, you would be disappointed. That's because analysts expect a 75% drop in earnings per share from 2010. They forecast Activision will earn a penny a share -- down from 4 cents a share the year before .And revenue is expected to be down 25% to $558 million for the quarter compared to the 2010 third quarter.

This decline does not come as  surprise. After all, in September, total U.S. game sales—including videogame console hardware and games—fell 6% to $1.16 billion in the year to date, down 6% from $1.23 billion a year earlier, according to NPD Group. And this decline is due in part to Activision and EA's slow response to social games like Zynga -- whose pending IPO could value it at $20 billion.

Zynga's prospectus indicates that it's outperforming Activision. For example, for the nine months ending Sept. 2011, Zynga's revenues rose 106% to $829 million while its net income fell 35% to $31 million.

But Activision's weak earnings will not be the public's focus Tuesday. Instead, attention will be paid to the debut of Activision latest "Call of Duty" game -- the $60 "Call of Duty: Modern Warfare 3" that will battle for shooter market share with EA's just-released "Battlefield 3."  Both companies are hoping these games will reverse the negative trend.

Meanwhile EA's latest results for its second quarter ended Sept. 30, were better than expected. Its adjusted profit of $17 million was 5 cents a share -- better than the 5 cents a share loss that analysts had projected.

And EA's sales rose 17% to $1.03 billion -- exceeding expectations by over 9%. However, without the adjustments, EA reported a loss of $340 million -- $139 million worse than its 2010 second-quarter loss.

So here's what the investment choice between Activision and EA boils down to:
  • Activision: Strong growth, decent margins; slightly expensive stock. Activision's sales have increased a small 3.9% in the past 12 months to $4.77 billion, but net income has soared, up 270% to $645 million – yielding a 13.8% net profit margin. Its PEG of 1.17 (where a PEG of 1.0 is considered fairly priced) is a bit expensive on a P/E of 24.1 and expected earnings growth of 20.63% to $0.89 in 2012.
  • EA: slow growth, losing money; cheap stock. EA's sales have dropped 1.8% in the past 12 months to $3.86 billion while its net loss declined 59.2% to ($290 million). Its PEG of 0.54 is cheap on a forward P/E of 27.8 and expected earnings growth of 51.47% to $0.88 in fiscal year 2013.
I would rather take a chance on Activision than EA. Both are facing a considerable threat from social gaming to which they are having trouble adapting. But Activision's financial house is in much better order. Nevertheless, if EA achieves its fiscal 2013 earnings goal, it's stock is now screamingly cheap. I think that target could be hard to hit.

In this shooting war, I'd give the edge to Activision.


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