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Monday, March 25, 2013

Playing In The Gaming Industry

Electronic Arts (NASDAQ: EA) saw its stock tank last week, falling as much as 8%, after CEO John Riccitiello announced plans to step down at the end of the month. The company also announced that its fourth quarter results could come in at the low end of its previous earnings guidance of $1.08 billion. But is this just a minor set back for the company?

Despite the stock's pullback on the news, the company is still up nicely year to date:


The push to online gaming

DFC Intelligence estimates that the online video grame market will grow from $19 billion in 2011 to $35 billion in 2017. By 2017 online gaming is expected to account for over 40% of the total video game revenues. Meanwhile, Gartner also has robust estimates for the industry, expecting that consumer spending on online gaming will grow at an annualized rate of 27% through 2015.

The good news is that EA has a strong online presence which presents solid growth opportunities for the company. The digital (online) business is expected to be an important growth driver for the EA as growth in packaged games appears to be declining.

For 2012, the digital business made up 54% of EA's total revenues and grew 47% year over year basis. The other big positive is that EA expects its digital business to grow by an annualized 20% over the next four years.

Activision Blizzard (NASDAQ: ATVI) is another major game maker, with a market cap nearly triple that of EA. Activision has also been making the transition to digital, with 57% of its revenues generated from the segment last quarter. Credit Suisse believes that the company's 4Q earnings beat was a result of higher-quality games -- including its Call of Duty series. The investment firm also believes that high-quality content will continue to be the drivers for long-term company growth. However, I think EA is the better value -- explained later (read about Activision's move to mobile gaming).

Take-Two Interactive Software, Inc. (NASDAQ: TTWO) currently only derives 23% of its revenues from digital. Last quarter, Take-Two posted EPS of $0.67 compared to the $0.27 for the same quarter last year, and beating consensus of $0.56 handily. This was in large part thanks to its NBA 2K13 and Borderlands 2 games. Take-Two should be able to ride the coat tails of is upcoming game releases from its BioShock and Grand Theft Auto series through 2013, but I think the growth potential of Take-Two is not as pronounced as that of EA.

Industry headwinds include the emergence of online games on social networking websites, including Facebook (NASDAQ: FB). Facebook, however, does expect revenues via payments from the games platform to remain subdued. Facebook games are mostly desktop based and declining desktop usage in the developed markets is expected to hurt its top-line growth in 2013. Facebook is instead focused more on monetizing its mobile presence and breaking into the search industry (read about Facebook's search ambitions).

The other side of the coin

If online gaming is one side of the coin for gamings' future, then mobile is the other. Zynga (NASDAQ: ZNGA) has already recognized such a trend. The social gaming company is now transitioning from online gaming and Facebook to a mobile-focused strategy. This should be a big positive for the company as the number of people spending time on smartphones and tablets is rapidly growing.

Mobile will need to lead the future for Zynga, which reported flat revenues year over year last quarter, but a net loss of nearly $50 million and a 15% decline in bookings year over year. Although Zynga is looking to make its move into mobile never fear, EA has quite the presence here (in mobile) too; "EA Mobile is the world's leading publisher of mobile games."

Don't be fooled

EA appears to be one of the best positioned gaming stocks and the recent pull back could be a great opportunity to get into the stock. EA is also the best "value" from a valuation perspective. The company trades at a 1.4 price to sales ratio, compared to Activision's 2.2; meanwhile, their growth rates are very similar. Analysts expect the companies to grow at 14% (EA) and 13% (Activision) over the next five years. I would be remiss if I did not mention Take-Two, which trades at a mere 0.86 times sales. Yet, I think the stock warrants the low valuation multiple given its long-term expected earnings growth rate is only 9%

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