2 Video Game Stocks to Consider for Your 2013 Portfolio

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Console gaming and computer gaming are in decline, but the industry is far from dead. Many gaming companies continue to do well in the console and PC space, and many will find ways to exploit new gaming interfaces in 2013.

Below, I will explain why investors should consider purchasing some of the stronger game companies at attractive valuations. Specifically, Konami (NYSE: KNM) and Activision Blizzard (NASDAQ: ATVI) are trading at attractive price multiples that justify jumping into this lagging industry. These two firms have strong balance sheets and intangible assets that do not deteriorate, making them survivors in a violent competitive environment.

Atari Files for Bankruptcy

Yes, there are casualties in this industry. Atari, the iconic video game company, filed for bankruptcy protection in Manhattan to separate from its French parent which is unprofitable.

The company was established in 1972 and was a founder of arcade and video games. The company owns and manages over 200 brands, such as Missile Command, Rollercoaster Tycoon and Centipede. Its games can be played on consoles and mobile devices from Sony and Microsoft. Currently, it lags behind various game-manufacturers such as Activision Blizzard, the world’s largest company by sales, and Electronic Arts (NASDAQ: EA).

The company is expected to sell its assets within the next 90 or 120 days. It would be a free and clear sale under the U.S. bankruptcy laws or it could authenticate reorganization plans that would substantially carry out the same results.

According to a statement, the manufacturer of video games such as Pong and Asteroids, as well as its affiliates Atari Interactive, California US Holdings and Humongous, asked to be jointly administered in filings on Jan. 21, 2013 in the US Bankruptcy Court.

Atari’s French parent has not earned profit since 1999 despite the sale of its assets and restructuring. The company forecast a significant loss in 2012-13 and announced that it would weigh all sources of raising cash and has been in talks with potential investors.

The company owes between $10 million and $50 million to at least 200 creditors as per its Chapter 11 petition. Atari reported assets of $1 million to $10 million.

According to a statement by the company, “The Chapter 11 process constitutes the most strategic option for Atari’s US operations, as they look to preserve their inherent value and unlock revenue potential unrealized while under the control of Atari. During this period, the company expects to conduct its normal business operations.”

The company's market value has fallen to approximately $33.8 million, representing a drop of about half of its value last year.

The U.S. companies are looking for an approval to obtain $5.25 million in debtor-in-possession financing from funds managed by Tenor Capital Management.

The company also requested permission from the court to pay pre-filing wages and benefits to approximately 48 employees. Court documents indicate that the average gross semi-monthly payroll is $258,600. According to the filing, approximately $90,000 of these wages and salaries remain unpaid as of its bankruptcy.

New Gigantic Touchscreen Gaming Product

As old gaming interfaces grow stale, others are opening up. For example, China-based Lenovo Group has introduced a high-end gaming device for family entertainment. The 27-inch Horizon Table PC, which allows for multiple players at a time, is targeting families who have been dissociated because of individual devices. The touch-screen device is expected to retail at $1,699 but analysts are skeptical that families are willing to spend such an amount for a gaming device. CIMB-GK Pte’s analyst Jonathan Ng also indicated that consumers may prefer competing products. According to Ng, “Families who enjoy games together are likely to stick to game consoles like Xbox and Wii.”

Though Lenovo has launched new games to be used on the Horizon Table PC, developers like Ubisoft and Electronic Arts will still have a chance to run their games. The device runs on Windows 8 software and comes with four joysticks and an e-dice. The device’s form lends itself to many familiar board games like digital Monopoly.

Electronic Arts reported GAAP net revenue of $4.1 billion in fiscal 2012. The game maker's latest release, Dead Space 3, was touted as one of the best games of this generation. The demo version of the game saw nearly 2 million downloads on Microsoft’s Xbox Live Marketplace and Sony’s PlayStation Network. 

Smartphones and tablets have promoted individualism and separated families, and Chief Executive Officer Yang Yuanquing hopes the gaming device will help family members get closer. According to Yang, “We believe people would like to reunite.”

Lenovo’s acquisition of International Business Machines components could explain its success in the PC industry, but Yang recognizes that there is need to venture into new markets if sales growth is to remain high. The company beat HP and Apple in the PC and smartphone industries, respectively, but it will have to counter market leaders in family entertainment like Nintendo and Microsoft. In addition to the Horizon Table PC, Lenovo also has four different smart television models that run on Google’s Android Operating system. Though Lenovo has distributed its products to the Philippines, Indonesia, Vietnam, Russia and India, its smart televisions are only available in China.

Lenovo has fast become a market leader in the PC and smartphone industries under Yang’s leadership, and this new product line may easily win the approval of customers like other products. JI Asia analyst Jean-Louis Lafayeedney attributes the high price of the gaming device to the technology needed for it to support multiple users and a 10-finger touch. The graphics, processors and general cost of making this device is fairly high, so it may take a while to sell. According to Lafayeedney, “This is an interesting and innovative product but end-demand will be limited at this point in time.”

Valuation

Game stocks trade at cheap price multiples:

<table> <tbody> <tr> <td> <p><strong>Ticker</strong></p> </td> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>P/E</strong></p> </td> <td> <p><strong>P/S</strong></p> </td> <td> <p><strong>P/B</strong></p> </td> <td> <p><strong>P/FCF</strong></p> </td> <td> <p><strong>D/E</strong></p> </td> <td> <p><strong>EPS Growth Next 5 Years</strong></p> </td> </tr> <tr> <td> <p><span>ATVI</span></p> </td> <td> <p><span>Activision Blizzard</span></p> </td> <td> <p><span>14.87</span></p> </td> <td> <p><span>2.87</span></p> </td> <td> <p><span>1.19</span></p> </td> <td> <p><span>11.24</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>9.3%</span></p> </td> </tr> <tr> <td> <p><span>EA</span></p> </td> <td> <p><span>Electronic Arts</span></p> </td> <td> <p><span>33.33</span></p> </td> <td> <p><span>1.23</span></p> </td> <td> <p><span>2.48</span></p> </td> <td> <p><span>19.3</span></p> </td> <td> <p><span>0.28</span></p> </td> <td> <p><span>13.8%</span></p> </td> </tr> <tr> <td> <p><span>KNM</span></p> </td> <td> <p><span>Konami</span></p> </td> <td> <p><span>14.24</span></p> </td> <td> <p><span>1.09</span></p> </td> <td> <p><span>1.19</span></p> </td> <td> <p><span>17.95</span></p> </td> <td> <p><span>0.16</span></p> </td> <td> <p><span>32.1%</span></p> </td> </tr> <tr> <td> <p><span>TTWO</span></p> </td> <td> <p><span>Take-Two Interactive</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.28</span></p> </td> <td> <p><span>2.38</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.67</span></p> </td> <td> <p><span>8.3%</span></p> </td> </tr> </tbody> </table>

Activision Blizzard and Konami trade at low price-to-book ratios. They are cheap even without considering their significant off-balance sheet intellectual property assets. These are substantial assets and can lead to genre-leaping licensing deals. For example, Konami has joined up with Hasbro to design and manufacture slot machines based on a Dungeons and Dragons theme. Activision’s Call of Duty is arguably as big a blockbuster as any movie release and could easily find its way into theaters and other media spin-offs. Buying these stocks near book value essentially buys the growth potential of these stocks for free.

Conclusion

The market appears to have priced in industry headwinds for Konami and Activision. Investors should mull over these stocks as cheap buy candidates.


BillEdson11 has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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