2 Ways to Play the Gaming Market

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

Investors are viewing the ecosystem that supports console gaming with skepticism. Are there stocks in this space that are cheap enough to justify jumping in?

The Big Picture for Console Games

In 2012, the video game market witnessed a major shift in consumer preference as they moved from conventional console games to mobile-based games on their tablets and smartphones. According to the data compiled by research firm NPD, sales of physical games in 2012 plunged 22% to $8.88 billion while digital game sales increased by 16% to $5.92 billion.

Some support to the video game industry is expected to come from China, which could lift its ban on game consoles after 13 years. According to TechWeb's 2012 China Game Industry Report, the video game industry in China is estimated to be about $10 billion in 2011. The Chinese Ministry said that they are reviewing the current policy about the opening of the game console market and have also conducted various surveys and entered into discussion with other ministries regarding this issue. The restriction was imposed by seven ministries, and hence approval would be required from all seven of them to lift it.

Individual Stock Outlook

Activision Blizzard’s (NASDAQ: ATVI) shares surged in February 2013 after it reported that its fourth quarter results were above analyst expectations. The company sales were boosted by its "Call of Duty" and "Skylanders" franchises, which ranked as the number 1 and number 3 best-selling game franchises in 2012. Take-Two Interactive Software reported that its net income increased to $71.4 million during the third quarter as compared to a net income of $14.1 million during previous year. The company expects to launch Grand Theft Auto V in September this year.

Sony (NYSE: SNE) is expected to launch a new “PlayStation 4” console system. The new console is expected to bring a new life to the video game business, which has suffered declining sales and questions about the future of game console systems. It has been seven years since the company launched PlayStation 3. This console was a hit, selling about 77 million units globally, but now the company’s game business faces a stiff challenge from Microsoft’s (NASDAQ: MSFT) Xbox and a secular disruption across the entire industry as smartphones and tablets have become competing game platforms. Microsoft is expected to commence the sale of a new Xbox with higher processing power and new home entertainment features by the end of 2013.

Sony and its peers are trying to entice gamers to pay premium prices with high-definition, immersive game experiences. Various companies are working together to put their consoles front-and-center in the home as entertainment hubs, making them replacements for set-top boxes that cable companies offer as a part of their service.

According to Colin Sebastian, an analyst for Robert W. Baird, “Sony and Microsoft have to convince consumers that there is a compelling reason to upgrade to the new hardware.” The new console would use off-the-shelf chip components, and Advanced Micro Devices is expected to gain the key slots for the central-processor and graphical-processor units. According to Michael Pachter of Wedbush Securities, “You’re going to get a box that’s 4-8 times faster than what’s currently out there, with a commodity CPU-GPU combination.” He also said that the technical innovation in the new console would offer larger things on the screen at once.

The greatest challenge for the company’s new PlayStation 4 and Xbox (which Microsoft is expected to be working on) is offering a similar level of performance leap with new generation consoles. There would be certain other changes, which may include the ability to take part in streaming game content that is not fixed to a plastic disc. According to the Wall Street Journal, the new PlayStation would also offer games that are streamed over the Internet, as Sony would make use of its previous year’s acquisition of Gaikai, a cloud gaming firm.

The support of game publishers such as Electronic Arts, Activision Blizzard, Take-Two Interactive, and Ubisoft would be required to help in the sale of the new console. But they would face pressures of their own, with struggles in social and mobile channels threatening their established retail businesses.

GameStop (NYSE: GME) said that customers would fail to acknowledge any new machine that limits the play of pre-owned titles in response to a report about features on Microsoft’s next Xbox video-game console. The Grapevine, a specialty retailer that generates about half of its profit from the sale of used discs, conducted a survey of its most active clients. According to Matt Hodges, a company’s spokesman, these clients would have fewer chances to buy a next-generation console that restricts trading in pre-owned games. He also said, “We know the desire to purchase a next-generation console would be significantly diminished if new consoles were to prohibit playing pre-owned games, limit portability or not  play new physical games.” The company’s PowerUp Rewards program provides early notice about sales collector’s items and promotions to the gamers.

Valuation

Not all of these stocks are cheap:

Ticker

Company

P/E

P/S

P/B

P/FCF

D/E

EPS Growth Next 5 Years

SNE

Sony

NA

0.2

0.66

15.69

0.69

NA

GME

GameStop

NA

0.34

1.43

7.17

NA

12.0%

AMD

Advanced Micro Devices

NA

0.34

3.48

NA

3.8

2.7%

KNM

Konami

17.2

1.14

1.17

786.04

0.16

32.1%

TTWO

Take-Two Interactive

NA

1.29

2.48

NA

0.58

8.3%

EA

Electronic Arts

32.38

1.35

2.74

21.12

0.28

13.8%

MSFT

Microsoft

15.25

3.19

3.21

11.25

0.2

8.4%

ATVI

Activision Blizzard

14.37

3.32

1.43

12.69

NA

9.0%

Electronic Arts and Konami trade at high price-to-earnings ratios and high price-to-free cash flow ratios. Take-Two Interactive is worse still since it ran a loss and had negative free cash flows.

Instead, Sony is a more compelling, dirt cheap speculative play. It trades at a discount to book value and the lowest price-to-sales ratio on this list. Value investors should also consider Activision Blizzard. It is less speculative but less cheap, with reasonable P/E and P/FCF multiples. It is attractive considering that its low price-to-book ratio ignores the value of its internally developed intellectual property.


BillEdson11 has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard. The Motley Fool owns shares of Activision Blizzard, GameStop, and Microsoft. 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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