Why These 3 Game Stocks Are Set to Drop

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

In the wake of the video game industry's recent E3 conference, and the announcement of next-generation consoles from Sony and Microsoft, excited investors have bid video game stocks higher. But their euphoria now could lead to downside ahead.

These companies risk disappointing the market, because it could take several quarters for game publishers to grow sales after the newest generation of consoles is released. Investors in these game makers have ignored a decline in online subscribers, and possible selling action by major shareholders. When those events finally register with investors, game company shares could underperform.

Watch the game leaders

Electronic Arts (NASDAQ: EA) is one of the companies that could fall in the weeks ahead. There are no positive surprises greeting the company, since EA reiterated its $4 billion revenue guidance for the full year. To reduce its chances of releasing a flop, the company is developing fewer game titles. EA expects to make 25 titles in fiscal 2014 -- nearly half as many as the 46 it released in fiscal 2012. EA will improve its income statement by reducing its operating expenses, but a miss in sales for any one of the titles will really hurt that highly watched earnings number.

Looking longer out, the new consoles are expected to drive game sales over the next two years. For EA, it means that digital services and digital game delivery will gain importance. At the E3 investor presentation, EA noted the importance of a console update in driving growth in these two business lines: 

Source: EA Investor Presentation at E3, 2013

Online subscriptions drop

Activision (NASDAQ: ATVI) is another company whose shares could decline. In its first quarter, Activision reported a 9% decline in subscription sales, which comprises World of Warcraft (“WoW”) and Call of Duty Elite. The company badly needs a replacement for World of Warcraft, but does not expect to have another big multiplayer game ready until 2016 at the earliest.

Subscriptions for WoW dropped by 13.5% to 8.3 million during the March 2013 quarter. If the decline in WoW subscribers accelerates, investors will be caught off guard when Activision reports quarterly earnings that miss expectations.

Making things worse, Vivendi (VIVHY) is considering selling part of its 60% position in the company. Until it makes a firm decision, the resulting uncertainty will continue to weigh on shares. 

Debt issuance...for acquisition?

A company most often issues shares when their price is at a high, not when those shares are expected to move even higher. Take-Two Interactive (NASDAQ: TTWO) took advantage of its soaring share price by selling $250 million of convertible senior notes.

The financing will not dilute existing shareholders, but happen ahead of Take-Two's highly anticipated Grand Theft Auto V release in September 2013, which should bring in positive cash flow for the company.

Indirectly, the $500 price tag of Microsoft's Xbox One could deter consumers from buying premium game titles. The timing of the GTA V release coincides closely to both consoles' release dates in November 2013, which means all three product launches will be fighting to win over consumers' wallets.

EA data by YCharts

Conclusion

Investors exposed to this sector should anticipate weak share performance for game makers in the months ahead. Either initial console sales will be slow, or those consoles' monthly sales growth will decline after the Xbox One and PS4 are launched. Unfortunately, game makers' share prices aren't reflecting either possibility right now.

While Activision and Microsoft have been taking the headlines when it comes to console gaming, Fools following the gaming sector would do well to also keep tabs on Electronic Arts. The Motley Fool's new special report breaks down the risks and opportunities facing the company to help you decide if EA is right for your portfolio. Click here to get your copy now.


Chris Lau has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard and Take-Two Interactive . The Motley Fool owns shares of Activision Blizzard. 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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