Gaming These Gaming Stocks
Damian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
We’ve come a long way since Atari’s Pong; however, the end of video-gaming seems nowhere near. Since video games became publicly widespread in the early 70's, several companies have been competing to offer the best gaming experience.
Over the last few years, some game developers have stood out among the crowd for the quality of their games, catching larger portions of the public. This has been the case of Activision Blizzard (NASDAQ: ATVI), Electronic Arts (NASDAQ: EA) and Changyou.com (NASDAQ: CYOU). Let´s take a closer look at them and try decide if they stand as good investment opportunities as well.
Activision Blizzard: Only online games
Activision Blizzard is a worldwide leading pure-play online and console game developer. Its wide product portfolio includes blockbusters like World of Warcraft, or WoW, Guitar Hero, Call of Duty, and Tony Hawk, among many others. Usually on the top of game sales charts, this is a firm to watch.
Its expertise at making games has been reflected on the extreme loyalty of its customer base and the considerable amount of franchise royalties it receives from game distributors, like NetEase, around the world. Its WoW franchise has been particularly popular, massively played for over 9 years now. Monthly prepaid subscription fees make WoW a vast revenue source and, although the number of subscribers has been dropping lately, its contribution to cash flow and margin generation will remain significant.
The company is now trying to replicate the success of its WoW franchise model for other games. Given its track record, I expect Activision to continue to diversify revenue sources, maintaining its industry leading margins (including an operating margin of over 30%, about 10 times the industry average) and returns.
Emerging economies provide outstanding growth opportunities for Activision. As the middle class grows in these countries, disposable income and time available for video-games increase too. The company will benefit not only from its strong brand names and blockbuster games, but also from a strategic partnership with Tencent Holdings, China's largest Internet gaming company, which will help the firm penetrate the $8 billion online gaming market in this country.
So, trading at 13 times its earnings, at a 40% discount to the industry average, I would buy this stock for the long-term (and receive a 1.33% dividend yield).
Electronic Arts: Offline & online games
Electronic Arts, or EA, is another game developing and distributing company that operates in both the offline and online gaming segments. Its wide product portfolio includes blockbuster franchises like FIFA, Need for Speed, Battlefield, Medal of Honor and The Sims to name a few. Most of its revenue is derived from disk-based video game sales and, in a lesser degree, from subscription fees, micro-transactions and advertising.
Going forward, the firm should benefit from lowering its production costs and difficulty by leveraging its new development engines. Moreover, renewed contracts with several of its major sporting league partners assure continuity for some of EA's most valuable franchises.
However, it's EA's mobile and online games that represent its future. Its Origin platform positions the firm in an advantaged place to benefit from the rapid expansion of online gaming, while its “freemium” model for the mobile segment could deliver plenty of upside on the back of its games' quality. These segments are expected to drive growth and contribute to margin expansion over the next few years.
While forecasts are somewhat mixed in relation to the company's EPS growth going forward, its stock valuation at 74 times its earnings, over 3 times the industry average, reflects plenty of optimism. You will have to pay a premium if you want to hold this fairly moated, liquid company in your long-term portfolio.
Changyou.com: Chinese market
Changyou.com develops online games for the Chinese market. Unlike the aforementioned companies, Changyou is not very well known in the West. For this reason, its stock trades at only 5.5 times its earnings, a 75% discount to the industry 22 times average. However, its growth prospects look quite promising as the online gaming market quickly expands in China.
With its Tian Long Ba Bu, or TLBB, game as its biggest revenue contributor, the firm has been focusing on expanding its product offering beyond it through in-house development coupled with acquisitions and licensing.
Game offering diversification and the growth of the middle-class in China are two of the main growth catalysts for the company. Better monetization models and strategies that entice gamers to spend more money are also expected to drive growth in the years ahead. Furthermore, the wide and loyal user base created by TLBB not only allows the firm to “gain more insights into gamers' behavior and spending patterns, which should help it develop more popular and profitable games” (Morningstar), but also provides considerable cross-selling capabilities.
Finally, the company recently bought out minority shareholders in 7Road, a majority-owned subsidiary of Changyou. This will allow the firm to fully control the game pipeline, gaining an edge over competitors in the web-gaming space while consolidating its image as a firm with more than one battle horse.
Although all three of the aforementioned gaming companies provide plenty of upside potential, Changyou.com and, especially, Activision offer better combinations of decent valuations and strong growth projections than EA. I’d recommend adding these stocks to your long-term portfolio, and preparing to enjoy steady and sustainable evolution in the stock prices and earnings.
Damian Illia has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard. 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!