Did the Stock go up? Yes, but They're Still Bad Investments

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Back in August, I wrote that video game companies are terrible investments, with one lone exception: Activision Blizzard (NASDAQ: ATVI).

As a matter-of-fact, I'm pretty sure that I referred to the other video game makers as "deadbeats."  So let's see how that's panned out in terms of share price:

<img alt="" src="http://media.ycharts.com/charts/aa743e5edb3249fed63fb279007b0877.png" />

ATVI data by YCharts

So far, not so good if you're holding shares of Activision.  However, if you were smart enough to ignore my advice on Take-Two Interactive (NASDAQ: TTWO) and Electronic Arts (NASDAQ: EA), then you are making a little money, or at least doing better than the S&P 500. 

THQ, on the other hand, has filed for bankruptcy protection, and there are plenty of rumors flying around as to what will happen to the assets, which will likely be broken up and sold to the highest bidders. 

But what has sent Take-Two & EA up?

Good question, and as I recently discussed, it's oftentimes not (only) because of company performance.

One thing to point out before we dig into a little more detail.  In the chart above, with the exception of THQ and Microsoft, there is a distinct correlation in the overall gains and losses of the three companies that we are discussing, and it trends with the S&P in large as well.  So it's a reminder that the general market movement does play some role. But the question that matters is, What pushed Take-Two & EA higher, and Activision Blizzard lower?

It it seems that most of EA's moderate increase really has been a product of improving business performance.  From the Q2 earnings report (Oct. 30, 2012):

"EA is performing well, once again beating street consensus in fiscal Q2," said Chief Executive Officer John Riccitiello. "We delivered yet another quarter of sharp digital growth, with digital revenue up 40% compared to the same period last year, reflecting our strength across multiple brands and channels."

Continued:

"We delivered a very strong performance in the second quarter, backed by great performances from our EA SPORTS titles," said Chief Financial Officer Blake Jorgensen. "We are forecasting annual non-GAAP EPS growth of at least 25% at the midpoint of our guidance, and Operating Cash Flow of over $400 million."

It's important to note, however, that based on GAAP performance, EA is still losing money, with a GAAP net loss of $381 million in the quarter, or $1.21 per share.  Yet again, on the positive side, TTM GAAP Net Revenue increased to $4,095 million, up 6%, and TTM cash flow from operations maybe the most important metric to look at right now, is up more than four-fold, to $490 million.  Now it's a matter of turning that cash flow into net earnings. Q3 earnings are set to be announced in early February, so we will soon learn if the all-important holiday shopping season helped EA move the ball in that direction. 

Take-Two Interactive was also buoyed by a similar move closer to profitability, though in this case it was on a significant revenue increase from the prior period in FY12, though it is important to note that it is primarily on two blockbuster releases.  From the earnings report:

“Take-Two’s second quarter revenue and earnings exceeded our outlook, driven by the breakout success of 2K’s Borderlands 2 and robust demand for our catalog and digitally delivered offerings,” said Strauss Zelnick, Chairman and CEO of Take-Two. “Our business continues to fire on all cylinders, led by terrific early results from 2K’s NBA 2K13, and the outlook for our upcoming releases such as BioShock Infinite is stronger than ever. As a result, we continue to expect to deliver revenue growth and Non-GAAP profits in fiscal year 2013. Moreover, with Grand Theft Auto V slated for spring 2013, we are poised to generate substantial revenue and earnings growth in fiscal year 2014.”

On a GAAP basis, the net loss in Q2 was near $12.5 million, compared to over $47 million the year before, and showed a non-GAAP net income of over $10 million in the quarter.  So yes, it's a move in the right direction, but it's not the only thing that has lifted shares higher.

Carl Icahn ups his stake to over 10%:

"Mr. Icahn and partners most recently owned 9,693,874 shares of Take-Two after buying 1,007,800 for a total purchase price of $11.2 million, according to a regulatory filing. Mr. Icahn on Monday disclosed his stake had climbed to 9.6% from the 8.7% held days earlier. "

More, from fool.com's Rick Munnariz:

"As far as Take-Two Interactive goes, he's simply reading the tea leaves. The video game industry is in trouble, but that also provides an opportunity for consolidation.

Take-Two Interactive recently announced a springtime release for Grand Theft Auto V. The last time that Take-Two was gearing up for a Grand Theft Auto release, Electronic Arts stepped up with an offer to buy the company out."

What about Activision Blizzard?  If it's the darling of the industry, why is it down?

That's a question that I really can't answer.  Net Revenue is up.  Free Cash Flow is up.  Net Income is up.  And it's the only one of the bunch that is consistently profitable:

<img alt="" src="http://media.ycharts.com/charts/c926c99df2104f96b4df03680b36ab58.png" />

ATVI Free Cash Flow TTM data by YCharts

As you can see, consistent income and revenue growth, yet the stock is still down since this summer. 

So what's an investor to do?

Remember that this isn't a sprint -- buying stocks for short-term gains is risky at best, and irresponsible for most of us because it's so difficult to predict what could happen, and it could be something completely unrelated to the company specifically, or even the industry in general:

<img alt="" src="http://media.ycharts.com/charts/74461b16c164c971ebea3555d59cc38f.png" />

ATVI data by YCharts

And then something very bad happened, something that I hesitated to even put in this article:

<img alt="" src="http://media.ycharts.com/charts/27bdee74bdada26b95fffa8db5f3d337.png" />

ATVI data by YCharts

Quite frankly, how this affected the share price of the companies we are discussing is nearly inconsequential to the devastation of so many lives, it raises a very important point that we can all learn about the impossibility of accurate predictions, and how a single event can have a devastating impact in the short term, and we will never see it coming. 

Foolish Bottom Line

I am standing behind my recommendation to own Activision Blizzard, and while I may have been a bit heavy-handed in calling Take Two Interactive and EA "deadbeats," I cannot recommend either company until they show an ability to consistently generate profits. 

These aren't start-ups, or companies early in their growth cycles.  Both are mature, established brands, and the upside potential just isn't there to justify the risk. 

But that's just my take.  Get out there and do some more research, and share your thoughts in the comments below.


elihpaudio owns shares of Activision Blizzard. 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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