This Video Gaming Stock Is A Better Bet Than Zynga

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

The PC and video game industry has been doing poorly recently. Therefore, it should come as no surprise that one of the leading companies in the industry, $4.5 billion market cap Electronic Arts (NASDAQ: EA) is struggling so far this fiscal year (which ends in March). The company’s first fiscal quarter showed a 4% decline in net revenue driven by a 21% decline in product sales, with an increase in service and other revenue (which includes subscription services and additional content) salvaging an at least respectable performance. Still, net income ended up falling 9%, and even with some reduction in share count earnings per share were down as well. On a geographic basis, North America saw the steepest revenue decline

Electronic Arts Inc. has recognized the growth of new game platforms, including social networks and mobile devices. In the company’s last fiscal year (FY 2012) it grew related revenues by 56% compared to the 2011 fiscal year. EA is also adapting by releasing fewer games: according to the 10-Q only 14 “primary packaged goods titles” are expected in the current fiscal year, less than half the figure from two years ago. In addition, in July EA’s board approved a $500 million repurchase program after having exhausted their previous repurchase program in April.

While EA trades at an incredibly high multiple (82 times trailing earnings), the Street actually thinks that investors are underestimating how much the company will benefit from trends in the industry. Given analyst expectations for the next fiscal year (ending in March 2014) the forward P/E is 11 and looking out over the longer term the five-year PEG ratio is 0.8. Electronic Arts Inc. could- if the sell-side is correct- be considered a beaten-down stock which has become a good value (it has lost 36% of its value over the last year, as opposed to a 21% gain in the S&P 500).

Some hedge funds have taken a look at EA and decided that it is a buy based on its value proposition. Glenview Capital initiated a position of 7.5 million shares during the second quarter of 2012. Glenview’s manager, Larry Robbins, was a trader at billionaire Leon Cooperman’s Omega Advisors (see more stock picks from Glenview Capital). Citadel Investment Group and Renaissance Technologies, large hedge funds founded by respective billionaires Ken Griffin and Jim Simons, both more than doubled their stakes in EA. Citadel reported a position of 7.7 million shares (find more stocks Citadel owns) while Renaissance had 4.2 million shares in its own portfolio (research Renaissance Technologies's favorite stocks).

Electronic Arts’s closest peer and competitor is Activision Blizzard (NASDAQ: ATVI). Activision Blizzard has not been immune from the decline of the gaming industry: its earnings fell 45% last quarter compared to the same period a year earlier. It trades more cheaply than EA on a trailing basis (P/E of 17) but the two companies’ valuations are set to converge with Activision Blizzard carrying the same forward P/E (11) as the smaller EA (Activision Blizzard has a market cap of $13 billion). It’s possible that the company is not as well positioned in mobile and social networking as EA, but it appears to be a better value. We would also compare the company to Take-Two Interactive Software (NASDAQ: TTWO), to online-focused Zynga (NASDAQ: ZNGA), and to Microsoft  (NASDAQ: MSFT), whose software is primarily business-oriented but has also tried to break into entertainment. Take-Two is unprofitable on a trailing basis- including a substantial loss last quarter- with analyst expectations implying a forward multiple of 11. Zynga is in a similar boat: barely profitable (1 cent per share in EPS last quarter) but with analysts expecting a much better performance next year. However, its forward P/E of 29 is high and we are skeptical that the company can generate enough growth to justify this premium compared to the more established companies. We would take EA over either of these latter two peers. Microsoft trades at a trailing P/E of 16 and a forward P/E of 9; the imminent release of new versions of Windows and Office will probably skew next year’s earnings up, but it is also possible that recent earnings have been low as consumers and businesses wait to buy the newer software. On a forward basis it is therefore in about the same boat as EA, if analysts are correct that gaming is about to make a comeback. 

Take A Closer Look

Zynga's post-IPO performance has been dreadful, and investors are beginning to wonder if it's game-over for this newly public company. Being so closely related to the world's largest social network can be a blessing and a curse at the same time. You can learn everything you need to know about this company and whether they're a buy or a sell in The Motley Fool’s new premium research report. Don't even think about picking up shares before you read what the Fool’s top tech analyst has to say about Zynga. Click here to access your copy.  


This article is written by Matt Doiron and edited by Meena Krishnamsetty. Meena has a long position in MSFT. The Motley Fool owns shares of Activision Blizzard and Microsoft. Motley Fool newsletter services recommend Activision Blizzard and Take-Two Interactive . 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.If you have questions about this post or the Fool’s blog network, click here for information.

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