Is It Time To Get Your Game On?

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

Electronic Arts (NASDAQ: EA) has rallied approximately 23% over the past week, putting its stock up 50% year-to-date. With this increase, is there any room left for investors to make money?

Examining EA

A big win that helped to drive EA's climb was the guidance of 2014 earnings that were well above expectations; management guided 2014 earnings-per-share to $1.20, in comparison to the average analysts' estimates of $1.10 per share.

Part of the run up in EA's stock goes beyond revised guidance and includes its deal with Disney for the gaming rights to the "Star Wars" franchise, which is a major part of Disney's recent purchase of Lucasfilm. EA plans to allow its in-house game teams DICE (Battlefield) and Visceral (Dead Space) to work on the Star Wars titles. However, I think the run up in the stock is overdone. 

EA is expected to see revenues fall by some 7% in each of the next two quarters as no major game releases are slated, with no major game launches other than Madden Football and FIFA 2014 coming over the next three quarters. Major franchise releases, including a new Dragon Age game and Battlefield 4 were supposed to be released in 2013 but no official announcements have been made.

EA has been cutting staff and reorganizing studios lately in preparation for the rollout of new gaming platforms from Sony and Microsoft. The cuts will help the company to cut costs, allowing it to adapt to tougher market conditions. 

One of the positives for EA is the rise of digital revenue, which was up 45% year-over-year last quarter. This presents a significant market for EA, with DFC Intelligence estimating that the online video game market will grow from $19.0 billion in 2011 to $35.0 billion by 2017; this is estimated to represent approximately 43% of total video game revenue at that point.

Activision-Blizzard

While EA was soaring last week, Activision Blizzard (NASDAQ: ATVI) has seen its stock pushed down by as much as 8% despite posting decent EPS results. The company's EPS for the first quarter came in at $0.17, compared to $0.06 for the same quarter last year and consensus estimate of $0.10 per share.

Although the numbers were actually pretty good, what spooked investors was Activision's guidance. The company expects the second half of the year, which includes the holiday quarter, to be weak due to heavy competition and uncertainty surrounding the launch of new video game consoles. Activision now expects to post a full-year 2013 EPS result of $0.80, falling below Wall Street expectations of $0.85. This wasn't helped by the fact that the company saw subscribers for its popular World of Warcraft online game fall from 9.3 million to 8.3 million.

However, Activision does own the major "Call of Duty" franchise, which competes directly with EA's "Battlefield" games. For 2013, Activision plans to launch Call of Duty: Ghosts, the follow-up to the gaming industry's top-selling game for 2012, Call of Duty Black Ops 2. Activision should also have interim tailwinds until the next "Call of Duty" release thanks to the release of Heart of the Swarm, the expansion to Starcraft II which it released in 2010. 

Take-Two

Take-Two Interactive (NASDAQ: TTWO) is another big game maker, and is a major turnaround story in the industry. The company posted a negative $0.71 EPS for the fiscal year 2012, but analysts expect the company to turnaround nicely in 2013 and post a full-year $0.18 EPS in 2013 and $2.25 in 2014. 

Consensus estimates also forecast a 48% increase in revenue for the 2014 fiscal year, following a 45% projected increase for 2013. The game maker trades the cheapest of the three major companies at only 7.2 times forward earnings, but it features strong key franchises on which it is heavily reliant. 

Driving its strong revenue increases should be its BioShock Infinite and Grand Theft Auto V offerings. The company has a lot vested in GTA V especially, which is expected to account for some 50% of its fiscal year 2014 revenues. However, one of the positives, which could help bring revenue diversity in the future is Take-Two's purchase of the rights to make "WWE" franchise games during the bankruptcy auction for defunct game publisher THQ earlier this year. This will help the company expand its sports lineup (beyond just its 2K lineup) and better compete with EA's "Madden" and "FIFA" sports lines.

By the numbers 

Although Take-Two might appear to have good growth potential as the cheapest of these companies, it still has a ways to go for a full turnaround. When stacking up EA and Activision, it appears Activision could be the best buy. 

EA trades at 19.8 times forward earnings, while Activision is at 14.3 times. EA trades at a 11.3 EV/EBITDA multiple as well, while Activision trades at an 8. What makes Activision's case even greater is the fact that it has a return on investment of 10.6% while EA's is only 3.5%. 

As mentioned before, Activision also has a solid cash position that it can use to make strategic investments. Its cash-per-share to price ratio is 26.6%, compared to 22.5% for EA.

Hedge fund trading

At the end of 2012, Activision had 25 hedge funds long on the stock. This includes its top hedge fund owner by market value, Levin Capital Strategies, with a $57 million position that made up 1.1% of its 13F portfolio (check out Levin's high yielders).

In a close second was EA, with 24 hedge funds long on the stock. The top hedge fund owner was Larry Robbins' Glenview Capital, with a position close to $118 million that accounted for 1.7% of its 13F portfolio (check out Glenview's healthcare picks).

Meanwhile, Take-Two had the lowest amount of interest, with 19 hedge funds long on the stock which was a 21% decrease from the previous quarter. Billionaire Carl Icahn was the top hedge fund owner, however, with a $132 million position that made up 1% of the fund's 13F portfolio (check out Icahn's small cap picks).

Bottom line

If you want to invest in the gaming industry, the question is which company is the best pick for the job? I think EA appears to be too rich, especially after its recent run up, despite its deal with Disney to produce "Star Wars" games. Take-Two still has a little too much uncertainty related to its over-reliance on GTA V in the interim. Activision, meanwhile, appears to be rather cheap for its value and has a large chunk of cash that it plans to put to work for investors. I would go for Activision, which still has a lot of room to grow in the digital space as well.

While Activision and Microsoft have been taking the headlines when it comes to console gaming, investors following the gaming sector would do well to also keep tabs on Electronic Arts. The Motley Fool can help. The Motley Fool's 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.

 


Marshall Hargrave 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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