Gaming Stocks: Leveling Off or Leveling Up?

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

I admit that I've lost far too many hours to video games. Time better spent reading, exercising, with friends and family, was spent with my fingers diddling over a controller and my face cast in the cold blue light of a monitor... and I loved every minute of it. For most gamers this is the case, and when a new game comes out, they're all in a tizzy -- it has this, you can do that, I can't wait to see these. So it surprises many when they find out their favorite game's designer/producer/publisher isn't doing so hot in the market.

Today we're going to take a look at three video game designers that fall into this category: popular, but wallowing in 52-week lows. The first of these is THQ (NASDAQOTH: THQIQ), who produce games for all manner of platforms (from consoles to computers), often using licensed material like SpongeBob Squarepants or the WWE; Electronic Arts (NASDAQ: EA), who is perhaps most widely known for its NFL, NHL, and FIFA lines; and Two-Two Interactive Software (NASDAQ: TTWO), whose Rockstar and 2K labels are best-known for producing 'edgy' titles like Grand Theft Auto and Borderlands.

Respawning

THQ has announced that it will be releasing yet another edition of its Saints Row franchise of video games on Nov. 6, in the midst of the Christmas shopping season, as is traditional in the industry. At that time last year, their stock was trading at what is now their 52-week high of $25; right now, they're trading at 15% of that. In December of 2011 they saw their stock decline sharply, primarily on news of poor sales of their uDraw for non-Wii consoles. Will the stock continue to stay depressed -- or drop even further -- or is it a bargain to snatch up while you still can?

THQ is finally operating in the black again; while sales have dropped by over 50% since December, THQ has managed to turn a profit out of it, with gross profit margin rising to 36% from the dark days of March's 2% -- a stark increase reflecting recovery from the December '11 underperformance that saw their stock value fragged.  Part of this is reflected in the cutbacks made in expenses: R&D has declined by an average of 30% over the past four quarters, with its steepest decline reported in the most recent (and solely profitable) quarter, suggesting that THQ's venture into the Wii-like accessory-gadget-games has scared it off of working on anything more than the formulaic, licensed material that they know sells well.

THQ has also managed to drop their general expenses down by an average of 46% over the past three quarters, while since the previous quarter, depreciation and amortization has dropped 75%; compare this to the relatively smaller drop in sales, and overall we see a company tightening up. For a company like THQ, the properties depreciating are typically software royalties and the like. THQ's exit from the 'cutting edge' of video game tech and renewed focus on existing titles, the production of which requires less licensing and more in-house development, bodes well.

Flagging Football

EA has a rather bearish reputation on the Fool, and not without reason; net cash for the most recent quarter was -$244M, an over 200% drop from the previous quarter, and their debt has skyrocketed.  Yet it too has recently posted its first quarter in the black, clawing its way out of four quarters ago when they reported ($1B) net income. Gross operating profit, which is strongly cyclical for this particular company, is just below an impressive 80%.

EA's return on equity is an unimpressive 2%; why invest if they can't seem to do much with the money in the first place? (Sales have remained stagnant, after all.) Yet, it is also important to note any trends in the company's financials: The previous quarter saw their first positive return on equity since late 2007. All of this may indicate that, despite recent setbacks vis-a-vis actual profits, the company is beginning the long, slow process of pulling itself back towards a more respectable stock price.

Third Time's the Charm

Take-Two has hovered around $10/share since its steep decline in the summer or '08, now trading at less than half its 52-week high. Sales have risen by an average of 45% quarterly this year, but expenses have risen out of all proportion as well: general expenses have risen on average 34%, and depreciation/amortization has risen, on average, nearly 100% per quarter this year. Combined, these have produced increasingly unprofitable quarters for Take-Two, as reflected in a return on equity of -36%. They can make sales, but they can't seem to turn a decent profit on them.

A decrease in receivables and a substantial increase in cash & other assets have led to a current ratio of 2.8; Take-Two has managed to assemble a war chest that will bear it through its current outstanding debts, and perhaps propel it into the December profits that businesses in the gaming industry pin all their hopes on; most CAPS members seem to predict that the high sales of future well-known releases like Grand Theft Auto V will lift the stock price on the wings of its expected profits. Comparing this to the company's actual ability to make money off said sales leaves me skeptical but hopeful.

Epilogue

That last one sort of hurt for me; I've always enjoyed Take-Two's products, and as I said, it's strange to see a company whose work you respect doing so poorly. Still, the video game industry is, as I said, very cyclical in nature, especially for console-related sales, in which all three of these companies have a stake this season. They're all down, sure, but not necessarily out.


tmloyd has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend 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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