November 08, 2011 at 12:08 PM EST
Activision Is a Good Video Game Play, but Keep Electronic Arts on Your Radar
Activision’s "Call of Duty" lead and solid margins help it compete at a reasonable valuation. Electronic Arts is losing money but could enjoy an earnings pop.

The electronic gaming industry is in a shooting war between traditional console gamers and social network gaming. With Activision (NASDAQ:ATVI) reporting its earnings Tuesday after the bell, investors can see just how well it’s doing. But should you invest in Activision, or would rival Electronic Arts (NASDAQ:ERTS) be a better bet?

These two companies are in a shooting war. That’s because Activision’s Call of Duty controls 90% of the so-called shooter segment, and EA wants to take that down a peg through games like its Battlefield series. EA’s Jens Uwe Intat told ButtonCombo in September that the company wants to take ATVI’s segment share down to between 70% and 60%.

Experts agree with EA’s assessment of Activision’s market position. As Jesse Divnich, an industry expert, told IndustryGamers, the “Call of Duty franchise is outperforming the category’s growth, and since release counts have been similar over the year, the data would conclude that Call of Duty is both growing the Shooter category while growing its share.”

And that category has been growing — although not as fast as social gaming. Since 2008, the number of shooter games sold has been growing at an 8.5% annual rate, from 68 million in 2008 to 80 million in 2010. That amounts to $5 billion in revenue — up from $3 billion in 2006 — a 13.6% annual rate, according to IndustryGamers.

But there is some bad news for Activision. In September, total U.S. game sales — including video game console hardware and games — fell 6% to $1.16 billion year-to-date, according to NPD Group. And this decline is due in part to Activision and EA’s slow response to social games like those made by Zynga, whose pending IPO could value it at $20 billion.

Zynga’s prospectus indicates that it’s outperforming Activision. For example, for the nine months ending September 2011, Zynga’s revenues rose 106% to $829 million while its net income fell 35% to $31 million.

Analysts expect a 75% drop in third-quarter earnings per share from 2010 for Activision. ATVI will earn a penny a share — down from four cents a share the year before. And revenue is expected to be down 25% to $558 million for the quarter compared to the 2010 third quarter. Thanks to competition from social gaming, this decline does not come as complete surprise.

But Activision’s weak earnings Tuesday could be overshadowed by a positive product announcement. That is, attention will be paid to the debut of Activision’s latest Call of Duty game – Call of Duty: Modern Warfare 3, sold at $60 – that will battle for shooter market share with EA’s just-released Battlefield 3. Both companies hope these games will reverse a negative trend.

Meanwhile, EA’s latest results for its second quarter were better than expected. Its adjusted profit of $17 million was five cents per share — better than the five-cent loss analysts had projected.

And EA’s sales rose 17% to $1.03 billion — exceeding expectations by more than 9%. However, without the adjustments, EA reported a loss of $340 million — $139 million worse than its 2010 second-quarter loss.

So here’s what the investment choice between ATVI and ERTS boils down to:

  • Activision: Strong growth, decent margins; slightly expensive stock. ATVI’s sales have increased a small 3.9% in the past 12 months to $4.77 billion, but net income has soared, up 270% to $645 million — yielding a 13.8% net profit margin. Its price/earnings-to-growth ratio of 1.17 (where a PEG of 1.0 is considered fairly priced) is a bit expensive on a P/E of 24.1 and expected earnings growth of 20.63% to 89 cents in 2012.
  • Electronic Arts: Slow growth, losing money; cheap stock. EA’s sales have dropped 1.8% in the past 12 months to $3.86 billion, while its net declined 59.2% to a loss of $290 million. Its PEG of 0.54 is cheap on a forward P/E of 27.8 and expected earnings growth of 51.47% to 88 cents in fiscal year 2013.

I would rather take a chance on Activision than EA. Both are facing a considerable threat from social gaming; both are having trouble adapting, though EA admittedly is doing better than ATVI. But Activision’s financial house is in much better order. Nevertheless, if EA achieves its fiscal 2013 earnings goal, its stock is screamingly cheap. But I think that target could be hard to hit.

In this shooting war, I’d give the edge to Activision.

As of this writing, Peter Cohan did not hold a position in any of the aforementioned stocks.


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