3 O'Clock High: Playing Games
Often wrong but always honest, baby!
The video game makers are about to report earnings for the last time prior to the release of Microsoft's (MSFT) X-Box 360 at the end of November. For my money, that makes "right about now" a good time to start placing bets on the software makers. We've got maximum market uncertainty, low near-term expectations. We've got both the X-Box 360 and the new Sony (SNE) PlayStation 3 each coming out in the next 6 months.
The next platform cycle is upon us and, while the numbers may still come down a bit until the middle of next year, we'll be seeing big revenues from both new platforms by this time next year. But I don't want to wait until then. Six months from now we'll already know who the winners and losers are for at least the early (read: important) part of this cycle. The stocks will have moved by then.
I've got a notion on how this cycle is going to play out and I'm starting to make my bets now, before my opinion becomes conventional wisdom (or are proven utterly stupid... but we'll deal with that outcome if/ when). We'll do the non-specific, non-advising positions in a minute. First, let's do some refresher work, drawing from previous columns.
The Video Game Platform Cycle Primer
I've been writing about the Game Makers for Minyanville since literally my first column. I was bearish then because I felt the numbers for 2005 were way too high.
In the last year we've seen plenty of numbers cuts and an unusual amount of Corporate Intrigue in the space, with Electronic Arts (ERTS), Take-Two (TTWO) and Activision (ATVI) positioning themselves for the coming platforms.
After a year of rampant rumors, it seems as though the XBox 360 will be released on time, though not with some of the expected titles, as ERTS pulled its Godfather game less than 3 days after the title was fawned over in a lengthy NY Times article.
With the exception of the trainwreck at TTWO this year, the gamemaker stocks seem to have put in at least a temporary bottom, after ERTS warned in May, suggesting that the stocks have priced in the bad news.
Where we are Today
As mentioned, both Electronic Arts and Activision report this week. Electronic Arts is up first, on Tuesday night. It figures to be more of a "color" call than new information as the company has already guided down for the quarter.
FQ2 '06: $627M Revenues and 4-cents of EPS.
FY '06: $1.63B Revenues and $1.43 of EPS.
FY '07: $3.78B Revenues and $1.86 EPS.
The company has yet to give '07 guidance. I expect that the numbers will be worse than expected and, as a result, I don't like ERTS as a long idea for the following reasons:
- ERTS blamed the large warning last month almost entirely on the Godfather delay. While this gives them some "cushion" it also suggests greater problems at the company.
- ERTS has a trailing P/E of 40 and has expected long-term growth of 17%. These figures obviously assume that Electronic Arts is going to continue to dominate the video game space.
- The industry is littered with winners in prior cycles who failed to retain their leadership in the next round. ERTS may win the next cycle just as they did this one but, if they do, they will dodge the fates of: Atari, Nintendo, Sony, Mattel (Intellevision) and others before them.
- ERTS will need to add to their golden sports portfolio to continue to dominate. Madden et al are already #1 and will face greater pressure to retain those positions.
- The company may ultimately dominate the new PlayStation and 360 consoles but they are off to a very weak start with product delays in new titles and what amount to souped-up sport game ports for the initial XBox release.
Activision reports on Wednesday of this week. The Street is looking for:
FQ '06: $204M Revenue and a loss of 7-cents on EPS
FY '06: $1,481B Revenue and 53-cents of EPS
2007: $1,627B Revenue and 62-cents.
I started getting long ATVI calls this morning. I think the company is going to have the games people want for the new consoles. I think Call of Duty II is going to be fantastic and Quake IV will be huge (though without me... I'll be busy with the former title).
Activision has ripped people's faces off before. What's more, if ERTS misses on Tuesday (and I think a guide-down is about an even-money bet) ATVI will get punished in sympathy.
So I may be early. And I may be wrong. And I'm not giving advice. But I think Activision has a lot more room to grow than ERTS. They've been executing better and they have better titles in the pipe-line.
In short, I think they take share from Electronic Arts. In the big picture, I think they close much if not all of the 12+ Billion mkt cap spread between the two companies. I'm willing to add to my position on weakness because I think now is finally the time to start building longs in the game makers.
At least that's how I'm playing it, for whatever that may be worth.
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