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How to Score Big on Video Game Stocks

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Games with hardcore appeal, crossover potential, is where industry should be trending.

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When the Wall Street Journal runs a headline like "Videogame Makers Can't Dodge Recession," I'm tempted to go into "contrarian for the sake of being contrarian" mode. By the time a major media outlet covers a story about a niche area like videogame investing, it's a dead story, right?

French software publisher Ubisoft, which delivered some stinky-as-old-cheese first-quarter numbers after the close yesterday, may have given us the answer. Ubisoft saw a 51% drop in sales, driven largely by weakness in sales of casual and catalog titles -- something we also saw with Take-Two Interactive (TTWO) 2 weeks back.

If anything has defined this console generation, it's the emergence of casual fare like the Nintendo (NTDOY) Wii console and Activision's (ATVI) Guitar Hero, which drove the industry to blistering levels of growth. Those casual gamers, previously driving incremental expansion, are now pulling back in light of the recession.

Catalog titles -- older games selling at lower prices -- are also feeling the heat. In my opinion, the booming used-games business is the culprit. I suspect that the weak economy is driving more gamers to trade in or sell games to shops like GameStop (GME). In turn, this has created large channel inventories of high-quality older titles at reasonable prices.

On the positive side, Ubisoft's full-year guidance reduction doesn't look so bad – it was mostly driven by pushing back key titles like Splinter Cell Conviction and Ghost Recon. And the company has actually raised its expectations for Assassin's Creed 2, due out in November.

That's one piece of anecdotal evidence that the hardcore gamer is still playing and spending. There are others.

THQ's (THQI) UFC 2009 Undisputed continues to smash expectations with over 3 million unit sales in as many months, while Activision's (ATVI) state-of-the-art bang-bang Call of Duty: Modern Warfare 2 is rocketing up the charts despite its premium price. There also appears to be enormous pent-up demand for Microsoft's (MSFT) Halo 3: ODST.

So back to the Journal headline: It would be more accurate, but less exciting, to say "Some Videogame Makers Can't Dodge Recession." At any given time, the industry's growth is driven by a small number of titles and that can mean huge profits for some.

In this recession, those titles will be blockbusters like Modern Warfare 2 that are hardcore in nature but still have crossover appeal. That's why I'm avoiding Electronic Arts (ERTS), whose software portfolio is far too diverse for my liking, and the casually-oriented Nintendo.

To use a movie analogy: Think like Michael Bay, and you'll make money.
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Positions in ATVI, THQI, and TTWO
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