With a dismal 2009 finally in the rearview mirror, expectations are low for the industry as key game publishers prepare to release results from the crucial holiday season.
That could present a buying opportunity in a sector that underperformed the market last year, some analysts say.
Many expect video game software sales to grow robustly this year over the depressed levels of 2009, and say investors may have been a too bearish on the sector, particularly Activision Blizzard Inc, whose shares look attractive.
The world's most valuable stand-alone game publisher trades at about 14 times 2010's expected earnings, or 11 times excluding cash. Analysts say that is cheap for a company with recurring revenue and attractive margins from its hugely popular online multi-player game World of Warcraft.
We have enough to be encouraged, we've stabilized the macroeconomic situation, said Janco Partners analyst Mike Hickey. He added that valuations in the sector look appealing, and that even value guys are sniffing around.
To be sure, no one is projecting stellar performances from a sector grappling with rising production costs, and weakening growth in casual and music-oriented games.
Indeed, questions surround efforts at struggling Madden NFL publisher Electronic Arts Inc, which is still trading at a relatively rich valuation. And action in the stock of Grand Theft Auto Publisher Take-Two Interactive Software Inc is mainly fueled by speculation about the intentions of billionaire activist investor Carl Icahn.
But despite some publishers delaying the release of a number of major titles into 2010, there is still a solid lineup for the year. Factor in lower-prices home consoles and some analysts expect to see double-digit growth in U.S. game software sales for the year.
Expectations are high for first-half titles such as EA's Mass Effect 2, Take-Two's BioShock 2, and Sony's God of War III.
Video game industry sentiment is near an investible bottom due to an impending turn in U.S. retail sales trends, Cowen & Co analyst Doug Creutz wrote in a research note last week. We expect Activision Blizzard to be the biggest beneficiary of an improvement in investor sentiment.
A TOUGH YEAR
Video game industry sales in the United States -- the largest market -- fell 8 percent in 2009 to $19.7 billion, as casual fans that had fueled the industry's growth dialed back spending. Game software sales slid 11 percent.
Investors have also watched a wave of bad news from video game industry in January, including a weak holiday sales performance from GameStop Corp, and lowered outlooks from EA and French game maker Ubisoft. Shares of game software companies fell sharply in the month.
Right now sentiment is really low, said MKM Partners analyst Eric Handler, who also thinks Activision is oversold.
On Wednesday, smaller publisher THQ Inc provided investors their first glimpse into the holiday quarter, posting lower-than-expected profit but issuing a forecast that was a bit better than Wall Street's targets.
The industry will see a spate of earnings reports over the next two weeks with PlayStation maker Sony Corp on Thursday, followed by EA and Activision next week.
Activision is expected to report in-line results, according to estimates from Thomson Reuters StarMine, which give more weight to predictions from top-ranked analysts. The company also traditionally provides conservative guidance.
Its results will be fueled by blockbuster game Call Of Duty: Modern Warfare 2, which was launched in the December quarter and went on to sell nearly 12 million units in the United States, Japan and the United Kingdom, according to research groups NPD Group, GfK Chart-Track and Enterbrain.
EA had a difficult 2009 and pre-announced its December quarter results. Its performance has frustrated its long-term investors, analysts say [ID:nN11164434].
But the company still trades at an expensive 23 times next fiscal year's earnings, despite its execution problems.
EA gets a premium multiple because you still have a lot of people who will buy it on a turnaround play, said Handler, who has a sell rating on the stock.
Some analysts say EA's valuation looks more reasonable, at around 15 times forward earnings, when you exclude its cash.
Investors could also roll the dice on Take-Two, which many believe may again become a takeover target.
Icahn recently upped his stake in Take-Two to 12.3 percent, and the company agreed to nominate three new directors at his request. Analysts say Icahn could push for a sale of the company or at least agitate to improve its performance.
The announcement of a next installment in the Grand Theft Auto series could also provide an instant boost to shares.
(Reporting by Gabriel Madway; Editing by Bernard Orr)