Opportunity Knocks in Electronic Arts' Slide
Updated from 2:44 p.m. EST
The console cycle finally seems to be catching up with
Electronic Arts
(ERTS)
. But is that a reason to sell off the video game sector?
At least in the short term, investors seemed to believe it is, with most of the major game publishers and retailers falling on Tuesday. But at least some analysts think that movement has presented a nice buying opportunity.
"We're absolutely in the back end of the current cycle. We cannot deny that any longer," said Joe Spiegel, a fund manager who follows the video game sector at Dalek Capital.
But investors are overreacting to EA's warning, he said.
"I'm tempted to buy some EA down here," said Spiegel, who has no current positions in the sector. EA's warning "doesn't mean that EA's falling apart. It doesn't mean the industry's falling apart. It's just clearer evidence that it's still in a cyclical business."
Many investors seemed to be focusing on the end of the cycle on Tuesday. In recent trading, shares of EA were off $9.46, or 14.3%, to $56.89.
While EA was taking the largest hit, other video game publishers were also trading off.
Activision
(ATVI) - Get Report
was down 46 cents, or 2%, to $22.53, and
GameStop
(GME) - Get Report
was off 93 cents, or 4.5%, to $19.68. Other related stocks in the red Tuesday included
Take-Two Interactive Software
(TTWO) - Get Report
,
THQ
(THQI)
,
Midway Games
(MWY)
,
Atari
(ATAR)
and
Electronics Boutique
(ELBO)
.
The declines followed EA's announcement after the bell Monday. Blaming slow catalog sales and the impact of a hardware shortage, the company
slashed its revenue and earnings outlook for its fiscal year that ends March 31.
EA's announcement comes as the video game sector enters one of its periodic hardware transitions. The major game machine manufacturers --
Sony
(SNE) - Get Report
,
Microsoft
(MSFT) - Get Report
and
Nintendo
-- are expected to unveil their next-generation consoles in May and to start selling them as early as this fall.
During previous console transitions, the video game publishers had seen revenue slow or slump as prices declined for games on the older consoles, and costs skyrocketed as they developed titles for the new machines. Analysts and investors have feared publishers would face similar troubles as this console cycle comes to a close.
But the game publishers saw better-than-expected sales last year, which helped to lift the sector. Meanwhile, both Sony and Nintendo have released new portable game machines in recent months. Many analysts have hoped -- or expected -- that sales of titles for the portable systems would help game publishers better weather the console transition.
Fueled by strong sales and results in recent quarters, the publishers have seen their stocks soar. Through Monday, shares of Activision were up 252% in the last two years. Shares of Electronic Arts were up 126% over the same time period, while THQ's stock was up 112%. Even Atari, which has struggled with disappointing titles and sales, has seen its stock rise 76% over the past two years.
However, EA's announcement indicates that the publishers will indeed feel the effects of the console transition, analysts say. And some think that transition will start hitting game companies' stocks.
"We think the next 18 months is a tough time for them," said Evan Jones, managing partner of Brightleaf Partners, a consumer-sector hedge fund. While the new portable machines may add incremental revenue to the publishers' top lines, those sales are "not going to be strong enough to make up for the difference as we switch
game platforms."
Brightleaf is short Take-Two, and Jones is wary of the entire sector. Not only do the publishers have to worry about the transition in the short term, but in the long term they could face a big problem with pricing, Jones said. Development costs will go up on next-generation platforms, but it's not clear whether the publishers will be able to pass those costs on to consumers, he said.
"With video prices coming down and DVD prices coming down, it's hard to believe that video game prices will go up, yet that's what they will need to maintain strong margins," Jones said, adding that he wouldn't be long names in the sector until he gets more clarity on that issue. "We're kind of like 'wait and see,'" he said.
Other analysts, though, are far more bullish. EA's warning could be a good thing for the industry -- and for shares in the companies' stocks -- because it's helping reset investors' expectations, said Spiegel. The companies may post subpar results in coming quarters and investors should be ready for that.
With the selloff, stocks such as Electronic Arts are "much better buys," said Spiegel.
Although Spiegel hasn't jumped back into the sector, another portfolio manager used today's selloff to buy shares of Activision, Take-Two and Atari. The industry is likely to see some turbulence in the short term as it goes through the console transition, acknowledged the portfolio manager, who asked to remain anonymous.
But the game companies' stocks generally appear cheap on a price-to-earnings basis, he said. And their stocks are likely to be buoyed by the possibility of a major acquisition in the sector. Rumors have swirled in recent months about the possibility that
Walt Disney
(DIS) - Get Report
,
Viacom
(VIAB) - Get Report
or another of the major media companies may buy one of the video game publishers.
Selloffs such as what happened on Tuesday "are short lived, because these guys are all in play," said the portfolio manager. Investors who have been predicting a downturn in the video game companies' shares are like those who have been calling for a similar downturn in the shares of homebuilders, to no avail, the portfolio manager said.
"I have no concerns. I don't think this is the end of a run," the portfolio manager said.