The flood of new video game consoles has not turned into a rising tide that lifts all boats. In the $9 billion video game industry, it is yachts that are being buoyed. Blue-chip game publisher Electronic Arts ( ERTS) and No. 2 Activision ( ATVI) are coming off blowout quarters, bucking seasonal sales trends, and have raised second-half estimates beyond already ambitious targets. Even Take-Two Interactive ( TTWO), once whipped by accounting issues and the target of an ongoing Securities and Exchange Commission probe, shows signs of a turnaround. A disturbing trend is taking hold at the other end of the video game food chain, even as the industry heads into what observers are calling one of the hottest-ever game-selling seasons this year. Despite watching top-tier brethren bust through projections, once-shimmering Midway ( MWY) and Acclaim Entertainment ( AKLM) are scraping along, barely able to meet guidance. Both of those companies have practically written off the year to date and are betting on a miracle sales turnaround on hit games for the holiday season. Despite the perception that an upswing in hardware sales naturally leads to a boost in software sales, driven largely by the drastic price reductions on Sony's ( SNE) PlayStation 2, Nintendo's GameCube and Microsoft's ( MSFT) Xbox, game stocks have not all traded on the same premise. And the gap between the haves and have-nots looks to be growing wider.
and you will notice that shelf space is going disproportionately to Electronic Arts and Activision," said Investec analyst James Preissler, whose firm has not performed banking for any of the game companies. "The trend is clear on all fronts." Sega, which shut down its hardware unit, has publicly stated that it is looking to ascend the software hierarchy and is in full-blown acquisition mode. Industry observers said Sega was close to announcing a major acquisition in May -- Midway was the target, according to market scuttlebutt -- but the move fell through. Sega spokeswoman Gwen Marker said in an email exchange that the company planned to grow, especially in the U.S. and Europe both organically and through acquisition. Meanwhile, Electronic Arts has been quietly snapping up smaller talented developers hoping to add new wholly owned intellectual properties to its arsenal. In June, it acquired a 100-person studio, Black Box, for an undisclosed sum, to acquire the team that produced such hits as the Need For Speed car-racing series, NHL games and the NASCAR series. For good reason: In its latest quarter, the game giant revealed that games developed in-house and not through any sort of third-party licensing arrangement yielded phenomenal profit margins that soared as high as 70% to 80%, compared with an average of 54.4% for its overall game-publishing division, according to the company. Among the games that brought in the highest margins was Medal of Honor, the product of a team acquired from a joint venture involving Microsoft ( MSFT) and Dreamworks SKG in 2000. Activision also has been bolstering its cash reserves, now at $550 million (compared with EA's $827 million, Midway's $94 million and Acclaim's $40 million) that experts say may be used to close the wide gap between it and No. 1 Electronic Arts. Almost half of the cash was raised in a June share offering of another 7.5 million shares. In the past few quarters, the company has purchased three development studios, Treyarch Inventions, Grey Matter Interactive Studios and Shaba Games, each of which have developed games that have sold more than 1 million units each, according to Activision SEC filings. So where are the smaller players left? Quite simply, at the bottom, for the time being. "It's a function of costs and shelf space," Wallace said.