An earnings report from GameStop ( GME) on Tuesday provided further evidence that -- industry hopes to the contrary -- the transition to a new generation of machines will likely be a disruptive time for the video-game sector. As part of its
report, the video-game vendor warned that sales of new games are weaker than expected. While demand is strong for Microsoft's ( MSFT) new Xbox 360 game console, supply of the devices has been hard to come by. Noting these developments, GameStop dramatically slashed its outlook for same-store sales in the fourth quarter. Separately, at an investor conference, Electronic Arts ( ERTS) said that it saw soft sales in early November and plans to cut the price of its flagship Madden NFL football title by $10, according to Briefing.com. Weakening demand for new games, short supply of new consoles, price cuts and disappointing sales are not unusual for a console transition. But industry analysts, investors and executives had hoped this generational jump would be different. GameStop's announcement, however, adds to the recent evidence that this transition will simply be more of the same, a reality that could weigh on the stock prices not only of GameStop but of game publishers such as Electronic Arts and Activision ( ATVI). "We should all know that there's an awkward transition they're all going through right now," says Steve Monticelli, president of Mosaic Investments. "We should expect weak results from these guys." Still, the market seemed somewhat surprised. In recent trading, shares of GamesStop were off 4 cents, or less than 1%, to $35.14. But the software guys were taking significantly bigger hits, with EA shares off $1.67, or 2.9%, to $56.43; Activision's stock off 40 cents, or 2.8%, to $13.80; and shares of Take-Two Interactive ( TTWO) off 47 cents, or 2.5%.
In its earnings report, GameStop disclosed weaker-than-expected sales of new games in November. The company attributed that fact to game enthusiasts saving up for the Xbox 360 and to bargain hunters buying used video games. GameStop expects to continue to see strong sales of used games in the rest of the quarter. The company sold out of its initial shipment of Xbox 360s, and expects to receive another allotment of the consoles next week, but executives had little insight into how many of the devices the company will receive in the near future, according to analyst reports. The company now expects same-stores sales, which compare results of outlets open more than a year, to be between flat with last year's results to up 2%. Previously, the company had predicted comparable-store sales to grow 8% to 10% in the fourth quarter. GameStop also attempted to rein in bottom-line expectations, reducing the top of its forecasted earnings range for the fourth quarter. The company now expects to post a profit of 98 cents to $1.02 a share; previously, it had predicted a range of 98 cents to $1.06 a share. Still, the bigger impact could well be on the game publishers. Many have been investing heavily in games for the next generation of software consoles. Few expected large immediate returns on those investments, but many had hoped that sales of games for current consoles and for new handheld machines such as Sony's ( SNE) PlayStation Portable would be able to help tide them over until sales of the next-generation games picked up. Instead, the opposite could well be occurring. If GameStop is an indication, Microsoft seems to be shipping far fewer of the Xbox 360s than expected in the near term. Because software sales are largely tied to the sale of hardware, the slow pace of the Xbox 360 rollout could mean that software publishers have to wait longer to see significant returns on their next-generation investments.
With sales of current-generation software slowing, software publishers might now have to wait longer -- and go through a tougher transition period -- before seeing sales rebound. That realization is why the publishers' stocks sold off further on Tuesday even after dipping in previous recent sessions, said one portfolio manager, who asked not to be named. "Clearly people are nervous now, as they should be," said the portfolio manager, whose firm is not currently involved in the video-game stocks. Should the soft sales trend continue, Activision could be the company most at risk, said the portfolio manager. Activision has nine new titles out for the PlayStation 2 this holiday season and three for the Xbox 360, meaning that the company was making a bet on strong sales. "People are not buying the PS2 stuff, so they're getting hurt," said the portfolio manager. But Tony Ursillo, a buy-side analyst at Loomis Sayles, believes Activision's problem is not the weak overall software market, but worse-than-expected games. True Crime: New York City has gotten fairly poor reviews, while those for Gun, a new Western-themed title, have been somewhat average. "If they had been better products then this seasonal issue or console transition would matter less," said Ursillo, whose firm has a long position in Activision. The problem of being overexposed to slow sales of new games probably affects EA the most, said Ursillo, since the company has the broadest lineup. In contrast, the best positioned is probably THQ ( THQI), said Ursillo, who has no position in the stock. THQ doesn't yet have a title out for the Xbox 360, and the company's specialties are mainstream and kids games that tend to sell well to late in console cycles.