Gamers Flirt With Bargain Bin

Shares of video-game publishers are nearing rock-bottom prices, but is it time to start betting on a rebound?

That depends on who you talk to and how long you feel like waiting. Some investors, for instance, see short-term plays to be made in at least some of the names -- Electronic Arts ( ERTS) comes up repeatedly -- in the run-up to the holiday season.

"Clearly, there are big catalysts on the near-term horizon," says Darren Chervitz, a research analyst at Jacob Asset Management, pointing to the expected release this fall of new game machines from Sony ( SNE) and Nintendo. "When the market environment gets better, as we get closer to the holiday season, these stocks will benefit," adds Chervitz, whose firm is long EA and THQ ( THQI).

Others buysiders say that with publishers' stocks having sunk so low, they're also starting to look good for the longer term. Activision ( ATVI) and Take-Two Interactive ( TTWO) both hit 52-week lows this week, while EA and THQ are within spitting distance of theirs.

Thanks to the selloff, many of the stocks have started to look particularly cheap, relative to where they've historically traded, especially for what has been one of the fastest-growing sectors. For instance, excluding net cash, Activision is trading at about 15 times next year's expected earnings and Take-Two at about 12.

"We're there. We're still buying. We still think it's time to be buying," says one hedge fund analyst who asked to remain nameless, but whose firm is long shares of EA and Take-Two and is looking at Activision. Although short-term results at many of the firms won't be good, "longer term, we're definitely not worried," the analyst says.

Still, other investors say that the best play right now is to simply stay away. Even if these stocks rally going into the holidays, they'll likely sell off afterward, just like they did last year. And the stocks likely won't pick up for good until sometime next year -- if that soon.

"If I had to make a timing call, I would probably say, 'wait till after Christmas,'" says Tony Ursillo, a buy-side analyst with Loomis Sayles, which is long Electronic Arts. "I'm not sure if we will get the same rock-bottom price in February that they are at right now, but you probably won't have to pay a whole lot more, and you'll potentially miss six months of frustration."

And the sector's investors have already seen a lot of aggravation. Over the last year, shares of EA, the behemoth of the industry, are off 27%. Shares of smaller rivals Activision and THQ have fallen 16% and 8%, respectively, over the same time period. Take-Two, caught up in a string of snafus, including the discovery of the explicit "hot coffee" sex scenes which forced it to pull its latest version of hit franchise Grand Theft Auto from store shelves, has seen its stock fall a whopping 65%.

Although each company is dealing with its own issues, the rocky transition to the new generation of video-game technology has weighed down the entire sector. Sales of games for older consoles have been dropping steadily. While companies have been investing heavily in games for new consoles, they haven't seen much of a payoff yet because there simply aren't enough consoles yet in consumers' living rooms.

Analysts don't generally expect the financial results to rebound until sometime next year when the new game consoles start to gain mass audiences.

Regardless of the longer-term outlook, however, some investors are betting on a repeat of profitable short-term trades. Last year, THQ and Activision and, to a lesser degree, EA, saw a run from the summer until mid-November as excitement built prior to the release of Microsoft's ( MSFT) Xbox 360 console. With two more consoles on the way this year, similar enthusiasm could lift the sector.

And some investors are betting that EA will be the largest beneficiary. The Madden NFL maker has lowered its outlook so much that surpassing those targets won't be difficult, they say.

The company appears poised to post a better-than-expected quarter later this month, as the popularity of the recently concluded World Cup likely boosted sales of its FIFA Soccer title, those investors say. And with a relatively strong lineup for the fall compared with its rivals, the company should continue to see better-than-expected results, they say.

"The risk/reward is good" with EA in the short term, says a hedge fund manager who owns the stock as part of a near-term trade. "For the long term, I don't know."

But some investors believe the short-term play is too risky. Many are worried about the strength of consumer spending this fall, particularly if the economy goes into recession. And few believe publishers will benefit all that much from the new consoles in the short term to make a difference for their stocks.

"Developing games for the next generation is going be obscenely more expensive and at least initially, there's not going to be enough units to offset the increase in the expenses," says another anonymous hedge-fund manager, who is short THQ and Take-Two. Now is a better time to go long the sector than it would have been six months ago, "but I would probably hold off for a few more months. It's tough to hit the bottom."

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