3 Video-Game Companies, 3 Different Futures

BOSTON (TheStreet) -- The video-game industry is dominated by a few large companies -- Activision Blizzard (ATVI), Electronic Arts (ERTS) and Take-Two Interactive Software (TTWO) -- and it's tough to single out a winner because their success relies on titles that are hits with gamers.

But each have in common three dominant trends that are inescapable.

First, due to the sluggish economy, consumer spending on home entertainment remains weak, as reflected in a decline in the sales of video-game consoles, as well as a jump in the resale of used games, both of which hurt new-game sales.

Second, there is a shift from console games to mobile gaming and online games, some played over social-networking sites, and that has created a new challenge for the already highly competitive industry.

And, finally, the target market of video games is relatively fixed as it is largely composed of males between the ages of 18 to 35.

But analysts are bullish on these companies as long as they continue to come up with gripping new games, either developed in-house or bought from outsiders. They each had at least one home run, a "franchise title," that defines the company and produces years of steady revenue as the game is revised.

Revenue and profit margins depend on the success of those titles, as the longer they run, the better becomes the operating margins.

Take-Two's top-seller has been the long-running Grand Theft Auto, while Activision-Blizzard's is Guitar Hero. Electronic Arts is known for its sports games, and its big seller is Madden NFL.

Here's an analysis of the prospects for those three companies:

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Activision-Blizzard ( ATVI) was formed via the July 2008 merger of Activision and Vivendi Games. Its most popular games are World of Warcraft and StarCraft II. Blizzard is a leader in online multiplayer games based on internally developed content, a big plus for the company's future.

It also has a long-term exclusive license from Marvel's comic-book franchises for Spider-Man and X-Men and a multi-year publishing agreement with DreamWorks Animation.

The company reported a strong fourth quarter on May 9, driven by sales of digital online games, and raised its 2011 earnings outlook to 73 cents per share from 70 cents. Digital revenue generally has higher margins than packaged games on discs sold in stores.

Based solely on analysts' views, it is the best bet for investors as it garnered 18 "buy" ratings and four "holds," according to Bloomberg. Standard & Poor's, in its survey, found 11 "buys," 10 "buy/holds" and three "holds" from analysts.

This year, its shares are down 8.2% but they're up 11% over the past 12 months. The company has a market value of $13 billion. The S&P 500 Index, in comparison, is up 5.5% this year and 25% over the past year.

Analysts' consensus price target is $14.04, which offers a 25% premium to the current share price.

But there are signs Activision-Blizzard may be a weak player. Standard & Poor's wrote May 18 that it estimates that revenue will fall 5.4% in 2011, which would have been minus 13% without a one-time gain from deferred net revenue. It has a "hold" rating on its shares and a $12 price target.

And the company's earnings outlook is only fair. Analysts surveyed by S&P project the company will earn 75 cents per share in fiscal 2011, and that will grow by 21% to 91 cents per share in 2012.

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Electronic Arts ( ERTS) has strong support from analysts, with 13 "buy" ratings, nine "holds" and two "sells." Its product-line strength comes from sports games developed under license from sporting leagues. Top selling-games include Madden NFL, The Sims and Need for Speed.

Morningstar analyst Sunit Gogia said in a research note May 6 that the company's "future position in the industry depends on its ability to create new hit games and successfully navigate the transition to online game play and distribution. The firm has the scale and resources to pursue the development of new games and gaming models, but turning the ship around will require astute management."

The company has more than $2.2 billion in cash and no debt, which provides it a cushion to develop new games.

Electronic Arts' shares are up 42% this year. Analysts' consensus target price is $23.35, according to Bloomberg, which doesn't offer much of a premium given its current price of $23.47. It has a market value of $8 billion.

Pacific Crest Securities has an "outperform" rating on its shares and a $24 price target and raves about its "Battlefield 3" game that is soon to be issued. But it said in a May 20 research note that it expects the company's "growth rate and earnings power will lag that of its top competitors in the near term, but its value is underestimated by the rest of the market longer-term."

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As with the other firms, Take-Two Interactive Software ( TTWO) is dependent on its crack in-house product-development team to duplicate previous successes. The new Red Dead Redemption may help it do that as it is getting good reviews.

Take-Two is best known as the developer of Grand Theft Auto, among the most successful video games in history, with sales of more than 65 million units.

But it faces several big challenges, not the least of which is a new management team. Major shareholders replaced the chief executive and board of directors in March 2007 after previous management was found to have engaged in improper revenue booking and backdating of stock options.

Analysts give it seven "buy" ratings, seven "holds" and one "sell," with two of the "buys" on Wednesday, according to Bloomberg.

On Tuesday, the company reported a net loss of $22 million, or 27 cents per share, for its fiscal fourth quarter, which ended March 31, compared with a loss of $9.8 million, or 13 cents, a year earlier.

In addition, Take-Two also announced it has renewed employment deals with key creative developers involved in several top-sellers.

Take-Two has about $227 million in cash and relatively low long-term debt, so it can freely spend on the development of new games.

The company released the much-anticipated L.A. Noire on May 17.

Take-Two's shares are up 31% this year and 49% over the past year. The company has a $1.5 billion market value.

Adding to its credence as a decent long-term pick, Take-Two is the top stock holding of the Oppenheimer Quest Opportunity Value Fund ( QVOPX), at 5.6% of the $1.6 billion portfolio.

Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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