Video game publishers stuck on pause

Q3 slow for sector biggies as crowded market eyes Christmas sales

After a rocky start, the video game upgrade cycle has been chugging along so well that it often is a chore finding a store stocked with a Wii, Xbox 360 and PlayStation 3. Apparently, though, the wealth hasn't yet trickled down to video game publishers.

This month, for example, Electronic Arts, THQ and Midway each reported on the same day that they lost money in the most recent quarter, and two of the three missed revenue expectations. EA even lowered its fiscal 2008 earnings guidance.

A few days later, Activision said it managed a $698,000 profit in the quarter, but only after shipping more copies of "Guitar Hero III: Legends of Rock" during the quarter than any other game in the company's history.

So why such meager financial results? Observers said it's still a bit early for publishers to cash in, given that the third quarter historically isn't anything to write home about, and that publishers still are getting their heads around the fact that Nintendo's Wii is so popular.

"Console transitions are often very, very bumpy," NPD Group analyst Anita Frazier said. "Publishers need to make their product plans well in advance and they have to lay their bets about what new, unintroduced platforms might succeed."

High prices for the new consoles and big costs associated with making games that take advantage of the complicated technologies built into them also have tempered financial gains for publishers.

Some predict that Christmas will be a turning point. "Xbox 360, PS3 and Wii installed bases, collectively, will achieve enough of a critical mass this holiday season to materially drive operating margin expansion," BMO Capital Markets analyst Edward Williams said this month in a 92-page report.

Williams, however, cautions that the current upgrade cycle will be trickier to play than the former ones because it's "marked by the lack of a clearly defined global winner. In fact, the order could vary from country to country, adding to the complexity."

In the U.S., there were 7.1 million Xbox units, 5 million Wii boxes and 2 million PS3s at the end of October, NPD said.

Williams, like NPD's Frazier, added that backing the correct platform with the right games has become more challenging. "With cash development budgets measured in the hundreds of millions of dollars, betting incorrectly could lead to far worse ramifications as compared to prior cycles," he said.

Despite challenges so far during this upgrade cycle, analysts and investors seem overwhelmingly bullish. Williams concludes that, ultimately, video game publishers will benefit by having "three well-established companies jockeying for position in the living room of households around the world." Like all analysts, he definitely has his favorites.

"We are no longer in a position where the tide will lift all boats -- as the stronger developers will produce higher-quality and better-performing games," Williams said. Among publishers, he prefers THQ and EA, rating stocks of both companies "outperform."

One fund manager focused on the video game industry, though, said bullish analysis concerning THQ misses the mark because of its reliance on last generation's PS2. Also, THQ is seeing increased competition in kids' games because of the popularity of Wii and it faces the possibility of losing one of its biggest franchises: World Wrestling Entertainment.

Analyst Rick Munarriz of the Motley Fool also said it's too early to expect publishers to have benefited much from consumers' voracious appetite for new video game platforms.

"It will get better," Munarriz said. "If you don't like the reports this time around, set the snooze bar for three months. You'll like what you see then.

"The fun doesn't have to end after Christmas" thanks to Web-enabled consoles and virtual "add-ons" that for the first time bring recurring revenue to game publishers, he added.

Munarriz names Take-Two Interactive Software, famous for the "Grand Theft Auto" franchise, as a favorite stock in the sector. "Analysts left it for dead after a few scandals, but the company is back," he said, adding that the firm's "BioShock" game is a sleeper hit and "Manhunt 2" will score well.
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