Games investment advice: Be on target

Next-gen consoles fueling EA, THQ, Activision

Some consumers waited in line for four days to get their PlayStation 3 consoles, and many video game software stocks sit just below their 52-week highs.

With all the retail hype and the strong stock moves, some warn that only smart and selective investors stand to make more money in the sector.

Analysts seem agreed: The potential for stock gains depends on which stocks you buy and at what prices.

Bear Stearns, for example, recently resumed coverage of video game stocks and rated shares of Electronic Arts Inc., Activision Inc. and THQ Inc. "peer perform," while Take-Two Interactive Software Inc. received an "underperform."

Bear Stearns analyst Edward Urban said that one of the key problems with Take-Two is that the company's hit franchise, "Grand Theft Auto," already has sold more than 40 million units in one form or another, so "meaningful growth" from here could be a challenge. He does say that "GTA" is "an undeniable juggernaut in the game world."

As for EA, the leader in the industry, Urban likes the company's aggressive move into next-generation gaming, particularly the 30 or so games it is developing for the PS3, but he said the good news already may be priced into shares.

He has a similar attitude about Activision, which makes popular games based on DreamWorks Animation SKG and Marvel Entertainment Inc. characters, and THQ, which has licensing arrangements with Nickelodon, World Wrestling Entertainment Inc. and the Walt Disney Co.'s Pixar unit.

So far this year, THQ shares are up 30.9%, while Activision shares are up 18.3% and EA shares have gained 9.4%.

Take-Two shares have fallen 6.2% and shares of Midway Games Inc. have been clobbered for a 60.1% loss.

Midway's stock, however, had soared fourfold in the past couple of years as media mogul Sumner Redstone built a large position, but the company's history of losses and poor sales of its games, along with uncertainty over Redstone's plans, has taken a toll on shares this year, industry observers said.

Besides the just-released PS3, the Xbox 360 from Microsoft Corp. and Nintendo Co.'s Wii should keep business momentum humming in the video game sector.

At $249, Wii sells for less than half what the PS3 goes for at retail (and about one-fifth what PS3's fetch at eBay auctions), a price point that should help Nintendo wage war against the fancier PS3 and Xbox 360 consoles.

Because of Wii's relatively paltry price, and the fact that it is focusing on simpler-to-play games than the competition, analysts see Nintendo taking at least a small bite out of Sony and Microsoft.

"We are shifting cycle-end market share from the Sony PS3 to the Nintendo Wii," Cowen and Co. analyst Lowell Singer wrote in a 46-page report on the video game sector this month.

Singer also raised his full-year forecast for the U.S. video game software industry from $6.7 billion, which would have amounted to a 4.1% year-over-year decline, to $7.4 billion, a 5% increase compared with last year.

Singer rates Activision shares an "outperform," while EA, Take-Two and THQ are each a "neutral."

"Activision should benefit next year from a strong release slate and carries a significant valuation discount to EA," Singer wrote.

His firm predicts that, in 2008, the installed base of Xbox 360 consoles in the U.S. will reach 16.1 million, with the leaders being PS3 (15.8 million) and Wii (10 million).

Some analysts see retail stocks as a smart way to play the next-generation video game sector.

Alan Rifkin of Lehman Bros., for example, recently wrote: "With 160 Xbox 360 software titles available for holiday 2006 versus only 30 last year, and an estimated 27-30 software titles each for both the Wii and PS3 out for the holidays, profitability at both Best Buy and Circuit City will likely be enhanced."

Similarly, Piper Jaffray recently raised its price target on shares of retailer GameStop Corp. from $51 to $63, following the firm's third-quarter earnings release and guidance.

Beyond Wall Street, researchers also have set their sights on this year's video game wars. Brandimensions, for example, scoured Internet chat rooms and blogs looking for positive and negative buzz surrounding all next-generation game titles. The firm ranked the top 50 using its proprietary method.

Scoring highest, in order, were "Gears of War" from Microsoft, "The Legend of Zelda: Twilight Princess" from Nintendo and "Madden NFL 07" from EA.

" 'Gears of War' has set itself apart from the competition by boasting intricate and exciting multiplayer features," Brandimensions said. "Voice recognition and level designs have gamers excited about co-operative game play."