Setting the standard

Wii has others clamoring to keep up

The fabulous success Nintendo is having with its Wii console presents a high-quality problem for the video game software industry: creating games that take advantage of its capabilities, including the inventive motion-sensor controller.

Lehman Brothers analyst Eric Handler initiated coverage on video game stocks last week, concluding that they are mostly overpriced, but nevertheless recommending one — Electronic Arts — for purchase.

One of the problems he sees is that the game makers were surprised by the popularity of Wii, so now they must reallocate money and effort into creating more product for that platform and perhaps less for Sony's PlayStation 3.

Concerning the Wii, Handler wrote: "Developers need more time to experiment with the console's capabilities, which we believe will lead to a higher-quality gamer experience as the cycle matures."

And the Wii, of course, competes with PS3 and Microsoft's Xbox 360, which also feature some pretty compelling technology that gamemakers need to take advantage of.

"Costs associated with developing games for next-gen consoles are higher than traditional consoles," Handler said.

Handler sees strong four-year growth in the sector, but also cautions that "much of the sector's potential upside" is at least 12 months away. And, being that EA, Activision, THQ and Take-Two Interactive Software sell for an average 51 price-to-earnings multiple, much of the good news is already priced into the sector.

The analyst initiated EA with an "overweight" rating and $63 target. Shares closed Monday at $50.35.

Handler said he likes EA because it "has done a very good job in building a best-in-class portfolio of assets through the development of a deep slate of franchise titles and an increasing number of wholly owned properties."

Activision and THQ were each started with "equal weight" ratings. Activision, which closed Monday at $18.40, has a $21 target, and THQ, which was at $31.03, has a $35 target.

Handler's least favorite is Take-Two, which is in the midst of a turnaround. He rates it "underweight" with a $19 target. Shares closed Monday at $20.23.

"As we have seen with several of the major Hollywood movie studios and television production operations over the past five to six years, turnarounds in content-driven entertainment businesses are not a quick undertaking and can take multiple years to fully reflect management's vision," Handler said.