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Video game makers are scoring points with digital sales

23 May 2016 in Trading Ideas

Key Takeaways

  • The sector’s top game makers just surpassed Wall Street’s earnings expectations, due largely to online game sales.
  • Activision’s report affirmed its decision in February to buy Candy Crush maker King Digital
  • Motifs mentioned: Online Gaming World
  • Stocks mentioned: Electronic Arts (NASDAQ:EA), Sony (NYSE:SNE), Microsoft’s (NASDAQ:MSFT), Activision Blizzard (NASDAQ:ATVI), NetEase (NASDAQ:NTES).

In the video game industry, having a hit title or two can make a huge difference to a company’s bottom line.

Now, it’s just as important to serve gamers on the platform they prefer, and increasingly, that means moving online and embracing subscription services.

Take the recent quarterly results of game titan Electronic Arts (NASDAQ:EA), for example. The company posted strong gains in revenue and operating income, getting a big kick from its Star Wars Battlefront title, which was released last December with the movie franchise’s seventh episode.

What really pumped up investors, however, was the performance of the company’s Ultimate Team –its online service for flagship sports games like FIFA and Madden NFL, which helped EA post an 18 percent increase in adjusted digital revenue that beat Wall Street’s targets.1 The jump in digital performance also helped the company forecast a strong performance for its upcoming fiscal year. This is notable since no new Star Wars title is on tap for the coming 12 months.

As the sector moves away from packaged software and ultimately from consoles like the Sony (NYSE:SNE) PlayStation and Microsoft’s (NASDAQ:MSFT) Xbox to online gaming platforms, companies want and need to capture the digital opportunity. And EA’s trend is moving in the right direction – more than half the company’s revenue comes from a digital business mostly driven by expanded content and full-game downloads, the Wall Street Journal reported. The added bonus is that these games also offer higher profit margins than those sold at retail.

In a research note following EA’s earnings, MKM Partners analyst Ertic Handler summed up what he saw as the company’s bright future, noting that full-game downloads now exceed 20 percent of unit sales and could rise to about 45 percent within the next five years.2

Meanwhile, gross margin for downloads are in the low to mid-80s percent versus low to mid-60s for physical disks.

Handler also pointed out that extra digital content has proven to accelerate revenue growth and in the case of FIFA with Ultimate Team can actually increase unit sales of the physical software game. “Subscriptions help drive profitability as EA Access users play more games, play for a longer amount of time and spend more money than those that play EA games but are not utilizing the company’s membership initiatives,” Handler wrote.

Candy crushing

Investor also cheered the recent quarterly results of EA rival Activision Blizzard (NASDAQ:ATVI) which posted better-than-expected first-quarter revenue and earnings as the company benefited from its recent acquisition of mobile game publisher King Digital.

Activision said first-quarter revenue rose 29 percent from a year earlier, thanks to King’s launch of Candy Crush Jelly Saga and continued strong sales of Activision’s franchise hit Call of Duty: Black Ops 3, as well as associated downloadable content.

Last February, Activision bought King, best known for its Candy Crush Saga smartphone games, in a deal for nearly $6 billion that allowed it to spread beyond its core business in console and PC games like Call of Duty and World of Warcraft.

That said, analysts are also bullish about the company’s May 24 launch of Overwatch, its first new game franchise in years.3

Shares of both Activision and EA have rallied since their earnings reports earlier this month, which has helped lift the sector overall. The two stocks combine for a 43.2 percent weighting in the Online Gaming World motif, which has gained 5.3 percent in the past month. During that same time, the S&P 500 has decreased by 1.9 percent.

Over the last 12 months, the motif has increased 15.7 percent; the S&P 500 has lost 3.5 percent.

A third power member of the motif, NetEase (NASDAQ:NTES) with a 17.3 percent weighting, has been no slouch. The stock has gained nearly 19 percent in the last month, as it also posted its own strong quarterly results. Meanwhile, the future could be equally as bright after the company just last week signed a five-year deal to distribute the mobile and PC editions of Microsoft’s popular MineCraft game within China.4

All three companies just went a long way in proving that gamers are still a growing and enthusiastic bunch – they’re just more likely to be away from the PC and console.

  1. Dan Gallagher, “Electronic Arts: There Is Life Beyond ‘Star Wars’, wsj.com, May 11, 2016.
  2. Johanna Bennett, “Electronic Arts: Could Earn $5/Shr By 2020, Says MKM Partners,” barrons.com, May 19, 2016.
  3. Patrick Seitz, “Activision Crushes Q1 Earnings, Gets Lift From Mobile Games, investors.com, May 6, 2016, http://www.investors.com/news/technology/click/activision-crushes-q1-earnings-gets-lift-from-mobile-games/?ven=YahooCP&src=AURLLED&ven=yahoo, (accessed May 22, 2016).
  4. David Z. Morris, “After Regulatory Hurdles, Minecraft is Finally Headed to China,” fortune.com, May 22, 2016, http://fortune.com/2016/05/22/minecraft-china-regulatory-hurdles/?xid=yahoo_fortune.

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