These Gaming Stocks Need a Second-Half Spurt

The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.

This newsletter lists the key events (including key game releases and financial news) in May, previews our expectations for June, and provides our views of the current state of the video game industry.

This newsletter also includes our E3 2013 Preview. E3 (The Electronic Entertainment Expo) takes place next week in Los Angeles. Events start Monday, June 10, and continue through Thursday, June 13. The E3 Expo will be hel d at the Los  Angeles Convention Center, and as many as 50,000 at tendees are expected. We expect E3 to again be a spectacle, full of news and useful information for video game fans and investors.

We expect the focus of E3 to be the two new next-generation consoles, Microsoft’s (NASDAQ:MSFT) Xbox One and Sony’s PlayStation 4, both of which will be released later this year. The official unveilings for both consoles left many questions unanswered (including pricing and specific release dates, with controversy about whether the Xbox One will limit transfers of used games), and we expect additional clarity next week.

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The most high-profile games will again be headlined by sequels including for Activision Blizzard’s (NASDAQ:ATVI) Call of Duty, Electronic Arts’ (NASDAQ:EA) Battlefield, and Ubisoft’s (EPA:UBI) Assassin’s Creed franchises, although we expect to learn more about many new IPs (including Activision Blizzard’s Destiny and Ubisoft’s Watch Dogs). In addition, we expect many new games to be unveiled, including for the two next-gen consoles and for Nintendo’s (TYO:7974) Wii U, which has struggled since its November 2012 debut due in large part to mediocre content.

We also expect the hardware manufacturers to announce price cuts. We expect the prices for the PS3 and Xbox 360 to drop by at least $50 as we approach the holidays, with the Wii dropping to $99. In addition, Nintendo may look to spur Wii U sales through either a hardware price drop of $50 or a bundle that includes some of its more popular software. Sony will likely cut price for its PS Vita handheld, which has struggled since release due in part to its high starting price point of $249.

We expect E3 to have a positive impact on the share prices of many of the major publishers. We believe additional details on the PS4 and Xbox One will help to drive share prices higher as investor perception about the long-term outlook of the video game industry improves. Attractive starting price points for hardware and software will be a key factor in the success of the next gen consoles, and we continue to believe that ISP or MSO subsidized boxes remain a possibility. In addition, Microsoft, Sony (NYSE:SNE), and the publishers will likely see k to provide strong release slates for he next-gen consoles early in their life cycles in order to avoid one of the major pitfalls that has hindered Wii U’s success thus far.

In May, Activision, GameStop (NYSE:GME), Take-Two, and Ubisoft reported better-than-expected quarterly EPS, while EA reported results that were in line with its negative preanno uncement. In addition, Sony reported Q4 results.

The Wedbush Video Game Index — our market cap-weighted index of video game companies — was roughly flat for the month of May, below the broader market averages due to declines for three of the larger companies. The Russell 2000 and S&P 500 increased 4 percent and 2 percent, respectively, due to the continuation of quantitative easing and easing concerns around the European debt crisis and the China slowdown.

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Electronic Arts and Ubisoft were up 31 percent and 19 percent, respectively, after providing bullish FY:14 guidance. Nintendo had the worst month, down 6 percent, the result of sluggish Wii U sales and the belief that the next-gen consoles from Microsoft and Sony may trample the Wii U. GameStop was down 5 percent over concerns that Microsoft will alter the used gaming landscape. Activision Blizzard was down 4 percent due in part to uncertainty over its relationship with Vivendi. On a constant f/x basis, the Index increased 1 percent. It increased 4 percent excluding Nintendo (on a constant f/x basis).

April U.S. console/handheld software sales were $25 4 million, down 17 percent from last year’s $307 million, and well below our estimate of $300 million (down 2 percent). April sales were the second-lowest since May 2004, with only August 2012 lower. Sales have now been down 16 of the last 17 months. A relatively strong new release slate, a slew of high-profile releases last month including Take-Two’s (NASDAQ:TTWO) BioShock Infinite, and an easy comparison (down 39 percent) did not mitigate catalog weakness and continuing declines in a transition year. In addition, Easter fell in March this year and in April in 2012, likely having a minor, but negative impact on sales. PC SW sales were down 15 percent, despite two recent high-profile releases.

Solid new releases could not offset sluggish catalog sales in April. New release Warner Bros.’ Injustice: Gods Among Us (360, PS3, Wii U) led sales by a wide margin, with fellow new release Deep Silver’s Dead Island: Riptide (360, PS3, PC) having a decent debut. The multiple high-profile March releases performed well below our expectations,with older catalog content performing poorly for the most part, as gamers appear to be waiting for next-generation consoles to launch. Only a deep price cut for current-generation consoles is likely to spur sales over the balance of the year.

Michael Pachter is an analyst at Wedbush Securities. 

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