Why I Bought Activision After Electronic Arts Disappointed the Street

Electronic Arts (ERTS), long considered the king of video game publishing, reported earnings Thursday that met estimates to the penny. However, EA's guidance was less than stellar, and as I write this (3:20pm, Halloween Friday) the stock is getting punished to the tune of -17%. Where it will close is anyone's guess in this volatility. But the bigger question for video game investors is this: Should we be worried about the video game industry, or just about EA in particular?

There is plenty to worry about in consumer-land, but as I've written in the past, a growing video game cycle can cause gaming stocks to overcome a recession. Here's a chart showing how ATVI, ERTS, and THQ (THQI) held up from 2000-2004 while the S&P 500 lost ground (click on chart to enlarge).

In this case, I consider EA's stock to be a victim of EA itself. Expenses were high, catalog sales were weak, and a game (Tiberium) was killed due to quality issues. The sports games are great (I have Madden 09 in my Xbox 360 right now, literally), but appear to have reached something of a saturation point and can no longer drive growth. Some of the new titles are decent, but I don't see anything on the holiday slate that gets me excited to shop. I read the earnings call transcript on Seeking Alpha, and nothing in it gets me excited to own the stock either. The only reason I'd have to own the stock right now is that EA could become a takeover target, as reported by the Wall Street Journal. But I'd rather own it under $20.

So, as ERTS sold off Friday, I bought some more Activision. ATVI was down more than -7% in sympathy with ERTS at the beginning of the day--a gift, in my opinion. (ATVI finished the day down -2%.) Activision, unlike EA, is executing well. And it shows in the stock comparison--here's the past 6 months, with the S&P 500 thrown in for comparison (click on chart to enlarge).

Guitar Hero and Call of Duty are still growing, and the new James Bond title is buzzworthy. But the real kicker is Blizzard. With the addition of Blizzard, ATVI will benefit not only from millions of World of Warcraft addicts, but also from StarCraft enthusiasts who are finally getting the sequel they've been waiting for. If you don't think StarCraft is big, just check out this video of a televised StarCraft tournament in South Korea. I especially recommend jumping to the 5:00 minute mark to hear the crowd shrieking and play-by-play announcers yelling as one player wipes out the other.

I'm not fluent, but I think at the end there I heard the Korean for "Do you believe in miracles?!"

No one knows how the combination of Activision and Blizzard will perform, but I think this company has the biggest upside of any video game play because of the Blizzard factor. According to Gamespot, there are rumors of a next-generation Massively Multiplayer Online Game for video game consoles (as opposed to PC), and that could be a huge development, albeit probably a few years out for the next game cycle.

There are risks in the short term. Broadly speaking, the stock market is one big risk with the current volatility. The widely-reported "most difficult holiday season ever" for the consumer is also a risk. The biggest risk in my view is ATVI's earnings report on November 5th. I expect Activision to beat, but the reaction to the news can be unpredictable. Therefore, I'll be looking to manage my risk heading into the number.

Video game investors and players: See you and your calloused thumbs back here next week!

Disclosure: Long ATVI.

Comments

[1 of 4:]

How about more commentary on ATVI fundamentals, as opposed to game hype?

2008 Nov 02 10:37 PM

[The Stock S...:]

In my opinion, there's not much insight to be had by looking backward at numbers on a video game publisher. You can get that information anywhere. The Street knows the numbers, but is more concerned about future catalysts.

So where's your edge? You need to know the games. You might disagree on which games will be successful, but if you don't know about StarCraft (to pick one example), you are missing an important catalyst. It has nothing to do with hype.

Why did ERTS and THQI have poor earnings? Weak game sales and weak projected sales. Why did ATVI have good earnings? Solid game sales and solid projected sales. That's the business after all--they sell games.

On Nov 02 10:37 PM 1 o 4 wrote:

> How about more commentary on ATVI fundamentals, as opposed to game
> hype?

2008 Nov 05 09:34 PM