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With the biggest conference for the video game industry E3 2010 concluding last week, interest in the video game industry is high as both gamers and investors look towards the crucial second half of the year.

Beyond the standard racing and war games as well as the umpteenth iteration of Donkey Kong, gamers got a glimpse of two new innovations from Microsoft (NASDAQ:MSFT) and Sony (NYSE:SNE) that take the concept of Nintendo’s (OTCPK:NTDOY) innovative Wii controllers or Wiimote to the next level by allowing parts of your body to become the controller. We covered Microsoft’s Kinect (formerly known as Project Natal) a few months ago in an article titled Project Natal: Revolutionary Technology For an Industry in Distress.

Kinect, which is scheduled for launch on November 4, 2010 is already the second best seller on Amazon’s video game best sellers list. Attempting to describe Kinect in words would not do the technology much justice and I will let the following video speak for itself. (If you are reading this by email and not directly from the SINLetter blog, click here)

The video game industry can certainly use any boost it can get from these new innovations mid way through the console refreshment cycle. While May video game software sales numbers are yet to be released, April was a dismal month with sales falling 22% year-over-year. If there is any company in this industry that can use a shot in the arm, it is Electronic Arts (ERTS). Once the largest game company, Electronic Arts, with its aging franchises like The Sims and Need For Speed, has been displaced from its perch by Activision Blizzard (NASDAQ:ATVI) both in terms of revenue and market cap.

Bobby Kotick, the CEO of Activision Blizzard, who was once a developer for Electronic Arts, achieved his goal of “pushing Electronic Arts aside and becoming No. 1 in the industry” in the words of Josh Resnick, a former director of production for Activision according to this outstanding LA Times article Activision’s modern warfare. For a slightly kinder profile of Mr. Kotick, check out this Kotaku article titled A Delightful Chat With The Most Hated Man in Video Games.

With Activision Blizzard the largest position in the SINLetter model portfolio and my personal portfolio I have been asked from time to time about my thoughts on Electronic Arts as a potential turnaround play or an acquisition candidate. On the surface it does appear that Electronic Arts has a lower valuation than Activision Blizzard with EA selling for less than 1.5 times sales and has a market cap of $5.2 billion while Activision trades at over 3 times annual sales and has a $14.35 billion market cap. However when you compare the two companies on every other metric including strength of the balance sheet, margins, growth rate and cash flow, Activision emerges as the clear choice. During the conference call announcing fourth quarter 2009 and full year results, Activision’s CFO and now COO Thomas Tippl remarked “we generated a record $1.2 billion of operating cash flow, which is more than ten times ahead of our next best competitor.”

One of the driving forces for the high margins and cash flow at Activision has been the contribution of the Blizzard unit and specifically the high margin subscription business from World of Warcraft (WoW). Is it conceivable that Electronic Arts may someday create a Massively Multiplayer Online Role Playing Game (MMORPG) that could challenge WoW’s dominance? Could Electronic Arts have a hit in its pipeline that could rival the success of Call of Duty: Modern Warfare 2?

To answer these questions and to look into the potential of Electronic Arts as a turnaround play, I asked contributing author Jackie Judge to explore Electronic Art’s pipeline of upcoming games. Given below are some of her thoughts.

2010 bodes well for EA Games. The year was kicked off with the release of the highly anticipated Mass Effect 2 – developed by Bioware, and published by EA Games – a game that sold over two million copies within a week of its release, and holds near perfect scores from game reviewers, according to Metacritic, close to 100 for both the PC and consoles. Following closely in the successful wake of Mass Effect 2 are several highly anticipated games being released later this year.

1. One of these projects is Project Redlime by Starbreeze Studios that promises a “reinvention of the classic action/strategy game Syndicate”. Project Redlime was recently chosen, as evident through a March press release given by Starbreeze Studios’ CEO Johan Kristiansson, to continue onward in development over another game in development with EA, one based on the ever-popular Jason Bourne franchise.

The Bourne license was last used in Robert Ludlum’s The Bourne Conspiracy, which received solid reviews in 2008. However, following Activision’s merger with Vivendi that same year, the Ludlum family reacquired the rights to make games based on Robert Ludlum’s novels, eventually shopping them out to EA in February 2009. According to the LA Times, EA will remain in partnership with the Ludlum estate, though no games based on the authors work are currently in development. An EA spokesperson reportedly told the newspaper that, “EA and the Ludlum Estate are still discussing making a game based on the Bourne franchise.”

2. Another highly anticipated game from EA Games this year includes a remake of the highly successful Medal of Honor game, originally released in 1999 by DreamWorks Interactive for the Playstation, and so popular it spawned an entire series. This first person shooter will launch on October 12, 2010 in North America, and will veer away from the original settings to a modern day Afghanistan one, and will emphasize a greater sense of realism; to achieve this, EA consulted with the United States Military on real issues faced overseas, like raiding terrorist hideouts, hostage situations, undercover operations and more.

Electronic Arts' Medal of Honor

Medal of Honor

3. EA has partnered with Warner Bros. Interactive Entertainment to develop two Harry Potter and the Deathly Hallows games to coincide with the equally anticipated final movies in the much-loved series. The first part will be released on all major gaming platforms alongside, purportedly, the release of the first half of the movie this autumn of 2010. When fans leave the theatres in droves this autumn, giggly from the scent of butterbeer and pumping adrenaline from throes of wand casting, this game could await them at home, to continue the story.

Harry Potter Videogame

Harry Potter Videogame

4. Another highly anticipated game from EA called Crysis 2 is expected to release in the fourth quarter (November 2010 by some accounts). The sequel to the original PC only title will now be available for PC, XBOX 360 and Playstation 3 and could very well surpass sales of the original, which sold more than 1 million copies.

5. Star Wars: The Old Republic built by Bioware in association withe Lucas Arts could be EA’s answer to World of Warcraft. Slated for release in 2011 and built around a strong franchise, this massively multiplayer game is expected to hit 2 million subscribers according to some analysts.

With EA’s foray into the social gaming through their acquisition of Playfish for $300 million, an interesting pipeline of products, new innovations on the console/controller front, the potential of a successful MMORPG in 2011 and $2 billion in cash/investments on its balance sheet, EA is certainly worth a second look.

However given current market conditions and the fact that I already have exposure to the industry in my portfolio through Activision Blizzard and Glu Mobile (NASDAQ:GLUU), I prefer keeping EA on my watch list for now.

Disclosure: Author holds positions in ATVI and GLUU; see portfolio holdings here.

Source: Can Microsoft Kinect and Sony's Move Revive Electronic Arts?