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The video game industry has struggled and underperformed broader indexes of late. Over the last three months, Activision Blizzard (NASDAQ:ATVI) and Electronic Arts (NASDAQ:EA) fell by 2.9% and 12.1%, respectively, while the NASDAQ rose by 7.9%. I have warned the bulls earlier (see here) to rethink their positions and continue to have a reserved outlook. This is a sentiment not shared by the Street, which rates Activision a "strong buy" and EA a "buy".

From a multiples perspective, Activision is the more expensive of the two. It trades at a respective 19.1x and 12.9x past and forward earnings while EA trades at 16.1x forward earnings. At the same time, Activision has a dividend yield of 1.4% and has more room to expand margins, which stand at 52.2% compared to 58.2% for its competitor. While both companies have strong brand loyalty, the industry as a whole is often unpredictable and demands change. One positive thing to note is that both companies have adapted well to shifting interests.

At the third quarter earrings call, EA's CEO, John Riccitiello highlighted this in his speech:

"We are pleased to report a strong second quarter with results ahead of the top and bottom line expectations that we provided on our last earnings call. Our results reflected a tremendous performance by our EA SPORTS titles and a strong showing for our newest game on the Facebook platform, The Sims Social.

EA has delivered solid results in the first half of our fiscal year, and we are now focused on our biggest titles for the holiday. FIFA 12 is having its best year ever with a critical index of 92 and record sales in both North America and Europe. Battlefield 3 was launched on Tuesday and has opened very strong. We shipped 10 million units to retail and we are already receiving reorders. The data is still early but sell-through is strong."

Note, specifically, the reference to "The Sims Social." EA's penetration into the online field represents a major catalyst that other traditional video game producers are not exploring. This game has become a popular hit, in addition to Lord of Ultima. Overall, I find that tapping into this market hedges against uncertainty in other segments. Star Wars: The Old Republic will be disappointing to earnings due to a late release, which is doubly bad since the title has the capability of generating sustainable free cash flow from subscriptions.

Consensus estimates for EA's EPS are that it will grow by 28.6% to $0.90 in 2012 and then by 36.7% and 26% more in the following two years. Assuming a multiple of 16x and a conservative 2013 EPS of $1.19, the stock would decline. Accordingly, again, I recommend holding out for now.

Activision has higher upside, but not enough to merit calling it a "value play", in my view. Third quarter earnings were impressive and management raised guidance so that it is now targeting record EPS and operating margins. However, Activision is experiencing churn in its flagship title, World of Warcraft, which will damage the value of the brand and scare off investors. Investors would be wise to remember that the firm nevertheless performed incredibly well both in a challenging economy and in an industry vulnerable to the subsequent headwinds.

Consensus estimates for Activision's EPS are that it will grow by 8.9% to $0.86 and then by 11.6% and 12.5% more in the following two years. Assuming a multiple of 16x and a conservative 2012 EPS of $0.94, the rough intrinsic value of the stock is $15.04, implying 22.9% upside. If the multiple were to decline to 14x and 2012 EPS turns out to be 14.6% below the consensus the stock would fall by 5.1%. Put simply, the company may be safe, but any dividend screen will suggest that there are more attractive defensive plays out there.

Source: Dangers For Activision, EA Shareholders