Key points from Kaufman Bros. analyst Todd Mitchell's recent note to clients (for a full-length .pdf version of this report, click here):
Shares were up yesterday on the news Electronic Arts (ERTS) is expanding its line up of Wii titles, which prompted price target increases for a stock that is already expensive.
Of the four video game publishers we cover, we are most favorably disposed toward EA at current levels. Yes, it is expensive, but we think investors have misread market share shifts over the past holiday season, and we believe EA is making the correct investments (Asia, online, MMOG, mobile) for the coming cycle and will ultimately be far better positioned for changes in the industry than its peers.
However, we are getting tired of what we believe is irrational exuberance about the Wii. Yes, it is popular, and yes, it is taking share, but one investor recently told us how he thought it would revolutionize the way Americans exercise...
As we highlighted in our Video Game Publishers: Valuation and Technical Analysis, published on 4/9/07, we are not sure the publishers will benefit from the Wii. Did the Wii really enlarge the market or did it just further segment it to Nintendo's (OTCPK:NTDOY) advantage? Most likely it is a little of both, so we feel the real questions is, did it enlarge the market by more than the amount of share Nintendo was able to take from the other publishers by dominating sales on the popular platform?
Moreover, we think Nintendo's software share gains could be more sustainable. The Wii may not have as long of a product life cycle as the PS3 and Xbox 360. Therefore, it might not develop a big enough installed base necessary to build and amortize strong independent franchises despite lower development costs. Also, with a shorter hardware upgrade cycle, Nintendo could remain one step ahead of the other publishers in developing titles for its own platforms.
Yes, the Wii has caused the overall pie to get bigger, but the independent publishers may be getting a proportionately smaller slice.
ERTS 1-yr chart