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On Tuesday evening, Majesco Entertainment (NASDAQ:COOL) disappointed investors with lackluster October results and 2012 guidance that trailed Wall Street estimates. However, both disappointments relate to Majesco's ongoing transformation into an interactive fitness leader.

The emergence of motion-based gaming has set the stage for fitness “games” to revolutionize the industry. Demand for fitness DVDs continues to growth as the sluggish economy encourages people to find more affordable ways to work out from home. The meteoric success of “The Biggest Loser” has also been a boon. However, consumers are increasingly turning to the Internet (i.e. YouTube) for free videos to work out with. This threatens to decimate the DVD industry, which produces hundred of new fitness DVDs each year.

Enter motion-based gaming. With blockbuster platforms like the Wii and the growing popularity of Microsoft Kinect, home fitness is becoming an interactive experience. Up until recently, you would need to attend classes or hire a personal trainer to ensure proper workout form and enable progress to new levels. DVDs and YouTube videos have never cut it in this regard. Unfortunately for most, classes and trainers can cost hundreds to thousands of dollars per year. But now, for less than $50, Wii and Kinect titles like Zumba Fitness provide customers with the best of both worlds.

Getting back to COOL’s earnings results, management revealed that its October-quarter disappointment stemmed from poor sales of its traditional video game titles. This was partially offset by continued strength in its Zumba Fitness titles. What made Zumba’s success so surprising is that it was released over a year ago. Most games are long-dead within the first three months of its release.

The distinction is that Zumba is not a video game -- it’s an interactive fitness product. Such products are characterized by a slower starts and longer lives. This is exactly what the Zumba franchise has displayed thus far. However, looking at COOL’s disappointing guidance, management’s commentary made it clear that they prefer to take a wait-and-see attitude as it pertains to Zumba’s life cycle as we enter 2012:

…the Wii platform is another year older. So we take that into consideration as to what the year will look like, which I take as reasonable an approach as possible as it relates to that, like we felt like we did last year with our approach to Zumba 1. And the Kinect SKU hasn’t launched yet, and until we get some real initial feedback to how well that does, it’s hard to really get too bullish on it until we really get some feedback, which is just the way we’ve historically managed our forecasting for these things.

It’s important to note that Majesco’s traditional forecasting has centered around video games, not interactive fitness products. Indeed, last year's guidance proved to be very conservative. Thus, it’s likely that COOL will deliver upside surprises as the year progresses. Its longer term prospects should also improve, as long as it continues to transition away from the ailing video game business and towards the emerging interactive fitness market. So far, so good. The company expects over 70% of its 2012 revenue to come from fitness titles, led by the Zumba franchise.

Its fitness opportunity is tremendous. Almost anyone can produce a fitness video, but very few have the expertise to deliver a world-class fitness experience for the Wii or Kinect platforms. As such, Majesco is uniquely positioned to serve this role for the hundreds of fitness gurus whose DVD businesses are being threatened by the emergence of YouTube.

To date, Majesco’s experience in this segment is unparalleled. It delivered its first million-selling fitness hit, "Jillian Michaels Fitness Ultimatum", back in 2008. It followed that up with a sequel in 2009 which helped the franchise to approach 2 million units (even as Jillian Michaels’ star has lost some of its luster). In 2010, Majesco released its first Zumba title, which quickly doubled the success it experinced with Jillian Michaels. Finally, in late 2011, Zumba 2 was released and is already on track to outsell the original.

This year, Majesco will release new installments of the successful Zumba franchise. It will also introduce a new title built around Harley Pasternak, who has already authored two best-selling fitness books and several DVDs. He is perhaps best known for training megastars like Lady Gaga and Robert Downey Jr. With his fame on the rise, he landed a show on ABC called “The Revolution”, which debuted last Monday.

Based on these factors, it’s clear that COOL’s share price is giving investors a second chance to get in on the ground floor of its interactive fitness opportunity. The stock's 52-week high of $4.53 came long before anyone knew the Zumba franchise would sell over 6 million units. It also came before Harley Pasternak debuted as a national TV regular. Thus, if its shares were worth $4.50 last June, investors can decide for themselves what those shares will fetch in the coming months.

As they do, several developments should be considered and monitored:

  • The success of Zumba 2 for Wii, which has already sold a million units. This title has also spurred a renewed demand for Zumba 1, which has sold another million units over the past few months.
  • This week, COOL announced that Microsoft will put heavy marketing support behind Zumba Rush for Kinect. This title is due to be released in just a few weeks and will coincide with Microsoft's commitment to make it a big success.
  • Majesco's dedication to the interactive fitness opportunity. With greater success, we can expect the company to shift more of its focus away from traditional video games, unprofitable ventures, and fading stars (like Hulk Hogan). This will give it increased resources to uncover hot new fitness trends (and perhaps old legendary ones -- Jazzersize anyone?) to expand its burgeoning interactive fitness business.
  • Majesco thrives on the non-male demographic. Four of its most successful titles (Zumba, Cooking Mama, Jillian Michaels, and Let’s Draw) all target women and their children. This is a unique quality in the video game industry and directly in-line with the strategy Microsoft is currently taking with its Kinect platform. This makes COOL a valuable partner and potential acquisition target for the software giant.

Last but not least, the average Wall Street price target for COOL is $4.75. In the most recently released initiation report, Rodman & Renshaw called for a $7 target. With earnings expected to hit 35-cents this year, the stock is trading with P/E of 5 ex-cash, on what have historically been conservative estimates.

Based on these measures, it appears that COOL's sell-off marks a capitulation point for the stock -- the shares are now more than 50% off of their highs. Options expiration seems to have fueled the recent downdraft, setting up a unique opportunity for investors to prepare for relaunch.

Disclosure: I am long COOL.

Source: Majesco Shares Will Rebound As Interactive Fitness Takes Flight