Video Game Values ...

12/16/2005 12:00 am EST


Stephen Biggar

Director, Product Strategy, Argus Research Corporation

With the rollout of new video game consoles such as the Xbox 360, two top advisors see opportunity in video game developers. Standard & Poor's Stephen Biggar goes with Electronic Arts, while trading expert Bryan Perry plays this trend with THQ. Here are their reviews.

"The next-generation cycle in video game consoles has begun," says Stephen Biggar in Standard & Poor’s The Outlook. "Microsoft's release of Xbox 360, Sony’s PlayStation 3 expected release this spring, and Nintendo’s mid-2006 release of its GameCube, will be the key drivers for the video-game software firm. And we believe that Electronic Arts (ERTS NASDAQ) will be a major beneficiary of the next-generation hardware console cycle, as it has the strongest and most diversified interactive video-game software library in the industry.

"ERTS will be a winner as new consoles hit the market. It's the largest independent video-game software provider in the world, based on revenues and market cap. Its leading franchises include Madden NFL, FIFA Soccer, NCAA Football, Need for Speed, Harry Potter, The Lord of the Rings, and The Sims. In fiscal 2005, Electronic Arts developed or published products for 11 different hardware platforms. As planned, the company released five titles in time for the Xbox 360 launch.

"Research and development is also paying off. Other new growth opportunities include the wireless and handheld gaming markets. Sony's PSP and Nintendo's Dual Screen have helped to provide a more diversified revenue stream for the video-game software companies. Company revenues bottomed in fiscal 2005, in our view, even though Electronic Arts still grew revenues 6% in the middle of a transition period to the next-generation hardware consoles. We see revenue growth accelerating to 8% in fiscal 2006, and a further 14% in fiscal 2007, as the installed base for the next-generation systems continues to build out.

"The stock trades at about 32 times our fiscal 2007 earnings per share estimate of $1.86 (including 24 cents in stock-options expense), at the lower end of its historical range. We believe that ERTS can grow at a five-year compound annual rate of about 20% over the next cycle, as we anticipate it to grow faster than the rest of the video-game software market. We view this market leader as an excellent way to participate in the secular growth in the video-game industry. The stock carries S&P's highest rating of 5 STARS, or ‘strong buy’. Our 12-month target price is $70."

Trading expert Bryan Perry in The Tactical Trader, notes, "Electronic Arts is in the sweet spot for specialty retailers going into the height of the holiday shopping season. As one of the top three software game makers, this company stands to have a very robust next couple of quarters, thanks to the rollout of Xbox 360 and Sony's PlayStation Portable. Also, the emergence and widening acceptance of playing games on cell phones is a huge potential boost to business for the game makers.

"And this wave is just in the first stages of happening, so there is big upside to carriers that offer advanced gaming features. Electronic Arts is the 800-pound gorilla in the game software publishing business. But alongside Electronic Arts in this sector is THQ Inc. (THQI NASDAQ). The company is a leading worldwide developer and publisher of interactive entertainment software. It has some very lucrative licenses, including strong licensing agreements with Nickelodeon and Viacom and a lock on publishing games like Saints Row, SpongeBob SquarePants, and Finding Nemo . These are all extremely successful releases with huge audiences.

"The firm recently completed a 3-for-2 stock split (my favorite kind) at the end of September. The company posted this quarter earnings that came in 6 cents better than expected. They have a good track record of surprising to the upside, as the data shows, and now we are seeing a progression of higher upside surprises. There are 22 Wall Street analysts who follow the company. Sales will top $1 billion this year. And, with no debt, $300 million in cash and trading at two times book value, the stock represents a compelling value. I believe the stock has the potential to trade up to $29 during the next three months, representing a potential gain of 25%."

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