Online Gaming Stock Losing Its Luster

05/15/2012 10:30 am EST


One of the hottest stocks in online gaming is having a tough go at maintaining supremacy, and there are a couple of stocks more attractive in the space, writes Chad Fraser of Investing Daily.

In 2011, consumers spent roughly $74 billion on video games and related gear such as consoles and controllers. By 2015, that number is expected to skyrocket to $112 billion.

Even so, gaming companies face a lot of risks. For one, they have to spend a huge amount of money on research and marketing just to get a shot at producing the next hit game. And even if they’re successful, there’s an excellent chance that an even more popular game will quickly come along and knock it off its throne.

Right now, Activision Blizzard (ATVI) leads the online gaming market with its hugely popular World of Warcraft, which boasts over 10 million subscribers. Looking to close that gap, rival Electronic Arts (EA) rolled out its latest online game, Star Wars: The Old Republic, in December 2011.

Star Wars Overshadowing—and Not in a Good Way
It was against that backdrop that the company reported its latest earnings last Monday.

Without unusual items, Electronic Arts said that it earned $56 million, or 17 cents a share, in its fiscal 2012 fourth quarter, which ended March 31. That’s down from $83 million, or 25 cents a share, a year ago. Despite the decline, the company’s latest earnings were ahead of the Street’s forecast of 16 cents a share.

Sales fell from $995 million to $977 million, but that was still ahead of the $966 million that analysts were expecting. (It’s important to keep in mind that Electronic Arts makes most of its money around Christmas, which falls in the third quarter, and only makes small profits, or posts losses, in the other quarters.)

There were two major black spots on Electronic Arts’ earnings report that grabbed investors’ attention, however. The main one was that the company said that it expects to lose 40 to 45 cents a share in the first quarter, which was a steeper loss than the 33 cents that analysts expected.

As well, Electronic Arts said that Star Wars subscriptions had fallen 24% in the fourth quarter, to 1.3 million from 1.7 million at the end of the third quarter. All of that prompted investors to overlook the earnings beat and send the stock down 4.3% last Tuesday, and an additional 2.5% on Wednesday. 

Declining Star Wars Subscriptions Are a Concern
Electronic Arts executive Frank D. Gibeau explained the declining Star Wars numbers this way: “What we’re seeing is that some of the initial casual customers have gone through a billing cycle, and decided not to subscribe to the game. But for the most part, we’re seeing very good retention amongst core users. So the percentage of paying subscribers from our peak until now has actually gone up.”

Many in the investment community weren’t convinced, however, including Justin Fritz of, who wrote: “Sure, any game is bound to have its fair share of short-term players who just want to kick the tires for a few weeks. But 24% is a huge hit, especially considering such a wildly popular game should have been adding enough new subscribers to make up for those heading for the exit."

Even more worrying is the fact that, as BBC News reported, Star Wars’ subscriber numbers fell during a period when the company was increasing its promotional spending on the game. It also launched Star Wars in Australia, New Zealand, Hong Kong, and Singapore in March.

Fritz, a gamer himself, thought Electronic Arts had rushed Star Wars out before it was ready. He lists a number of faults that he experienced as evidence: “For a while, it seemed like there was a new glitch to deal with every week. Like getting stuck in walls, characters’ eyes changing to silver during conversations, or entire characters becoming shadows. And then there’s my personal favorite: companions falling on the ground randomly, appearing to play dead for ten seconds, and then standing back up.”

Look to Hasbro for Lower-Risk Gaming Gains
One way to tap into rising video game demand with less risk is to buy shares of companies that are exposed to—but not totally dependent on—this volatile market.

A good example is Hasbro (HAS). As we highlighted on February 7, the company makes video games, but it also has a wide range of other products.

Hasbro is best known for making board games, like Monopoly. However, it also controls some of the most established brands in the toy business, including GI Joe, Transformers, Play-Doh, Tonka, Nerf, and Playskool.

In addition to selling these brands of toys and games directly, the company is profiting by licensing them to video game makers and movie studios. (In Hasbro’s latest quarter, licensing revenue jumped 19% from a year ago, to $24.6 million, partly due to ongoing box office revenue from the latest Transformers film.)

Hasbro’s overall sales have been held back by ongoing weakness in North America. However, the company is working to offset that by boosting its presence overseas. In its latest quarter, sales outside North America rose 14% to $289.7 million.

To top it off, unlike most pure video game makers, Hasbro pays a dividend, and an attractive one at that: quarterly payments of 36 cents a share yield 4.05% on an annual basis.

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