The Next Great Game

Video Game Sales Slump Again

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The video game industry continued its gloomy run after reporting a year-over-year sales decline of 6.0% for the month of September, according to a recent report from market research firm The NPD Group. According to NPD, U.S. video game retail sales declined for the fifth consecutive month to $1.16 billion (including games released for personal computers). This compares unfavorably with $1.23 billion generated by the industry in the year-ago month.

However, we note that video game retail sales recovered strongly from $669.9 million reported in the month of August. The year-over-year decline also moderated compared with 23.0% in August, 26.0% in July, 10.0% in June and 14.0% in May, respectively.

The improvement was largely on account of marginal growth in new software sales, which increased 3.0% down 1.0% year over year (including PC) to $630.2 million. However, a 9.0% decline in hardware sales and 17.0% plunge in accessories sales fully offset this growth.

Electronic Arts Inc.’s (ERTS) late August release Madden NFL 12, was the top selling game in the month. Microsoft Corp.’s (MSFT) Gears of War 3 and Deep Silver Inc.’s Dead Island were ranked # 2 and #3, respectively. On the hardware front, Microsoft’s Xbox 360 was the top selling video game platform in the month, despite the fact that unit sales were down for the third consecutive month.

Our Take

Although retail sales remain a major part of the Video game industry, higher adoption of digital gaming driven by increased usage of portable devices, smartphones and tablets are gradually lowering its relevance. As NPD does not track digital sales, we believe that it will be difficult to gauge the video game industry performance going forward.

Nevertheless, we think that the upcoming holiday season will look brighter given the many new games scheduled for release. The next three months will witness the release of some of the highly anticipated titles from popular franchises such as Battlefield 3 and Star Wars from Electronic Arts, Call of Duty: Modern Warfare 3 from Activision Blizzard Inc. (ATVI), Batman Arkham City and Uncharted 3: Drake’s Deception.

However, many analysts believe that despite this unusually robust line up of blockbuster titles, retail sales in 2011 will decline from 2010 due to a devastating summer (May, June, July and August) performance.

We remain cautious on retail sales and believe that strong growth in the digital business will further cannibalize market share going forward. Moreover, the US video game industry remains fragmented with cut-throat competition, which will further hurt top-line growth in our view.

Despite competition and a lacklustre macro outlook, we believe companies with significant exposure to the digital business will stand out in this sluggish market going forward. Hence, we remain Neutral on Electronic Arts over the long term (6-12 months).

We also remain Neutral on Activision Blizzard, the other gaming company in our coverage. Although Activision does not have the significant exposure to online and social gaming as its arch rival Electronic Arts, we believe Activision’s product pipeline is much stronger. Call of Duty has a strong fan following and its last instalment Black Ops was the top selling game in 2010. We expect the upcoming Modern Warfare 3 to help Activision maintain its lead in 2011.

Both Electronic Arts and Activision Blizzard have a Zacks #3 Rank, which implies a Hold rating on a short-term basis.

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