In an article we published last week, we dove a bit into the console manufacturers and Electronic Arts (NASDAQ: EA) in our article. EA is the best performing of the major game producers up over 60% YTD while Activision Blizzard (NASDAQ: ATVI) and Take-Two Interactive Software (NASDAQ: TTWO) are up 22% and 33%, respectively. All three of these stocks, especially Activision stock, pulled back last week after the August sales numbers were released.
This week, we take a look at Activision and Take-Two and try to identify the best gaming company of these three to buy.
August Video Game Sales Data
In August, console sales were again the headline behind sales of Microsoft’s Xbox One (NASDAQ: MSFT) and Sony’s PlayStation 4 according to the NPD data. Sales of video game related products was up 8% in the month. Software sales, ex-PC, were down 21% in the month. This decline was larger than expected, hence the decline in the game producers stocks late last week. On the surface this looks bad for the game manufactures. The decline in software sales in August was a repeat of all but one month this year.
While August disappointed, things are still looking up. Wall Street works based on future earnings. When a new console is introduced, it takes time for the game publishers to create new content. There is a lag between the acceleration in new console sales with software related sales. Games are starting to come out, and this will accelerate in 4Q14 and early 2015. Higher than expected console sales, increases the user base, and should drive strong sales at the game manufactures.
Activision’s new game, Destiny, beat initial sales expectations in early September especially digital sales. The game sold ~$500 million, 10 million copies, in its first twenty-four hours. We talked last week about how this trends is negative for game retailers like GameStop (GME). That said, there is concern that lackluster reviews will lead to lower than expected sales of the game.
Destiny is important to Activision’s future. It plans to release a new installment in each of the next three years. If sales can reach or surpass the $1 billion threshold, it will be a success for the company and likely the stock. Activision had non-GAAP sales of $4.3 billion in 2013 and guided for $4.7 billion in 2014, with Destiny responsible for some of the increase. In addition to new game sales, Activision will benefit from the sales of expansion packs for Destiny or downloadable digital content (DLCs). With 10 million copies sold, the company should exceed the 15 million copies some bullish analysts are forecasting for 2014.
While Destiny is a new franchise for Activision, it still has new installments to the highly successful Call of Duty and Skylanders games. Call of Duty: Advanced Warfare will launch on November 4, 2014. A YouTube video trailer was the most viewed entertainment video in 2Q14 on the site with over 23 million views.
The new Skylanders game (Skylanders Trap Team) has a release date of October 5, 2014. This franchise had generated over $2 billion in sales so far and a successful launch is also expected.
For 3Q14, Destiny should result in Activision beating current estimates given the higher than expected sales of the game. However, there is concern around Call of Duty since pre-orders are lagging 50% behind last year’s Ghosts at this point. Destiny may have taken pre-order sales from Call of Duty. In addition, digital purchases are not accounted for in pre-orders. Destiny sales beat expectation behind larger than expected digital sales. Since they are taking share, this can account for some of Call of Duty’s shortfall.
Take-Two has a more balanced risk-reward situation in our view than Activision. Take-Two historically lived and died based on the latest iteration of its blockbuster franchise Grand Theft Auto. In years that lacked a GTA release, profitability declined.
Management has worked hard to create more stable earnings through more balanced lineup, so earnings should be more consistent. It will release GTA V for the new consoles this November. The next big launch date is with Evolve in February 2015, and there is the possibility of delays there. With fewer new titles coming in the next few quarters and possible delays to planned releases, we do not see a compelling reason to own Take-Two right now. Upside is likely limited to better than expected industry sales numbers until next year.
Destiny is the big positive for Activision and delays for EA’s Battlefield Hardline and Take-Two’s Evolve should make it the best-selling game in 2014. With release dates for both of these other highly anticipated titles, the holiday season should be Activision’s for the taking with three titles (Call of Duty: Advanced Warfare, Skylanders Trap Team, Destiny) designed for the new systems all released. The stock is set up to beat earnings in 3Q14 and guidance and analysts’ estimates to increase for 4Q14.
John has seven years of experience as an equity analyst following various stocks and sectors. As a senior equity analyst, he received awards from the Wall Street Journal and Financial Times for his writing.