Graham
I am probably a day late and a dollar short on the Sony Software Games stocks, but here is a start:
Activision Plays the Improvement Game
New York, Aug 18, 2000 (123Jump via COMTEX) -- Santa Monica, California-based
Activision (NASDAQ:ATVI) was one of the earliest players in the video game
industry. Founded in 1980, its first game, Pitfall, entertained youngsters who
were lucky enough to have clunky Ataris hooked up to their television. Twenty
years later, Activision is the second largest third-party developer, with more
than $500 million in sales. Activision Inc. is the holding company for
Activision Publishing Inc, an international publisher, developer and distributor
of interactive entertainment and leisure products. Activision's games span a
wide range of genres (including action, adventure, extreme sports, strategy and
simulation) and are targeted to a range of demographic segments (including game
enthusiasts, mass-market consumers, value buyers and children). The company
publishes, develops and distributes these games on a wide variety of platforms,
including the ubiquitous Sony Playstation, Sega Dreamcast, Nintendo's N64
console systems and Gameboy Color handheld, and the lowly PC.
While Activision doesn't feature cutting-edge games, it does feature well-known
brands that appeal to the more casual gamer audience. Moreover, their games
don't require a PlayStation2 or a PC powered by a 1 GHZ chip and GeForce2 3D
graphics accelerations. Activision has done quite well with proven brands such
as Star Trek, the X-Men and skateboarder Tony Hawk. Approximately 60% to 70% of
Activision's earnings come from proven brands.
The Video Game Market
The video game industry has come a long way from the cheesy graphics of Space
Invaders. Since 1998, television viewership in America has slipped, while hours
spent playing video and PC games and surfing the Internet have climbed
substantially, according to NPD Group. Last year, market researchers at The NPD
Group reported that game software revenues exceeded $8.4 billion, topping the
$7.5 billion brought in by movies at the box office. Moreover, sales have
averaged 20% to 25% growth over the last five years, and currently three out of
five Americans are game players. In addition, one third of American homes
possess a gaming console, such as the popular PlayStation, and many more are
expected to purchase one. As a result, the lion's share of sales are in console
games, while PC CD-ROM games accounted for a mere $1.5 billion, or 18%, of total
sales.
However, the industry is now undergoing a period of soft sales as it waits for
the delivery of the new generation of video game console hardware. Since
consumers are delaying their purchases in anticipation of newer, more powerful
systems, software prices on old products have dropped and sales are slumping.
The overall game market expanded 18% in the first half of this year,
substantially higher than what analysts were expecting. Though the pace is still
lower than the industry's growth rate for the previous five years, there's still
a large segment of the market interested in those technologically obsolete but
cheaper consoles for $99.
The PlayStation2 will be the first of a new generation of game consoles. With
computing and graphics power rivaling even high-end PC's and the capability to
double as a DVD player, the PlayStation2 has video game addicts drooling. Given
the PlayStation2's sell-out success in Japan, where consumers lined up days in
advance to purchase a console, and its lower than expected selling price of $299
U.S., the PlayStation2 is expected to completely sell out the initial 1
million-unit shipment within a few days.
More important, the PlayStation2 is backward compatible, allowing consumers to
play their favorite PlayStation games without using any adapter. This is
important to Activision since the introduction of a new console diminishes the
value of their games, since sales will drop off in the older games.
Next year promises even more growth for the industry. Microsoft has announced
that it will release its own gaming console, the X-Box, in fall 2001. The X-Box,
like most PCs, will be based on the Windows and DirectX platforms that will
enable developers to shave months off development time. Although sales of the
X-Box are expected to be much lower than for the PlayStation2, the ease of
converting games will result in COGS lower than the current 67% and lower R&D
costs as a percentage of sales for X-Box games. Finally, the introduction of
Nintendo's Dolphin, in 2001, will provide additional impetus for consumers to
purchase software.
Competition
Competition in the rapidly growing video and computer game market has lured many
heavyweight competitors into a realm that was previously filled with small
startups. Activision competes against industry heavyweights Nintendo, Sony
(NYSE:SNE), Hasbro Interactive, (NYSE:HAS), LucasArts Entertainment and
Microsoft's (NASDAQ:MSFT) own gaming division, all of which are major
subsidiaries of larger corporations.
Publicly traded competitors include Electronic Arts (NASDAQ:ERTS), Acclaim
(NASDAQ:AKLM), Eidos plc (NASDAQ:EIDSY), GT Interactive (NASDAQ:GTIS), Interplay
(NASDAQ:IPLY), iEntertainment (NASDAQ:IENT), Midway Games (NYSE:MWY) and
Take-Two Interactive (NASDAQ:TTWO). In almost every case, all of these companies
have been suffering recent losses since consumers are waiting for the
introduction of new, advanced gaming consoles.
There is a clear valuation difference between large competitor Electronic Arts,
and smaller companies. Due to the seasonality of game sales and the fickle
tastes of consumers, well-capitalized interactive entertainment firsm are better
positioned to succeed in the long term - one quarter of poor product releases
won't kill a large firm but could spell the end for a smaller company.
However, while Electronic Arts has the size to withstand a temporary downturn,
Activision generates roughly half the revenue of EA, and has a market
capitalization less than 5% of ERTS. This provides an opportunity for investors
seeking a large upside and who are able to tolerate substantial risk.
Financials
From 1997 to 2000, Activision's revenue grew steadily: from $154.6 million in
1997 to $572 million in 2000. However, Activision's revenue has stagnated
recently. Net revenues for the first quarter of fiscal year 2001 (the three
months ended June 30, 2000) increased a mere 0.5% year over year, from $84.1
million to $84.6 million. While publishing net revenues increased a mediocre
14.2% from $53.4 million to $61 million, this increase was largely offset by a
23.5% decline in distribution net revenues from $30.8 million to $23.6 million.
This decline was mainly attributable to the continued weakness in the European
console market.
Product costs represented 51.6% and 63.6% of net revenues for the first quarter
2001 and 2000, respectively. The decrease in the cost of sales was due to a
shift in the product mix, since in the first quarter of fiscal year 2001 more PC
titles were published than console titles. Though PC products reach a smaller
number of consumers, they have a higher gross margin per unit compared to
console products. Approximately 75% of Activision's revenues come from console
games while 25% comes from PC game sales.
Moreover, Activision's publishing net revenues versus distribution net revenues
as a percentage of total net revenues increased. Publishing generates a higher
gross margin per unit than distribution because publishing is based on selling
intellectual property while distribution involves shipping and selling a
physical good. Royalty and software amortization expense represented 16.1% and
11.7% of net revenues for the first quarters of 2000 and 1999, respectively.
This increase was primarily due to an increase in the number of branded
products, which have higher royalty obligations, in the product mix as compared
to the prior fiscal year.
Operating loss for the first quarter of 2001 was $6.5 million, or 21 cents per
share, compared with the $6.1 million, or 19 cent per share, loss in the first
quarter 2000. While this increasing loss may seem bad, analysts had been
expecting a much larger loss of $7.5 million or 29 cents per share due to the
general slowdown in video game sales. Thus, this unexpected improvement in
Activision's operating loss precipitated a general rise in stock price.
Division-wise, the publishing operating loss remained constant at $5.9 million
for both 1Q 2001 and 2000. Distribution operating loss for 1Q 2001 increased to
$591,000, compared with a loss $154,000 in the year-ago period. As noted
earlier, the worsening of distribution earnings was due to the continued
weakness in the European console market.
The company anticipates revenue for 2001 and 2002 to be less than the $572
million recorded in 2000. However, due to the unexpected improvement in the
market and the upcoming release of next generation video consoles, like the
PlayStation2, Activision expects 2001 fiscal revenue to be about $525 million,
with revenue rising slightly more in 2002.
Robert A. Kotick, chairman and CEO of Activision, was extremely bullish about
his company's performance. "Our performance was better than expected and our
competitive position is stronger than ever. For the first quarter, our results
exceeded First Call consensus earnings estimates and our net revenues increased
over the prior year. According to NPD TRSTS, Activision ranked as the No. 2
third-party U.S. publisher for the quarter and the only console publisher to
show triple digit year-over-year growth on a monthly basis in dollars for the
last eight consecutive months. U.S. retail sell through of our console and PC
games increased 125% over last year's first quarter, versus the market's overall
increase of 23%. For the quarter, Activision achieved an overall market share of
6.9% of dollar sales, almost double our 3.8% share for the same period last
year, as reported by NPD and PC Data," Kotick stated in the 1Q 2001 earnings
press release.
Activision's U.S. retail sales for the month of June increased 193% year over
year as compared to the market's overall increase of 18%. For the first six
months of the calendar year, Activision's retail sales grew 71% compared to the
overall market, which rose 23%.
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