NW, Good to hear from you again. Here is segment two of the four part coverage from Individual Investor Online...with the focus on ELBO and FNCO due out on Thursday.
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Game Makers Have Seen the Future, and It's 128 Bits
Zoom! Kabooom! Can Video Game Stocks Soar to the Moon?
individualinvestor.com
by Adam P. Lowensteiner,
Senior Research Analyst
(9/28/99)
Part II
Editor's Note: This is the second installment of a four-part series of the video-game sector that individualinvestor.com will publish this week. Today's piece focuses on the makers of video-game consoles -- Sony Corp. (NYSE: SNE - Quotes, News, Boards), Nintendo Co. (OTC: NTDOY - Quotes, News, Boards) and Sega Enterprises (OTC: SEGNY - Quotes, News, Boards). Yesterday, we looked at the overall market and the reasons for the generally bullish outlook on its prospects. Tomorrow's segment will examine the investment outlook for publishers of game software, while on Thursday, the series will conclude with an examination of two specialty retailers of video games.
The video game industry may be relatively young by some measures, although in an era when everything seems to move at Internet speed, it is practically ancient. In recent years, industry trends have been set by the three leading game console makers -- Sony Corp. (NYSE: SNE - Quotes, News, Boards), Nintendo Co. (OTC: NTDOY - Quotes, News, Boards) and Sega Enterprises (OTC: SEGNY - Quotes, News, Boards) ? who periodically introduce products with more power than their existing wares. Software publishers then introduce titles taking advantage of the more powerful platforms, which drives sales of both hardware and software through toy retailers.
The cycle is renewed every few years.
With the annual Christmas shopping frenzy just around the corner, the hardware and software makers with the most sought after products are sure to see dramatic top line growth. The trick is determining which hot products and hot companies will drive stock prices.
Unfortunately, it's not easy determining the proper share prices for these issues, given that all three companies are based in Japan, although their American Depositary Receipts are traded in the US. While Sony's ADRs are listed on the New York Stock Exchange and the company must file financial statements with US regulators, both Sega and Nintendo ADRs trade over-the-counter, and the filing requirements are less stringent. Accurate sales and earnings figures for Sony and Nintendo are harder to come by, and investors must make more of a shot in the dark before determining the best investment strategy.
Currently, the industry is in the midst of a major transformation to 128-bit game consoles, which are every bit as powerful as the current generation of home computers. Sega Enterprises just introduced the Dreamcast earlier this month to replace its disappointing 64-bit Saturn. Its competitors, Sony and Nintendo, are expected to roll out 128-bit upgrades next year. But for this holiday season, the attention will be focused on the benefits Sega gains by being the only supplier with a 128-bit machine available.
Sega Enterprises (OTC: SEGNY - Quotes, News, Boards) $4.63
Sega is counting on its Dreamcast console to reverse its fortunes, if not guarantee its survival. The company suffered drastically with the failure of the older 64-bit Saturn. But more importantly, the product could take consumer and investor interest in the video game market to a new level.
Sega may appeal most to investors looking for the 'riskier play' with lots of upside potential. The ADRs were once worth $15 a share. But lately, they have languished down in the $5 range. As recently as June, the ADRs were as low as $2.88. On Monday, Sega was down $0.19 closing at $4.63, and it is off 16% for the year to date.
The consensus forecasts for next year, according to I/B/E/S, is for a loss of $0.67 per ADR. The company is still struggling to do undo the damage from Saturn, and interest payments from the debt on its balance sheet are still hobbling it.
If the financial picture is going to get brighter, everything depends upon Sega's ability to score with its Dreamcast product.
The console is packed with more technology than most kids could dream of. The 128-bit microprocessor and 56-kbps modem allow players to interact with one another over the Internet.
Sega has also created a visual memory unit (VMU) ? the appearance is similar to Nintendo Co.'s Gameboy pocket-sized game machine ? and it allows players to play games specifically geared to the VMU. The VMU also allows players to download pieces of games from a console, play them on the VMU individually or with other players.
Following the Saturn disaster, there was management reorganization both in Japan and in America. Saturn was particularly painful a company that claimed more than 40% of the console market earlier this decade. Today, the company's share number is less than 1%.
But if initial news reports are any guide, Sega's bet on Dreamcast is paying off.
Surprisingly, Sega has been paying investors about a 2% dividend yield, despite its sagging stock price.
Shares perked up with regard to the launch of Dreamcast, which got droves of press, as the company spent $200 million to launch the product's advertising campaign.
Sega broke a previous entertainment record this past week, bringing in $98 million from Dreamcast in the first 24-hours of its debut. That surpassed the previous record held by Star Wars: The Phantom Menace, which received $28 million in its first 24-hours. In both instances, people were lined up for the debuts at midnight, but Sega blew past the previous record by more than three times.
Sega expects its Dreamcast to sell 1 million units by the end of this year. In just four days after its launch on September 9, Sega reported that it sold a total of 372,000 systems.
(Sega scheduled the launch to coincide with the "9.9.99" date, with was expected to cause software problems similar to those in the looming Year 2000 data change. But the date came and went without disaster. Dreamcast, however, made a huge splash.)
With about 100 days until Christmas, Sega would have to sell approximately 6,300 systems each day, which is well within reason. Sales could even hit two million units by the end of March.
If the company hits the sales goal, it could earn at least $0.25 per share during the next six months. With earnings like that, the ADRs are cheap at $5, and $7 range is not out of the question.
While the stock is not widely held by institutional investors, there is plenty to trade, all of 418 million shares. If momentum investors decide to hype the stock, $7 could be a low target.
Nintendo Co. (OTC: NTDOY - Quotes, News, Boards) $19.38
Nintendo's ADRs have surged like any other stock related to Pokemon, which it owns. The price has almost doubled in the last six months, although before Pokemon, the ADRs floated between $8 and $12 and had not seen much action for a couple of years.
But there's much more to the Nintendo story than just Pokemon. Investors who wish to go long should assess the full-range of products, starting with the Nintendo 64, which is still a successful platform with a 64-bit microprocessor.
First Call consensus forecasts are for the company to earn $0.64 per ADR in the next 12 months, and given the Monday's closing price of $19.38, the company's forward earnings multiple is roughly 30. That's inexpensive relative to other technology companies.
The product line also includes Game Boy Color, a joint venture with Konami, another Japanese video game maker. In addition to these products, Nintendo has plans for a new Game Boy called 'Game Boy Advance,' which will have better graphics and embed a 32-bit central processing unit, instead of the 8-bit processor presently found in the handheld devices.
The Game Boy Advance will also have a cellular phone adapter, so users can download and play games via the Internet. After unveiling the Game Boy product in April, Nintendo expects to launch its own 128-bit machine now being referred to the 'Dolphin,' later in the year.
Unfortunately, there is worrisome buzz in the industry is that Dolphin will not be ready to ship by next fall. If this is true, Sony's Playstation 2 could dominate the 128-bit console market, as it will be a 'backwards compatible' machine, which will be able to play games made for the Playstation system, or vice versa.
Game Boy owns 99% of the hand-held video game market, and its sales grew by more than 250%, averaging approximately 94,000 units per week earlier this year about, above the 31,000 per week last year.
Nintendo also owns the Seattle Mariners, although the team's star centerfielder, Ken Griffey Jr., is eligible for free agency. The company will have to offer a contract large enough to satisfy Griffey, without breaking the bank, in order to keep the baseball team financial viable.
Even in the game market, we're not talking about play money.
Like Sega, Nintendo pays a cash dividend, but it is tough to find financial information on the company. As a retaliation to the Dreamcast, Nintendo lowered its price on the Nintendo 64 console to $99, while the Dreamcast retails at $199 a system. Nintendo will likely benefit from Pokemon games this fall, and should soak up lots of business with its Game Boy unit, which has made a significant comeback. But unlike Sega, Nintendo is not relying on one product for survival, and would make a safer investment on that front.
Sony Corp. (NYSE: SNE - Quotes, News, Boards) $150.69
Of the three console-making companies, Sony is the only one that is not a pure play investment in the video game business. Games do account for approximately 20% of the corporate total of $63 billion in sales, but the company generates significant revenue from products such as laptops, televisions, camcorders, and digital video disc players.
Sony's ADRs have been highly successful, climbing to a recent high of $157.50, up from a $90 price this past June. Some of the price run-up could be credited to the announcement of the pending launch of Playstation 2, the company's 128-bit console. The Playstation 2 will debut in Japan early March, and later make its way to the U.S., in time for next year's holiday season. Sony's stock soared $12 a share, or 9%, to $148 a share on the news of its intended release date.
On Monday, the stock closed up $1.75 to $150.69, and it is up 109% for the year to date.
Like Nintendo, Sony lowered its pricing on its present console, the Playstation, to $99, which should also capture those gift givers looking to save money. Sony, though, is an expensive stock, and if investors like it, they need to look at the whole company. The game component may have generated plenty of publicity, but it is only part of the story.
Unlike the previous two mentioned companies, Sony's financials are bit easier to find, as their ADRs trade on the New York Stock Exchange. As of June 30, the company had a healthy $5.8 billion on its balance sheet, but it also has a mound of debt, yielding a ratio of more than 100% debt-to-equity.
In addition, forward looking estimates have been dampened based on slow sales in the consumer electronics and movie segments. The First Call consensus calls for earnings of $0.66 per share in the next 12 months, compared to $3.75 per share in the trailing 12 months.
But rumor has it that Sony's next console, the Playstation 2 is going to literally be a category killer. The company is rumored to be constructing the station so that it could be a set-top box for cable providers. The prospect of seeing Sony enter the set-top market is behind Microsoft Corp.'s (NASDAQ: MSFT - Quotes, News, Boards) wish to enter the video game market.
Both companies apparently believe they can satisfy two sets of customers, those looking to play games, and those looking to have cable access to their TV and PC. The Playstation 2 will also be DVD-based, so it is essentially a DVD player as well, and will be able to play games from the original Playstation, preventing players from shelling out more money for new games.
Sony trades at about 43 times its trailing earnings, which is not shabby for a technology stock. Still, Sony's earnings were down from the previous year because of depreciation costs, and the stock has been spared further damage because of its success with its video game business.
Therefore, investors seeking a dominant name in the electronics industry might go with shares of Sony, although the stock has now entered a momentum phase, which could create ridiculous valuations. For those value investors out there, Sony is not for you.
Bottom Line:
Sony, Nintendo and Sega all have good upside to them, as their new systems are debuting within a 12-month timeframe. On the downside, they are all Japanese companies and could suffer from a stronger Yen. The rising currency could cripple their export sales. Another wild card is the possibility of Microsoft entering the console market. The software giant has been making noises about such a step. Moreover, it could team up with Intel Corp. (NASDAQ: INTC - Quotes, News, Boards), which would probably supply the chips for this potential console. Until then, Sega is a decent play, although risky in the sense that it is riding on the success of Dreamcast, and little else. Sony, as a large, diversified consumer electronics company, is just a great stock to put away. Nintendo is less risky than Sega, but not as diversified as Sony--still as long as there's a market for video games, Nintendo should be around. A portfolio could have room for all three based on your investment style.
Wednesday's segment will focus on game software publishers Electronic Arts (NASDAQ: ERTS - Quotes, News, Boards), GT Interactive (NASDAQ: GTIS - Quotes, News, Boards), THQ Inc. (NASDAQ: THQI - Quotes, News, Boards), Take-Two Interactive (NASDAQ: TTWO - Quotes, News, Boards), Activision Inc. (NASDAQ: ATVI - Quotes, News, Boards), Acclaim Entertainment (NASDAQ: AKLM - Quotes, News, Boards), Midway Games (NYSE: MWY - Quotes, News, Boards), 3DO Company (NASDAQ: THDO - Quotes, News, Boards), Eidos plc (NASDAQ: EIDSY - Quotes, News, Boards), Interplay Entertainment (NASDAQ: IPLY - Quotes, News, Boards).
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Good luck,
RBL |
