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'Playing' the market
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June 23, 1998: 3:14 p.m. ET
Computer gaming stocks engage in Mortal Kombat on Wall Street
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NEW YORK (CNNfn) - They might make their fortunes developing complex mazes, but some computer gaming companies are finding Wall Street a difficult road to navigate.
Consolidation and fierce competition have squeezed industry profits and several public gaming companies are trading near 52-week lows. That's not stopping other developers from jumping into the fray, however. And it's not keeping analysts from recommending the stocks.
"1998 is going to be the biggest year ever," said Michael Wallace, an Internet and new media software analyst with UBS Securities. "1999 is going to be even hotter."
The latest gaming company to brave the market is Interplay (IPLY), which began trading Friday. Shares opened flat around $6 and haven't moved far from the IPO price.
Interplay is one the better known names among gamers, with hit titles such as Descent, Fallout and Carmageddon. Investors, though, are a bit more concerned about the company's bottom line. Interplay had fiscal 1997 revenues of $83.3 million, but it reported a net loss of $27.2 million.
Another gaming company, Interactive Magic, will launch its IPO in mid-July. Like Interplay, its earnings have been less than spectacular. In the three months ended March 31, the company lost $618,000. 1996 and 1997 losses total nearly $11.5 million. Analysts expect shares to open like Interplay -- sluggish.
"The industry itself is very strong and on the rise, but the stocks are not very much alive," said Robert Peterson, senior research analyst and vice president with Piper Jaffray. "The Street doesn't really like the unpredictability of the industry."
Multiplayer
While there are dozens of companies in the gaming industry, Wallace said five lead the field: Cendant Corp. (CD), Electronic Arts (ERTS), GT Interactive (GTIS), Broderbund (BROD) and Hasbro (HAS).
Cendant, EA and GT Interactive have all grown over the past few years by acquiring smaller competitors. Cendant has been on the largest buying spree, adding Sierra, Blizzard Entertainment (maker of the popular Diablo title), Berkeley Systems (along with its popular You Don't Know Jack line of games), racing simulation developer Papyrus and six other companies.
Broderbund found itself on the other side of consolidation Monday, as The Learning Company agreed to acquire the company for $420 million in stock.
While Broderbund had a monster hit with Myst, the best selling PC game of all time, it failed to capitalize on that momentum. And Riven, the much anticipated follow-up to Myst, has been a financial disappointment, relative to expectations.
Analysts say the Broderbund story shows the need for consistent title success.
"It's a hit strewn business," said Wallace. "Much like the movie business, you need to come up with something new and exciting. If there are expectations for a product that doesn't pan out, then you're in trouble."
In an industry as volatile as computer gaming, there are a few factors to consider before you invest. Look first at the track record. One hit title does not guarantee success. It's best to choose a company that has a variety of popular offerings in a variety of genres.
Platform performance
Diversity is a necessity these days as well. Companies that focus exclusively on personal computer games (such as GT Interactive and Microprose) are having a rough time right now, said John G. Taylor, managing director and analyst at Arcadia Investment Corp. Those that have titles for different platforms (such as the Sony PlayStation or Nintendo 64) are generally doing quite well.
"As a rule, the console gaming guys have more sunshine and have more opportunities than the PC guys," said Taylor.
Other things on Taylor's check list for investors:
- Does the company own its own brands? If not, the developer might take the game to a higher bidder when it becomes a hit.
- Do they have an in-house or sophisticated external development division?
- Do they have a sales and marketing branch in Europe to maximize profits?
Analysts agree that there's one gaming company that's diversified, rich in hit titles and meets all the other criteria: Electronic Arts.
"There's one company that does everything well -- that's Electronic Arts," said Taylor. "The other companies move through cycles, so you just have to catch them."
Arcadia ranks EA as a buy. Piper Jaffray and CIBC Oppenheimer both rank it a strong buy.
Other gaming companies that have caught analyst eyes include GT Interactive, Activision (ATVI) and Midway (MWY), all of which UBS' Wallace calls undervalued. Robert Fagin, director of equity research at CIBC Oppenheimer , calls Midway a "pretty good buy for people with a long term view."
Long term is the best way to view any investment in the gaming industry. Because of the seasonal trends of the industry (hot titles are typically released in the months leading up to the holidays), quarterly earnings can be deceiving.
"People who invest in these companies should not pay attention to quarter-to-quarter numbers," said Wallace. "They should look at the yearly numbers. You need to take a long term approach."
-- by staff writer Chris Morris
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