Video Game Spending Outlook: SNE, MSFT, AVTI, ERTS, TTWO, DIS, TWX, VIA

Market research firm Gartner recently reported that the video game industry is poised for strong growth in 2011. The market research firm expects the video game industry to grow 10.4% to $74.4 billion from the 2010 level of $67.0 billion.

Gartner estimates that software spending in 2011 will be roughly $44.7 billion (60.4% of total spending), and it will continue to dominate the overall gaming market in the next five years as it absorbs almost two-thirds of consumers’ gaming budgets. Spending on gaming hardware and online gaming are expected to reach $17.8 billion and $11.9 billion, respectively, in 2011.

Gartner expects video game related spending to reach $112.0 billion by 2015, with 50.4% of spending on software ($56.5 billion). Over the next five years, the share of gaming hardware as a percentage of total spending on gaming will remain constant, while spending on the fast-growing online gaming outpaces software spending.

Gartner estimates that consumer spending on global online gaming (subscriptions and microtransactions) will reflect a compound annual growth rate of 27% through 2015. Online gaming is expected to grow from 15.6% in 2010 to 25.2% by 2015, representing the highest growth among all other gaming platforms.

Gartner believes that this significant growth will be driven by increasing usage of portable devices such as smartphones and tablets, instead of a traditional gaming devices, such as Sony Corp.’s (SNE) PlayStation, Microsoft Corp.’s (MSFT) Xbox or Nintendo’s Wii.

Online gaming is also expected to witness growth at the expense of retail sales, owing to the growing popularity of digital distribution and free-to-play browser games. Gartner believes that the subscription-based business model will be gradually replaced by the freemium model, where a game is provided for free to gamers but is monetized through advertising. This model has already been adopted by social gaming companies such as Zynga.

Our Take

The gaming industry is undergoing a transition toward digital and online gaming. The rapid adoption of online games is expected to drive the top-line growth of major video game companies over the long term, particularly those with diversified portfolios, such as Activision Blizzard Inc. (ATVI) and Electronic Arts Inc. (ERTS).

In the recently concluded Electronic Entertainment Expo (E3), every major video game publisher recognized the need to digitize their products. They have therefore, been shifting the business model to the digitized format where the popular and new titles would be available in their digital versions. This would generate a revenue stream that is likely to benefit the video game publishing companies going forward.

We also believe that the tremendous success of online social gaming will further change the dynamics of the video game industry going forward. We believe that the social gaming market is well positioned for continued growth, primarily attributable to its casual, social and interactive environment compared to the more conventional platforms.

However, the video game market remains highly fragmented with a number of competitors, including Activision, Electronic Arts, Take Two Interactive Software Inc. (TTWO), Capcom, Infogrames Entertainment SA, Koei, Konami, LucasArts, Midway, Namco, Sega, THQ and Ubisoft.

Diversified media companies such as Fox, Walt Disney Co. (DIS), Time Warner Inc. (TWX) and Viacom Inc. (VIA) are also expanding their software game publishing efforts, which may put further pressure on the traditional video game companies and lead to market share losses.

Moreover, the video gaming industry has been facing the brunt of the economic slowdown. Weak consumer spending, lack of new game releases, intense price war, deferred discretionary purchases and severe pricing pressure resulted in stagnating revenue for companies in the sector. US videogame sales shrank 14% in May 2011 from the comparable period in the previous year to $743.1 million.

We remain Neutral on Electronic Arts and Activision, but have an Underperform recommendation on Take Two Interactive over the long term (6-12) months.

Currently, Activision has a Zacks Rank #2, implying a Buy rating over the short term. Electronic Arts has a Zacks Rank #3, implying a Hold rating over the short term. Take Two Interactive has a Zacks Rank #5, implying a Strong Sell rating in the short-term.

TAKE-TWO INTER (TTWO): Free Stock Analysis Report

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