In the wake of the video game industry’s recent E3 conference, and the announcement of next-generation consoles from Sony Corporation (ADR) (NYSE:SNE) and Microsoft Corporation (NASDAQ:MSFT), excited investors have bid video game stocks higher. But their euphoria now could lead to downside ahead.
These companies risk disappointing the market, because it could take several quarters for game publishers to grow sales after the newest generation of consoles is released. Investors in these game makers have ignored a decline in online subscribers, and possible selling action by major shareholders. When those events finally register with investors, game company shares could underperform.
Watch the game leaders
Electronic Arts Inc. (NASDAQ:EA) is one of the companies that could fall in the weeks ahead. There are no positive surprises greeting the company, since Electronic Arts Inc. (NASDAQ:EA) reiterated its $4 billion revenue guidance for the full year. To reduce its chances of releasing a flop, the company is developing fewer game titles. Electronic Arts Inc. (NASDAQ:EA) expects to make 25 titles in fiscal 2014 — nearly half as many as the 46 it released in fiscal 2012. Electronic Arts Inc. (NASDAQ:EA) will improve its income statement by reducing its operating expenses, but a miss in sales for any one of the titles will really hurt that highly watched earnings number.
Looking longer out, the new consoles are expected to drive game sales over the next two years. For Electronic Arts Inc. (NASDAQ:EA), it means that digital services and digital game delivery will gain importance. At the E3 investor presentation, Electronic Arts Inc. (NASDAQ:EA) noted the importance of a console update in driving growth in these two business lines:
Source: EA Investor Presentation at E3, 2013
Online subscriptions drop
Activision Blizzard, Inc. (NASDAQ:ATVI) is another company whose shares could decline. In its first quarter, Activision Blizzard, Inc. (NASDAQ:ATVI) reported a 9% decline in subscription sales, which comprises World of Warcraft (“WoW”) and Call of Duty Elite. The company badly needs a replacement for World of Warcraft, but does not expect to have another big multiplayer game ready until 2016 at the earliest.
Subscriptions for WoW dropped by 13.5% to 8.3 million during the March 2013 quarter. If the decline in WoW subscribers accelerates, investors will be caught off guard when Activision Blizzard, Inc. (NASDAQ:ATVI) reports quarterly earnings that miss expectations.
Making things worse, Vivendi (VIVHY) is considering selling part of its 60% position in the company. Until it makes a firm decision, the resulting uncertainty will continue to weigh on shares.
Debt issuance…for acquisition?
A company most often issues shares when their price is at a high, not when those shares are expected to move even higher. Take-Two Interactive Software, Inc. (NASDAQ:TTWO) took advantage of its soaring share price by selling $250 million of convertible senior notes.
The financing will not dilute existing shareholders, but happen ahead of Take-Two Interactive Software, Inc. (NASDAQ:TTWO)’s highly anticipated Grand Theft Auto V release in September 2013, which should bring in positive cash flow for the company.
Indirectly, the $500 price tag of Microsoft Corporation (NASDAQ:MSFT)’s Xbox One could deter consumers from buying premium game titles. The timing of the GTA V release coincides closely to both consoles’ release dates in November 2013, which means all three product launches will be fighting to win over consumers’ wallets.
Conclusion
Investors exposed to this sector should anticipate weak share performance for game makers in the months ahead. Either initial console sales will be slow, or those consoles’ monthly sales growth will decline after the Xbox One and PS4 are launched. Unfortunately, game makers’ share prices aren’t reflecting either possibility right now.
The article Why These 3 Game Stocks Are Set to Drop originally appeared on Fool.com and is written by Chris Lau.
Chris Lau has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard (NASDAQ:ATVI) and Take-Two Interactive . The Motley Fool owns shares of Activision Blizzard.
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