October 29, 2010 / 5:09 PM / 7 years ago

PREVIEW-Video games shares looking for a catalyst

* Activision, EA, THQ to report starting next week

* Gaming stocks underperforming broader market

* StarMine: Activision undervalued, EA overvalued

By Gabriel Madway

SAN FRANCISCO, Oct 29 (Reuters) - U.S. video game publishers will provide a snapshot of consumer sentiment as the critical holiday season nears, with investors awaiting that elusive catalyst to shake the industry out of its doldrums.

Shares of Activision Blizzard Inc (ATVI.O) , Electronic Arts Inc ERTS.O and THQ Inc THQI.O -- which report quarterly results starting next week -- have underperformed the market this year, as sales of traditional hardware and software in the $60 billion industry continue to slump.

Consumers have not stopped spending on games, but they have changed how they spend. Sales of music titles such as "Guitar Hero," which boosted industry sales over the past half-decade, have fallen off precipitously.

"If the games are good, they're buying them, so the onus is on the publishers," said MKM Partners analyst Eric Handler.

At the same time, momentum is shifting away from packaged titles played on home consoles. Industry retail sales in the U.S., the biggest market, are down 8 percent this year.

They are flocking to social games like Zynga's "Farmville," game apps on Apple Inc's (AAPL.O) iPhone, along with online and downloadable content. In the United States, as much as $2.9 billion was spent on such games in the first half of 2010, according to research firm NPD. [ID:nN14144890]

Among the U.S. names, many investors like the stability of Activision, the world's largest stand-alone game publisher. It forecasts conservatively, pays a dividend and boasts two cash-cow franchises: "Call of Duty" and "World of Warcraft."

EA is a turnaround story but sports a higher price-to-earnings multiple than Activision. It lacks its rival's tent-pole franchises, but is in improved financial health and is making an aggressive push into social, online and mobile games. [ID:nN16188698]

HOME STRETCH FOR THE HOLIDAYS

Activision's quarterly results, helped by the strategy game "StarCraft II," will get less attention than the publisher's expectations for the current holiday period.

Wall Street is looking ahead to Nov. 9, when Activision will release what should be 2010's biggest title, "Call of Duty: Black Ops." But it may have a tough time outselling its predecessor "Call of Duty: Modern Warfare 2," which set a record with first-day sales of 4.7 million copies last year.

Although pre-orders are strong, Wedbush Securities analyst Michael Pachter noted that the newest "Call of Duty" was developed by a different Activision studio, and there is more competition today.

"It will probably sell slightly less than last year," he said.

Activision will also release "World of Warcraft: Cataclysm" in December, the latest update to the multiplayer online game that boasts 12 million subscribers. [ID:nN07188020]

EA is also expected to report a solid September quarter relative to expectations, helped by soccer game "FIFA 11." But "Medal of Honor" -- a key holiday quarter release often deemed a "Call of Duty" challenger -- garnered poor reviews.

EA's holiday lineup lacks the heavy hitters featured in Activision's, and it should pull in nearly $1 billion less in revenue in the holiday quarter, according to analysts.

EA trades at roughly 24 times forward earnings, while Activision trades at 15 times. But according to a valuation analysis by Thomson Reuters StarMine, Activision warrants an earnings multiple closer to 19, the same as EA deserves.

Activision, which reports next Thursday, is expected to post earnings of 9 cents a share on revenue of $750 million, according to Thomson Reuters I/B/E/S.

EA, whose results are due Tuesday, is expected to report a loss of 10 cents a share on revenue of $815 million.

Smaller publisher THQ, which reports Wednesday, is expected to post a loss of 61 cents a share on revenue of $66.7 million.

EA, whose portfolio includes long-running hits like "Madden" football and "Need for Speed," had a tough 2009, slashing jobs and narrowing its game portfolio.

While the vast majority of EA's revenue still comes from traditional packaged games, sales of digital, downloadable and mobile content rose 30 percent last year, and the company expects to see another 30 percent gain this year.

"What people need to focus on for EA is coming from digital services, and online free-to-play games," said ThinkEquity analyst Atul Bagga.

EA investors are also pinning their hopes on its multiplayer online game "Star Wars: The Old Republic," which it hopes will rival "World of Warcraft."

Industry watchers believe EA is spending more than $100 million to create "Star Wars." The company has not yet announced a release date.

"For EA, 'Star Wars' and casual and social (games) are the story; it's certainly not packaged games," Wedbush's Pachter said. (Reporting by Gabriel Madway, editing by Gerald E. McCormick)

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