2010 provided a great opportunity to invest in some gaming companies. We also saw the beginning of tectonic shifts in content delivery as emerging platforms along with mobile and social gaming came to the forefront as industry growth drivers. As 2011 kicks off, we would like to revisit our post-E3 stock ratings and add one more company to our coverage universe. We will also take a broader view of the U.S. equities market.
Changes to Our Ratings
We are downgrading Take-Two Interactive and Activision Blizzard to Holds from Buys, and initiating coverage on Google at Buy.
The Buys
Apple - AAPL
June 23rd price 270.97
January 22nd close 326.72
20.57% Gain
High during the period 348.60
Low during the period 235.56
Apple has had a mammoth run powered by iPhone, iPad, and Mac sales growth. They continue to execute while delivering great earnings and revenue growth. Trading at around $325/share, or 12.6 times forward earnings, this stock is rather cheap given its growth. We remain bullish on the stock, but it is impossible to expect future returns to compare to the gains some longer term Apple investors have enjoyed over the last 10-15 years. We would add that no company has ever reached a $300 billion market capitalization while still growing earnings and revenues at this pace. We would be remiss not to mention that Steve Jobs took another medical leave and that this cloud is now over the stock once again. Even though Mr. Jobs is a technology icon akin to Henry Ford for automobiles or Walt Disney for cartoons, we would point out that Ford and Disney are still making cars and movies. Founders of companies are definitely viewed differently than most other executives, but Jobs has cultivated a great team around him. COO Tim Cook ran day-to-day operations in 2009 and 2004 successfully and we have the utmost confidence in his abilities. CFO Peter Oppenheimer has done a great job managing the balance sheet as Apple now has nearly $60 billion in cash. Apple is a much different company than it was in 1985, when the board ousted Jobs. We believe Mr. Jobs has ingrained his passion for innovation into the company in ways that will be seen for years to come. If you want a large cap multinational company with a great American brand trading at a discount to the S&P 500, then Apple is your stock.
Electronic Arts - ERTS
June 23rd price 15.29
January 22nd close 15.13
1.05% Loss
High during the period 18.06
Low during the period 14.06
Next Earnings Report: 2/1/2011
"At the end of [2011], the digital business is bigger than the packaged goods business, full stop. No questions in my mind. Then, you know, I think that we’ll find ways to even sell our packaged goods content in chunks and in pieces and subscriptions and micro-transactions," CEO of Electronic Arts, John Riccitello, told IndustryGamers in a recent interview. This is exactly what we want to hear from our new favorite 3rd party software company. Unlike Activision Blizzard, EA is jumping with both feet into the fastest growing sectors of gaming. At the same time they have a great lineup on Xbox 360, PS3 and Wii, which includes Dead Space 2 and Bulletstorm. We also feel that they stand to benefit from the growing PS3 sales momentum in international markets. The cherry on top is mobile gaming, where they will benefit from higher margins. In October, 2010, EA bought Chillingo for $20 million. We feel that management has a vision for the company and that we are at the very beginning of a long term recovery for ERTS shares. The stock has returned to the levels where we recommended buying it after running up to $18/share and we reiterate our buy opinion here.
GameStop - GME
June 23rd price 18.89
January 22nd close 20.90
10.64% Gain
High during the period 23.23
Low during the period 17.70
Next Earnings Report: 3/25/2011
Another year has passed, and DLC hasn’t killed GameStop. NPD data showed that games sales dropped 6% in retail outlets while total games sales including digital distribution was flat to down 1%. Trading at 7.18 times forward earnings, we still feel this stock has upside. The launch of Kinect and the upcoming 3DS and PSP2 product launches will definitely help the top-line at GameStop as they are still the go-to place for gamers in pre-ordering. It remains to be seen just how badly the used games market will be hit with the advent of online pass by Electronic Arts. Resale values of sports titles should be hit at the very least. GameStop has tried to counter this by offering special DLC when customers pre-order games through them. With the purchase last year of Kongregate, they are not going to sit back quietly in the Casual Gaming Arms Race. We see a potential opportunity for the company to gradually change their business model as Netflix has done with online streaming. Buying OnLive wouldn’t hurt.
Google - GOOG
As we mentioned in the Casual Gaming Arms Race article, Google has been acquiring companies in the social and casual gaming sector. Last week, Google announced a blowout quarter and a shakeup in management. Co-Founder Larry Page will take over the CEO position from Eric Schmidt in April. We believe Page and Sergey Brin are most likely irked at the love Mark Zuckerberg has been receiving with the success of FaceBook, and want to make sure Google doesn’t stray too far away from their vision. As with most of the stocks in this market, Google has run up a lot. It would be nice to pick some shares up below $570. The stock currently trades at 15.77 times forward earnings, which is not much of a premium for a company that is executing so well. Growth from Android smartphones and tablets this year will be a huge driver of earnings. Motorola’s XOOM tablet and Atrix smartphone (which both run Android OS) were two of the most interesting products to be shown off at CES this year. We continue to wait for Google to unveil their next social networking and/or gaming initiative.
Nintendo - NTDOY
June 23rd price 37.40
January 22nd close 34.14
8.72% Loss
High during the period 37.05
Low during the period 31.10
Next Earnings Report: 1/27/2011
This is the premier franchise in gaming trading at dirt cheap valuations. After lowering their six-month guidance, investors are being given another great entry point for a long position. We continue to like NTDOY right here and it is probably our strongest buy recommendation. This is not going to be a fast money trade and it could take investors 1 year before you start to see any positive momentum come back to this beaten down gaming giant. Earnings come out this week, so traders and investors might do well to wait for their earnings to disappoint yet again before jumping in. The upcoming launch of 3DS is obviously a big catalyst that bulls on this stock will be watching closely. We do not feel that Nintendo has “blown it” and expect to see a recovery in the company over the next 8 quarters. Their team has proven to be trend setters in the past, and time will tell if the lack of a Wii HD will be their undoing. Selling a low cost device with obvious planned obsolescence like the Wii during the Great Recession was not the worst strategy, and leaves them in a solid financial position whenever the console wars heat up again.
The Holds
Activision - ATVI
June 23rd price 11.21
January 22nd close 11.24
0.27% Gain
High during the period 12.65
Low during the period 10.32
PMC sold Activision at 12.60
Next Earnings Report: 2/9/2011
What do you do when your investment thesis runs out of catalysts? You sell. This is what PMC did for clients at the end of last year with our Activision Blizzard position. Starcraft 2 did fantastic,Black Ops was a success, and the shares in the $12.50 range reflected most of the optimism surrounding the stock. Our main concern with Activision Blizzard is the Activision part. The company has shown us they are more interested in buying back their own shares instead of acquiring social and casual gaming outfits. They also have a history of pounding their IP down the throats of gamers until we can’t take it anymore. Tony Hawk much? The potential upside to this stock still remains at the Blizzard side of the company. The best thing Bobby Kotick ever did was let Blizzard be Blizzard, allowing them to manage from within and take their time in making quality titles. Diablo 3 and whatever Bungie ends up making for them will be the next tradable catalysts for the stock, but if the sales from Black Ops and Starcraft 2 didn’t get the stock to pop above 13, we are not sure what will. As a result, we are downgrading Activision Blizzard to a hold from buy. Of course, our opinions are a function of price and we would be willing to get back in at lower levels on the stock. Shares are trading at 13.5 times forward earnings and oversold on our technical indicators so a pop would not be surprising in the short term.
Microsoft - MSFT
June 23rd price 25.31
January 22nd close 28.02
10.71% Gain
High during the period 28.85
Low during the period 22.73
Next Earnings Report: 1/27/2011
It’s Microsoft, hold. While we are excited by the prospects for Kinect and even Windows Phone 7, Microsoft is a tech behemoth that moves very slowly. The stock has drawn the attention of noted value investors Whitney Tilson and David Einhorn over the last year due to just how cheap the stock got. Trading at a 10.46 times forward earnings while paying a 2.3% dividend is better than taking a PS Move controller to the head. Our philosophy for those that want to own Mr. Softy, buy below 25. Don’t think it will get there? Just wait.
Take-Two Interactive - TTWO
June 23rd price 9.57
January 22nd close 12.15
26.96% Gain
High during the period 13.62
Low during the period 7.98
Next Earnings Report: 2/8/2011
Their 2011 lineup has LA Noire, Top Spin 4, Duke Nukem Forever and MLB 2K11 with Spec Ops: The Line, XCOM, and BioShock Infinite most likely due out in 2012. Max Payne 3 looks to be delayed again as it is not listed in the 2011-2012 lineup. It was originally set to be released in late 2009. Also missing from the lineup is Agent, the Rockstar Developed PS3 exclusive originally announced back in June 2009. The success of Red Dead Redemption really helped out earnings last year and it remains to be seen if they have another hit on their hands for 2011. Always bet on Duke, or always bet on Carl? Noted activist investor, Carl Icahn, has added to his already large holding in Take-Two and that could lead to a sale of the company down the road. The company is no longer as cheap as when we recommended it as a buy. Trading at 14.82 times forward earnings could be a tall order for a fiscal year that doesn’t include a GTA title. While we still think that there may be a bit of upside to the stock, there are better buys in the gaming industry. This stock has a lot of bears betting against it as well with a 24% short interest.
The Don’t Buys
Sony - SNE
June 23rd price 27.74
January 22nd close 34.22
23.36% Gain
High during the period 36.88
Low during the period 25.85
Next Earnings Report: 2/3/2011
Well, we were wrong... We think it is insane that Sony outperformed Apple during this time period, but it happened. At the time we rated Sony as “Don’t Buy” we noted that the stock was trading at 0.87 times book value, which was too cheap to sell. At this point the stock trades right at book value. The main reason we currently don’t like this stock is our lack of confidence in 3DTV technology and the price declines of LCD TVs we have noticed over the last year. We also believe that the company’s management continues to miss great opportunities to take advantage of synergies throughout the conglomerate. This leads us to believe that Sony may be worth more broken up than in its current state. We can only hope that what happened last year for Sony will happen to Nintendo this year, as Sony returned to a profit in 2010. SCEA seems poised to have a great year in 2011, with international sales momentum continuing for the PS3 as the price has come down and with the PS3 having at least 20 exclusives coming down the pipe.
THQ - THQI
June 23rd price 4.68
January 22nd close 5.61
19.87% Gain
High during the period 6.49
Low during the period 3.33
Next Earnings Report: 2/2/2011
Gary Rieschel, a Director of THQ bought $200k of THQI on 11/26/10. He must know something we don’t because we don’t see much to love about THQ. Homefront, THQ’s big new first person shooter IP, will be released on March 8, 2011. We don’t predict that title to make any sales records with gamers still glued to Halo Reach and Modern Warfare 2. They also have to fend off Killzone 3and Bulletstorm (includes a Gears of War 3 beta) which both will be released a few weeks before it. If you have a knack for taking risks on corporate turnarounds then it may be up your alley. For the time being we will continue to pass.
The Market
Oil spills, Euro Debt Crises, Tax Cut Expirations, Oh My! 2010 was a volatile battleground in the equity markets, but everyone loves a good comeback story and the U.S. equity markets were able to end the year higher. Stocks enter 2011 with a bullish tailwind but we remain concerned with overbought conditions in some overheated sectors. From a technical standpoint we see potential resistance on the S&P 500 at the 1300 level, the Nasdaq Composite at the 2800 level, and the Dow Jones Industrials at the 12,000 level. As with any of the previous corrections we have faced in the recent bull market, a pullback in early 2011 will be another buying opportunity as corporate earnings have gained some visibility. Sovereign and municipal borrowing rates remain on our radar as risks to the global economic recovery. At the same time, rising commodity prices could impair a consumer-driven recovery. It remains to be seen if these markets are indicating true inflation or speculation brought on from central bankers' efforts. Also, the unemployment rate in the United States is still at 9.4%. For the U.S. economy to really get firing on all cylinders, people need to be put to work. Lastly, the U.S. housing market needs to bottom or at the very least stabilize. These last two problems we cite remain our biggest worries going into 2011. Unemployment and home prices are obviously related. With all the money printing going on around the world, we have seen some asset prices jump and others rally, while home prices sit there and in some regions are falling again. Given all of the problems the global economy faces, we take solace in the fact that equities remain attractive on many valuation metrics.
--------------------------------------------
Investors should do their own research or consult their advisor before acting on this information. Panoptic Management Consultants, Inc. is a Registered Investment Advisor that was founded in 2008. Please go to our website www.panopticinvesting.com for more information about fundamental investing as well as technical analysis. For prospective client inquiries please contact us at panopticmc@gmail.com.
Full Disclosure:
At the time of this article our CEO, Asif A. Khan, CPA, his family members and/or Virtue LLC had the following positions:
Long Activision (through a Short Put Option Position. We sold ATVI shares with clients.)
Long Apple
Long Electronic Arts
Long GameStop
Long Google
Long Microsoft
Long Nintendo
Long Take-Two Interactive
Short Sony (through a Put Spread)
At the time of this article, clients of Panoptic Management Consultants Inc. had the following positions:
Long Apple
Long Electronic Arts
Long GameStop
Long Google
Long Nintendo
