The Industry

Apologies to all readers for the lack of updates … I have been much too tired the past few days to perform a meaningful analysis and post online. But I felt documenting something about the overall video game industry is important.

Currently the US is in the midst of a credit crisis, an oil shock, a recession, a failure within the financial industry, etc. however the media would like to spin it. But to sum it up, basically, America is right now in deep $h!+.

Ok … so what does this have to do with Video Games? Everything.

Video games are more or less recession-proof, oil-proof, XXX-proof (and no XXX does not mean porn … its a placeholder to replace with any other problems America has). But what this all comes down to is money. Less money in the pocket of the consumers. Why is video games this-proof and that-proof.

Video games offer one of the highest value proposition when it comes to someone getting the bang for the buck. One good game on a console or a PC generally lasts a good 30-60 hours, maybe even more. A good example is WoW. Over the course of 1 week a person would play on average 2 hours a day, or 14 hours for the week. For the month, it would result in 56 hours. For $15 bucks a month, the consumer gets 56 hours worth of entertainment … w/o traveling expense … that is one heck of a deal compared to other forms of digital entertainment.

Gaming sales have not slowed in the wake of these problems the overall economy is facing. Rather it is still growing in mid-high double digit figures, an impressive rate considering the size of the industry. Sales should continue, and the cash strapped consumer will find every more creative ways to spend the money extract the largest possible value from each dollar spent. For more and more people it will be video games.

*Small Note (for myself in the future and everyone else): This post focuses purely on the overall crisis of money leaving the pockets of customers and it’s impact on the video game industry.

“The NEW Take 2″

The numbers are out and TTWO, has smashed analyst expectations.

Q2 Revenues came in at about $538.9 Million w/ EPS of $1.52, far exceeding the average analyst estimate of $499 Million and $1.13. My own estimates was a bit too high on the revenue side ($608 Million) and a bit too low on the EPS side of $1.36.

Taking a deeper look into the numbers and my analysis, I overestimated the impact of Take 2’s back catalog of games (excluding older GTA games). During the conference call, Take 2 management indicated the GTA Franchise made up 78% of the publishing revenue or a total of $378.3 Million. All non-GTA related products combined produced $160.6 Million. Even if $25 Million of the $378.3 Million came from older catalog sales of GTA products, it still leaves non-GTA IV revenues at $185.6 Million, far behind the previous year’s $205 Million. My $608 Million revenue estimate was much too high due to the expectation of better sales from non-GTA IV games.

On another note, my EPS estimate was too low as I was anticipating a much higher production costs for GTA IV and higher operating costs. I had completely forgot the fact that TTWO had improved their overall operations earlier this year for a anticipated gain of $25 Million in cost cutting initiatives.

Overall, I am impressed with Take 2’s performance and hope this trend continues well into the next year. The stock did not move big as I had expected … Not sure what the reason is, but could be caused by several factors as I am the not the only one who was surprised by the lack of movement:

1. ERTS overhanging bid (<– the Current Scapegoat)
2. Whisper expectations were met and not exceed
3. The past history of management still hangs over the company
4. Guidance wasn’t as good as people expected
5. etc.

Lots of reasons with the ERTS being the current scapegoat. But in the end the performance cannot be denied. The management team’s execution cannot be denied. These factors might not be taken into consideration now, but it will be accounted for over a period of time. This is not a one time fluke, this is, as Zelnick put it yesterday, “The New Take 2″.

Numbers!!! (End of Pre-Earnings Analysis of Take 2 Q2)

Today is the day Take 2 will announce their Q2 earnings. Following is the final post on the series of pre-earnings analysis of Take 2.

The average analyst is expecting $499 Million in revenue and $1.13 EPS. My own estimates are set at $608 Million in revenue and $1.36 in EPS, significantly higher. Analysts, in general, appear to have a very negative view of the company. 11 analysts have hold recommendations, 1 under weight, and 1 buy. The average price target is $27. Yet with $500 Million in sales from GTA IV in the 1^st week, and a very favorable exchange rate you would expect them to be singing a different tune. But nope, most analysts are saying GTA IV sales have been considered in their estimates. I do not think they give proper credit to Take 2’s new management team and internal IP Portfolio, but we shall see this afternoon.

On the sentiment front, a quick look at the front month June Options shows heavy open interest at the $27.50 Call and $25.00 Put. There are a total of 85,000 calls compared to 62,000 puts, producing a put/call open interest ratio of .73. From this, it can be seen the general sentiment towards TTWO are neither bullish nor bearish. Even though calls outnumbered the puts, this is natural, since in general more people play the upside of a stock rather than the downside.

If Take 2 does happen to beat analyst estimates, and not just beat by a penny, but a solid beat of $0.05 – $0.10, we should be looking at some strong upward price action. Breaking even or even a small beat will fuel the argument GTA IV was already valued into EA’s $26 a share bid for Take 2. With a solid beat, we are looking at a possible re-valuation of the company by the market and can potentially expect a jump to $30.

Current guidance set forth by Take 2 management for FY08 is $1.35 – $1.50 EPS. Average analyst estimates are currently set at $1.53 for FY08. I am expecting Take 2 to increase guidance for FY08 to $1.50 – $1.60 range, and am expecting Take 2 to push 1 or more key titles scheduled to be released this fiscal year into the next fiscal year.

Overall, from the factors and variables discussed in my previous posts, plus the low estimates provided by analyst and sentiment, Take 2 is set to move big. My call is move big upwards.

Disclosure: Cause apparently this is necessary on every blog about investments and earnings that I have read. I do have a position in Take 2 and it is not a small holding but rather a core holding. Sooo … I am not blowing smoke out of the chimney, there is a fire burning at the bottom.

The Competition

Apologies for the lack of detail. I woke up a bit later than usual, and had some stuff left over from yetserday to finish for work. Anyway …

1. Sony’s MLB: The Show 08 was the dominating game for PS2 and PS3, stealing sales away from MLB 2K8.
2. Devil May Cry 4, Army of 2, and other top notch new releases reduced the overall catalog sales Take 2 is generally accustomed to. The better new releases are, the more money people spend on the newer games.

Take 2’s significant releases for Q2 were GTA IV, Bully:Scholarship Edition and MLB 2K8. Aside from GTA IV, most people don’t consider Bully or MLB 2K8 as much of anything and there is a good reason. MLB 2K8 lost a large chunk of its core players to Sony’s MLB: The Show 08. Bully: SE is an older port from the PS2, not a new game at all. There is no reason for older players to purchase the same game on a brand new platform. Add in the heavy competition from some of the awesome games released during Q2 from competitors and the impact those releases had on Take 2’s older catalog of games, and people will wonder whether or not Take 2 will be making money again this quarter.

Though, luckily for Take 2, the market has never been kind to the company, actually, in all honesty the market hates Take 2. It doesn’t have high expectations to beat, just meeting the estimates might be enough for a good pop after earnings.

Historically speaking, Take 2 earned $205 Million last year in revenue. This year, it should be safe to TTWO is expected to earn around $225-250 Million without GTA IV. With GTA IV, Take 2 is looking at double that amount around $450 – $500.

Frankly though, GTA IV is gonna to make them the most money this year. It is the game that will fill their coffers and make their current valuation seem ridiculously low. It is the game that will move them out of the crap light and into the spot light. It is … blah blah blah … Sadly, from this point of view, Take 2 still depends on the Grand Theft Auto Franchise, and without it they would become a THQ.

“A Rising Tide Lifts All Ships”

A company’s performance in any quarter is influenced by many additional factors and not just the execution of strategies and ideas. Each company adheres to the basic laws of economics and demands of the marketplace. The current conditions have shown preferential treatment to the video game industry, boosting overall revenue and profits in high double digit growth figures year over year. It is truly an incredible time to be watching the changes and transformations that are occurring in this industry.

Though, the primary focus for the next few days will be on the continued discussion of Take 2’s performance for Q2. This part of the discussion takes a deeper look at general industry factors and the impact these factors would have had on Take 2’s business for Q2 FY2007.

General Macro-Economic & Industry Factors:

1. The video game industry has grown by leaps and bounds within the past year. The install base of the Wii, Xbox 360, and PS3 has improved dramatically and the overall quality of games has risen. With a larger install base of consoles and better games, the market as whole is expanding. (Bullish, Medium Revenue Impact, Small Earnings Impact)
   
2. Video gaming has become more socially accepted form entertainment on an international basis. This acceptance removes one of the main obstacles that prevented consumers from accepting and enjoying the world video games. It can be seen by the willingness of young females carrying Nintendo DS handhelds within their purses, seniors enjoying the interactive experience of Wii Sports, and older gamers, who have all but given up on the consoles, take up a controller once again. This generation of games saw not only new demographics entering and enjoying the digital interactive experience, but also the revival of an older and more outcast group of the originally NES and SEGA gamers. (Bullish, Medium Revenue Impact, Small Earnings Impact)
3. Video games are a near recession-proof business. In times when budgets are squeezed, the games will still find a way into people’s homes. Simply put, it is because of the value proposition that each games provides in terms of hours enjoyment. A $60 game would provide anywhere from 30 Hours – 90 Hours of enjoyment, this averages out to $0.50 – $2.00 per hour of fun. Compared to movies ($3-4 per hour) or music ($1 per 3 Mins or $20 per 1 hour), no other form of entertainment provides as solid of a value proposition as video games. In addition, during hard times, people generally flock to entertainment to escape the harsh realities of life. (Bullish, Medium Revenue Impact, Medium Earnings Impact)
4. The value of the dollar has fallen against all major international currencies. The average exchange rate for EURO to USD during this period was 1 EURO = $1.32. 1 year later, it has fallen an additional ~16% in value and is now at 1 EURO = $1.53. Since Take 2 is a US-Based company, all sales on an international level increased ~16% just on currency conversion rates alone (with all else equal). (Bullish, Large Revenue Impact, Large Earnings Impact)

The industry trend is proving to be extremely favorable for almost all publishers. Take 2 Interactive is not an exception to the rule. Its games should see increased sales from the expanding industry and favorable sentiment from the consumers. Even though the world is in a credit crisis, the video game industry should feel little to no impact.

Yet, I was being asked “where was all the negative news?” Indeed, the 4 points above only show bullish comments and as someone informed me, the tide can’t rise forever. The next post will focus much more on the competition and the impact it has had on Take 2.

Take 2 Interactive Q2 Pre-Earnings Analyses

Take 2 Interactive is set to announce Q2 earnings on June 5, 2008. For the current quarter, Take 2 released several high profile games for the period of Feb 2008 – Apr 2008, chief among those releases were Grand Theft Auto IV. The average current analyst estimates is $499 Million in revenue with the high end estimate at $525 Million. Earnings are estimated to be $1.13 per share with the high end estimate at $1.30. But due to company specific, industry wide and economic factors, I strongly believe Take 2 should top even the high end of estimates in Q2.

Below is an overall summary of positive and negative variables that should have a small or large impact on Take 2’s numbers.

TTWO Company Specific:

1. Most analysts did not expect record breaking sales during GTA IV sales. Prior to the announcement of $500 Million in sales, the highest reported estimates by analysts were at $400 Million. (Bullish, Large Revenue Impact, Large Earnings Impact)
2. Bully: Scholarship Edition was successfully released internationally on 3/3/2008 with little or no legal/regulatory/political problems. In addition, this is a much older game re-ported to newer console systems. Significantly lower development and production costs, plus non-existent legal and regulatory fees that come standard with all RockStar releases. (Bullish, Small Revenue Impact, Medium Earnings Impact)
3. The Xbox 360 version of Bully: Scholarship Edition was plagued with quality control issues, (i.e. game freezes, laggy frame rate, etc.) that are usually non-existent within a RockStar product. This resulted in additional development time and cost spent to patch the issue and potentially turned away willing consumers from purchasing the game. (Bearish, Small Revenue Impact, Small Earnings Impact)
4. Most Analysts largely consider Take 2’s internal franchises to be worth of little value with the exception of the Grand Theft Auto franchise. As such, the value of each franchise is not fully recognized, and in addition, the expectation of success for each franchise is extremely small. BioShock and Carnival Games are 2 such franchises. (Bullish, Large Revenue Impact, Large Earnings Impact)
5. Take 2 has taken steps to releases several older catalog games on Valve’s Steam Online Digital Distribution platform. These release, though cheap have extremely high profit margins as there is no physical or development costs necessary. (Bullish, Small Revenue Impact, Medium Earnings Impact)

Industry-Wide & Economic variables affecting Take 2 earnings will be continued in another discussion.

Research In Motion (RIMM) – Pre Earnings

Today at 4:00 PM eastern time, RIMM will be announcing their Q2 earnings. Analyst expect EPS to increase by about 104% QoQ to $0.49 and revenues to double QoQ to $1.3 – 1.4 Billion. This is based on strong domestic and international sales.

As of now, these estimates do not mean anything. Analyst are not sure whether or earnings will beat or miss. As a result, a number of analyst have lowered their ratings but increase the price targets and estimates at the same time. So either way it moves, they will be covered.

Currently almost all options trading down on RIMM at the moment is pure speculation. There are only about 12K ITM Put options compared with 102K OTM Put options. Its about the same spread with the call options with 85K open interest out of the money, with 39K near ITM and only about 14k Deep ITM. With a Put/Call Ratio of about .82, we are looking at an equal amount of speculation on both sides of the equation. Implied volatility for all near the money put and call options is around 90-95.So with these numbers it can be seen that RIMM will be shooting up like a rocket and falling like a rock. Either way the moves will be huge.

Earnings wise, RIMM should beat. My own prediction is set for RIMM to announce earnings at $0.51. But expectations on how much it beats is another question. Beating by a penny or 2 is not going to cut it for the company. At least a solid beat of $0.04 – $0.05 is needed.

Outlook wise, if China blackberry sales are good then outlook should improve. The overall market for handsets is still continuing to grow as more consumer switch over from normal cellphones to smartphones.

Overall prediction:

Earnings @ $0.51, and a conservative revised upwards guidence for fiscal year on both EPS and revenue.

Stock should end up at around 105-110.

Palm, Inc. Post-Earnings Analysis Q1 2007

Palm, Inc. reported a loss of -$0.01 on Friday, August 31, 2007. Revenue QoQ was up 12% to $302.2 million. Smartphone sell through was up 21% to 689,000. The full report can be found here (link).

Overall, analyst were expecting an EPS of $0.08. Though, missing earnings was not the prime reason for the 4% drop. The biggest factor was the revised downward economic outlook. Palm sees Q2 earnings to be at about $0.06 – $0.08 a share with about $370 – $380 million in revenues. Wall Street analyst were expecting around $0.10 a share with $397 million in revenues. (link).

Prediction analysis:

I was off the mark with the improved financial outlook. It appears that either Palm, Inc. itself does not believe in the success of their new product or they are being extremely conservative in their estimates. My personal belief is the latter, as the overall sentiment on the company from the market is one marked with negativity. Managing future expectations at the moment is extremely important for company management.

Earnings wise, it was common knowledge that Palm, Inc. would not be able to beat since they issued a warning 1 month in advance. So no huge surprise there. The reason though given by analyst was interesting, as they state it was competition from AAPL’s iPhone that resulted in low sales, (more on this later).

Next Qtr (Q2):

Palm’s next 3 months (Sept, Oct, Nov) will be extremely interesting. The first holiday season after the horrible subprime summer. With the current credit crunch, loss of jobs in the mortgage sector, high mortgage payments due to rising interest rates, large numbers of foreclosures and even heavier competition with the release of many new smartphone models from competitors, Palm is looking at a very tough environment.

Subprime:

• The subprime fallout would make low prices an even larger player when it comes to buying smartphones. With the new Centro model, Palm has somewhat adequately accounted for this.

Palm’s biggest weakness is it’s competition. RIMM’s own blackberries are steamrolling PALM’s Treos on the business side. Nokia is pulling away everyone else whom wish to have a more eye catching phone.

• RIMM has released their new Blackberry Curve to great reviews. This and other blackberries with their exceptional OS should continue to take more market share away from Palm.
• NOK has expanded and is continuing to expand into the smartphone market. Worldwide, they command a 50% market share, mostly at the expense of Palm. With the release of the new N95 and a constant pipeline full of wonderfully designed phones, they should continue to sell very well. Unlike RIMM, NOK poses a considerable threat to Palm’s new Centro.
• AAPL’s iPhone is an entertainment device. Most corporations have it out right banned, and will not allow it to be connected to their mobile network. As a result, I do not believe it poses a significant threat or any threat at all for that matter. Most people who would consider buying an iPhone, will not consider Blackberries or Treos, because the targeted audience is different.

General Market:

The general market for smartphones continues to grow and expand. As it is starting to become a more profitable business, it can be expected for Samsung to beef up its own product lineup in this category. Also, Sony-Ericsson and LG should be joining the fray soon. MOT already has a few out on the market … but the quality of those phones just are just not up to par with the result.

Overall, I do not expect Palm will beat earnings next quarter either. The Subprime problem should weigh down consumer spending. Heavy competition will once again crimp Palm’s turnaround efforts. And if the general market for Smartphones expand, it can be expected for the rest of the big cell phone manufactures to jump on board.

Palm, Inc. Pre-Earnings Q1 2007

Palm, Inc. a maker of handheld devices and smartphones, will be announcing earnings @ 4:30 PM on Monday, October 1, 2007. According to Thompsons, analyst expect an EPS of $0.08. Palm has been kind enough to reveal preliminary EPS results at -$0.01 or breakeven (link).

The obstacles facing PALM are large and numerous.

• Heavy competition from RIMM for the business end users, AAPL for high end consumers, and NOK for the general market.
• Possible recession in the future.
• Slim margins
• No new software or OS updates to keep up with the changing markets and needs of users

Yesterday, after Sprint and Palm announced the release of the new Palm Centro for $99, shares shot up almost 6%. Is this product, the savior of Palm? or does it mark their final stand?

Initial reviews on GSMArena (link) are very negative when compared to the other offerings on the market. But a price point of $99 opens up the product, and the smartphone market to hundreds and thousands of potential consumers, whom original could not afford such a phone. My own personal opinion about this phone is that it will not succeed.

For Palm, Inc., I believe, it will move up to about $17.00 before Monday afternoon on improved Fiscal Year Outlook and fall after earnings announcement.