TCS Daily

Game Makers Poised to Profit

By James K. Glassman - August 6, 2001 12:00 AM

The economic landscape may look pretty dreary with GDP growth churning below 1 percent. And in technology markets, it's hard to see the silver lining amid all the clouds, or as they call them in the securities business, "lack of earnings visibility." But there's at least one tech market where the sun is shining. Sales of video games are booming, and we're not even into the Christmas season yet, when Microsoft will release its heralded Xbox video game console and Nintendo will offer its latest, greatest device for misspending youth.

This is a wonderful time to be a game developer -- someone who writes game software -- because there's a rapidly expanding number of platforms on which to run this software. Microsoft is entering the fray, this time as a company offering hardware as well as software with their new game player, and the company is bringing along about $500 million to promote the Xbox. This of course will only encourage Sony, Nintendo, and Sega to step up and spend millions more to market their machines and defend their turf. The bottom line is that the box makers will be fighting like crazy to get more machines into the hands of youngsters. And each one of those youngsters is then a motivated customer for software -- games to run on their new machines.

This is not news to people who follow this industry, so many of the game software stocks are not exactly cheap. But they definitely seem poised to grow, even if the economy continues to muddle along. Entertainment companies tend to hold up pretty well in tough economic times. Furthermore, these are software companies, and software is a great business that only gets better as more and more customers download their purchases instead of buying packaged CDs or diskettes. In other words, the marginal cost of manufacturing and distribution in this business will approach zero. And that means an opportunity for very high profit margins, especially since this is an intellectual property business with unique franchises. A kid doesn't want just any football game - he wants John Madden's NFL 2001. Young gamers don't want just any adventure babe - they want Lara Croft.

Gaming also may be well suited to the subscription sales model that many software companies want to develop. With the possibility of ongoing competitions against players around the Internet, game makers might eventually be able to charge monthly fees the way cable TV operators do, creating ongoing revenue without additional marketing costs.

The giant of the industry, with most of the best-selling titles, is Electronic Arts (symbol: ERTS). As Dean Takahashi notes in the technology magazine Red Herring, "EA's gaming revenues of $1.3 billion are more than double its nearest competitor, and it has the development clout to make or break a console." That's why it was such a big win for Microsoft when Electronic Arts agreed to develop games for the Xbox. ERTS is the market leader and a great company for the long term, but you might also consider one of the smaller players. Number two in this game is Activision (ATVI), which specializes in games related to extreme sports. ATVI markets games based on skateboarding legend Tony Hawk, among others. THQ (THQI) makes games based on the World Wrestling Federation and Eidos (EIDSY) owns the Lara Croft Tomb Raider franchise.

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