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Video Game Industry Investing

Video Game Industry Investing

Shigeru Miyamoto is a rock star.

Fans sleep on the sidewalk for days just for a chance to meet him or get an autograph. A third of his peers list him as their “ultimate hero.” And when Miyamoto takes the stage, it’s to a chorus of cheers.

But Miyamoto isn’t a musician. He’s a video game designer.

In 1981, Miyamoto unleashed Donkey Kong upon the world. Not only did it make a century-old company a household name; it revolutionized an industry, taking it from the fringes to a $51 billion per year powerhouse.

Back when it first debuted, that game was considered a smash hit when it sold an unparalleled 65,000 units.

Of course, the days of teenagers hovering around bulky, coin-operated machines are ancient history. Now, 72% of people between the ages of 6 and 44 in the United States play video games.

This year, an average of 406 video games are being sold every minute. And the number of American households that play them is expected to increase to 80% by year-end 2012. By 2014, the video game industry is projected to be three times the size of the music industry, raking in some $84 billion per year.

Sound unbelievable?

Consider that opening days for video game launches routinely obliterate anything that Hollywood could ever dream of producing.

For example, the third installment of the Twilight saga, Eclipse, set box office records by grossing $30 million on opening day midnight screenings.

But in November 2009, in the first 24 hours of its release, Activision Blizzard Inc.’s (Nasdaq: ATVI) Call of Duty: Modern Warfare 2 totaled $310 million in sales in just the U.S and the U.K.

In the first five days, it topped $550 million in sales worldwide.

By the end of its second month of release, Modern Warfare 2 brought in more than $1 billion.

The only thing in entertainment history that’s a close second is Take-Two Interactive Software’s (Nasdaq: TTWO) 2008 release of Grand Theft Auto IV, which recorded $500 million in sales in its first week.

By comparison, calling Miyamoto’s Donkey Kong a “smash hit” seems ridiculous. But that arcade game is what inspired an industry to put a console in nearly every home in America.

And it continues to up the ante each year. Over the next few years, consumer spending on video games will increase at an annual rate of 10.5%… with launches for highly-anticipated titles likely going from mind-boggling to downright absurd.

But there is a catch.

Lost in the Crowd

Being a “gamer” has gone mainstream.

The average age of a video game player is 32 years old. And that person has likely been playing video games for at least 13 years. That’s a substantial investment on the individual level with consoles costing around $300 a piece (not including peripherals) and new games costing around $25-$60 per piece.

Plus, once a gamer, always a gamer. Today, 28% of people over the age of 50 play video games. That’s three times what it was just a decade ago.

And it’s not just men. Women 18 years and older make up almost double the portion of gamers (34%) than boys under the age of 17 (18%).

So we are in an era where gamers meet, fall in love, reproduce and spawn a new generation of video game players that are plugged in before they start pre-school.

Video games are being introduced at younger and younger ages. Take LeapFrog Enterprise’s (NYSE:LF) My First Computer. It’s designed for kids ages three and up. The average age of first computer use is now a mere five-and-a-half. And video game use seriously begins at the age of 6.

Game designers have really started keying in on this. Despite all the outcry about violence and depravity, in 2009, seven of the top 10 selling games were family-oriented. Almost 20% of all video games sold are of the “family entertainment” genre, with 45% of video games having an ESRB rating of “E” for everyone.

And this market segment is ruled by a single company. All seven of those top-selling, family-oriented games were released by casual gamer-marketer extraordinaire and the industry’s 800-lb. gorilla, Nintendo ADR (OTC: NTDOY).

Nintendo’s Wii Sports, Mario Kart Wii, Wii Fit, Wii Fit Plus and New Super Mario Brothers Wii dominate all titles sold because of their broad social appeal. They’re “family night” games and titles enjoyed at parties at the same time.

Of all software sold so far this year, 48% is for Nintendo’s Wii and handheld DS systems. And Nintendo owns the title to 13 of the top 50 best-selling games of 2011.

The Hit Parade

Thanks to Miyamoto’s string of some of the industry’s most profitable franchises, Nintendo is approaching the 4 billion mark in total video games sold.

Last year, the company’s Wii console sold 205 million games, along with 26 million consoles. That was a 71% increase in software sales over 2008 and a 40% increase in hardware sales. All that helped spur the company’s 10% increase in net sales to $9.2 billion.

As an industry, software sales growth is on a tear. In 1996, video game sales were $2.6 billion. In 2011, that had increased six-fold to $17 billion.

Nintendo remains the top dog, while publishers Electronic Arts Inc. (NYSE: ERTS) and Activision are left in the dust. But companies like Activision still benefit from envious cross-platform title sales.

For example, one-in-four owners of Microsoft’s (Nasdaq: MSFT) X-Box 360 or Sony ADR’s (NYSE: SNE) Playstation 3 own Activision’s Call of Duty: Modern Warfare 2. The title has sold more than 15 million units combined on the two consoles. And Activision’s Call of Duty: Black Ops was 2011’s most popular game of the year, bringing another major payday for the publisher.

This kind of title loyalty is imperative in today’s industry. Despite sales being slightly lower in 2011 than in 2010, the number of titles released actually increased to a record. Over the past seven years, the number of video game titles released each year has steadily gone up, while the average unit sales per title have gone down.

So, it’s very easy for a game to get lost in the crowd. And popular titles – like Modern Warfare 2 and Wii Sports – demand constant shelf space from retailers, meaning less room for new titles.

That’s why franchises are everything. Nintendo was the first to prove that. Donkey Kong’s hero, a carpenter named “Jumpman,” became a plumber named “Mario.” And more than 230 video game titles followed under the Mario Bros. franchise, selling more than 220 million copies worldwide. It’s hands down the best-selling video game franchise in history.

Other companies have to carve out their own niche segments. For example, Take-Two’s target audience is hard-core gamers that like violent titles such as Grand Theft Auto, Bioshock, Red Dead Redemption and Mafia, as well as turn-based strategy games such as Civilization. Because of fan devotion, Take-Two is basically guaranteed $1 billion in sales every time it releases a Grand Theft Auto sequel.

This is what makes software publisher plays so difficult. Electronic Arts – publisher of premiere titles like Madden NFL, Medal of Honor and Need for Speed – was trading at $61.40 per share in 2008. Today, it’s at $17.06. THQ Inc. (Nasdaq: THQI) – publisher of games like WWE: Smackdown and UFC: Undisputed – was trading at $30 in January 2008. Now, it’s under $0.65 as it watches profits bleed away. Take-Two has also suffered, falling from $27.36 in June 2008 to around $16 per share today.

Only Activision has remained fairly insulated, falling from a peak of $18.62 in July 2008 to around $12.50 today… Not so bad for an entertainment company during the worst recession in history.

The Next Level

Nintendo is staying ahead of the game with a new 3DS product that cashes in on the 3-D blitz.

Mobile devices are encroaching on the video game industry, which is why all video game publishers are focusing on mobile video game sales. Sony’s PSP, Nintendo’s DS got pummeled by Apple Inc.’s (Nasdaq: AAPL) iPhone and iPad. Sales of the PSP and DS were down 40% for the quarter after Apple introduced the iPhone and iPad. While sales of iPhones, iTouches and iPads were up 49%.

As a whole, the industry is seeing hardware sales trail downward. But software sales continue to get a shot in the arm and a blossoming industry segment is peripherals and accessories. Last year, accessories accounted for $6 billion in sales.

But to really survive in hard times, companies need to attack the family-unit segment.

So both Microsoft and Sony have jumped on Wii’s wildly successful bandwagon of motion-detection game play. It also allows the two console manufacturers to try and chip away at Nintendo’s family entertainment dominance. The combined sale of X-Box 360s and PS3s just barely tops Wii sales this year.

Like it or not… Video games are now embedded in our culture. Movies are based on popular titles, and they spawn comic books and television shows. Even in times of a recession, almost half of all Americans say they plan on buying at least one video game over the next year.

In other words, this is an industry to pay attention to.
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