Three winning plays among gaming stocks

These companies are well positioned to benefit from the video game market's long-term growth potential.

Vikram Barhat 8 August, 2016 | 5:00PM
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The mobile game Pokémon Go created a worldwide sensation and caused the Japanese videogame maker Nintendo's stock price to double within seven days of its release in the United States last month. It has also shone a spotlight on the fast-growing video game industry that is pushing all the right buttons with consumers globally.

The worldwide video game market is growing exponentially. The industry is going digital, smartphones and tablets use is exploding, and an increasing number of people are buying and playing games routinely, generating huge revenue for gaming firms. In the United States, 63% of households have at least one person who plays video games regularly, which resulted in a staggering US$23.5 billion spent on games -- including content, hardware and accessories -- in 2015, according to the Entertainment Software Association, which represents companies that publish computer and video games.

PwC's annual Global Entertainment and Media Outlook projected the U.S. video games market to grow at 3.6% annually to reach US$20.28 billion by 2020. Globally, the video games market is projected to hit US$99.6 billion in revenue in 2016, up 8.5% from 2015, eventually reaching US$118.6 billion in 2019, forecasted Newzoo, a Dutch company that provides data on the digital games market.

Although there are many players in the industry, only a handful lead the market with product offerings that enjoy worldwide popularity. These companies make highly innovative games in a range of genres, marrying the newest themes to the latest technology and tapping into large social networking ecosystems. With compelling new versions of their existing franchises, and by creating new experiences, these companies are well positioned to benefit from the trend and the market's long-term growth potential, according to Morningstar equity research.

Electronic Arts Inc.
Ticker EA
Current yield -
Forward P/E 20.1
Price US$78.63
Fair value US$78
Data as of Aug. 3, 2016

 Electronic Arts (EA) is one of the world's largest third-party video game publishers. It owns some of the most popular game franchises including FIFA, Madden and Battlefield.

The company claims to be the number one publisher for titles on the PlayStation 4 and Xbox One consoles and had, as of March 31, 2016, more than 160 million monthly active users. The game publisher boasts more than 300 million registered players around the world, while the number of unique players engaged with its titles surpassed 54 million during fiscal year 2016, up 65% year-over-year.

Having recently signed a 10-year contract with Disney, EA has acquired the exclusive rights to develop Star Wars games for core gamers across all platforms.

"The firm will consolidate its leading position by developing compelling new versions of its existing franchises and by creating new experiences with the Star Wars license," said a Morningstar report, noting that the firm will "continue to benefit from the upgrade cycle to the current generation of consoles (Xbox One and PlayStation 4), the ongoing revitalization of PC gaming, and the growth in the mobile gaming space."

The bright outlook for console and mobile revenue and gross margin prompted Morningstar equity analyst Neil Macker to raise the stock's fair value from US$72 to US$78, implying "fiscal 2017 price/earnings of 30 times, an enterprise multiple of 18 times, and a free cash flow yield of 4%."

Macker projected the firm's revenue growth to average 7.1% over the next five years, and operating margin to expand from 20.4% in fiscal 2015 to 24.2% in fiscal 2021.

Activision Blizzard Inc.
Ticker ATVI
Current yield 0.64%
Forward P/E 20.9
Price US$40.38
Fair value US$36
Data as of Aug. 3, 2016

 Activision Blizzard (ATVI) is one of the world's leading video third-party game publishers, whose stable of blockbuster video game franchises includes multibillion-dollar World of Warcraft and Call of Duty.

The firm is well positioned to maintain its leading position by churning out gripping new versions of its existing franchises and entirely new experiences such as Hearthstone and Heroes of the Storm. "Its portfolio of widely successful franchises allows the firm to monetize its intellectual property year after year by delivering content via sequels, expansion packs, downloadable content and toys, exemplified by the decade-old World of Warcraft franchise and the annual versions of Call of Duty," Macker said in a report.

Moreover, Activision engages users beyond the initial game sale through "extending the monetization window by expanding the use of multiplayer options and releasing downloadable content," said Macker, noting that a dedicated user base enables Activision to push more games through direct digital channels "thus bypassing retailers, generating higher gross margins and improving returns on invested capital."

Activision has recently launched a number of attractive game franchises and has more in the pipeline, which could make up for sales declines in its maturing franchises, noted Macker who put the stock's worth at US$36 reflecting the impact of the proposed acquisition of King Digital this year. The deal gives Activision the ownership of the popular Candy Crush Saga franchise, which holds two of the top five slots on the highest-grossing apps charts for both iOS and Android. The King acquisition will provide a revenue bump of 32% in 2016, said the Morningstar report forecasting a 12.6% revenue growth over the next five years.

Take-Two Interactive Software Inc.
Ticker TTWO
Current yield -
Forward P/E 18.8
Price US$40.79
Fair value US$36
Data as of Aug. 3, 2016

Another leading name in the world of third-party video game publishing,  Take-Two (TTWO) owns one of the largest and most sought-after video game franchises in Grand Theft Auto (GTA).

The firm is well positioned not only to capitalize on the success of GTA, but also to continue diversifying its revenue beyond its signature franchise. Take-Two recently announced it plans to bring XCOM 2, sequel to the award-winning strategy game XCOM, to the PlayStation4 and Xbox One platforms.

"Take-Two generally focuses on the higher end of the market, using both its capital to fund the higher-budget blockbusters and its marketing advantage to support its titles across multiple advertising platforms," said a Morningstar report. "Over the past five years, the firm has established new franchises such as Borderlands and Bioshock while reinvigorating older ones such as XCOM."

The company is well placed to exploit the widespread adoption of mobile games. "Its portfolio of successful franchises allows the firm to monetize its intellectual property by delivering content via sequels, expansion packs and downloadable content, exemplified by the current popularity of the new GTA Online and the NBA 2K games," said Macker, asserting that "these franchises can also spawn games that move the company into new arenas such as mobile."

The addition of multiplayer GTA V to the franchise allows the company to benefit from a longer revenue tail, added Macker, who appraised the stock's worth to be US$36, incorporating an enterprise multiple of 17 and a free cash flow yield of 3%. Morningstar forecasted an adjusted revenue growth of 5% during the next five years.

Complete access to Morningstar's research on equities, mutual funds and exchange-traded funds is available to subscribers to Morningstar Canada Premium.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Activision Blizzard Inc77.03 USD-0.22Rating
Electronic Arts Inc136.68 USD2.18Rating
Take-Two Interactive Software Inc122.69 USD-0.75Rating

About Author

Vikram Barhat

Vikram Barhat  Vikram Barhat is a Toronto-based financial writer specializing in investing, stock markets, personal finance and other areas of the financial services industry. He also writes for CNBC, BBC, The Globe and Mail, and Toronto Star.

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