(ERTS) Video Game Sales Slips in August

The video game industry continued its dismal sales performance, reporting disappointing numbers in the month of August. According to market research firm, The NPD Group, U.S. video game retail sales declined for the fourth consecutive month to $669.9 billion in August 2011, down 23.0% year over year.

Although NPD’s data does not include sales from Xbox Live, PlayStation Network, Steam or other online channels, revenue from online social games, mobile games and subscription services such as World of Warcraft, used games and rentals, its relevance lies in the fact that retail sales continue to represent 75.0% of the total video game industry.

Year-to-date, video game sales slipped 5.0% year over year, and have fallen to their lowest level in the last five years. Earlier, sales in May, June and July declined 14.0%, 10.0% and 26.0%, respectively.

NPD cited the late release of Madden NFL 12 from Electronic Arts Inc. (ERTS) as one of the major factors behind the decline. Madden NFL 12 debuted on August 30 this year instead of early August.

We believe that the lack of new title release, particularly big brands and crowd-pullers from the major publishers and developers led to the decline. A gloomy U.S. macro environment was also responsible for the dismal sales, as consumers remain reluctant to spend.

This is evident from the fact that console hardware sales slipped 12% to $249.4 billion, compared with $282.9 billion last year. Even the attractive pricing from major hardware makers Sony Corp. (SNE) and Nintendo failed to drive sales.

Nintendo reduced the price of its portable 3DS gaming system to $170 from $250, in late July. The company sold 235,000 3DS systems, including about 185,000 after the price cut. According to NPD, the price cut drove handheld devices unit and dollar sales in August. However, Nintendo’s Wii console witnessed lackluster growth, selling a meager 190,000 units, down 22.2% year-over-year.

Microsoft Inc. (MSFT) also suffered due to the weak macro environment. The Xbox maker posted a drop in unit sales (13.5% year over year) for the second consecutive month. Despite the decline, Xbox was the top-selling video-game player in August. The company garnered a 43.0% share of the hardware market at the end of August.

Software sales were $264.8 million, down 34.0% year over year. Including the sales of PC, console and portable games, software sales ended the month at $285.9 million, down 37.0% from $455.0 million a year ago.

Deus Ex: Human Revolution, a futuristic detective/shooter game from Square Enix, edged past Electronic Arts’ NCAA Football 12 to become the #1 video game in terms of sales in August. NCAA Football 12 slipped to the #2 spot from July’s top position, whereas Activision Blizzard Inc.’s (ATVI) all-time favorite Call of Duty: Black Ops retained its #3 position.

Sales of videogame accessories were $134.7 million, down 1.0% year-over-year.

Outlook

According to NPD, the remaining four months of calendar year 2011 is of utmost importance for the industry’s growth, as the period will see a number of blockbuster releases from big publishers.

Apart from already released Madden NFL, the industry will see a spur of new releases during the period, including the much-hyped Battlefield 3 from Electronic Arts and Call of Duty: Modern Warfare 3 from arch rival Activision. According to NPD, strong sales from these franchises are expected to drive industry sales to growth territory at the end of 2011.

Our Take

We believe the video game industry is undergoing a massive transition from physical to digital and the corresponding retail sales decline (9 times over the last 12 months) supports our view. Digital online games – including used games, rentals, mobile games and social games have gained tremendous popularity in recent times.

According to NPD data, consumers spent a total of $1.85 billion on digital online games in the first quarter of 2011, up from $1.68 billion from the year-ago period. We believe that companies having an exposure in these segments will rule the market going forward.

We remain cautious about console makers owing to the growing popularity of portable devices, such as Nintendo’s 3DS gaming system, Microsoft’s Kinect for Xbox Live and various smartphones and tablets from Apple Inc. (AAPL), Samsung and a host of other companies, which we believe will cannibalize their market share going forward.

The video game market remains highly fragmented with a number of players such as Activision, Electronic Arts, Take Two Interactive Software Inc. (TTWO), Capcom, Koei, Konami, LucasArts, Midway, Namco, Sega, THQ and Ubisoft. This has increased competitive pressures and has kept a lid on prices.

Moreover, with the growing popularity of digital games, social gaming companies such as Zynga have gained significance and are expected to give the traditional video game companies a run for their money going forward.

We maintain our Neutral rating on Electronic Arts and Activision, two of the biggest video game companies in our coverage, over the long term (6-12 months). Both the companies have a Zacks #2 Rank, which implies a Buy rating in the near term (1-3 months), based on their strong product pipeline for the upcoming period.

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