Smartphones Come Out To Play

The business of computer software-generated video games has become a game within a game.

Vendors both large and small are scrambling to keep up with the rising migration of game players from dedicated console devices such as Xbox, Wii and PlayStation to less-involved, casual games played on social networks using PCs and mobile devices.

The video game maker's ultimate goal: develop the game that captures the most players. More users mean more recurring revenue. And it means new and supplemental revisions of the game introduced and sold over several years.

It's what decides success and failure for game companies, says Michael Cai, vice president of research for Interpret LLC, a research firm.

"It's definitely a pretty hit-driven industry," he said. "If (gamers) play your game for a long time, sometimes for years, you can continue to monetize them.

As serious as the business may be, a game is still a game. Video games are recreation, and tap into basic desires to have fun, says Brian Blau, an analyst for Gartner, a research firm.

"When you look at the reason why the industry does well, (it's because) games have been part of the human psyche forever," he said. "People love to play video games.

1.Business Over the past four weeks, the 19 publicly traded stocks in the computer software game group made the largest advance among the 197 industries tracked by IBD. The industry is home to thousands of independent game developers churning out new product. From an investor's point of view, only eight of the biggest game-maker stocks trade over 10 a share. They tend to compete in different segments of the market.

Activision Blizzard (ATVI) and Electronic Arts (EA) built their success on console and PC-based games, and are moving into the emerging mobile games market. Chang-you.com (CYOU) and NetEase (NTES) are leaders in China's market for massively multiplayer online games (MMOG) and massively multiplayer online role-playing games (MMORPG). Zynga (ZNGA) is the world's leading provider of social-network-based games.

2.Market Global spending on electronic games will reach $112.1 billion by 2015, up from $70.1 billion in 2009, says Gartner. The growth includes consumer spending on gaming hardware, software and online games as well as investments by game developers in their products.

Consumers in the U.S., United Kingdom, France, Australia, South Korea and Japan spent $21.5 billion on games and related hardware last year, says Interpret.

And don't make the mistake of thinking it's all about kids. Children ages 6 through 12 accounted for only $1.5 billion of the spending.

Activision, best known for its World of Warcraft game, grew revenue by 26% in Q4 after posting 12% growth in the prior quarter.

Changyou also grew revenue by 26% and 29%, respectively, in its last two quarters while the much larger NetEase increased revenues more slowly, by 9% and 4%, over the same period.

NetEase is the exclusive dealer of WOW games in China. But its own games also appeal to consumers, says Tian Hou, an analyst for T.H. Capital, in a Feb. 7 report.

"NetEase has constructed a robust pipeline of diversified content that meets gamers' interests," she wrote.

Some game makers, and overall game sales, are not faring as well.

Electronic Arts saw revenue declines in its last two quarters. Zynga reported that year-over-year revenue growth stalled in its fourth quarter. Zynga's number of users are up from a year ago, but daily and monthly active users and overall visitors declined quarter-over-quarter.

Analysts say one reason for the decline is the slowing user growth on Facebook, the world's leading social media site. Zynga grew out of Facebook's meteoric rise.

Zynga's games are mostly free to users. Game players who want a more advanced experience pay. But most don't, says Cai.

"You can only convince a small percentage of your players to pay, and in Zynga's case that is typically 1% or less," he said.

3.Climate Wireless is fast becoming an important part of the games landscape.

By 2016, the number of consumers playing video games on mobile phones and tablets in the U.S. will reach 174 million, up from 61.5 million in 2010, says eMarketer, a research firm.

Mobile has opened the door to the rise of so-called "freemium" games, which consumers can play for free and decide later if they want to pay to add more advanced features. Many freemium games are supported by ads in or around the games.

Non-console PC games dominate in China. Game developers there also face stiff government scrutiny before selling any new games. Sales could spike with a government reversal of its ban on game console sales, says Lewis Ward, an analyst for IDC, a research firm.

"That could possibly change the dynamic for that market," he said.

Zynga is looking at online gambling to change its fortunes. On Feb. 22, Nevada became the first U.S. state to legalize online poker, followed by New Jersey on Feb. 26. Zynga hosts one of the world's largest communities of poker players on the Web. It's one of several companies that have applied for a license to serve Nevada residents.

Venture funds poured $356.9 million into game companies last year. That is slightly below the prior year, but up 119% from 2007, says PricewaterhouseCoopers and the National Venture Capital Association.

Investments in the sector could slow this year if the market is sluggish, says Tracy Lefteroff, PwC's global managing partner of the venture capital practice.

"If the public markets don't pick up, you may have a flat or down year," he said.

4.Technology Last year global shipments of smartphones topped more than 722 million, up 46% from 2011. Tablet shipments jumped even higher, up 78% to 128 million worldwide vs. 2011, says IDC.

Game developers have taken notice, says Gartner's Blau.

"All of the big game developers are looking at mobile and will continue to," he said.

But consoles remain the largest piece of the business. Sony (SNE), Nintendo (NTDOY) and Microsoft (MSFT) will deliver new game consoles later this year. Sony hasn't yet revealed pricing or other details about its upcoming PlayStation 4, says Brian Pitz, an analyst for Jefferies Group, in a Feb. 21 report.

"Sony will likely withhold this information until it learns more about Microsoft's launch strategy," he said.

With about 60% of game revenue coming from games that play on consoles, evolving console technology is pivotal, says Blau.

"This is the time of year when the games industry is going to find out what is going to happen for the rest of the year," he said.

5.Outlook The market appears poised for continued growth as more developers enter the market. Faster Internet speeds and the fast growth of mobile devices will also help push the games market.

• Upside: Growth of smartphones and tablets provides a rising platform to reach more consumers, says Interpret's Cai.

"The sheer number of people who have smartphones and tablets is several times larger than the installed base of three consoles combined," he said.

Mobile has also opened the door to freemium games, says IDC's Ward.

"If you have those devices, you already have the gaming platform and you can access games and pay if you want to," he said.

Mobile is also bringing games to new markets: Brazil, India, Russia and China, Ward says.

"The rising standard of living in the BRIC region means that many more people who didn't have access to games five years ago now have the financial capability of investing in games," he said.

• Risks: Companies counting on console games as big revenue drivers could be in trouble, says IDC's Ward.

"If you are invested in console games, you are running a significant risk if the customers you are anticipating end up migrating over to tablets and smartphones and free PC games," he said.

Mobile devices can also provide a tougher landscape for game makers, says Gartner's Blau.

"There is a lot more content available on smart devices and PCs so there are other distractions other than games," he said.

Hit games are also necessary for continued interest and revenue from gamers, says Interpret's Cai.

"The risk is always there; you just have to continue to make hits," he said.

Changyou gets 80% of its game revenue from its longtime game, "Tian Long Ba Bu.

But in a Feb. 6 report, T.H. Capital's Hou warns that TLBB is losing users and that Changyou's "pipeline lacks possible hit games for long-term growth."