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Video Games Sales Slump Continues

Video game retail sales declined for the ninth consecutive month in August 2012. According to market research firm NPD, U.S video game store sales slumped 20.3% year over year to $515.6 million in the month of August. Although the year-over-year decline was flat with the prior-month level, dollar sales deteriorated from $548.8 million reported in July.

According to NPD, retail sales figure represent approximately 50% of the total consumer spending on games. According to NPD’s preliminary estimates, used & rental games sales were approximately $104.0 million in the reported month. Consumer spending on subscriptions, mobile games, social network games, digital full game downloads and add-on content was $391.0 million.

According to NPD, total consumer spending in the month of August was approximately $989.0 million. The weak retail sales were primarily due to the ongoing transition from physical to digital platform, aging hardware consoles and lack of big new releases as publishers continue to postpone titles for the upcoming holiday season.

This is evident from the fact that both hardware and software sales continued to decline in August. Hardware sales plunged 39.4% year over year to $150.6 million, while software sales declined 9.2% year over year to $237.7 million.

According to NPD, Darksiders 2 from THQ Inc. (THQI) topped the game sales chart pushing July topper NCAA Football 13 from Electronic Arts (EA) to #4. New Super Mario Bros. 2 from Nintendo was placed at #2, while Square Enix’s Kingdom Hearts 3D: Dream Drop Distance grabbed the #3 spot.

Microsoft Corp’s (MSFT) Xbox 360 was again the top-selling console for the 18th straight month with 193k units sold. However, this was down from 308k sold in the year-ago quarter. As per NPD, Nintendo’s DS and 3DS shipments, as well as Sony’s (SNE) PS3 increased on a month-over-month basis in August.

Nintendo benefited from the recent release (August 19) of its new gaming console 3DS XL, which accounted for approximately 44% of total 3DS unit sales in the month of August. In this regard, the upcoming release of Nintendo’s Wii U in late September will be eagerly watched by investors.

Our Take

We believe that the ongoing transition from the physical to the digital platform will ultimately benefit the video game industry over the long term. As compared to the physical platform, digital games are more profitable since they require minimum packaging cost. This cost effectiveness will enable publishers to keep a popular franchise running profitably over a long period of time.

Moreover, increasing spending on mobile and social gaming bodes well for the overall video game sales. We believe that publishing companies with a focus on the digital segment will stand out even amid sluggish market conditions. For instance, some companies like EA, Zynga (ZNGA) and Activision are well positioned to benefit from this trend going forward.

However, lack of visibility around the monetization of the digital platform (particularly social & casual online games) compels us to remain on the sidelines. Since most of the digital and online games are offered as free-to-play, they remain significantly dependent on advertising revenues and online sales of the in-game virtual items. Moreover, the highly fragmented video game market continues to witness increased competitive pressures, which are hurting overall profitability.

We maintain our Outperform recommendation on Activision over the long term. We remain Neutral on EA and Zynga over the long term (6-12 months).

We believe that growing popularity of the Call of Duty franchise will drive Activision’s growth story in the near term. Currently, Activision has a Zacks #1 Rank, which implies a “Strong Buy” rating in the near term. EA and Zynga both have a Zacks #3 Rank, which implies a Hold rating in the near term.

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