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Harry Koza

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Game on!

Harry Koza

 

Pinball games were constrained by physical limitations, ultimately by the physical laws that govern the motion of a small metal ball. The video world knows no such bounds. Objects fly, spin, accelerate, change shape and color, disappear and reappear. Their behavior, like the behavior of anything created by a computer program, is limited only by the programmer’s imagination. The objects in a video game are representations of objects. And a representation of a ball, unlike a real one, never need obey the laws of gravity unless its programmer wants it to..

— Sherry Turkle, U.S. psychologist, sociologist. Second Self: Computers and the Human Spirit, ch. 2, Simon & Schuster (1984).

I fidget with the digit dots and cry an anxious tear
As the XU-1 connects the spot
But the matrix grid don’t care
Get a message to my mother
What number would she be
There’s a million angry citizens
Looking down their tubes at me

Com-pu-pu-pu-pu-pu-pu-pu-pu-pu-pu-puter-puter, puter games
Com-pu-pu-pu-pu-pu-puter-puter-puter-puter, computer games"

— Mi-Sex, from the album, "Computer Games"

TORONTO (GlobeinvestorGOLD) — I must confess, somewhat sheepishly, that I am inordinately fond of gaming.

I don’t mean heading to the casino to lose the mortgage money — the government shills for that sort of activity like to call it "gaming" instead of the less politically correct “gambling,” or the far more accurate “tax on the stupid” — but rather, I am fond of computer games.

This activity is normally considered the realm of teenaged boys and geeks, not to mention teen-aged geek boys, but here I am, squarely into my fifties, and you’re just as likely as anything to find me of an evening ensconced in front of my computer, gleefully breaking heads and completing quests in some computer dungeons and dragons scenario. Diablo, Doom, Dungeon Siege, Myst, Baldur’s Gate, Neverwinter Nights: I’ve played them all, and many others, too.

In fact, I’ve been playing these things since back in the days before computers when you had to do it with pencil and paper and a fistful of 8, 10, 12, and 20-sided dice. My wife thinks I’m nuts, but tolerates this behaviour in exchange for me never saying anything about her addiction to the TV decorating channels. Fair enough.

But gaming, far from being the underground province of kids and nerds any more, is getting big. The papers were all full of coverage of the launch of the new Halo 2 game for the X-Box and other game consoles recently, giving the subject the kind of breathless coverage normally reserved for the premiere of Hollywood’s latest blockbuster. Come to think of it, these days, Hollywood is cranking out movies based on games (Mortal Kombat, Resident Evil). You could argue that computer and video gaming is now bigger than Hollywood.

Big business

Gaming is big business. Nintendo’s Mario alone (Super Mario, Mario Brothers, and all the other permutations) has generated gross revenues in excess of $10-billion (U.S.). To put that into perspective, Harrison Ford, one of Hollywood’s biggest stars, and the lead in some of the biggest grossing movies of all time (Indiana Jones, Star Wars, etc.) has generated total gross earnings of about $7.5-billion. And, unlike Mr. Ford, who gets millions per movie, Mario works for nothing.

Total computer game sales in the U.S., including console and pc games, were $11.2-billion in 2002. In 2003, PC games grossed $7.2-billion, and console (Nintendo, X-Box, and PlayStation) games another $5.8-billion. U.K. sales in 2003 totaled over £2-million (including consoles). World-wide game sales were $14.2-billion back in 1998, and have only grown since. And with the recent development of on-line variants of many popular games, the field is expanding. On-line gaming is forecast to generate $1.8-billion in 2005 and $2.55-billion in 2006.

The theme of this month’s issue of Trade by Numbers is that Santa Claus has given me $10,000 (Canadian) to invest in anything I choose. Let’s face it, you must be getting tired of me writing about safe, boring, prudent investments like bonds and electric power trusts — I know I’m getting tired of writing about them. So I thought that with this hypothetical windfall to invest, I would look at investing in the companies that make the games. Buy what you know, as Peter Lynch used to say.

Let’s forget about Nintendo, even though the company expects to ship 5 million of its new GS game console by the end of March 2005, plus 16 million games, and another 77 million Game-Boy cartridges. The stock only trades in Japan, which makes it hard to buy, and the game hardware business is highly competitive and cutthroat, so this year’s star can easily become next year’s bum. Nintendo, Sony’s PlayStation and Microsoft’s X-Box dominate the console business. Sony and Microsoft have their tentacles in many, many other pies besides games, so aren’t pure game stocks anyway. I’m more interested in the makers of games for these consoles and for PCs. Here’s a couple of interesting plays.

The arts

Electronic Arts is the world’s leading independent developer and publisher of interactive games for computers and consoles. It has 33 game franchises that have each sold over a million units. Revenue in fiscal 2003 was $2.5-billion (U.S,), in 2004 $3.0-billion. First-quarter revenue for 2005 rose 22 per cent t $432-million. The company earned 8 cents a share in the quarter, up 33 per cent from a year ago, generating a return on invested capital of 84 per cent. For the second quarter, ERTS grossed $716-million in revenue. And for the all-important Christmas season this year, ERTS has a strong line-up of new games, including Madden NFL 2005, Tiger Woods PGA Tour 2005, Def Jam Fight for NY, a new Lord of The Rings-based game, and new releases in established franchises like The Sims, the Need for Speed Underground, Command and Conquer, Harry Potter, James Bond 007, among others.

ERTS stocks is trading near $50 and near its 50-day moving average. The GlobeinvestorGOLD fund activity scale rates the stock at 2.2, on a scale where 1 is a new buy recommendation and 5 a closed position. That makes it, on average, a “buy.” In the U.S., the stock is also rated a "buy" by 23 brokers. The average analyst earnings forecast for the current fiscal year is $1.95 a share, up 6 per cent from last year.

The company’s Sims series has sold over 41 million units, and the latest offering, The Urbz: Sims in the City will be hot this season. Next March, ERTS will roll out Sims2 College, the latest expansion pack for the Sims franchise. My daughter and all her friends seem to spend hours playing with the Sims: ask any girl in the 9–14 age group about the Sims: the Sims are hot, hot, hot. (My daughter generated a Sims family based on our own, and then left the Sims mom unattended in the kitchen while working on another part of the computer-simulated house, only to have the Sims-Mom start a fire that burned the house down. Much hilarity ensued, but my wife was not amused.)

I don’t have a target for the stock, but the company is a powerhouse in the gaming business, and boasts strong market share in games for all the major consoles as well as for the pc. I figure they should do well, now that gaming is becoming so main stream. In South Korea, they have a professional gaming tour that attracts millions of fans, so there is still plenty of room for upside in North America. If you think that this year’s Christmas retail season is going to be a good one, this stock could be a good punt.

French connection

ERTS is a U.S. dollar stock, and you may want to invest instead in a game stock that trades in a currency that is appreciating rather than sinking. You might consider Ubisoft, one of the top 5 independent game developers in Europe and the U.S. Ubisoft generated 453 million euros in 2003, including 11 million units of Myst, 12 million units of Rayman and 7.5 million units of Rainbow 6, among other best-selling games.

The stock is listed on the “Premier Marche” (first market) of the Paris Stock Exchange. Ubisoft managed to grow its market share in the US market with a series of award winning games, including the Prince of Persia : The Sands of Time game, designed in its Montreal subsidiary. (I’ve played this one, and the graphics are stunning, although game play was kind of hard for a fumble-fingered old-timer like me.)

Ubisoft’s Montreal studio on Rue St Laurent is one of the best in the world, according to Billboard, and responsible for four hot new titles rolled out this fall (Tom Clancy’s Splinter Cell Pandora Tomorrow, Tom Clancy’s Rainbow Six 3 Black Arrow, Myst IV: Revelation and Prince of Persia Warrior Within).

The stock is trading around 16 euros. That’s well off its Dec 2, 2003 highs at 26.77, and there is plenty of room for improvement with a decent season this year. You’ll need to talk to your investment advisor about how to buy Paris-listed stocks, however.

The waiting game

My favourite gaming company is a Canadian one, and unfortunately is not publicly traded, at least not yet. That is Bioware, founded in 1995 in Edmonton, by Dr. Greg Zeschuk and Dr. Ray Muzyka. The privately-owned company now employs 180 people. Bioware is the developer of the Baldur’s Gate series of games (over 5 million units sold and still going strong); Neverwinter Nights (shipped a million units at launch and still selling faster than Baldur’s Gate). The company also cut a development deal with George Lucas back in 2000, launching the first Star Wars game, Knights of the Old Republic.

That game was released for consoles in 2003, and has been the fastest selling X-Box title in history. It has won over 100 awards, and is rated the 19th best game of all time and the third best X-Box game of all time Game Rankings.

Bioware has couple of neat things going for it. One is the Aurora Toolset, a user friendly component of its games that allows the user to build add-on modules. They have an on-line community of 1.7 million registered users that has developed over 3,000 expansion modules for the Neverwinter Nights game that can be downloaded for free by the Bioware Community. That’s a network of 1.7 million happy gamers that will be waiting to buy the next new game that Bioware releases. And Bioware has licensed its game engine technology to other makers of role-playing games, including the critically acclaimed Icewind Dale and Planetscape series. They have also branched out into designing console games, and have three major new pc titles in development. If these guys ever decide to do an IPO, I’ll be all over it faster than the government on a dumb idea.

In the meantime, it looks to me like computer gaming has reached a tipping point. Hollywood stars are now fighting to win ’roles’ in games. Game development is pushing the envelope for computer chip makers, who are scrambling to keep up. The graphics systems developed for games are just starting to be used in movies like The Polar Express. Major media are dedicating regular coverage to the sector.

Some major gaming stocks that have been beaten down in price since the Tech Wreck now look poised for a big retail season this year and offer some stock price upside potential. Maybe it’s time to go down to the rec room and ask your kids what they think about the idea of investing in gaming. As for me, I’m off to Neverwinter to break some heads and save the Kingdom.

Harry Koza is Senior Analyst in Canadian markets for Thomson Financial/IFR. At various times in his career, Mr. Koza has been a prospector, metallurgist, project manager, engineer, as well as an institutional bond salesman for 15 years. His current area of expertise is in high-yield distressed securities and corporate bonds in general.

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