Video games: still a long term growth story

For a few years now the video/computer games sector has looked attractive as an investor. 

As most people would now be aware video games have passed movies in terms of gross revenue and there are a bunch of  factors which make them extremely interesting as a long term growth story.

For example:

1. increased availability of high speed broadband
2. increased availability of large, high definition screens in the home
3. the growth of whole new genres which are different from the traditional shoot-em-ups such as edutainment titles which teach children far more effectively than any human teacher could, and gaming physical fitness titles exemplified by the Nintendo’s Wii Fit series which have redefined the user interface so that physical activity forms a strong component of the game
4. social gaming systems such as World of Warcraft (owned by Activision) with 11m players
5. new generations for whom gaming is not a marginal activity such as the under 20s and increasing numbers of women gamers

At the same time as a sector it’s pretty damn scary. 3-5 year console cycles cause stock prices to fluctuate like a yo-yo and it perhaps bears a passing resemblance with large title production costs and big marketing budgets to the movie business (not a business that looks tempting as organisations like Vivendi and Sony have learned to their cost). Equally there is the argument that, like the music business, titles can be pirated with high speed connections. Looking at all this you just have to keep reminding yourself equity investors really get returns for taking on risk…

However something that has significantly changed is that the multiples on all these gaming stocks have fallen over the last couple of years which is what makes them more interesting at the moment from the perspective of a value investor in what used to be regarded entirely as a growth stock play.

The big cap pure-play video games companies

The three big (pure) players are Activision, Electronic Arts, and Nintendo (given the risk levels on individual titles the smaller companies seem to be significantly riskier). None of these companies have any debt and all have significant cash on the balance sheet (in Nintendo’s case net assets excluding intangibles accounts for over a third of its market cap – about US$8bn of which is cash).

Whilst Sony and Microsoft are of course large in the games industry as well they also have other priorities and it looks hard on the surface of it to disentangle their games activities and the resulting impact on their stock prices from their other businesses.

Long term (see chart here) Activision seems to have tracked Nintendo (both of which are generally thought to have excellent management teams) up until the beginning of 2009, whilst comparatively Electronic Arts has languished in the last 2 years (EA focusing heavily on sports titles compared to the other two).

Comparative valuations for Activision, Nintendo and Electronic Arts

Some comparative valuation metrics for all three stocks are listed below:

 

Valuation Comparisions 14/12/09	Forward PE	Price / Cashflow	Price / Cashflow 3 yr avg	Market Cap USD Billion	Rev Growth 1Y %
Activision	14.06	21.55	54.43	13.6	124
Electronic Arts	13.61	62.11	53.86	5.2	15
Nintendo	12.09	13.33	54.28	34	10

 

There is some degree of fear out there on these stocks – see “Can Nintendo Rebuild?” for example in Businessweek. Generally video game sales have not been good recently (Nintendos’ sales fell for about 8 months straight this year and it expects annual revenues to fall for the first time in 6 years), there is nervousness about the impact of social gaming via systems like Facebook, and the rise and rise of iPhone games has made people wonder what impact that might have on dedicated handheld devices like the Nintendo DS or Sony PSP.

Nintendo, for example is trading at half its price in 2007:

 
 and even Activision with the recent success of its Call of Duty: Modern Warfare title is trading at $10 or so from a high of $18 back in 2007 (but not an apples for apples comparison given its 2008 merger with Blizzard and their World of Warcraft franchise). 

Of these 3 stocks it is Nintendo that seems to jump out (although both Activision and Electronics Arts are trading below Morningstar’s fair value estimate and it would probably be entirely reasonable to take a diversified bet on all 3).

The case for investing in Nintendo?

As a US$34bn company with the majority market share in many areas (Sony has sold about 9m PS3 units in the UK with Nintendo selling 25m Wiis)  Nintendo is surprisingly hard to find investor coverage on – Morningstar in the USA for example does not provide analysis on it.

If the reason is concerns about the way that some Japanese companies are run, these don’t seem warranted in Nintendo’s case.  At current stock prices they even pay a 5% dividend – the only company of these three to do so and a rarity in the games industry generally.

Nintendo is however definitely a long term bet. Their revenue has halved in the last 6 months compared to a year ago and a chartist probably wouldn’t touch them with a bargepole.

However they are still busily shipping units of the Wii (with a price cut) and the portable DS (with roughly 10% of the all time entire total sold in the last 6 months) and if you look at their geographical revenue split what happens in the US is both very important but equally very impacted by US dollar weakness (the USD having fallen against the Yen by about 20% over the last 2 years).

 

Nintendo by region
6 months to Sept 30th 2009 (million yen)
Japan	92071	17%
Americas	228938	42%
Europe	186630	34%
Other	40418	7%
Nintendo by activity type
6 months to Sept 30th 2009 (million yen)
Hardware	312556	57%
Software	234187	43%

 

As the activity type table above suggest Nintendo is not just a hardware company with revenue over this period (during which not many new titles were released) being split about half software, half hardware. Recent falls in revenue reflect a lack of new compelling titles or hardware launches but the company’s franchise with casual gamers places less stress on coming up with radical new cutting edge consoles (as is the case perhaps with the Xbox or Playstation). Their Mario Brothers franchise is still going strong and the title was released in 1983!

The concerns about the iPhone seem to be overrated to me. The iPhone lacks gaming controls so you have to use your fingers on the screen (reducing its visual area), it comes with data charges, and to argue that gaming apps are cheaper for the iPhone is a little like arguing  that nobody is going to go to the cinema because they can watch movies for free on television (the better movie experience still counts for the consumer).  Just on that minor point $10 for  cinema ticket for a one-off 2 hour’s enjoyment still seems to be outranked by potentially weeks of enjoyment in sharing a game with your family at home.

Neither, if you look at Nintendo’s R&D spend, does it look like Nintendo intends to stand still with a high definition Wii supposedly in the works as well as link-ups with organisations like Netflix. Yes, motion-sensing controllers may well be on the way from Sony and Microsoft but this is a company with a history of innovation.

Nintendo’s management has successfully broken into whole new areas – with a market share for example of up to 80% of US female gamers and almost singlehandedly created a new genre, the fitness/exercise game.

Nintendo’s profitability and track record makes their US ADRs look like a buy (US: NTDOY) and the rumours of a stock split would make them more attractive as well. However looking at their chart averaging in looks warranted – this is not for the faint-hearted.

More information on Activision at http://investor.activision.com/reports.cfm

More information on Nintendo at http://www.nintendo.co.jp/ir/en/

Posted under individual stocks

In the never-ending quest for the unpopular asset class that you might be able to pick up on the cheap it is difficult to go past commercial real estate at the moment.

But there are a few problems:

1. commercial real estate can be very illiquid
2. with the gearing in this sector, falling property values, and historically low interest rates that may increase, there may be risk in a particular fund that it is hard to identify

So what might be interesting would be a commercial real estate exchange traded fund that is both liquid and spread across a number of different property trusts.

In Australia you can find exactly this with the State Street Spider S&P/ASX 200 Listed Property Fund (roughly $15 billion market cap with 16 holdings and a .4% management cost with quarterly income distributions).

SLF Net Asset Value has halved over the last year

If your approach to buying stocks is chartist/technical, stop reading here because the chart (ASX:SLF)
 is a bit ugly to look at, with net asset value at 1/2 of its 12 month high, and down 2/3rds over the last 2 years.

We have started (and intend to continue) buying it in multiple small parcels and as a long term investment.

SLF income picture

SLF is currently trading at a  nominal double digit yield which is estimated to fall to about 8-9% i.e. you can assume that a further fall in income distribution is already factored into the current price.

Roughly 7 out of 10 of the top 10 holdings are trading at single digit PEs and the outlook from analysts for the whole property industry is still gloomy.

Stock-Specific Risk in SLF

It seems strange to talk about stock specific risk with an ETF but as of August 7th Westfield made up 47% of total assets so if you don’t like Westfield don’t buy this (here are the top 10 holdings): 

Issue Name	Sector Classification	% of Total Assets
Westfield Group	Retail Reits	47.09
Stockland	Diversified Reits	13.11
Gpt Group	Diversified Reits	7.83
Cfs Retail Prop	Retail Reits	6.30
Dexus Property Gp	Diversified Reits	6.11
Mirvac Group	Diversified Reits	5.32
Cmnwlth Prop Offic	Office Reits	2.97
Ing Office Fund	Office Reits	2.64
Goodman Group	Industrial Reits	2.21
Macquarie Office	Office Reits	1.91
Macquarie Countryw	Retail Reits	1.32
Bunnings Warehouse	Industrial Reits	0.99
Abacus Property Gr	Diversified Reits	0.66
Ing Industrial Fd	Industrial Reits	0.61
Charter Hall Group	Diversified Reits	0.58
Astro Japan Proper	Diversified Reits	0.35

Here’s the sector breakdown:

 

  

Sector	% of Total Assets
Retail Reits	54.34
Diversified Reits	34.42
Office Reits	7.51
Industrial Reits	3.73

Like it? Hate the idea? Let us know by commenting below!

Posted under index trackers

The current wholesale sell-off in global stock markets is leading to many a baby being thrown out with the bathwater! Inevitably there are some stocks which are being sold off which are sound businesses.  There are certainly far more exciting investment opportunities out there than there have been at for a good four years.  No doubt the forthcoming economic recession will have an impact on all industries, and most companies will see a significant reduction in revenue, profits and cash flow. Many however are currently being priced as if they will go bankrupt, or head into a long painful terminal decline. Some of these very undervalued companies might even manage to grow earnings in the forthcoming recession. 

Cable & Wireless: business segments and spin-off discussions

One example is Cable & Wireless in the UK.  Cable & Wireless essentially has two distinct businesses. The growing internet and broadband division for corporate customers in Europe, Asia and the US, and the International division which includes the legacy cash generative telecoms businesses in the Caribbean, Panama, Macau and Monaco.  For years shareholders have argued that the combination of these two divisions is not strategically compelling and that a demerger would be the best way to realise value.

Earlier this year management announced that they were considering strategic options including a demerger and returning cash to shareholders.  In the following months, the share price rose 20%, dramatically outperforming the sector, but in the last few weeks it has fallen over 30%.  Part of the reason for the recent stock price sell off is that management have suggested, quite sensibly in my view, that the current market turmoil is hardly the time to be realising value via a demerger and spin-off.  This does not signify a change in strategic thinking but rather a delay until more rational markets prevail.  

Cable & Wireless’s acquisition of Thus

C&W has also recently completed a takeover of its smaller UK rival, Thus.  Even after paying £361 million for Thus, the company will still be significantly underleveraged with a net debt position of £184 million, less than 10% of equity. The purchase of Thus, following on from the acquisition of Energis in 2005 gives C&W increased market share and helps them consolidate their position as a clear number two to BT in the provision of internet services to corporate customers in the UK.

Cable & Wireless: guidance and valuation

In the June 2008 interim statement, management said it was on track to achieve its guidance of a 20% increase in operating profits for this year. Let’s be conservative and assume that current economic circumstances mean C&W will not achieve any improvement in the underlying going concern this year or next. At the current price, this would put the business at a very reasonable 6.6X cash flow.  The dividend should be secure too; giving a current yield of 6%. Throw in likely cost savings from the Thus acquisition, and a potential special dividend from the eventual separation of the two key businesses, and it seems to me that Cable & Wireless is a bargain.

Disclaimer:  Note the author may hold investments in any of the companies mentioned in this article. Any new investment should only be considered in the context of the risks in your existing portfolio.

Posted under individual stocks