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A lot has changed in the video game industry in the two years since Motley Fool co-founder David Gardner and I first attended the Electronic Entertainment Expo (E3) in the spring of 2009. The industry had just come off three consecutive years of impressive sales growth that saw total dollars spent on video gaming surge 56% to a record $11.7 billion. The tremendous momentum from the previous console cycle -- which ushered in Microsoft's (Nasdaq: MSFT ) Xbox 360, Sony's (NYSE: SNE ) PlayStation 3, and Nintendo's (NTDOY.PK) groundbreaking Wii -- remained firmly intact. And at that E3 in 2009, David and I first got a glimpse of Project Natal, which would eventually produce the fastest-selling consumer electronics device of all time, the Microsoft Kinect.
Times were good, and the future looked even better -- not to mention more fun.
But times have changed. The economic recession took its toll on the industry in 2009, as video game sales fell 10%. And something else happened around the same time: The market's perception of the traditional video game maker changed. Once lauded for their impressive growth and uncanny resilience during (prior) consumer slowdowns, traditional game developers such as Activision Blizzard (Nasdaq: ATVI ) , Electronics Arts (Nasdaq: ERTS ) , Nintendo, Take-Two Interactive (Nasdaq: TTWO ) , and THQ (Nasdaq: THQI ) suddenly fell out of favor. Their stock prices tanked, then never really recovered in the market rebound of late 2009 and 2010.
What changed investors' enthusiasm for these stocks? Why are shares of Activision Blizzard still stuck some 35% below their all-time high? Why is Nintendo trading near a four-year low?
The name might not be familiar, but I'm sure at least a few of you have spent time playing its games. Zynga is the developer of Farmville, CityVille, and other popular social free-to-play games on Facebook. Nearly 250 million people spend some amount of time playing Zynga's games every month just on Facebook. And though the games are free to play, Zynga makes money by selling virtual goods that enable players to reach higher levels and unlock other facets of the game.
And there is nothing virtual about the sheer amount of cash those goods bring in. Zynga is reported to have pulled in more than $850 million in revenue last year, and it has its sights set on an initial public offering, perhaps as early as this month. According to one marketplace that facilitates trading in privately held shares, Zynga is currently valued at around $8 billion. A recent private funding arrangement pegged its value as high as $10 billion. That puts Zynga ahead of the $8.1 billion market cap of Electronic Arts, and within sight of industry leader Activision Blizzard's $13.7 billion market cap. Not bad for a company that didn't even exist prior to 2007.
More digital, more social
Zynga's rapid rise tells me that the video game world has become much more digital and much more social. That hasn't been lost on Activision Blizzard -- quite the contrary, actually. World of Warcraft basically invented the concept of a massive, worldwide social network of gamers. Activision has been selling virtual goods in WoW for years. (Can I interest you in a flaming, eagle-winged lion for $25?) Activision's map-pack downloads for Call of Duty are digital best-sellers. And the recently announced Call of Duty: Elite promises to bring a real social networking experience to the record-breaking franchise later this year.
So while Zynga's achievements are impressive, I don't think the advent of social gaming spells doom for traditional video game makers. There will always be a large segment of the gaming population willing to shell out serious dough for more expansive, polished traditional games — and all the peripherals that go with them. I promise you (and I'm speaking from personal experience here), the hardcore gamer is alive and well. And as we can see with the moves Activision is making, the rise of social gaming is an opportunity to reach more gamers in more places — and, most importantly, at more points of sale.
A refresher, California-style
In their zeal for Zynga and all things social, investors have tossed traditional video game developers aside. But the companies that embrace the opportunities social gaming presents -- and I truly believe Activision is one of them -- will eventually be rewarded. Who gets it and who doesn't? Answering that question is just one reason Rule Breakers analyst Sean Sun and I are heading to Los Angeles to attend next week's E3.
We'll be talking to some of the top brass at Activision Blizzard, Bethesda Softworks, Nintendo, Take-Two, and many others to get their take on social gaming and the future of the video game business. Could Zynga actually be a worthy investment post-IPO? Can WoW hold on to its position as the world's largest MMORPG? Which companies have the best slate of games heading into the holiday season? And just how much will David regret not being able to attend this year's show?
Stay tuned to Fool.com for answers to those question and other exclusive insights from the show. I'll also be taking over Stock Advisor's Twitter feed so you can follow Sean and I in real time, right from the floor of the expo: @TMFStockAdvisor. The action begins tomorrow.