Game Developers: Have the Gains Come and Gone?

Activision Blizzard, Zynga, and Glu Mobile: Can any of these stocks continue to trade higher?

Feb 12, 2014 at 9:00PM

Activision Blizzard (NASDAQ: ATVI), Zynga (NASDAQ:ZNGA), and even Glu Mobile (NASDAQ:GLUU) have soared in recent weeks following increased optimism surrounding video game developers coupled with bullish reaction to earnings. Many investors like these companies as investments following strong console sales with the PlayStation 4 and the Xbox One, but are any a buy moving forward.

Investing in games
One fact investors must understand about the gaming industry is that it's volatile to say the least.

The success of a game developer often hinges on its ability to create franchises out of games, best-sellers, and to evolve with the wants of the consumer. Clearly, all of these factors to success are highly unpredictable. Yet, Activision, Zynga, and Glu Mobile are all trading at or near 52-week highs.

These companies have all reported quarterly earnings in the last month, and have seen a positive reaction. Yet, have the gains come and gone?

The king of games
Activision Blizzard is trading at levels it hasn't seen since the 1980s, as games such as Call of Duty, World of Warcraft, and Skylanders have been a hot commodity with consumers.

The company reported fourth quarter earnings on Feb. 6 that beat expectations. However, Activision's five-day 15% return really comes down to two things. First, management believes that the much anticipated release of Destiny could result in the company's third billion-dollar franchise . Second, subscribers to World of Warcraft had been declining in recent quarters, but in the fourth saw a 200,000 rise to 7.8 million total subscribers .

Still, despite the anticipation for new titles and the presence of subscription growth, Activision's guidance was below analyst estimates at $4.6 billion for 2014. In other words, growth will be near flat this year.

Therefore, with the stock soaring higher and expectations already high, the stock looks vulnerable for a large pullback due to a lack of measurable growth.

A dead cat bounce?
In the last two years, Zynga's shares have fallen more than 65%, which is a great testament to why companies in this space must continue to produce best-sellers.

Yet, many are buying into the notion of a rebound, especially following the company's fourth quarter earnings beat. Furthermore, Zynga acquired a competitor called NaturalMotion for $527 million and decided to cut another 314 jobs.

With that said, both cutting jobs and acquiring NaturalMotion seem like a desperate move on behalf of the Internet gaming company. NaturalMotion has a game called CSR Racing which is very popular on iOS devices. But, as Zynga's learned, a hit today doesn't necessarily translate into riches tomorrow.

Furthermore, Zynga's bookings (revenue) for the quarter represented a 44% year-over-year loss, a familiar trend for longs. And according to the company's outlook for 2014, fundamental losses will continue, as $780 million in bookings represents a year-over-year loss and a significant decline from 2012's $1.28 billion.

Hence, Zynga's recent pop might very well be a dead cat bounce rather than a fundamental recovery.

Moving in the right direction
Glu Mobile was the final gaming company to report earnings, and has soared 25% since beating expectations.

Glu Mobile is much smaller than its peers Activision and Zynga – having quarterly revenue of just $42.8 million – but is the only company to have posted year-over-year growth. In fact, Glu's 62% revenue increase and its guidance for both the upcoming quarter and full-year were significantly better than the consensus; Glu was the only company to issue guidance better than expectations.

This is a company that develops games in iOS, Android, and Amazon, which are all growth markets of the gaming industry. While the company is not yet profitable, its growth can not be questioned.

Year

Revenue (millions)

2011

$74.03

2012

$108.18

2013

$105.61

2014

$147.59

Clearly, 2014 revenue is based on the growth outlook of analysts, but with the exception of 2013, Glu Mobile has been rather consistent. Furthermore, 2012 was expected to be somewhat of a lagging year, as many of the company's top catalysts occurred in the fourth quarter and now into 2014.

These catalysts include new games Eternity Warriors 3, RoboCop, and Deer Hunter 2014. Thus, by all accounts it appears the company is moving in the right direction.

Final Thoughts
Glu Mobile is far from being a powerhouse in this industry, but with solid growth and an attractive valuation of $380 million, it likely presents more upside than its fundamentally weakening peers.

With that said, successful video games often lose momentum fast, and the outlook for these companies can change in a matter of months. Therefore, understand that this is a risky space, and despite the fact that its trending higher right now doesn't mean that next month will be the same story.

Thus, a company as small as Glu is easy to monitor, and with many new releases in early 2014, the stock has the potential to soar considerably higher.

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Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard. The Motley Fool owns shares of Activision Blizzard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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