Take-Two Interactive (TTWO) stock has had a very tumultuous run of late.  Just over two weeks ago, they reported a worse than expected fiscal fourth quarter where both sales and earnings missed analysts’ targets (Bad Quarter Causes Investors to Double Take).  Furthermore, they reduced EPS guidance for the current quarter from a loss of $.26 to a loss of no less than $.40 per share.  However, it appeared that Take-Two would bounce back quickly as the stock began to rise, thanks in part to activist investor Carl Icahn raising his stake in the company in mid-December.  Some analysts upgraded the stock following the disclosure of Icahn’s 11% stake in hopes that he would spearhead a turnaround and perhaps eventually replace some members of the board.

After the bell on Monday, Take-Two announced more disappointing news to their investors as they are selling the company’s video game distribution business.  The Jack of All Games unit, which distributes not only Take-Two’s games but also video game products from Activision Blizzard (ATVI), Electronic Arts (ERTS), and Sony (SNE), will be sold to SYNNEX (SNX) for a total of $43.25 million in cash.  Considering the unit brought in revenue of $282 million in fiscal 2009 (just under a third of revenue), the price seems to be a very cheap.

As a result of the sale of their “non-core” game distribution unit, the company was forced to reduce their guidance once again.  Now management sees a loss of $.45 to $.55 in the fiscal first quarter, and perhaps more distressing sales are now expected to range between $90 million and $140 million, down from the previous guidance of $210 million and $260 million.  If revenue comes in at the midpoint of their range, that would make it just half the average revenue prediction of analysts for the quarter.  Obviously, shares are selling off in after hours activity.

At Ockham, we have a Fairly Valued rating on Take-Two Interactive basically because the stock has been so beaten down that it no longer looked Overvalued.  That being said, we will have to readjust our analysis based on the new asset sale, especially for what amounts to a fire sale price.  It is very likely that we will downgrade Take-Two once these numbers work their way into our analysis.

November was not a great month for video game sales according to an industry research firm NPD.  Overall sales dropped 7.6% from a year ago to $2.7 billion in the month, which is certainly a disappointment considering the month included the most successful game launch of all time in “Call of Duty: Modern Warfare 2″.  The blockbuster launch of Call of Duty strengthened software sales as they slid only 3.1% but still missed analysts’ expectations.  That being said, software sales were robust compared to console or hardware sales which dropped by 13% in the month.  Console makers have lowered prices significantly in the last year to help entice buyers to take the plunge into the newest generation of hardware.  Nintendo’s Wii is the cheapest and still best selling console, edging out competitors Microsoft (MSFT) and Sony (SNE).

The industry group said that there is still a chance that the industry reaches the $20 billion threshold for the full year, but it would take a robust December in which sales would have to be 11% better than a year ago.  Considering how much weaker sales were in November than a year ago and the relatively subdue raise in holiday retail sales from last year, this sounds like wishful thinking.  This is an industry facing a lot of challenges as we pointed out following last week’s disastrous quarterly report from popular game maker Take-Two Interactive (TTWO) (Take-Two’s Bad Quarter Causes Investors to Double Take).

With the difficulties in mind, we continue to believe that there are a few stocks that have attractive value in the sector.  We have been written in the past few months that we believe GameStop (GME) is attractively priced.  Competition from other bricks and mortar retailers as well as from the emergence of digital downloads have many traders bearish on GME.  Coming into Friday, the stock was trading at just over 8 times this year’s earnings and 7 times next year’s expected earnings!  Furthermore, the company released word today that in spite of the industry’s difficult monthly sales, new games sold 15% better than a year ago and continued to grab market share.  Not surprisingly, we have an Undervalued stance on GME for long term investors looking to play a rebound in video games.

For one other bright spot, we also have an Undervalued stance on Activision Blizzard (ATVI) the market of “Call of Duty: Modern Warfare 2″.  While its valuations is not as attractive as is GME’s, it still has potential to rise in the next few months as the sales numbers are reported at the quarter’s end.  Much has been made about how sales in the first week of Call of Duty were greater than any other major media release in the United States including blockbuster movies.  The stock is actually down nearly 5% since that blow-out numbers, which seem to have been brushed off by the market.  We think that the current fundamentals would support a price of $12 per share without even factoring in the bump from Call of Duty.

As November sales totals demonstrate, these are difficult times for the video game industry as a whole.  However, value seeking investors could do worse than picking some unloved players in this market that continue to perform adequately through the challenges.

Barnes & Noble (BKS) reported today that their new eReader product has sold out of the entire supply for delivery before the holidays.  This may be a positive sign for Barnes & Noble in the long run as demand appears to be quite strong, but it is clear that production limitations are restricting sales this holiday season.  Yesterday, Sony (SNE) pushed back the shipping date for their Daily Edition Reader to between December 18th and January 8th.  This puts Sony’s August promise to have the Reader available for holidays in serious jeopardy.  All of this is great news for Amazon.com (AMZN) and their Kindle device, and these delays are just another reason why it is great to be the among the first products to market and letting the others play catch-up.

Amazon is ready to roll with Kindles in stock and ready for sale in the rapidly growing segment of consumer electronics.  There is no doubt that the holiday shopping season is of massive importance to a consumer electronics product, and eReaders should be some of the hottest gifts on the market.  It appears that this will be another step forward in their market leading position, and it is a lost opportunity for the competitors.  It is too early to tell if BKS’s Nook or Sony’s Reader will be the equivalent to Microsoft’s (MSFT) Zune, but extending Amazon’s lead is troubling.

The Kindle has a year head start on its primary competitors, remember it was the Kindle that sold out prior to last year’s holidays.  Sony has other models of readers available already, but the Daily Edition Reader is the closest competitor to the Kindle.  It is also a bit surprising that a seasoned electronics manufacturer like Sony would be caught off guard by supply chain and manufacturing hold ups.  For Barnes & Noble, it is much more understandable given their history as a retailer.

All the while, Amazon.com’s stock just continues to set new all-time highs which is truly amazing considering the stock was under $40 less than a year ago.  Now trading at nearly $130, we are reiterating our Fairly Valued stance on the company.  The Kindle has been a hit thus far and has the potential to dominate the digital book market the way the iPod has for digital music.  We all know how that has worked out for Apple (AAPL) in the last decade.  Not to mention, Amazon’s ecommerce site has never been hotter and should be a major destination for holiday shoppers.

“An interesting story we’re following, Electronic Arts shares selling off by 4% after an executive for Microsoft said there’s not a possibility of any deal here. There was options activity surrounding that. And shares of Electronic Arts actually over the past couple of days had risen in anticipation. Speculation of a possible deal not going to happen, apparently according to Microsoft.” — CNBC’s Power Lunch 9/24/2009

On Wednesday, traders gleaned to a rumor that quickly leaked through the market that Microsoft (MSFT) was planning to acquire video game maker Electronic Arts (ERTS).  There was little substantiating the rumors, but options activity turned heavily bullish on EA stock just the same and it finished 9% higher. 

Wall Street analysts universally panned the idea, saying that it makes absolutely no sense for a video game hardware producer to buy ERTS because it would put some of its best products in serious jeopardy.  For example, EA has exclusive licenses to with the NFL for its Madden franchise, which is a huge revenue producer each year for EA.  If this rumored deal were to happen, either Microsoft would produce games for other game consoles from Sony (SNE) and Nintendo or more likely the NFL would drop EA to partner up with another game maker.  This is just one example, but that sort of issue would make this deal extremely unlikely.

This morning, Microsoft’s VP of gaming stopped those rumors in their tracks and flat out denied any interest in acquiring EA.  After prodding from reporters, he would not comment on whether any talks had occurred only that they would are not pursuing Electronic Arts.  Not surprisingly, EA’s stock has fallen today but only a few percent, compared to its nearly 10% gain on the rumor.  So, the rumor that had analysts scratching their heads has now been exposed for having little substance.

It was apparent that EA was not a good fit for Microsoft, as Wedbush Morgan’s Michael Pachter said, “[It makes] no sense at all. One platform exclusives would likely nullify NFL exclusivity, could kill off all sports and other licenses.  EA’s value on one platform is probably half its value to a multi-platform buyer (such as a media company).”  So, there would likely be far less shock the rumor was surrounding a Disney (DIS), Viacom (VIA), Time Warner (TWX) or News Corp. (NWS).  Those major media companies are all more suited to putting out content, making them potentially a better fit.

As far as valuation goes, it is clear that the video game industry has been hammered lately and ERTS is just starting to pull itself out of some tough quarters.  We had believed that there was decent value in EA prior to the rumor fueled run up, but at this time we remain neutral on Electronic Arts and are reaffirming our Fairly Valued rating.

“GameStop, tough day for them, reporting second quarter profit, down 32%. $39 million was the figure. They had fewer hit video games and a 14% drop in same-store that’s forcing the company to cut its full year outlook. Wall street hates that as you can see by a 7% give back there.” –CNBC’s Closing Bell 8/20/2009

Shares of the largest retailer of video games slid more than 7% on Thursday as GameStop (GME) reported earnings that have fallen 32% from a year ago.  Management knew that comparisons to this quarter a year ago would not be favorable; it was this time last year that the ultra successful Grand Theft Auto 4 from Take Two Interactive (TTWO) was released with blockbuster sales.  Even with this in mind, fiscal second quarter results missed by a nickel analysts expectations for $.28 per share.  Same store sales figures were also extremely weak coming in 14.1% lower, although, through store expansions overall revenue fell only 3.7%.  Essentially, analysts were pessimistic coming into this release, but the actual results were even worse.  Gaming had been thought to be a relatively recession resistant industry, but that theory may be showing signs of cracking with the weak sales results. 

Further troubling investors in GameStop, the company issued guidance for the year that was significantly lower than previously thought.  This is the second straight quarter for a downward revision.  Management now expects $2.40 to $2.64 in earnings through the end of the year, revised from $2.83 to $2.93.  There is increasing competition in video game sales coming from Walmart (WMT) as well as Amazon.com (AMZN).  Not to mention, Best Buy (BBY) and the others have now entered one of GameStop’s primary business lines of selling used games, which is a source of high profit margins.  However, used game sales were up 19% in the quarter, evidence that GameStop is effectively fending off competition thus far.

There are reasons to be optimistic about the fate of GameStop.  For one thing, video game consol maker Sony (SNE) has lowered its price on its PS3 system by $100 this week.  GameStop executives have been clamoring for Sony to do just this, and flagging sales of the system prompted the move.  For GameStop, this could mean renewed interest in the systems and an increase in foot traffic to stores.  It is ultimately more important to push game sales, because hardware carries much lighter margins.  Also, management at GME said that they would anticipate the other major gaming systems will likely follow suit in order to compete.

It appears that this year, perhaps more than others, the holiday season will be a make or break one for the video game industry.  The delays of some major game titles just adds to the pressure on solid performance through the holiday season.  The company’s COO Paul Raines has said that he expects a big release from Halo 3, and claims that Activision’s (ATVI) Call of Duty: Modern Warfare 2 could be the best selling game in GameStop history!

At Ockham, we think that after today’s selloff the valuation of GameStop is compelling at current levels, despite the performance of the last quarter.  That is why we are maintaining our Undervalued stance.  We look at things from a long term view than just quarter to quarter, and GameStop has grown sales impressively over the long term; more than tripling over the last 5 years.  At the current price, GameStop is selling for less than 10x the low end range of its profit guidance.  This is an attractive price for the video game sales industry leader.  So, there are some headwinds for GameStop such as increased competition, but we think that much of the bad news is already priced into the stock.