The following is an excerpt from TWST‘s interview with Michael Pachter, managing director and equity research analyst at Wedbush Securities, where he provides coverage of the entertainment software, entertainment retail, and movies and entertainment sectors.
TWST: What are your favorite names in the video game space and why?
Mr. Pachter: The group has gotten just crushed this past year because as we had a decline in sales, I think investors tried to rationalize the decline as being evidence that we actually are seeing a secular decline in interest in video games. And I don’t believe that to be true, but the investment community does. So we’ve seen multiples for the group that have always been a premium to the market multiple – the S&P 500 multiple – decline to a discount of about 25% to the market multiple. We’ve always seen these guys trade at 25% to 50% above the market multiple. I think that as soon as investors figure out that I’m right and that growth is coming back, and that growth is sustainable, you’ll see multiples in the group expand dramatically. They will literally go from about 11x forward earnings, which is a discount of 25%, to call it 18x, which is a premium of about 20%. And that’s more than 50% appreciation. I think the whole group is going up 50%, so it’s kind of hard to have any of the stocks that I don’t like. I think the ones that will move first and farthest are the guys that actually show earnings growth, and that’s very clearly going to be Activision (ATVI); less clearly, Electronic Arts (ERTS), but I think they’ll do it; and less clearly, Ubisoft (UBSFY), but I think they’ll do it. It’s not clear that you’ll get earnings growth out of Take-Two (TTWO). They’ve already guided to a loss next year, so I don’t think that’s moving up on fundamentals any time soon. In terms of THQ (THQI), it’s not clear if they are going to grow earnings either, so I don’t think it’s going to trade up as much as the others. But I think the rising tide will lift all of them.
TWST: Any particular laggards?
Mr. Pachter: Nintendo’s (NTODY.PK) a little bit challenged because people are still trying to make sense out of this whole decline in casual game sales, and attach rates have been poor. The DS, I think, is just getting old; it’s going to be in its seventh year next year, so it’s kind of hard to believe that that thing keeps going as well. So I think that’s ultimately going to drop. I think the software sales are going to be challenged by iPod Touch games; not 50% declines, but a 5% decline or something. There will be some cannibalization of the market because an iPod Touch is an acceptable alternative for a kid to a DS. So I think Nintendo may remain kind of a laggard for a while. It’s hard to tell what Majesco’s (COOL) going to do.
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