Profit from video gaming's recovery

The release of the latest in the line of Modern Warfare video games demonstrates just how big the market is, where a new game's takings dwarf those of movie openings. And though it's been a lean year for the industry, things are about to pick up. Eoin Gleeson investigates, and picks the best bet in the sector.

At midnight last Monday, long queues formed on high streets around the country. Teenage boys jostled for room with men 20 years their senior. Everyone was waiting to get their hands on one thing a copy of Modern Warfare 2, the sixth instalment of the most successful ever franchise in video gaming. By the end of the first day, 4.7 million copies had been sold in the US and Britain. The tills rang up $310m by close of business in the US alone.

And make no mistake $310m is a huge haul. The biggest ever opening weekend for a film was last year's Batman epic The Dark Knight it took in $158.4m. Meanwhile, the UK's first video-gaming addiction clinic opened in Weston-super-Mare this week confirmation that this activity attracts a loyal, as well as lucrative, clientele. As a guide, for every $60 that a gamer handed over last week, $27 went to the game publisher, $15 to the retailer and about $7 to the console manufacturers Sony or Microsoft.

This year, however, has been a bit light for blockbusters; the recession has reined in consumers and game developers alike. So fewer games have come onto the market. But the past 12 months has seen a massive rise in second-hand game sales. Meanwhile, gamers have shunned expensive titles at high-street retailers such as Game. The latest figures from market research group NPD which exclude sales of second-hand games show a 23% fall in hardware sales and a 19% drop in software sales in October.

But that is about to change. The two months to Christmas are a bumper season for the game industry. Last year, 38% of the video game industry's revenue was generated in November and December. This year, a slew of delayed titles is being readied for release, says CNBC's Chris Morris. Game developers have been running scared of Modern Warfare delaying titles until after its release so they don't clash with it. Nobody wants to be in the same room as the gamer's King Kong.

Game developers also hold an ace card they don't work in the music industry. Once a music file could be compressed into an easily exchangeable mp3 format, the music industry was doomed. All the free music you wanted was only a short download away. Music fans loaded up their iPods. High-street music chains went bust. And record executives were left cowering in their boardrooms.

Piracy does not, however, threaten the survival of the games industry. Hardcore gamers have been pirating games with tremendous success since the Commodore Amiga and Atari ST in the 1980s, says veteran games marketer Bruce Everiss. But the game industry has continued to thrive by simply reinventing the games consoles they sell. The two or three-year shelf life of each new model creates enough of a window of opportunity to make money. And major titles such as Modern Warfare still the main driver of profits in the industry are just far too big for a broadband connection to download in a reasonable time, notes Dan Gallagher on MarketWatch.

Nonetheless, the game industry will move online, says Everiss. Many gamers already pay a subscription to download or stream games. This saves game publishers a fortune in fancy plastic wrapping and boxes. And it will allow developers to constantly update games plus offer extras to extend the life cycle of a game well beyond its usual six-month to one-year sales cycle. But it will also move the market away from blockbuster games. While that's bad news for game retailers second-hand games will go the way of the compact disc it's good news for developers who can continue to adapt, such as the one below.

The best bet in the sector

Activision Blizzard the maker of Modern Warfare 2 will soak up a huge volume of video game sales this Christmas. The stock has already risen in anticipation of the release and now trades on a forward p/e of 15.3. So we prefer another game developer that has been wisely biding its time Take Two Interactive (Nasdaq: TTWO).

Although it saw a 68% drop in revenues in the last quarter (leading to a loss of $55m) TTWO is about to release two updates to its flagship Grand Theft Auto franchise. And next year it will release a follow-up to its 2007 blockbuster BioShock a guaranteed multi-million unit seller, according to Michael Comeau on Minyanville.

The fact that Microsoft and Sony have recently slashed the price of their Xbox and Playstation consoles bodes well for sales of Grand Theft Auto and BioShock franchises both are targeted at those machines. The stock trades at around $12, down from $25 when the firm released its last BioShock in 2007. But with $213m in cash, and a string of million-selling titles in the pipeline, this $981m outfit is still worth a punt.

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