Analyst: 'Time to Look Forward Into the Past'

A new report from analyst group DFC Intelligence's David Cole attempts to understand the trends of this holiday season's transitional console period in terms of the last, and gives credit for the market's growth to an unlikely source -- one of the industry's biggest retailers. The full text of Cole's report, which was released with full charts as referenced in the text on the analyst firm's official website, follows below: "Holiday season always brings a great deal of attention to the video game industry. Therefore, December is the time of year DFC Intelligence likes to analyze how the hype has hit Wall Street. In the past, we have discussed how stock prices tend to rise in anticipation of the holiday season only to dip in December over worries that this year Christmas will not come. The usual trend is for a pickup in the early part of the New Year when the market sees Santa delivered more than just coal. January and February are usually the time when reporters are working on stories on how the video game business is bigger than Hollywood box office. However, this holiday season is different. Since the 1970s, the video game industry has gone through five year cycles of hardware. We are currently in a transition period between hardware platforms. In November 2006 the Nintendo Wii and Sony PlayStation 3 were introduced. Five years earlier, in November 2001, it was the Nintendo GameCube and Microsoft Xbox entering the market. Therefore, when looking at industry trends it is very important to look at what happened in past transition periods. Last year we described how a transition period can be different when it comes to stock prices. In our brief entitled “Are Game Company Stocks Due to Soar in 2006” we described how excitement over new game systems generates buzz that could help drive the stock prices for leading publishers. As the chart above shows, the major video game stocks did show an increase in 2006. Furthermore, the most dramatic increase occurred in the second half of 2006. In the first part of the year, most game company stocks were down significantly. Of course, game company stocks are also very subject to general market trends. However, the second half of 2006 proved much better than expected. The Xbox 360 has come into its own and after only a year on the market a big title like Gears of War can leap out of the gate with one million units sold in its first two weeks. However, if history is any indication there must be some concern that the market may have over expectations. In 2006, the real strength of the game industry has come not just from the Xbox 360 but more from the continued momentum of the PlayStation 2 and a resurgence for Nintendo platforms. The problem with this is 1) the PlayStation 2 is clearly on the decline as a platform for new software and 2) third-party publishers have struggled to make money from Nintendo platforms. As the charts below show, in 2001 there was a similar run up on game company stocks, followed by a slowdown in 2002 and 2003. The market did not really pickup until the second half of 2003 (THQ took until 2006 for its stock to reach the December 2001 price). It is just a cold hard marketplace fact that it takes awhile for a new hardware system to build an installed base. In the meantime, revenues and profits tend to suffer. Over the last five years the basic fundamentals of the game industry have changed very little. Despite all the hype about the Internet, MMOGs, digital distribution, advertising in games and so on, games are still very much a retail driven business centered around big name franchises, often times licensed from other media. The big products of holiday 2001 were Grand Theft Auto III, Halo, Final Fantasy X and Madden NFL 2002. Flash forward five years and we are talking Grand Theft Auto IV, Halo 3, Final Fantasy XII and Madden NFL 07. DFC Intelligence argues that probably the biggest driver of industry growth has been the emergence of the GameStop retail chain. What GameStop, and to a lesser extent Hollywood Video’s GameCrazy, did was bring games to suburban strip malls. We discussed this trend back in December 2003. Since that time GameStop has continued to grow. After buying rival Electronics Boutique in 2005, GameStop now has over 4,400 stores around the world. As the chart below shows, investors have clearly rewarded GameStop’s initiatives. December is always a great time to look back so that one can start to prepare for the New Year. At DFC Intelligence we spend a great deal of time discussing emerging trends. Nevertheless, we always like to stress the importance of understanding the basic bread and butter issues. Emerging technology creates new opportunity, but understanding the existing market is crucial. Market changes tend to be evolutionary, not revolutionary, and with a solid history as a guide there is really no excuse for being caught by surprise." [Thanks again to DFC Intelligence analyst David Cole for his work reprinted here.]