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Shares of  Electronic Arts (EA - Analyst Report) surged 11.9% ($2.56) to close at $24.10 on Jan 17, 2014, after market research firm NPD announced that three of its games for next-generation consoles were in the Dec 2013 top-ten sales list.

EA’s Battlefield 4 retained the #2 spot, while Madden NFL 25 captured the #4 spot, and FIFA 14 claimed #9. Per EA, this represents 30.0% market share among games available on Microsoft’s (MSFT - Analyst Report) Xbox One and 40.0% for Sony's PlayStation 4.  

We believe that the strong sales from these three titles will boost EA’s top line in the near term. Moreover, EA’s innovative product pipeline is a strong positive. The company is set to launch its much-anticipated first person shooter game Titanfall at the end of March this year on Microsoft’s Xbox One, Xbox 360 and personal computers.

December and 2013 Video Game Sales

Despite EA’s impressive performance, retail video game software sales declined 17.0% year over year to $1.31 billion in December. This was slightly higher than $1.09 billion reported in November, but considerably higher than $482.5 million reported in October.

NPD cited few game releases in the month as the primary reason behind this downfall. Moreover, growth in sales of new console games failed to offset the negative impact of plunging game sales for the older hardware.

Hardware sales soared 28.0% year over year to $1.37 billion, slightly better than November sales of $1.3 billion, as the gamers continued to spend on new consoles from Microsoft and Sony. However, NPD noted this huge spending on hardware as another reason behind the decline in software sales.

Activision’s (ATVI - Snapshot Report) Call of Duty: Ghosts and EA’s Battlefield 4 retained the #1 and #2 positions, respectively. Ubisoft’s Just Dance 2014 was the #3 game that pushed its own Assassin’s Creed 4: Black Flag down to the #6 position.

Nintendo’s 3DS portable was the top-selling hardware in December. Although Microsoft continues to face problems in supply chain, the company announced that it has sold 908,000 Xbox Ones and 643,000 Xbox 360s in the month, much ahead of Sony’s PS4 and PS3.

However, Sony claimed that PS4 remained the leading next-generation console on a cumulative basis. Earlier this month, the company announced that it has sold 4.2 million PS4 globally by the end of 2013.

Overall, video game sales increased 2.0% to $3.21 billion in December, better than $2.74 billion in November and $791.1 million in October. In 2013, video game sales declined 2.0% to $12.97 billion compared with $13.27 billion in 2012.

Hardware sales increased 5.0% year over year to $4.26 billion, while software sales declined 11.0% to $6.34 billion. Accessory sales increased 3.0% to $2.6 billion.

Take-Two Interactive (TTWO - Snapshot Report) had an impressive 2013, as its Grand Theft Auto V was the top-selling game followed by Activision’s Call of Duty: Ghosts and EA’s Madden NFL 25. Nintendo’s 3DS was the top-selling hardware platform in terms of unit, while Xbox one was the top-selling hardware in terms of dollar.

Digital Games Sales

According to market research firm Super Data, overall digital sales increased 11.0% to $11.77 billion in 2013 compared with $10.58 billion in 2012. In December, sales increased 36.0% year over year to $1.2 billion.

Revenues from social games decreased 22.0% to $1.8 billion in 2013. Mobile gaming revenues surged 29.0% year over year to $3.1 billion. Free-to-play revenues jumped 45.0% year over year to $2.9 billion.

Subscription-based MMO revenues were $1.1 billion, down 21.0%, while downloadable game content sales increased 13.0% year over year to $2.9 billion in 2013.  

Our Take

We expect video game retail sales to improve significantly in 2014 due to strong unit sales of new consoles from Microsoft and Sony.

Although we expect retail software sales to increase in 2014 (due to new game releases), the long-term outlook remains bleak. According to PwC, worldwide console game sales are expected to grow 4.2% to $26.0 billion in 2013 and 6.4% in 2014. However, this is much slower than the 28.0% growth reported in 2007, after the release of Xbox 360 and PlayStation 3 consoles.

We believe that slow software sales growth reflects ongoing consumer transition to smartphones and tablets. We expect increasing revenues from mobile and downloadable contents (DLCs) to drive digital revenues, going forward. Mobile has strong growth potential due to improving gaming quality, which is a major factor behind higher user spending.

Further, game developers such as EA and Activision are actively using the digital distribution platform to provide additional downloadable contents for popular titles such as Battlefield and Call of Duty. This will further boost revenues from DLC, going forward.

Among the traditional gaming companies, we believe EA, Activision and Take-Two Interactive have significant growth opportunities due to their innovative product pipeline in the near term. However, market fragmentation remains a major near-term headwind.

Currently, Activision has a Zacks Rank #1 (Strong Buy). Take Two has a Zacks Rank #3 (Hold), while EA carries a Rank #4 (Sell).

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