Video Games Sales in a Rough Patch

Video game sales for the month of May 2012 plunged 28% to $516.6 million from the comparable previous-year period, according to market research firm NPD. The downtrend is consistent with the decline faced by the industry in the last 6 months. Moreover, sales were down 18% sequentially. The decline in sales was primarily due to the lower number of title releases.

However, NPD noted that in addition to physical retail sales, consumer spending on social games, digital downloads, and used and rented games amounted to $1.17 billion, which increased from $1 billion in April 2012.

Software sales, including PC games sales were $335.2 million, which dropped 16% from the previous-year period. Interestingly, PC game sales soared 230% to $80 million primarily due to the release of Diablo III, which somewhat offset the fall in software sales. Excluding PC game sales, software sales dropped 32% to $255.4 million.

Amidst the dismal scenario, Activision Blizzard Inc.’s (ATVI - Snapshot Report) Diablo III had a blockbuster debut and was the top-selling video game title in May. Take Two Interactive’s (TTWO - Snapshot Report) Max Payne 3 and Ubisoft’s Tom Clancy’s Ghost Recon: Future Soldier claimed the second and third spots, respectively. The fourth and fifth spot went to Activision’s Prototype 2 and Take Two Interactive’s NBA 2K12. Popular titles such as Modern Warfare 3 and Battlefiled 3 lingered in the sixth and eighth positions, respectively.

Hardware sales had no respite either, dropping 39% from the comparable month in the previous year to $138.9 million. Apart from the Nintendo 3DS, which increased 17%, all other popular consoles suffered year-over-year declines in terms of units sold. Microsoft Corp’s (MSFT - Analyst Report) Xbox 360 was again the top-selling console for the 15^th straight month with 160K units of Xbox 360 being sold. Accessories sales increased 7% from May 2011 to $122.3 million.

According to NPD, new physical retail sales (software, hardware and accessories) generated approximately 50%-60% of total sales. The firm also noted that a 27% year-on-year decline in the new title releases accounted for the overall decline in the industry. However, NPD said that the recently concluded E3 meet had some promising titles, which, post their release in the latter part of the year, should positively impact the industry.

The ongoing transition from the physical to the digital platform will ultimately benefit the video game industry over the long term. As compared to the physical platform, digital games are more profitable since they require minimum packaging cost. This cost effectiveness has helped publishers to use the digital format to keep a popular franchise running profitably over a longer period of time. Online gaming is also expected to witness growth at the expense of retail sales, owing to the growing popularity of digital distribution and free-to-play browser games.

We believe that consumers are increasingly spending more on smartphones and portable devices (such as the iPad) as compared to traditional devices for playing online games. This trend keeps us optimistic on the video game industry over the long term.

The video game business is very much cyclical and is also highly dependent on time-to-time upgradation/introduction of new game hardware systems. Lower demand for hardware systems also hurts video game sales.

However, we believe that publishing companies that are focusing on the digital segment will stand out even amid sluggish market conditions. For instance, some companies like Electronic Arts Inc. (EA - Analyst Report), Zynga (ZNGA - Snapshot Report) and Activision are well positioned to benefit from this trend going forward.

We believe that including digital gaming, the video gaming industry is poised for significant growth going forward. However, the highly fragmented video game retail market will see continued competitive pressures. Therefore, overall profitability will remain a concern