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Market turmoil takes costly toll on video games

October 04, 2008|Alex Pham | Times Staff Writer

The swoon in video game shares this week, as with the rest of the stock market, can make any investor queasy.

The video game sector dropped much more sharply than the Nasdaq. Activision Blizzard Inc. saw more than $4 billion in market value vanish this week, close to a quarter of the Santa Monica company's value. Electronic Arts Inc. lost more than $2 billion.

Theories abound about why game companies are suffering worse than the broader market, calling into question the notion that the sector is recession-proof because it provides more entertainment bang for the buck.

One explanation is that no good deed goes unpunished. More than 90% of game stocks are held by institutions such as hedge funds and mutual funds that are attracted by the sector's strong sales growth. When the market collapsed Monday, hedge fund investors seeking to minimize their losses cashed out, said one hedge fund investor who declined to be identified. Mutual funds also dumped game stocks to take their profits sooner rather than later.

Panic is another explanation. "Sell first, ask questions later," said Michael Pachter, an analyst with Wedbush Morgan Securities. "It's an insane overreaction."

Games are also caught up in the hand-wringing over the retail sector heading into the holidays. With a big chunk of video game sales occurring during the last three months of the year, a collapse in consumer confidence could have a disproportionate effect.

"Consumers are going to be very value-conscious," said Jack Kyser, chief economist at the Los Angeles County Economic Development Corp. "This means you have to produce killer titles or it's going to be a rough Christmas for you."

Kyser said games, while vulnerable, could still do well if consumers switch away from more expensive forms of entertainment, such as theme parks and live sports events. "People are looking for alternatives," he said. "With video games, you can play it again and again."

Analysts remain bullish on the industry. Pachter projected that worldwide sales of games and consoles would grow 23% this year from 2007 to just over $50 billion.

"We're still going to spend the same amount of hours entertaining ourselves," Pachter said. "It's just a matter of which entertainment we choose to buy, and games are still perceived to be a super value."

With consumers feeling the pinch in their pocketbooks, this holiday season may turn out to be more cutthroat than usual for the hundreds of video games set to hit store shelves.

Analysts predict that only top-tier titles and those that are highly rated by critics will thrive as consumers pare down spending in the fourth quarter, when the industry typically pulls in 40% of its revenue.

This will be particularly true of shooter games. The genre is highly sensitive to quality rankings doled out by reviewers, generally on a scale of 0 to 100.

"It is pretty detrimental to sales for a shooter game to achieve a score below 80%," said Jesse Divnich, director of analytical services at Electronic Entertainment Design and Research in San Diego. "Simply put, if you want to make a first-person shooter, aim to achieve quality scores above 80%. If not, don't even bother."

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alex.pham@latimes.com

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