Competition from other console makers like Microsoft Corp. (NASDAQ: MSFT) and Nintendo Corp. (OTC: NTDOY) and a huge hacking scandal have combined to weigh on Sony’s sales of the Playstation. This could be more bad news for game designers like Activision Blizzard Inc. (NASDAQ: ATVI) and Take-Two Interactive Software, Inc. (NASDAQ: TTWO), both of which have seen customers move from packaged software to downloadable games. Game makers are selling more downloadable games, but revenue is lower than for packaged games although margins are higher.

The real culprits are smartphones from Apple Inc. (NASDAQ: AAPL), Nokia Corp. (NYSE: NOK), Motorola Mobility Holdings Inc. (NYSE: MMI) soon to be a division of Google Inc. (NASDAQ: GOOG), Samsung Electronics (OTC: SSNLF), and HTC Corp. We noted the continuing shift to smartphone games in our review of earnings from Activision’s earnings earlier this month.

Nintendo has already dropped the price of its 3DS handheld console from $249.99 to $169.99 in an effort to attract more buyers. After one week of sales in Japan, Nintendo’s efforts appear to have paid off with sales jumping to more than 214,000 from just over 32,000 in the week before the price cut.

Nintendo’s latest earnings were down by about 50% from the previous quarter and the company has lowered its sales target for its Wii console and lowered its profit target by more than 80%.

Sony would like to avoid that, but the debacle over the hacking attack and the lack of enthusiasm for the Playstation 3 from the beginning are going to be too much to overcome.

Combined with the continuing incursion from the smartphone makers, Sony may have waited too long to get on the latest train to leave the station. Sort of reminds us of how the company and its Walkman were blindsided by MP3 players. This won’t be the last price drop for the Playstation 3.

Paul Ausick

Game makers have finally gotten the message that packaged software sales are not likely to recover in the face of competition from digital sales. Activision reported second-quarter earnings yesterday, and adjusted EPS rose to $0.10, double the expected $0.05. Revenue also came in higher that the expected $602 million, at $699 million. Digital sales accounted for 60% of Activision’s revenue in the quarter.

Activision also raised its revenue guidance for 2011 from $4.05 billion to $4.18 billion and forecast an EPS boost from $0.61 to $0.68.

None of the traditional video game-makers is about to give up on packaged retail sales. The industry currently garners about 75% of its revenue from packaged sales, although some industry leaders expect that to drop to just 50% within the next five years.

For some game-makers that will mean a change in revenue mix, but a change in total revenues because digitally-distributed games generally don’t cost as much though margins are usually better. Revenue growth could be a problem unless game companies can figure out ways to get buyers to spend more on tokens and add-ons for the games they play.

Another thing that may have to change is the $40 price for a packaged game. That is considered by many gamers to be too high. If the game-makers are forced to drop their prices for packaged games and are, at the same time, seeing total revenues fall, they could find it difficult to convince investors of their value.

The other major shift is away from hand-held devices like Nintendo’s DS and 3DS and toward smartphones from Apple or companies using the Android operating system from Google Inc. (NASDAQ: GOOG). Even the pre-teen market, the largest for hand-helds, is perfectly happy to play games on an iPhone or other smartphone.

Nintendo and Sony have not fared nearly as well as Microsoft in the console/game market, primarily because Microsoft beat them to the punch with digital downloads and online gaming from the Xbox and Xbox Live. Nintendo expects to expand its digital offerings over the next three years. The company has already dropped the price of its 3DS in an effort to boost sales. It’s trying to avoid the same mistake that Sony made with its introduction of the PlayStation 3, when the $600 console kept buyers away in droves.

Avoiding past mistakes and adjusting to new distribution and revenue models is not going to be easy for game-makers. One thing that may make it easy to adapt is consolidation in the industry. That may be on the horizon sooner rather than later.

Paul Ausick

This week came news that the company is showcasing an innovative slate at E3, the 2011 Electronic Entertainment Expo, in Los Angeles from June 7 – 9.  Activision just announced that the beta for its much-anticipated online service “Call of Duty: Modern Warfare 3″ may be available as early as July 14, 2011. While the full capabilities of the service will not be on display until the launch of Modern Warfare 3, (expected in November) the early release will give users a taste of the experience and allow the service to be tested by gamers already playing Call of Duty®: Black Ops. In the five days since its announcement, the beta has already attracted over 1 million registrants.

Last year, “Call of Duty: Black Ops” became the most pre-ordered title in its history and “Call of Duty: Modern Warfare 3″ was noted as being significantly ahead of that pace.  Activision’s other current offerings also include Skylanders Spyro’s Adventure™ and PROTOTYPE® 2, Spider-Man™: Edge of Time, X-Men™ Destiny, The Transformers™: Dark of the Moon, and Wappy Dog.

One issue that we have had with the company is that it has kept its Activision brand site separate from Blizzard.  Maybe it wants the “Call of Duty” series to greatly outshine the “World of Warcraft” series from Blizzard, or maybe it wants to avoid cannibalization.

With all of the hack attacks hitting Sony Corporation (NYSE: SNE) and now hitting Nintendo (NTDOY), it seems that hackers might equally love to take down “the other monster” via World of Warcraft.  Is that a real threat, let’s just say “we’ll never know until we know.”  GameStop Corp. (NYSE: GME) has been turning itself around enough and becoming shareholder friendly enough that its shares have recovered handily.

Electronic Arts trades at $23.80 and its 52-week trading range is $14.06 to $24.79.  EA shares were at $40 to $45 before the end of 2008 and shares hit $60 back in 2007.

Activision Blizzard is harder to peg as a real long history because of the merger.  For the last two years this stock has been stuck in a trading range mostly between $10.50 and $12.50.  You can see it in the chart from BigCharts.com.  One thing it does have going for it is that it does pay a dividend.  In 2011, it paid a cash dividend of $0.165 per common share and that compared to a $0.15 dividend paid in 2010.  Our only suggestion on that front is that maybe a higher dividend could be paid, but more importantly it could move to a quarterly payout as American investors do not always want to hold a stock just for an annual dividend.

Thomson Reuters shows that a consensus analyst target is closer to $14.16 and most analysts have a positive ratings bias in the stock.  Part of the company is effectively an annuity business, and the other part is hit games.  We’ll see if the addition of the ongoing revenue model can help.

JON C. OGG

Sony’s plans hit the newsstands at the same time that Nintendo Co. Ltd. (OTC: NTDOY) announced the US release date of its 3DS portable game-playing console. The 3DS has two screens, one of which provides 3D images that are visible without special glasses. Both devices follow the release late last year of the Xbox Kinect from Microsoft Corp. (NASDAQ: MSFT), which has sold 8 million units in its first 60 days on the market.

Can either the new PSP or 3DS put a charge into the video gaming business? We noted last week that hardware sales fell 16% in December.  Without new hardware platforms, the video game industry could go into a tailspin, and the latest mobile hardware could wreak havoc on the console business.

The new Sony PSP will reportedly take advantage of Sony’s networked entertainment offerings to allow users to share games, movies, and music among a variety of devices. The PSP 2 will be announced next week, but pricing details are not yet available.

A more interesting device from Sony could be its smartphone for gamers, the so-called Xperia Play or PlayStation Phone from Sony Ericsson, which is also set to be shown at the Barcelona show. The bad news for the Xperia play is that it will have to go up against the iPhone from Apple Inc. (NASDAQ: AAPL). The Xperia Play is based on the Android operating system from Google Inc. (NASDAQ: GOOG), and besides competing with the iPhone, the new device will also have to contend with devices, yet unannounced, that use Microsoft’s Windows Phone operating system which Microsoft has committed to as its mobile gaming platform.

The hardware makers seem to be choosing to focus on the mobile gaming market. New consoles may not be able to match the mobile devices feature-for-feature, although the Kinect has demonstrated that there are still legs to the console market. Maybe Sony or Nintendo ought to look at improving their console players as well.

As in just about all things technological these days, though, mobile is the key. The greatest technological improvements are being made in mobile devices. Smaller, faster, cheaper, more energy-efficient mobile devices could drive a stake through the heart of the console business. The new PSP, the 3DS, and the PlayStation Phone may battle among themselves, but for game consoles, the war might already lost.

Paul Ausick

Our review for the best video game sector pick includes reviews of GameStop Corp. (NYSE: GME), ActiVision Blizzard, Inc. (NASDAQ: ATVI), Electronic Arts Inc. (NASDAQ: ERTS), THQ Inc. (NASDAQ: THQI), and Take-Two Interactive Software Inc. (NASDAQ: TTWO).  We have also had to focus on some key issues surrounding Microsoft Corporation (NASDAQ: MSFT) and Apple Inc. (NASDAQ: AAPL), along with Nintendo (NTDOY).

We have provided a basic table below.  After the table comes the company by company review, with our top video game pick of 2011.

THQ has announced uDraw™ GameTablet™.  This is the first product of the sort for drawing for gaming systems and this is a Wii™ exclusive for Ninetnedo (NTDOY).  In short, those digital artist pads that designers and recreational users have for their PCs will now have a junior version for the Wii gaming system.  It looks like it is for kids, but this will have a melt-up to mom and dad too.

The GameTablet launch is scheduled to hit retail store shelves for the holiday season with a suggested retail price of $69.99.  The tablet will come bundled with a drawing, coloring and art-based video game called uDraw Studio.

The other boost here is that two titles, Pictionary™ and Dood’s Big Adventure™, will also launch at the same time for $29.99 each.

The uDraw GameTablet will not be available to Europe and other international markets until early in 2011. THQ noted additionally that future waves of new video game titles are planned for next year and beyond.

The Tablet is approximately 9″ by 7″ and is 1″ thick.  It holds the Wii remote and art and drawings created in uDraw Studio can be saved to an SD card and emailed or printed out.

What is most surprising than anything here is that Wii did not launch this on its own.  It could have been free money.  Our last count on Wii consoles was more than 73 million units shipped worldwide, with about 35 million of those being from the Americas.

Wedbush Morgan research has been quoted around the web with this product being able to sell 1 million units without any real marketing efforts.  Our guess… there is a much larger opportunity here than 1 million units.  The Wii looked like a game terminal for kids when it launched.  It turned out that adults loved it too.

Thomson Reuters has estimates for fiscal-February 2011 estimates at -$0.04 EPS on more than $845 million in revenues and fiscal February 2012 estimates are $0.32 EPS and almost $923 million in revenues.  This will drive those estimates higher.

THQ shares are trading up over 7% up at $3.93 today on this launch.  Keep in mind that its 52-week trading range is $3.33 to $8.29.  It seems like the only real risk here is that the company either doesn’t spend a penny on marketing or if there are performance issues with the device.

This is one of those instances where demand is going to be created in a market that previously did not exist.  Sounds a lot like a mini-market that has an iPad comparison.  A page out of Apple’s playbook.

JON C. OGG

Apple has more than $45 billion in cash and equivalents.  We have to ask a simple question: would this even make a dent in the grand scheme of things.  A small company can be leveraged rapidly into the Apple operations.  There just seems to be no mega-hit in this move though.

There is a thought that Apple could consider.  There is a hot gaming platform out there that it is equally loved by its fans young and old alike.  The products also had much of the same look and feel to many of Apple’s products.  They make something called the Wii.

If Apple really wants into games, it should considering calling up Nintendo Co. Ltd. (NTDOY, 7974) while the video game sector is weak and suffering.  Steve Jobs could integrate the operations, and probably do it just in time for the next up-cycle in gaming.

JON C. OGG

This was out yesterday throughout the day but there have been rumors that Palm, Inc. (NASDAQ: PALM) may ditch the WebOS for Android.  Hardly seems fathomable, problems at Palm or not… (Wired)

More rumors keep coming about the Nintendo (NTDOY) 3DS launch after the company’s own announcement.

Verizon Communications (NYSE: VZ) is rumored to have the release date for its Nexus One launch next week.

Rumor or research from yesterday and today… Lexmark International (NYSE: LXK) is touted as a potential takeover target via an LBO according to Bank of America/Merrill Lynch.  You have to decide that one for yourself.

PAI Partners (French private equity) is considering an IPO of Danish food ingredients company Chr. Hansen. (Dow Jones)

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The 24/7 Wall St. Team

Where this story gets interesting though is not on Take-Two and the woes of one company.  Most video game stocks are not getting punished with Take-Two is not an “industry representative” for the whole sector.  But the problems are running deep in the sector and that is going to create more near-term uncertainty for many of the players.  The real cracks starting coming in October when NPD showed that the price cuts helped game sales only for a brief bit.

Nintendo (NTDOY) on the hardware side has been the real dog after being the hero for two years before.  And it has implications that run deep in the sector.  Nintendo was recently reported to have such low orders even after making formal price cuts to its Wii system that its parts and chip suppliers for the popular Wii gaming system now losing money. And to make matters worse, Wal-Mart Stores Inc.(NYSE: WMT) just came out with yet more price cuts and bundled-prices for the Wii and its game titles.  That is only one gaming system of the three major systems.

Amazon.com (NYSE: AMZN) also decided to make a steady push into the video game sector for both new and used games via trade-ins.  New games is one thing.  But used games, this goes directly head to head with GameStop (NYSE: GME).  GameStop took it on the chin when Wal-Mart made its price cuts for popular game titles, and that was not just for Wii.  There have also been price cuts announced by Sony (NYSE: SNE) for its PS3 system and Microsoft Corp. (NASDAQ: MSFT) for its Xbox 360.  Despite sales prices cuts there have not been any steady growth figures in systems sales when you look for prior comparisons.  In short, the system sales look to be dwindling over time.

The game titles are mixed out there.  Activision Blizzard (NASDAQ: ATVI) set a record and then some with the launch of “Call of Duty: Modern Warfare 2.” That launch was so large that it blew movie sales out of the water.  Activision Blizzard also has that huge World of Warcraft franchise that adds steady revenues in the MMORPG arena, and it also sells Guitar Hero and Band Hero.   Electronic Arts (NASDAQ: ERTS) did not do well with its last earnings report, not because its revenues beat estimates, but because the guidance failed to create excitement and because cost cutting via layoffs and development center closures does not exactly breed optimism that a turnaround is coming soon.

Most of the core video game players are at severe discounts to their recent highs if you go back beyond a 52-week period and into 2007.  GameStop is down almost by two-thirds.  Electronic Arts (NASDAQ: ERTS) is down over two-thirds, while Activision is now more steady and just within a long-term trading range as it is a matured and giant company after the Activision and Blizzard merger.  There is just one issue despite all this negativity and uncertainty.

It seems that the game systems will go for a next-generation platform upgrade with announcements starting in 2010.  But the industry expectation is that this will not be out until the Holiday Season for 2011… or even 2012.  If you can look out beyond the horizon of the coming days, then video game publisher valuations may start to look attractive.  Just don’t be looking for the quick buck on this sector.

There is a wild card and it is a big one.  Apple (NASDAQ: AAPL) is rumored to be wanting into the video game sector above and beyond its “App Store” games for iPhone.  It can’t cut out the game publishers in that arena, but how it prices systems and games and how it sells the games would be an open-ended question… as would be who wins and who loses.  There is also the notion that four major platforms might just be too many to go around.

Jon C. Ogg

For some further data, we noted at the end of October how Nintendo announced that from April to September it only sold 5.75 million units of the Wii, down from 10 million in the same period the year before.  And the figure for the year down to 20 million.

There is just one problem with all of this…. Nintendo followed Sony’s PS3 and Microsoft’s Xbox 360 price cuts for the gaming console.  This spells trouble for GameStop Corp. (NYSE: GME) and other pure-play gaming retailers.  Lower new units and lower priced and discounted video game titles galore.  That creates margin pressure even if unit sales hold up.

The recession and rise in unemployment was supposed to keep video games and other stay-at-home trade stocks somewhat insulated.  When prices are lower and unit sales are lower, that does very little for anyone.

There is a cure, and you’ll probably start hearing about it by mid-2010… A whole new slate of video game consoles from the manufacturers for 2011.

JON C. OGG