Cashing in on the Next Gaming Cycle

Cashing in on the Next Gaming Cycle

For some people, this holiday season will provide a very difficult choice. Though many people who buy gaming consoles are billed as "hard core gamers," this is a bit too broad of a brush stroke. Microsoft and Sony are rolling out their next generation gaming consoles in time for holiday shoppers. However, investors looking to cash in on this next cycle in gaming should probably consider the companies producing the games, rather than the companies behind the new hardware.

Do new consoles equal renewed interest?
Some news outlets have speculated that the Xbox One and the PlayStation 4 may spur renewed interest in gaming. While it's true that these consoles will likely sell well, the idea that these consoles will "reboot" the traditional gaming business might be a stretch.

One of the challenges is the age of the vast majority of popular consoles. The Xbox 360 was introduced back in 2005, and eight years of using one system is a long time in the gaming world. With the PlayStation 3 going on seven years old, gamers have become very comfortable with this system.

The problem with such a long lifecycle between systems is the amount of money and time that has been invested in them. For gamers who purchased multiple games and upgrades, and have spent countless hours perfecting their rosters, load outs, and profiles, starting over could be a daunting task.

The fact that Sony wants $399 and Microsoft wants $499 for these game systems is another challenge. For domestic consumers facing a government that can't seem to agree on anything and a challenging job market, dropping this kind of money on a new system might not be an option.

If the consoles won't bring the gamers to the table, what will?
What investors should focus on are the new games being launched by several of the industry's key players. Between Activision-Blizzard's release of Call of Duty: Ghosts, Electronic Arts selling Battlefield 4, and Take-Two Interactive selling Grand Theft Auto V, gamers have a lot to fight over.

With huge titles and new consoles, one might expect this to be another reason for gamers to make the switch to new hardware. However, multiple issues crop up. First, demand for Grand Theft Auto V has been huge, and that's not necessarily good news for Microsoft and Sony.

With Grand Theft Auto V generating over $1 billion in revenue without these consoles, this means gamers were more than willing to part with roughly $60 per copy to get the game for their existing system. For the millions buying this title, the likelihood that they will then buy a new gaming system goes down tremendously. Second, while Call of Duty: Ghosts and Battlefield 4 will be available on the Xbox One and PS4, they will also be heavily supported on Xbox 360 and PS3.

Long story short, it's the games that matter more than the systems. It's possible that gaming has reached the point that computers did years ago. Maybe the hardware advancements just aren't impressive enough to require an upgrade. With all of this in mind, investors need to look at the game lineup of the big players and decide who will benefit the most.

Invest for today, next year, and the year after that
If you are looking for the biggest beneficiary to the huge titles being released today, it's hard to argue that Take-Two Interactive might be the best short-term bet. With Grand Theft AutoV breaking sales records, and upcoming or current releases like NBA 2K14 and WWE 2K14, the company is betting heavily on the end of this year. With the stock selling for a forward P/E ratio of less than 7, and analysts expecting sales and EPS to double between 2013-2014, the stock looks like a deal.

If you want a long-term investment, Activision-Blizzard is a good choice, as the company's Call of Duty, Skylanders, Diablo, and World of Warcraft franchises are all doing well. In the short-term, the company's buyout of Vivendi's ownership will suck away a lot of cash from the balance sheet. That being said, the company generated over $3 billion in core free cash flow (net income + depreciation - capital expenditures) in the last four quarters.

If you are looking for a longer-term play, Electronic Arts could be a good bet closer to the 2014-2015 timeframe. The company's Battlefield franchise looks strong, and FIFA is a worldwide hit. However, problems with the NCAA will likely prevent future college football games. In addition, the company's connection to the Star Wars franchise with Disney may gain rekindled interest when new movies begin to surface in 2015 and beyond.

Foolish final thought
In the end, there is a lot of excitement about the new consoles. However, investors looking to buy Microsoft or Sony based on this new hardware are missing the point. Smart investors will look at the companies producing the games, and wait to evaluate when and if the hardware replacement cycle will really take hold.

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Chad Henage has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard and Take-Two Interactive. The Motley Fool owns shares of Activision Blizzard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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