Why These Once-Hot Stocks are Set for a Comeback

The risky part of investors blindly counting on long-standing hot streaks is that when the streaks finally turn cold, the fallout is enormous. On the flipside, the resumption of those winning streaks makes for incredible turnaround stories.

There’s no better example of this than the video game industry, which just became investment-worthy again.

In 2009 — and for the first time in many, many years — sales of video games and gaming consoles actually fell. So much for the “video games are recession proof” theory, right?

Well, no, not exactly.

While the recession got the blame for declining video game sales, there’s a more obscured reality that hasn’t been voiced about the industry’s 2009 demise. More important, it’s a reality that bodes well for the shares of video game software designers.

What really happened between 2008 and 2009? For lack of a better way of saying it, most of 2009’s new game releases stunk.

#-ad_banner-#The video game titles “Grand Theft Auto IV,” “Call of Duty” and “Guitar Hero” are quickly recognized as some of the most successful and best-selling video games in recent history. Their sales made decidedly-positive impacts on the bottom lines of their developers, too.

Take-Two Interactive (Nasdaq: TTWO), for instance, sold 11.9 million copies of “Grand Theft Auto IV” — the single best-selling title for the Xbox 360 and PlayStation consoles — pumping up the company’s top line by +56% in the same fiscal year of the game’s release. Activision-Blizzard (Nasdaq: ATVI) sold 12.0 million copies from its red-hot “Call of Duty” series and sold another 9.3 million copies of “Guitar Hero” games in the same year, and beefed up its top line by +124% for the annual period.

There’s one common element for all three games… each was launched in 2008, pushing the industry to its best-ever annual revenue.

Now fast-forward to 2009, when nothing even close to 2008’s game successes could be found on shelves… save one.

The single-best selling title in 2009 (among games that weren’t pre-packaged in the gaming console) was easily Activision’s newest entry into the “Call of Duty” series, “Modern Warfare 2.” About 15.0 million copies were sold, and Activision grew its top line by another +41%. One can only wonder how big the bump may have been if the company had published another version of “Guitar Hero.”

Take-Two Interactive, conversely, didn’t even manage to put a single game into 2009’s top-seller list. Not surprising, Take-Two’s top line shriveled by -37% that year.

Indeed, most designers were in the same boat as Take-Two was in 2009, failing to publish anything as exciting as what they had published in 2008. Game sales in 2009 weren’t a victim of the recession; they were a victim of lousy games nobody wanted to buy.

Yes, one could make the argument that gamers didn’t want 2009’s games because they couldn’t afford to buy them. The success of “Call of Duty: Modern Warfare 2” that year trumps the argument, though. More “Call of Duty” games sold in 2009 than in 2008, and the actual game play between all those versions is nearly identical. If gamers can cough up the money for a revamped version of a game they likely already own, they could reasonably spring for other gaming titles, too.

Now fast-forward to today. Not that one broken record is an absolute sign of perfect health for the entire industry, but it’s sure not a strike against it either. In any case, the all-time record for the first five days of sell-through for a new game title was witnessed in November of this year. The game? No surprises here — Activision-Blizzard’s latest entry in its “Call of Duty” line, “Black Ops.”

Take-Two, having learned the importance of blockbusters in 2009 (when it didn’t have one), righted that wrong. The company’s “Red Dead: Redemption” game has sold 6.7 million copies this year, putting it near the top of the heap for the year so far. Needless to say, this year should be much better than last year for Take-Two.

It’s not just better games driving the industry’s revival, though. The recent releases of Microsoft’s (Nasdaq: MSFT) motion-based Kinect controller for the Xbox and Sony’s (NYSE: SNE) similar Move for the PlayStation 3 open up a whole new creative outlet for game designers that didn’t want to develop a motion-based game that can only be played on Nintendo’s (PINK: NTDOY) Wii platform.

Bottom line? If the 2006 launch of the Wii is any indication, revenue growth could gain traction for years on the heels of the industry’s reinvention. And, with a new-found understanding that one hit title is apt to bear more fruit than several mediocre games, look for a slightly smarter business model from these companies going forward.

Action to Take –> The introduction of the Kinect and Move hardware won’t mean a great deal for the likes of Microsoft or Sony, each of which derives the bulk of revenue in other arenas. But, that new hardware will further boost game designer revenue.

With a legitimate blockbuster back on the list of Top 20 selling video games, Take-Two Interactive is positioned for strong revenue and earnings this quarter, and probably a couple more. And, not that Activision-Blizzard needed reviving, but another smash hit in its “Call of Duty” series can only bode well for the company, setting up more monster-sized growth. Both designers have compelling ideas in the pipeline as well. Each stock can easily be considered a worthy investment candidate once again