Video Game Sales Plummet in August: Are Smartphones to Blame?

Following flat sales in the month of July, video game sales plunged in August, according to market research firm NPD Group. NPD does not include sales from PC games in its monthly game sales data.

Overall US revenues decreased 10.0% year over year to $818.9 million, in sync with analysts’ expectations. Overall revenue dipped from $846.5 million in July and $1.1 billion in June. This was the worst performance recorded in August since 2006. Industry sales in the US are down 8%, year to date.

Hardware sales were down 5.0% year over year to $282.9 million. Handheld device sales fell 25.0% year over year, while console decreased 6.0%. We believe stiff competition from Apple Inc.’s (AAPL) iPod Touch and a higher number of smartphones caused the massive decline in the handheld segment.

Among the handheld devices, Sony Corp.’s (SNE) PlayStation sold 79,400 units in the reported month, down from 84,000 units in July, and 140,300 a year ago. Nintendo DS sold 342,700, down from 398,400 units in July, and 552,900 a year ago.

Microsoft Corp.'s (MSFT) Xbox 360 was the top-selling console in August for the third consecutive month. Xbox 360 sold 356,700 units, down from 443,500 in July, but up from 215,400 a year ago. The new slim format of Xbox 360 has gained immense popularity among video game players.

We anticipate further transitioning from old systems to new ones as the holiday season sets in, driving strong sales in the latter half of 2010.

Nintendo's Wii attained the No. 2 position while Sony Corp's PlayStation 3 came third. Sony PlayStation 3 sold 226,000 units, up from 214,500 in July, and 210,000 a year ago. Nintendo Wii sold 244,300 units, down from 253,900 in July, and 277,400 a year ago.

Software weakened further, with sales declining 14.0% year over year to $403.5 million. Accessories sales were down 6% year over year to $132.4 million.

Electronic Arts Inc's (ERTS) recently released Madden NFL 11 topped the best-selling video game chart for the month. Madden NFL 11 sold 920,800 units for the Xbox and 893,600 units for PlayStation 3.

Recently, Electronic Arts pre-released a portion of Medal of Honor. The Open Beta version allows players to play the game for three days through today, October 7.

Our Take
Although most industry analysts apprehend flat-to-negative growth for 2010, we beg to differ on the basis of a plethora of new releases in the second half of 2010 from Activision Blizzard Inc. (ATVI) and Electronic Arts, which are likely to drive sales in the second half.

We believe third-party publishers such as Electronic Arts and Activision Blizzard enjoy a healthy product portfolio. Electronic Arts is scheduled to release a new Medal of Honor in October and Activision Blizzard’s new Call of Duty: Black Ops will hit the market in November. Both the games are in the action genre with a strong fan following and have received satisfactory pre-release reviews.

In our opinion, the video game industry needs a blockbuster from either ERTS or ATVI to deliver strong sales in the near term. The second half has traditionally been a peak season for this industry. However, whether seasonal strength is sufficient to drive results this year remains something to look out for.

We believe this backend-loaded nature of growth adds to the risk of investing in video game companies, as underperformance of any single title would skew results, with sales and earnings missing expectations. Moreover, cut-throat competition, lack of price discounting opportunities in the holiday season and a higher cost of new game development make us cautious in the near term.