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Earnings Watch: Videogames entered the mainstream in the pandemic, but the industry faces a rough transition

For decades, Wall Street has viewed videogames like most Americans: A fun little diversion from everyday life, but not something to take too seriously.

The dynamic has been changing for years, and flipped permanently during the COVID-19 pandemic, which saw the videogame industry go far beyond just overtaking Hollywood in revenue and importance to the market. The three main public U.S. videogame publishers — Activision Blizzard Inc.
ATVI,
+0.06%
,
Electronic Arts Inc.
EA,
+0.40%

and Take-Two Interactive Inc.
TTWO,
+2.02%

— were worth nearly $150 billion at their 2021 peak, while some of the biggest names in tech — from Apple Inc.
AAPL,
+0.15%

to Microsoft Corp.
MSFT,
-0.55%
,
and Nvidia Corp.
NVDA,
-0.83%

to Advanced Micro Devices Inc.
AMD,
+3.15%

— depend on gamers for big revenue.

For more: Gamers spent billions more on videogames during the pandemic

With greater relevance comes greater scrutiny. Videogame studios have sometimes operated like the fun little diversions in product development, forming small groups willing to fail spectacularly in search of a big hit, while paying little and supervising employees even less. Those issues came to light again when the state of California recently sued Activision Blizzard, portraying a toxic workplace culture, and employees revolted after executives’ initial response. Activision executives reversed course after the internal revolt, which sparked renewed calls for scrutiny at another videogame maker that faced a similar reckoning last year, French company Ubisoft Entertainment SA
UBI,
-0.70%
.

Employees are not alone in seeking a change in practices in the videogame industry. MarketWatch readers may remember that Activision already faced a revolt from shareholders as well this year, thanks to a yearslong fight over Chief Executive Bobby Kotick’s compensation, and EA investors have voiced similar misgivings about executive-pay practices. Activision investors sent its stock to its worst week in more than a year amid the most recent controversy, down 8.6%, and shares are now down nearly 10% on the year despite strong growth.

Expectations for upcoming earnings reports show that Wall Street, like employees, are expecting these companies to show greater maturity. While the boom in videogames during the pandemic has brought new investors and attention, the companies are expected to struggle to show gains from last year as they lap the beginning of the COVID-19 pandemic.

Opinion: 7 smarter ways to play the boom in videogames and esports than buying GameStop

While Cowen analyst Doug Creutz doesn’t expect a major downturn in the third quarter, he cautioned in a recent note that investors “may see some softening” after a second quarter of beats, but believes fundamentals are strong “with 2020’s growth spurt due to shelter-in-place not appearing to reverse despite increasing levels of vaccination.”

Analysts also see the same problem that many gamers voice: The industry doesn’t seem to be heading anywhere new and exciting, with sequels and retreads lining the release calendar, and potential next-generation technology such as augmented- and virtual-reality and streaming not looking strong enough yet to support a strong “secular thesis,” Creutz wrote.

VR, AR and other new technologies “are good businesses, with above-GDP growth prospects for the foreseeable future (assuming competent execution), but we believe there is no shiny overarching thesis to bring new money in,” Creutz said.

See also: Videogames are about to get more expensive for the first time in 15 years

Creutz has outperform ratings on Take-Two, EA, and Zygna
ZNGA,
-1.08%
,
but a market perform rating on Activision. All four of those companies will report earnings this week — Take-Two on Monday, Activision on Tuesday, EA on Wednesday and Zynga on Thursday. Look for signs that the growth in videogames may slacken in the months ahead, and the companies themselves may be looking to change.

“Ultimately, we think commentary about trends the companies are seeing in Q3 will be the most important factor during reporting season, with the potential to reassure investors that the gains in engagement and monetization made during the pandemic are in fact quite sticky,” Creutz wrote.

The numbers to watch
  • COVID-19 vaccine sales. Moderna Inc.
    MRNA,
    +2.30%

    reports earnings on Thursday for the first time since joining the S&P 500 index
    SPX,
    -0.54%
    ,
    and all eyes will be on the company’s sales of its COVID-19 vaccine. Pfizer Inc.
    PFE,
    +0.05%

    reported roughly $8 billion in vaccine sales, putting it on pace to approach $34 billion in annual sales. Pfizer confirmed plans to seek U.S. approval for a booster shot while confirming a higher per-shot price in a recent deal with the U.S., from $19.50 to $24, according to Mizuho Securities analysts. Investors, who have pushed Moderna shares up more than 377% in the past year, will be looking for similar information from executives.
  • Ride-hailing recovery. Uber Technologies Inc.
    UBER,
    -2.75%

    and Lyft Inc.
    LYFT,
    -2.50%

    report results this week, and both ride-hailing companies are trading lower than the prices commanded during their 2019 initial public offerings. The companies have been struggling to get drivers back in their cars while struggling to properly incorporate new pay practices in California. Investors will be looking for signs that some of the pandemic-related issues in ride-hailing are easing, while looking carefully at Uber’s expensive attempts to boost its other businesses.

Full earnings preview: Uber looks beyond ride-hailing as rebound and quest for profit continues

The call to put on your calendar
  • Alibaba Group Holding LTD.
    BABA,
    -1.19%

    Amid questions about the future of Chinese stocks listed on U.S. exchanges, the biggest of that group will report earnings Tuesday morning. Alibaba stock plunged 13.9% in July, its worst monthly performance in more than two years, even though analysts such as Raymond James’s Aaron Kessler say, “We believe most of these new regulations do not impact Alibaba.” Expect executives on the call Tuesday to address those concerns, while playing up the company’s quarterly performance, which included the 6/18 shopping event in China.

Full earnings preview: Alibaba stock has taken a hit from China crackdown, but its earnings could be a different story

This week in earnings

Roughly 148 S&P 500 companies are expected to report this week, according to FactSet, while only one Dow Jones Industrial Average
DJIA,
-0.42%

component is on the calendar, Amgen Inc.
AMGN,
-0.38%

on Tuesday. The calendar is stacked with companies not in the major indexes, though, including Alibaba and Lyft on Tuesday, Uber on Wednesday, Beyond Meat Inc.
BYND,
-1.49%

and fresh spin-off Vimeo Inc.
VMEO,
-2.99%

on Thursday, and DraftKings Inc.
DKNG,
-2.59%

on Friday.

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