Investors tend to focus on companies that are No. 1 in their sector, which explains why videogame publisher Activision Inc., the No. 2 player, sometimes gets short shrift when compared with its nemesis, Electronic Arts Inc.


Activision is more than one-third the size of Electronic Arts, when measured by revenues. Yet with a market cap of just over $3 billion, it is afforded less than one-sixth the value of its larger rival.


Activision could soon find that the playing field begins to level out.


The Santa Monica-based company, which is poised to report quarterly earnings on Feb. 7, is breaking out of its image as the publisher known for the "Tony Hawk" skateboarder games, scoring recent hits with "Doom 3" and "Spider-Man 2."


And it is being viewed by larger media companies as a takeover prospect.


Activision shares got a boost on Jan. 13, when News Corp. President and Chief Operating Officer Peter Chernin, speaking at a Smith Barney Citigroup conference in Phoenix, talked about "kicking the tires of pretty much all videogame companies." Activision notched a 13 percent gain over two days before hitting resistance at $22.35 a share.


Chernin told analysts that he saw a gap between the price tag commanded by Electronic Arts, which reported ho-hum earnings last week, and the next tier of companies like Activision.


"People used to view Electronic Arts as Snow White, while Activision and the other publishers were the Seven Dwarves," said Michael Pachter, an analyst at Wedbush Morgan Securities, who has a $25 price target on Activision's stock. "But now Activision is focused on making every game a 1 million-unit seller. They have a bunch of good games with legs left in them, with sequels, and new content next year."


Worldwide video game sales hit $20 billion last year a figure that now exceeds the movie industry's annual domestic box office receipts.


The industry has attracted interest from Viacom Inc.'s Sumner Redstone, who has accumulated an 80 percent stake in Chicago-based Midway Games Inc., publisher of the "Mortal Kombat" series.


Microsoft Corp., maker of the Xbox device, is also rumored to be sniffing around.


Two other game publishers getting attention are Take-Two Interactive Software Inc., the maker of the "Grand Theft Auto" series, and Calabasas Hills-based THQ Inc., which has licensing agreements with World Wide Wrestling and Nickelodeon.


Optimism


With strong recent earnings reports and a solid title lineup, Activision has posted an 81 percent increase in its stock price in the past year, to $22.11 as of Jan. 26.


Analyst Bill Lennan at WR Hambrecht reiterated a "buy" rating on Activision last week with a 12-month price target between $21 and $27 a share. He said in a research note that Activision will benefit from consolidation in the industry given its substantial cash reserves.


Arvind Bhatia, an analyst at Southwest Securities Corp. in Dallas, said Wall Street is bullish on Activision because the company already gave strong guidance for the third quarter ended Dec. 31.


In December, the company said it expects to report a 12 percent rise in net income to 55 cents per diluted share, versus 49 cents per diluted share in the year-ago period. Revenue is expected to increase 23 percent to $615 million.


By comparison, Redwood Shores-based Electronic Arts said last week that revenues and profit both fell in the all-important holiday period, its third quarter ended Dec. 31. The company also handed out pink slips to 60 programmers, designers and managers in its L.A. studios in Playa Vista.


Like all video game publishers, Activision is hugely dependent on blockbuster titles to drive sales. "Spider-Man 2" and "Doom 3" contributed 42 percent towards revenue in the Sept. 30 quarter.


Its license with professional skateboarder Tony Hawk, which runs until 2015, has produced five titles and cumulative revenues of more than $820 million. Activision has nine games that shipped more than 1 million units each in 2004, up from just four blockbuster titles in 2003.


Still, competition is fierce. All game publishers are trying to gain economies of scale and create strong title lineups to prepare for the release of next-generation game devices.


Activision said its purchase earlier this month of Vicarious Visions Inc., its development partner for "Doom 3" on the Xbox platform, gives it technology it can incorporate into its own software for next-generation console games.


There is a legal question hanging over the company, and the industry as a whole. Last year, six separate securities class-action lawsuits were consolidated in Superior Court in Los Angeles with allegations that current and former executives and directors of Activision overstated revenue and assets during a 22-month period beginning in 2001.


And the Securities and Exchange Commission launched a formal investigation in mid-2003 into the accounting practices of videogame manufactures and distributors, with a specific emphasis on revenue recognition.


*Staff reporter Kate Berry can be reached at (323) 549-5225, ext. 228, or at kberry@labusinessjournal.com .

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