Throw This Stock Away

I'm not some bloodthirsty meanie. I do come right back with three related recommendations that I think will do better for your portfolio. Since the country's largest video-game maker posted ho-hum results last night, I know just whom to line up in the crosshairs.

Who gets tossed out this week? Come on down, Activision Blizzard (Nasdaq: ATVI).

Fall of duty
Shares of Activision Blizzard traded higher this morning. Investors seem to like last night's report, but I'm not convinced.

The software giant earned a third-quarter non-GAAP profit of $0.04 a share. But even though it met analyst expectations, you have to go back a few quarters to find the last time that it didn't top Wall Street's net-income targets. A merely mortal Activision Blizzard doesn't excite me.

We have seen some welcome surprises during earnings season, but Activision Blizzard isn't one of them. In fact, despite the improving economy, the gaming juggernaut is sticking to its previous outlook for all of 2009. It still expects to post a non-GAAP profit of $0.63 a share on $4.5 billion in revenue. In other words, it's expecting a slight dip on the top line and a small gain on the bottom relative to last year.

Now, I'm not stupid. I realize that Call of Duty: Modern Warfare 2 is now just four days away. It's going to be huge. Unfortunately, "huge" is a relative term, since video game industry sales have fallen in six of the past seven months. Lower-priced consoles are helping, but casual gamers are perfectly fine playing FarmVille on Facebook or downloading free ad-based casual games through Apple's (Nasdaq: AAPL) App Store.

My concerns for Activision Blizzard lie beyond the Call of Duty franchise, given that its Guitar Hero and World of Warcraft workhorses are appearing vulnerable these days. World of Warcraft could get shut out in China -- now the world's largest country of Internet users. That being said, the bigger worry is with Guitar Hero.

Guitar Hero 5 hit stores in early September, and you'd expect it to be a big winner. Activision Blizzard even offered fans who bought the game during the month a free copy of a Van Halen add-on that's due out next month.

"For the month of September, sales of music games in the U.S. increased 72% in dollars year over year, which demonstrates the sustained interest in this new and important game category," CEO Robert Kotick notes in last night's earnings release.

What Kotick fails to mention is that September's healthy showing was the handiwork of rival Viacom's (NYSE: VIA) The Beatles: Rock Band. According to industry watcher NPD Group, Guitar Hero 5 clocked in at an embarrassing ninth place on the list, despite the time-sensitive freebie. This sure isn't a validation of the niche. It's more like the passing of the market-leadership baton.

I'm sorry, Activision Blizzard. The game hasn't passed you by, but you're no longer ahead of the pack.

Good news
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting tossed. Let's go over three new fill-ins.

• Changyou.com (Nasdaq: CYOU) : The online-gaming turmoil in China is creating a great deal of anxiety. I'm a big fan of NetEase.com (Nasdaq: NTES), Activision's partner here, but I'm focusing on the recently public Changyou.com because it is trading at just 10 times next year's projected profitability, the lowest multiple among its rivals. Changyou's no slouch. Analysts see earnings growing by 23% this year and 14% come 2010. Clearly, there are risks, but the dirt-cheap valuations offer the potential for huge capital appreciation if Chinese regulators do the right thing and let the gaming companies play on.
• Take-Two Interactive (Nasdaq: TTWO) : I'm cynical about the stateside video-game market, but that doesn't mean all of the domestic players are toast. Activision Blizzard and Electronic Arts (Nasdaq: ERTS) will begin getting desperate as their organic franchises dry up, and when they do, they'll be forced into growing through acquisitions. Take-Two is the perfect candidate, given its juicy Grand Theft Auto and BioShock franchises. Take-Two was humbled after sidestepping a $26 buyout offer last year, so it's more likely to accept the next deal that comes in at a reasonable premium.
• Apple: Gaming companies will tell you that the iPhone and iPod Touch are not threats to their handheld systems. I disagree. Apple now has 100,000 applications available through its online storefront, with many of those being free -- or nearly free -- games. Even EA is an App Store developer! As the new gaming gateway, Apple can't be ignored -- by either developers or investors.

It's not personal, Activision Blizzard. It's just gaming business.

© 2009 UCLICK, L.L.C.