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Industry Analysis: Entertainment Technology
The Entertainment Technology Industry consists of a wide variety of com-panies that provide products and services used in electronic devices and by entertainment firms. Industry participants include software developers, which target various product markets (including video games), and providers of chips, processors, and circuits for the manufacture of digital cameras, DVD players, cellular phones, digital audio, and visual systems. Product offerings can vary considerably from one company to another. Accordingly, even though industry participants operate in a very competitive environment, they are not necessarily in direct competition, and the group lacks a clear leader. The industry is not particularly capital intensive, although spending on research and development is very important for some companies. When R&D makes up a sizeable part of operating costs, this expenditure, presented as a percentage of revenue, is included in the business description on the Value Line page. Healthy cash flow is also important, allowing companies to invest in their operations, fund research and development, and make acquisitions.
Companies operating in the Entertainment Technology Industry are subject to rapid change, which more often than not arises from the emergence of new technology. And since barriers to entry are not particularly high, a recent entrant with an innovative product may benefit at the expense of struggling competitors. Companies in this industry often have attractive growth prospects. Nonetheless, this group can be vulnerable to broad changes in the general economic environment, with the industry being particularly susceptable to widespread weakness in personal spending. That said, the demand for video games is strongly correlated with the release of new game consoles. Indeed, video game developers’ earnings may suffer every few years, as consumers defer purchases prior to the launch of a new system.
Revenue growth is an important factor to consider when analyzing companies in this industry, since it is often a key driver of earnings gains. Top-line advances can be generated in a variety of ways, including new product introduction and acquisition. Those companies that occupy a strong competitive position in markets with attractive growth prospects are typically best at delivering consistent revenue growth. Given the nature of the industry’s products and services, though, healthy top-line growth is far more difficult to achieve during periods of economic weakness than in periods of strength.
Profit margins can vary considerably throughout the Entertainment Technology industry, depending upon the particular markets a company serves and the associated cost structure of its operations. Indeed, several industry participants sport healthy operating and net profit margins, while others are less fortunate. We note that losses are not uncommon among Entertainment Technology companies, reflecting the disruptive effects of technological change and its vulnerability to general economic weakness. A company’s historical record for profitability can provide investors with a valuable measure for gauging its ability to weather the industry’s ups and downs.
New Product Introductions
The introduction of new products is an important way industry participants remain competitive. This is particularly relevant for video game developers, as the continued launch of new titles can prove an important growth driver for revenues and earnings. Providers of chips and processors operate in a rapidly evolving environment, as original equipment manufacturers are constantly seeking the latest technology to enhance their products. Continued advancements in electronics ensures that a focus on new product introduction will remain an important part of doing business for most industry participants.
Acquisitions and Strategic Partnerships
It is not unusual for Entertainment Technology companies to make acquisitions or form strategic partnerships. Such moves allow them to expand product offerings and gain market share. Moreover, the acquisition of new technology can allow a company to better serve its current markets. Overall, these deals can work to widen a company’s footprint, diversify its revenue stream, and increase earnings. Conversely, the divestiture of a business line usually allows the company to strengthen its balance sheet and increase its focus on core operations. We note that acquisition activity depends upon economic conditions, stockholder influence, and regulatory oversight. And although the scope of deal making has varied over time, acquisitions are an important influence in this industry and their potential should be considered in any prospective analysis.
As would be expected, cost-cutting efforts and restructuring initiatives—staff reductions, facility consolidations, and divestitures—are often implemented during periods of competitive weakness. Such moves can improve a company’s operations, and spawn a leaner, more-focused organization. That said, efforts to slash research and development expenditures might prove shortsighted, over time.
The financial position of Entertainment Technology companies is usually good. A healthy capital position affords industry participants greater flexibility, particularly during disruptive technological change or difficult economic times. However, the operating performances of many in this dynamic industry can fluctuate considerably from one period to the next. As a result, the stocks of many industry participants feature below-average scores for Price Stability and Earnings Predictability. This industry is not suitable for income seekers, as few Entertainment Technology companies pay dividends, and conservative accounts may prefer to look elsewhere. That said, these stocks are probably best suited for venturesome investors, whether their horizon is the year ahead, or longer. Accordingly, investors should pay close attention to growth in revenues and share earnings. Companies with an established track record for sustained profitability are preferable.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.