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The games software market is set to decline by as much as 20% a leading analyst has forcast.

SG Cowen & Co. analyst Lowell Singer in the USA has forecasted a 20% decline in video game software sales during the 2004-2006 console transition, and a 4% decline in 2006 alone.
Electronic Arts, Activision, and THQ have all guided to software sales that are flat to down 5% for 2006, whereas previously, the consensus expectations were for “at least a modest” sales gain year-over-year, the analyst wrote in a report.

The analyst cited a “slower-than-expected growth in the installed base of next-generation hardware,” as a reason for the softness in software sales. For instance, Sony (nyse: SNE – news – people ) won’t be releasing the new PlayStation 3 console until late 2006 at the earliest.

Lowell also cited certain secular risks over the longer-term that could be exacerbating the slowing of sales including a console transition that is “far worse” than the last transition in 1999 to 2001. The analyst also cited an increase in online video game play and criticism of a lack of creativity in the gaming industry, with “no Halo or Grand Theft Auto-type blowout titles launched in 2005.” The analyst said he still recommends Activision shares. “We believe that Activision’s focus on building high-quality franchises, sustaining above-average operating margins and ROIC, and aggressively participating in the expanding handheld market have positioned the company for industry-leading growth and market share gains throughout the next-generation console cycle.”

His view on Electronic Arts is neutral based on valuation, despite the fact that he sees the company as “the best-run company among the third-party publishers.”The analyst’s view on Take-Two Interactive Software is also neutral. Noting that there are investment positives on the stock, he also listed key concerns in game quality, the company’s “extreme reliance” on Grand Theft Auto as a driver for earnings, low ROIC and the company’s historically poor internal controls.
Singer also said he views THQ as neutral saying that its growth depends heavily on the average game quality of its new titles for Microsoft’s Xbox 360. “Although we believe that the video game stocks could be volatile over the next few months due to the ongoing console transition, we continue to have a positive long-term view on the group,” the research analyst said.

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