Electronic Arts: Stock Drops on Lowered Guidance

Video game publisher Electronic Arts (ERTS) just hasn’t been able to find its stride ever since the new game console units came out two years ago. The company discounted the marketability of the Wii, leaving R&D woefully behind for the social phenomenon.

Its heralded franchise games (that flat-out print money every year) have also failed to make up for the largely flop-ridden new lineup that the company has floated over the past three years. Even the company’s biggest strength in the past - having a bigger piggy bank than all the competitors - has faded as Activision Blizzard (ATVI), Disney (DIS), and Microsoft (MSFT) are all throwing money at video game publishing, which is now a bigger market than the global movie business.

An Old Friend

I have been covering this company for many years, and during most of this time felt that Electronic Arts had an aggregate value - including things like franchise strength & branding, distribution power, and upgrade cycles - that was much higher than the market cap of ERTS stock. However, shortly after my last bullish piece on the company before Christmas 2007, I started to question just how much of a premium multiple Electronic Arts deserved. Shares have been at P/Es of 30, 40, even 50+ in the past year, and that simply can’t hold up in the face of mediocre growth and a global recession.

Earnings, Guidance Trigger Sell-off

Well, the last of the chickens came home to roost on Friday morning, as shares were down 20% in early trading following a weak earnings report, game delays, and a wider net loss. As a result, the company now expects to earn about $1.40 in 2008, down from initial guidance as high as $1.70. EA has produced some extraordinary earnings beats over the years, so it’s not crazy to think that it might even come in with $1.50 or so for the year. That gets the valuation back down from nosebleed levels to a tidy 15-17x earnings, with strong secular trends, and a historical track record of selling through product well during consumer recessions.

Game-Changing Demographics?

The installed base of XBOX, PS3, and Wii consoles continues to grow; global hardware unit sales for the first half of 2008 totaled more than 12 million, following 30 million units sold in 2007. Sony (SNE) nearly went broke getting the PS3 to market, so look for the console cycles to slow down measurably from the past three or four years. This should drive margins lower for the video game publishers in 2009, and contribute to continued growth in online game play and distribution.

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Disclosure: None

Comments

[bricki:]

EA is making a huge mistake with its new DRM policies. They have alienated a large percentage of their traditional customers, and are likely to have declining sales due to this bonehead move. This company would clearly be a good shorting candidate.

2008 Nov 02 12:29 PM