Electronic Arts: What Is the Problem?

Includes: ATVI, EA, TTWO
by: Bruce Everiss

Electronic Arts (ERTS) infuriate me. In John Riccitiello, this company has one of the most perceptive, incisive and lucid managers in the whole video gaming industry. Yet as a company they continue to under perform.

The value of shares in a company is decided by just one factor, sentiment. So it is instructive to look at the share price of Electronic Arts over the last five years. Basically it has been going nowhere, fluctuating between around 40 dollars and around sixty dollars then collapsing to 22 dollars in the recent turmoil. So for five years investors have seen no improvement in the value of Electronic Arts at a time when the gaming industry has been booming like crazy.

Other big global publishers, like Activision (NASDAQ:ATVI)and Ubisoft, have performed much better.

There are two things, and only two things, that have value for a gaming publisher and which build profits and growth. The first is having the right people and the second is having the right IP. If you have these then everything else follows. Yet many times EA has spent fortunes buying companies only to squander the IP and lose the key staff. The new mix and match, user chooser, approach to corporate acquisitions should serve it better. But where is the organic growth? By making the best of what you already have and know well you can generate far more profits from a given investment.

I also wonder about the nature of much of EAs IP. Madden, Tiger, NHL and FIFA may well be cash cows but they are going nowhere and EA doesn’t even own the rights, it just rents them. Even with Warhammer the company is borrowing someone else’s IP. But times have changed, we live in the age of Wii Fit. The market is now everyone, not just the narrow niches that gaming historically served. EA have moved with the likes of Rock Band and Spore. But it could move a whole lot further.

One thing EA is doing better than anyone else is gearing for the future. This company got into casual gaming big and early. It is pushing micro transactions and subscription business models. And it leads the direct to consumer charge.

Over the last year it has been trying to buy Take Two (NASDAQ:TTWO) primarily in order to get the IP of GTA and also to get a virtual monopoly on sports games. This involved billions of dollars. Instead it could have done a Saint’s Row making its own game compete with GTA and could have grown its existing sports business organically.

And if it really wanted to take someone over then it would have done better buying the huge storehouses of IP that are EIDOS/Sci, Atari/Infogrames and Sega (OTCPK:SGAMY), all three of whom were available very cheaply.

Now EA has announced further disastrous results. (Call Transcript) Last year the company lost $454 million, so far this year the losses are $310 million. You would wonder how it manages this on such strong sales. Its response is a 6% cut in its workforce. This seems strange to me, as an efficient organisation like theirs surely hasn’t got that much dead wood. So isn't it limiting its potential for future organic growth? Surely it would be better knocking the $50 million saving off the marketing budget and forcing the marketeers to make up the difference by being creative. That’s what they are paid for.

If staff really have to go I hope that means every executive assistant, secretary and PA before a single development person goes. And I presume that every executive is handing their frequent flyer rewards back to the company.

I still think that EA is a good long term proposition. But more than that, with a market capitalisation of under $9 billion, it is a ripe takeover target.

Disclosure: None