We believe that the recent GameStop (GME) warning is a very short-term blow to the EA (EA) investment thesis. Obviously, EA's Q3 figures (28 January) could prove disappointing due to the current hardware transition phase but we remain convinced that the following quarters should be more supportive as positives continue to build up.
Initial success of PS4 and Xbox One points to a healthy new cycle
Both the PS4 and Xbox One have had a strong start with initial sales above 7m units (4.2 million units for the PS4 and 3 million for the Xbox One) in roughly 6 weeks. This fast growing installed base of PS4 and Xbox One gives confidence in gamemakers top-line acceleration in coming quarters, even if the very short-term remains obviously tricky as we said in our January 5 SA article. The retailer GameStop has just issued a profit-warning due to low margins on new consoles… and poor sales of "old generation" games (PS3 and Xbox 360).
The wait-and-see attitude from consumers in transition phases between old and next generations of hardware is not something new. This is the norm: consumers buy less old gen games in anticipation of the purchase of next gen consoles… leading game-makers to sharply cut ASP (average selling prices) in order to protect volumes.
EA could obviously be affected as well, something that should not surprise the financial community when the company reports its Q4 figures (January 28). Anyway, we remain convinced that the sector investment thesis is likely to benefit from rising FY14/15 and FY15/16 revenue expectations as next gen hardware installed base ramps up. Moreover, the current strong Opex control despite the R&D investments needed for next gen suggests that profitability will take off when top-line accelerates: margin expansion is likely to be a major driver in our view, with EA pointing to >20% margin within 3 years (vs 13%).
China to open to game consoles
Last week, China announced that it temporarily lifted the ban of video-games consoles: this is obviously great news for console manufacturers and for game-makers. Now the question is: how large can the Chinese market grow if its opening is confirmed?
Actually, the Chinese market is already large, i.e. $13bn, as Chinese are avid players of PC and online games. So the question focuses on the potential of game software for consoles. We have used the North American and European markets as references. They are estimated each around $10bn for console games and digitally distributed content, according to International Development Group.
Taking into account piracy and pricing issues, we believe that a conservative assumption for the Chinese console software games market could stand around $2bn in coming years: this would represent a +10% revenue opportunity for Western game-makers, with each additional $1bn representing a potential +5% revenue expansion.