Why Is Electronic Arts Trading at a Premium to Activision?

 |  Includes: ATVI, DIS, EA
by: Mark Riddix

I was searching through gaming stocks and noticed that shares of Electronic Arts (ERTS) are trading at a much higher valuation than Activision Blizzard (NASDAQ:ATVI). Does Electronic Arts deserve to trade at a premium to Activision?

Electronic Arts is trading just under $20 per share. EPS estimates for 2010 are 43 cents per share and 62 cents for 2011. This puts a 46 multiple on current year's earnings and a 32 multiple for 2011. The 5 year growth rate is 12.8%, which is pretty optimistic considering the negative earnings growth of the past five years. It's tough to have faith in Electronics Arts management considering the poor operating efficiency. Management has generated a negative ROE and ROA over the past few quarters.

One of the bright spots for Electronic Arts is the company’s storied brand name and solid balance sheet. Electronic Arts has cash cow franchises Madden NFL, The Sims, Battlefield, Rock Band, etc. The software developer has $1.78 billion in cash and no debt. The stock looks expensive using any valuation method including price to book and price to sales. Shares of Electronic Arts appear to be benefitting from improving trends in the video game industry. Video game sales rose 10% last month.

Activision Blizzard is trading just under $12.00 and has a projected EPS of 73 cents for 2010 and 82 cents for 2011. 2010’s PE ratio is 16 and 2011’s is 14.5. Earnings growth is estimated at 14.6%. Activision raised first quarter guidance last week due to strong sales from Call of Duty: Modern Warfare 2. While ROA and ROE are not very impressive, at least both numbers are positive for Activision. The management team has done a qualitative job at Activision with its acquisitions and ability to consistently grow the bottom line.

Compare this with Electronic Arts which has been trying to fix its internal problems for years. Activision has no debt and $3.25 billion in cash on its balance sheet. Shares are currently trading less than 1.5 times book value. Activision has a popular lineup of games including World of Warcraft, Call of Duty, Guitar Hero, and Starcraft.

Over the past five years Activision’s shareholders have been rewarded with a return over 105%. Electronic Arts shareholders have seen their investment drop 60% over the past five years. Activision pays a dividend to its shareholders whereas Electronic Arts does not. The premium valuation for Electronic Arts seems to be based purely on speculation of an acquisition by Disney (NYSE:DIS). Until there are signs that a turnaround is really under way at EA, investors may find Activision the better value play.

Disclosure: I do not own shares of either company.