Deutsche Bank analyst Jeetil Patel has downgraded the stock (ERTS) to “Sell” and issued a price target of $45. He says:
We think that the company still appears to be losing share in the video game industry ... Our investment thesis on Electronic Arts remains unchanged in that amidst solid growth industrywide, EA’s game quality remains questionable, which in turn could translate into ongoing market share losses and limit operating margin expansion to historical levels. In our opinion, the lack of major outperformance on unit volumes among a majority of EA’s titles, especially with a growing fixed R&D expense base, represents the single most important hurdle for the company.
And the news stories are not good. Headlines such as EA Chicago closed, EA-Chertsey-facility-to-close? , Job losses on the way at EA and EA announce Q2 losses do not help matters at all. So let’s look at what the problems are:
- EA has built itself on a formulaic dependency on other people’s IP. Harry Potter, Madden, Lord of the Rings. There is no true value to the company. The thing about this is that EA management know it better than we do and they are doing something about it, hence the recent purchase of Pandemic and Bioware.
- EA do not get the best value out of acquisitions. Perhaps historically they tried to absorb other companies. Now they seem to have a far more flexible mix and match policy, helping acquisitions only in the areas that they need help.
- The market has changed very rapidly. From adolescent boys playing shoot-em ups in their bedroom to the whole family being entertained in the lounge. And with a two-year development time it is difficult to adapt. This has caught the whole industry on the hop, not just EA. But EA has the financial resources and excellent management to make the most of the new market opportunities.
- The new generation-installed base profile is radically different to what EA expected. Yes the Wii has massively outperformed, but nobody expected this, even Nintendo. And the PS3 is very badly under-performing. This is 100% Sony’s fault for losing sight of their customers. And the analysts didn’t see it coming. This is bad news. Luckily EA support so many platforms now that they can weather through this.
We have to balance this with what EA has going for them:
- Excellent management who have a great record of making money and making the difficult decisions when they need to. This is important in an industry with much shoddy management.
- Size. There are huge economies of scale in global game publishing. Hence the drive for industry consolidation. The threats to EA here are the big global media companies. Rupert Murdoch could spoil their day. And online distribution which would give everyone a level playing-field.
- A huge catalogue of releases across the widest possible range of platforms. Nobody else comes anywhere near. This is a steamroller in the market.
Personally I think that John Riccitiello is the best there is in the industry. Erudite, decisive and contemplative. So I see no current threat to the EA crown. And to me EA is a buy. This industry is expanding massively and EA are the undisputed leader.