Electronic Arts: Wrongly Discounting An Apex

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About: Electronic Arts Inc. (EA)
by: Stone Fox Capital
Summary

Apex Legends continues on a path to surpass the success of Fortnite.

Reasonable estimates would suggest this level of active players would lead to revenue in excess of $1 billion.

Analyst estimates aren't factoring in the potential EPS boost from a free-to-play hit game.

The stock remains a bargain under $100, as the business appears poised to top the original estimates when the stock was above $150.

Despite additional strong numbers from Apex Legends, Electronic Arts (EA) isn't seeing any further boost in the stock. The market has become far too negative on the stock despite a Battle Royale game hitting record user totals. My previous investment thesis had pushed investors on buying the stock below $100, and that opportunity is set to sail for those who don't act fast.

EA Apex Legends logo

Image Source: Apex Legends website

Big Hit

In only 4 weeks, Apex Legends has reached a level of gamers that Fortnite could've only dreamed to match in that period. The game has gone from 25 million users after the first week to 50 million active players now. Fortnite didn't reach that player total until sometime after 16 weeks, or over 4x the time on market.

Source: TweakTown

The odd part is that the market and analyst community hasn't exactly become overly bullish on the stock. Cowen isn't bullish on EA due to stalling viewership on Twitch. The viewership levels are down from peak levels, but Apex Legends did achieve the highest level of viewers last month.

The company is in the process of launching Season 1 and a Battle Pass that costs up to $10, per online leaks. The pass will offer players loot and legends as rewards for completing specific tasks in the game. As mentioned by Baird, the average gamer only needs to spend $20 in order for the game to generate $1 billion in annual revenues. At 100 million active users, the average player would only need to spend $10 a year to rake in $1 billion in revenues. With multiple seasons each year, it only takes a fraction of those players buying a Battle Pass to reach a lofty revenue figure.

Fortnite has reached 200 million gamers and produced an estimated $2.4 billion in revenues last year and up to $3 billion in total lifetime earnings after about 1.5 years on the market. One can't just assume that Apex Legends matches or even tops these revenue levels, due to concerns about monetization and lasting power of the game, but one shouldn't quickly ignore the potential for this game to match the revenues of Fortnite.

Irrational Monetization Fears

Apex Legends is a free-to-play game offering in-app purchases. One of the prime revenue generators are loot boxes that are coming under a lot of regulatory pressure.

Loot boxes offer players in-app purchases of boxes that contain valuable items used in the game with various odds of winning the items. The EU is increasingly declaring the boxes as a form of gambling. Several countries like Belgium and The Netherlands have already banned the practice of offering in-app purchases that resemble gambling, and other countries are reviewing the practice. Though, to be clear, a lot of the discussion is focused on third-party sites where game players bet on items like skins.

The road bump doesn't mean the end of monetization for free-to-play games, but it does suggest a new plan is potentially needed by the industry. Clearly, Respawn Entertainment and EA have the talent and creativity to derive another monetization plan that doesn't include a perceived form of gambling that involves minors.

According to data from SuperData, the top 10 free-to-play games nearly all topped $1 billion in annual revenues. Amongst these games possibly exist solutions to getting around the loot box challenges facing Apex Legends and an industry full of game publishers fully incentivized to find a solution that bypasses the ire of regulators in the U.S. and Europe.

Source: Game Rant

As mentioned in the prior article, EA reduced FY19 bookings estimates to $4.75 billion. The numbers support a successful game pushing a target for FY20 closer to $6 billion than the current estimates closer to $5 billion.

Analyst EPS estimates for FY20 are bouncing off the bottom with a target of $4.41. Investors should look for a substantial rise in EPS estimates, as Epic Games was highly profitable based almost solely on Fortnite.

Chart Data by YCharts

Takeaway

The key investor takeaway is that the market continues to discount the success of Apex Legends before the Battle Royale game even starts Season 1. The unprecedented success of the game in the initial month sets up EA for a much stronger year than expected.

Even if the game doesn't achieve the success of Fortnite, a free-to-play game with 50 million active players could reap enormous rewards. Anything in the magnitude of the $2.4 billion in revenues generated by Fortnite would provide substantial upside to EPS estimates. Either way, at $100 the stock isn't pricing in the potential catalyst of Apex Legends on EA.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in EA over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.