Electronic Arts Faces Risk Heading Into Holiday Season

| About: Electronic Arts (EA)

Deutsche Bank is out with some fairly interesting comments on Electronic Arts (NASDAQ:ERTS) after the company said on Thursday it will buy two video game studios for $855 million in a deal that fills weak spots in its games lineup by adding role-playing and action titles. EA said the deal would be dilutive to its fiscal 2008 earnings by 30 cents to 40 cents per share. Excluding special charges, the purchase would reduce EA's earnings by about 5 cents a share in its fiscal fourth quarter, which concludes at the end of March.

Electronic Arts Inc expects to beat its earlier profit and revenue forecasts for its second quarter ended in September, Chief Financial Officer Warren Jenson said on Thursday. "We will be excess of our guidance," Jenson told analysts on a conference call, saying only that would apply to both net profit as well as adjusted profit.

Deutsche notes they remain on the sidelines on shares of Electronic Arts, and believe that while the VG Holdings acquisition should help add to the company's title portfolio longer-term, near-term share price volatility surrounding the upcoming holiday selling season in the video game industry has pushed shares of Electronic Arts higher. This is despite potential sell-through weakness for several of EA's major titles, which they will get a better sense of in next week's NPD data release.

The management indicated that September quart revenues and EPS will exceed its guidance, as the company sold its marquis sports lineup in the quarter. While the risk in fiscal 2Q is generally low, more importantly DB thinks that the December quarter represents a risk quarter for EA as the quarter is driven by new releases and re-orders on its existing titles. With title sell-through lower than expectations, they think the likelihood for weakness in fiscal 3Q is increasing (25% growth vs. 5%-10% industry growth in C4Q).

Maintains Hold and $45 target.

Notablecalls: First of all, ERTS' FQ3 represents calendar Q4, which in turn represents about 40-45% of the company's annual revenue. Although most firms are likely cheerleading ERTS following yesterday's news, Deutsche's comments throw cold water on it all.

Must say that after going over some sell-side checks over the past weeks, I have noticed some weakness in ERTS's line-up. The consoles are simply not selling well enough. Well, Nintendo (OTCPK:NTDOY) Wii is, but considering ERTS is only the 3rd largest supplier to this one, it's not enough to move the needle.

In order to hit CQ4 consensus estimate, ERTS needs to show growth way above the industry average. I see risk to this.

Should the stock gap on this guidance for FQ2, I suggest you short it.

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