By: Mr Eb
Electronic Arts (NASDAQ:EA) is probably the company dearest to my heart growing up. I had many pleasant childhood memories playing games like One-on-One and Seven Cities of Gold on the Commodore 64 and Populous on the Amiga. They simply made great innovative games then. Somehow however the company lost its way over the years. Last week's earnings report was the culmination of the demise as it announced one-third of its future title pipeline will be cut and another 1500 employees will be laid off on top of the 1100 fired just 9 months ago. Many of its AAA title launches such as Brutal Legend have flopped in the market-place. Even games like Dragon Age Origins and Need for Speed Shift are being discounted with promotional coupons and sales in the retail channel, a clear sign EA games are not selling to expectations.
Looking back, one of the warning signs was the famous EA Spouse blog, where people internally knew the company was burning people out. The pattern was hiring talent, buying companies, and churning games out. The intense development cycles even as short as one year, bureaucracy, and lack of respect for their employees drove some of their best talent away. Management clearly didn't mind as long as the profits were flowing, but if you squeeze the golden goose too hard eventually the quality suffers.
A key inflection point in my opinion is when EA decided to pay the NFL hundreds of millions more to get the exclusive on the football license. This told the world that money and power was all that mattered and this company decided it could not compete in the marketplace with Take-Two 2K Sports by making better games.
Although the seeds of the decline were there for a while, I believe a huge part of the blame has to be laid at the feet of the current CEO, John Riccitiello. John was the chief operating officer of EA from 1997 to 2004. He then went off to co-found a venture capital firm called Elevation Partners until April 2007, when he was brought back to become CEO of EA. From there he had a series of decisions that to this day destroyed hundreds of millions, if not billions of shareholder value.
1. Infinity Ward
If you have been reading the news the past week, you know that Activision's Call of Duty Modern Warfare 2 has launched to great fan-fare selling $550 million worth of product in its first five days setting the record for biggest entertainment launch in history. But did you know that Infinity Ward, the key developer team of the Call of Duty franchise, started out making Medal of Honor games for EA? During that time John Riccitiello was a important managerial executive when the key members of the developer team left and joined up with Activision. I do not know the details of the departures, but the simple fact is he was there when the most important, future best-selling billion dollar intellectual property value slipped to a major competitor.
After John left EA to start Elevation Partners, his first major deal was investing $300 million into Bioware and Pandemic in November of 2005. This was a head-scratcher to many people in the games industry. Most of acquisitions to this point have been the low tens of million dollar range from Irrational Games to Bungie which was bought by Microsoft. The only other mega-acquisition was Microsoft's $375 million cash buy-out of Rare, which by this point everyone knew was complete disaster.
It also didn't make any sense because the market was clearly going to action-oriented first person shooters on consoles like Halo and Call of Duty. To invest hundreds of millions in a primarily niche PC role-playing game developer (Bioware) and a second rate action game developer (Pandemic) was be-fuddling to say the least.
John became the CEO of VG Holdings (Pandemic + Bioware) until he quit to become CEO of EA in April of 2007. This is where things get interesting because six months into the job, EA announced it was going to buy Pandemic and Bioware for $620 million in cash and $155 million in equity retention. $775 million dollars to buy his ex-firm's portfolio company. The kicker is since John was a founder of Elevation Partners and ex-CEO of VG Holdings, he would make up to $4.9 million from EA buying the company he invested in 2 years ago. If that isn't a huge conflict of interest, I don't know what is.
EA in their press release said John recused himself during the board meeting where the acquisition was discussed, but that is a total joke. As a newly minted CEO of a company considering a $775 million acquisition, obviously he had to be a driving force in completing this deal. The EA CFO at the time said they expected Pandemic and Bioware to do "in excess of" $300 million in revenue in 2009 and 2010.
Flash forward today on news that the Pandemic founders of are leaving the firm, hundreds of people are being laid off, and Pandemic studio is essentially being shut down. Pandemic's core titles like Mercenaries 2 were flops. So two years after spending $775 million dollars for two studios, one of them has gone under. We are talking at least hundreds of millions of dollars at least in lost value. The $300 million of revenue projection at time of acquisition? A total pipe-dream.
3. The9 Limited
In May 2007, EA bought a 15% stake in The9 Limited for $167 million. Obviously John was excited about the potential of online games in Asia to do this large investment. The problem was The9 really didn't own much in terms of intellectually property. Over 90%+ of its revenue and earnings came from distributing and operating the World of Warcraft game in China which it licensed from Blizzard. Once Activision merged with Blizzard, it decided to pull its WOW license from The9 and give it to Netease. Consequently The9 plummeted in value as it lost over 90% of its revenue. The EA stake is now worth less than $30 million. Over $137 million of shareholder money lost from Mr. Riccitiello's investment skills. As a long-time gaming industry executive investing in a company that had that kind of risk with the WOW license at a sky-high valuation is unconscionable.
John decided he had to have the Grand Theft Auto franchise. In March of 2008, EA announced a $26 a share take-out offer for Take-Two, a huge premium to the company's stock price. This was a $2.1 billion offer. This time John was fortunate as Take-Two management repeatedly spurned the offer to the point EA gave up trying many months later. One year later, Take-Two was trading under $6 a share a stunning 77% below John's offer. Even at Take-Two's current stock price, if the deal went through, EA would of lost over a billion dollars in shareholder value.
5. No credibility
Forecasting one thing and then having reality be different over and over again has destroyed Mr. Riccitiello's credibility to the markets. Every year John goes on the earnings calls and repeatedly states how great games are. A year ago he told analysts how good the 2008 version of Need for Speed was. Last week he said previous Need for Speed games were lacking.
He also defended the $680 million EA spent for mobile cellphone game maker Jamdat in 2006 when he wasn't even at the compan. Everyone in the industry knows that the mobile cellphone gaming market is moving towards standardized platforms such as the iPhone and Android OS. To argue that Jamdat was a good acquisition when it's core competence is porting games across dozens of cellphone SKUs is becoming obselete is ridiculous.
After all these failed decisions, the fact that the Board of Directors let's John keep his job and do more over-valued pricey acquisitions is a travesty. Last week EA bought Playfish for up to $400 million for 4-5Xs revenue. Playfish is "the fad" of the moment developing social networking casual games. Given Mr. Riccitiello's investment track record, it wouldn't be surprising this is another disaster in the making.
The problem here is John is going to make his millions every year even though he destroys hundreds of millions and billions of shareholder value given the decline of the stock price. If the Take-Two deal went through, EA would of even been in worse shape. The people who suffer are thousands of hard-working EA employees who lose their jobs and see how life savings in company stock implode. The madness must end. It's clear that John doesn't know what he's doing. He must go.
Disclosure: At time of writing, the author does not have any position in Electronic Arts. If Mr. Riccitiello is fired, the author vows to buy EA stock that day. You can contact the author on Twitter: mreb or email: a(atsign)earningsbreakout.com
By: Mr Eb