What Makes Electronic Arts a Buy?

Ashit is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Electronic Arts (NASDAQ: EA) is a gaming company based in the U.S. that has exhibited solid growth lately. The company's stock grew 17% after its fourth quarter results were announced, representing its biggest jump since December 2000. Its stock price has appreciated 48% this year relative to a 14% gain witnessed on the Standard & Poor’s 500 Index. The company posted such exceptional results primarily due to control in its cost structure and a shift in its strategy from retail to the digital platform.

The entire gaming industry is experiencing a massive shift towards the digital platform at the moment. Hence, there is a noticeable increase in overall revenues generated through this platform. The decline in sales of consoles remains a serious concern for the gaming industry, however. It is imperative for potential investors to comprehend these shifts in the gaming industry in order to make the right investment choice.

Evolving trends in the gaming industry

The most noteworthy change in the landscape of the gaming industry is its shift from retail to the digital platform. EA’s digital revenue, from mobile games and online offerings, increased 45% year-over-year to surpass the $600 million mark. Going forward, sales of PC games are expected to increase at a rapid pace and bolster the digital platform. Similarly, the company's foray into social networking through games such as "The Sims Social" is also expected to prop up sales in the future. 

Digitization in the gaming industry has resulted in traditional platforms such as consoles competing with smart phones, tablets, social networking sites and online browser games. This has led EA into shifting its focus completely onto the new emerging gaming platforms.

According to valuation offered by Trefis, the company's mobile division contributes 9% to its overall stock value. It is worth mentioning that mobile revenues grew from $164 million during 2009 to $308 million in 2012, which is indicative of a major trend shift for the gaming industry.

The company has successfully integrated its Origin game service with the mobile platform, enabling it into offering mobile versions of the company's popular games. Furthermore, EA’s "The Sims Social" has witnessed a remarkable response on the social networking platforms and has surpassed competitors such as "Farmville" in terms of average daily users.

Key value drivers

EA is in a transitional phase, shifting gradually towards mobile and online gaming. This will certainly impact the company financials, as revenue generated through traditional sources such as consoles are the highest contributor to its net income. Nevertheless, the rapid growth experienced through the mobile platform will certainly offset for any decline. Moving ahead, EA must shift its focus to games with lower research and development costs and fewer administrative expenses such as the "FIFA" and "Need for Speed" franchises.

Furthermore, it is essential for EA to recognize that massively-multiplayer online games (MMOGs) have become extremely popular. In addition to offering high margins, these games also enable lower incremental spending for services offered to paid subscribers.

Competitive landscape

Activision-Blizzard (NASDAQ: ATVI) is the one of the largest players in the gaming industry. The company is strategically investing in new mobile and social gaming projects with an aim to maximize its revenues through non-traditional sources. The aggressive growth realized by Activision-Blizzard is through the success of popular games such as "Call of Duty" and "World of Warcraft."

The company has a diverse range of revenue streams. It generates the highest percentage of its revenue through sales of games for consoles at around 45%, which is followed by PC, mobile and social gaming at around 25%. The remaining revenues are split between online subscriptions, handheld games and distribution. Despite the industry-wide drop in the sales of console games, Activision-Blizzard’s stock has appreciated approximately 40% since 2013. The company is well positioned to absorb any headwinds caused by the decline of consoles as it is posting robust numbers through the new emerging platforms.

 Zynga (NASDAQ: ZNGA) is a leading provider of social gaming services. It has gained vast popularity on the social networking site Facebook through games such as "Farmville," which has approximately 40 million registered users. EA directly competes with Zynga in the social gaming space through its popular "The Sims" franchise. The company generates the highest percentage of its revenues through games such "Texas Hold'Em Poker" at around 40%, this is followed by new games developed for platforms such tablets and smart phones at around 46%. The remaining revenues are split between games such as "FarmVille," "CityVille" and "CastleVille."

The company is gradually shifting its focus towards real-money gaming as its core business is suffering due to a steep fall in active users. This has resulted in Zynga focusing on online gambling, which presents a huge opportunity for the gaming company. The online gambling industry is massive outside of the U.S. and presently stands at $32 billion. The online gambling industry is expected to grow at a rapid pace, implying that even a marginal gain in market share for Zynga could bring a strong upside to its present trading price. Investors must keep a close eye on how Zynga develops its business around online gambling.

Take away

Although EA performed remarkably during the previous fiscal year, it is going through a transitional phase. This may lead to a slowdown as the changing trends in the industry will reduce the dependence of gaming companies on the sales of consoles as their primary source of revenue. EA has strategically shifted its focus towards the digital platform as the landscape of the gaming industry is expected to go through a complete shift.

Recently, the company sealed a multi-year licensing deal with The Walt Disney Company, allowing it to develop innovative games for various platforms based on the iconic "Star Wars" franchise. This is expected to bolster demand, as is the launch of the new Xbox which is just around the corner. The company certainly operates in a highly competitive environment, though with strong fundamentals and various growth opportunities its stock certainly has a strong upside.

While Activision and Microsoft have been taking the headlines when it comes to console gaming, investors following the gaming sector would do well to also keep tabs on Electronic Arts. The Fool can help. The Motley Fool's special report breaks down the risks and opportunities facing the company to help you decide if EA is right for your portfolio. Click here to get your copy now.

 


Ashit Gulati has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard. The Motley Fool owns shares of Activision Blizzard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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