This Video Game Maker is Going Digital

Jason 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) has shed 26% of its market cap over the past year -- does this mean it's time to snap up shares, or is it a sign of more trouble to come?  We will examine EA through the lens of their 2013 Q2 earnings call on Oct. 31, 2012, which evidenced the following themes:

1) EA is aggressively moving from a packaged goods business model to a digital services model, hoping to build a more robust recurring revenue stream.  This means engaging gamers beyond a one-time, in-store purchase, especially since we’re near the end of the current gaming console cycle (can you believe the PlayStation 3 and Xbox 360 have been out for 6 and 7 years, respectively?).  These digital services, which have been growing rapidly over the past few years and now represent some 45% of total revenues, include social gaming, tablet and smartphone gaming, direct downloads, free-to-play, and in-game micro-transactions.  But competitors are taking a more measured approach, containing their digital experiments largely to Asia, and industry analysts remain unconvinced that this doubling down on digital services will be the game-changer the company expects.

2) EA is reducing the number of titles but making each one bigger and better.  They’ve cut numerous titles and delayed the launch of NBA Live until 2014, focusing their efforts on key brands such as Battlefield, FIFA, Madden, The Sims, and SimCity.  But this approach may contribute to the lumpiness of the company’s earnings (see point 3 below), as the bottom line will be greatly affected if one of these key brands performs below expectations.  For instance, Star Wars: The Old Republic and Medal of Honor Warfighter both underperformed recently, which affected Q2 results and will likely impact fiscal 2013 as well.

3) Earnings are lumpy – EA has posted positive GAAP earnings per share (EPS) in 6 of the past 12 quarters; the remaining 6 quarters, it has posted a GAAP loss – we’d prefer a company that was more consistently generating a profit.  Take-Two Interactive (NASDAQ: TTWO), the maker of Grand Theft Auto, also has had trouble generating a consistent profit over the past few years, with just as many losing quarters as winning ones, including some negative earnings surprises.  In contrast, Activision Blizzard (NASDAQ: ATVI), which makes Call of Duty, StarCraft, and World of Warcraft, not only has consistently positive GAAP and non-GAAP earnings (excluding a small loss in 2008 due to a merger with Vivendi), but it also has zero debt, $3 billion in cash, and generates enough free cash flow to pay a dividend, currently at 1.7%.  We’ll report later on whether EA’s lumpy earnings are due largely to complex GAAP accounting requirements, or if EA needs to cut costs to maintain profitability.

4) There are significant differences between EA's GAAP and non-GAAP results, with EA often posting a non-GAAP positive quarter but a GAAP loss, so we have to wonder if EA is posting lots of one-time impairment charges.  We don’t want these charges to become a recurring drag on earnings, so we’ll examine the differences between the GAAP and non-GAAP results.  Here’s a hint that partially explains the differences:  EA is required to hold revenue from some of its digital business until Q4 of each year, even if the actual transactions occur in earlier quarters.  More on the why and how in a future post.

In sum, by doubling down on digital services across a wide range of platforms, EA has a unique strategy that it hopes will drive revenue and EPS growth in calendar 2013 while we await the release of the “big two” next-generation gaming consoles, PlayStation 4 and Xbox 720.  Stay tuned for follow-up posts, where we dissect each of the above themes in more detail.

cajafuerte has no positions in the stocks mentioned above. The Motley Fool owns shares of Activision Blizzard. Motley Fool newsletter services recommend Activision Blizzard and Take-Two Interactive . 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!

blog comments powered by Disqus