Why Digital Matters So Much to This Industry

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

Every time I turnaround it seems that Electronic Arts (NASDAQ: EA) is soaring by nearly 10% in a single day. Over the past year the company is up over 110%, compared to the Nasdaq Composite's 22%. 

When I looked at Electronic Arts back in May, the stock was up over 23% in a matter of days, and the company kept the status quo earlier this week, jumping 8%. This jump comes as fiscal 1Q 2014 digital revenue was up 17% year-over-year, accounting for 76% of total revenue. Its leading revenue generators were Battlefield 3 and FIFA 13.

Electronic Arts also has an impressive balance sheet, like many of the other gaming companies. Its balance sheet has over $1.6 billion in cash. This gives the company plenty of room to make even more investments in the digital space. As well, the company is also returning cash to shareholders, repurchasing over $278 million in shares during fiscal 2013.

Now for the real exciting part, digital revenue expanded robustly across the fast- growing console and smartphone platforms last quarter...

<img alt="" src="http://g.fool.com/editorial/images/60483/ea-digitla-rev_large.png" />

One big thing helping drive the company higher, and the sector, is that the industry is coming out of a transition period. The global console-game market is expected to hit $20 billion by 2015-end after seeing a slight pullback in 2013. 

<img alt="" src="http://g.fool.com/editorial/images/60483/ea-growth-phase-transition_large.png" />

Source: EA

One of the big benefits of digital is that it translates into higher margins. Electronic Arts' gross profit margin is now head and shoulders above its comps.

<img alt="" src="http://media.ycharts.com/charts/217a4d5e06f433fd925a6f54bda736a7.png" />

DFC Intelligence believes that the online video-game market will grow from $66 billion in 2013 to $79 billion by 2017. What's more is that DFC estimates that 47% of total console-gaming revenue will be digital by 2018. Another key growth driver for the industry will be the launch of next generation consoles from Sony and Microsoft

The usual suspects

Notable comps include other major game companies Take-Two Interactive (NASDAQ: TTWO) and Activision Blizzard (NASDAQ: ATVI). Take-Two owns the Grand Theft Auto and 2K brands. Activision's key brands include the Call of Duty and Guitar Hero franchises. 

Analysts expect revenue to grow another 50% in fiscal 2014 for Take-Two after already growing 50% in fiscal 2013. What's more is that analysts also expect operating profit to hit $310 million in fiscal 2014 versus the $49 million in 2013. Driving this earnings growth will be its much-anticipated September launch of Grand Theft Auto V. Other revenue tailwinds will come from continued sales of BioShock. 

Activision, according to analysts, is expected to see revenue fall 16% in 2013. This is mainly due to tough sales comparisons related to the previous success of Call of Duty in 2012. 

Other recent news for Activision includes a possible one-time dividend. Parent company Vivendi is looking to force the game company to pay a $3 billion dividend. Vivendi owns 60% of the company and would look to use its $2.3 billion dividend payment to pay down its $17 billion in debt. The slight downside to this dividend is that the majority of Activision's cash is held overseas, and so it's likely that Activision will have to take on debt to complete the deal. 

Bottom line

EA still trades at a sub-1 PEG ratio, but Activation's is now much lower after EA's recent run up. 

<img alt="" src="http://media.ycharts.com/charts/b3e5d62e47d3170d2e284308c3c2d8c3.png" />

Even with Electronic Arts' run up over the past year, its PEG is still below one? Yes, but if you look at Activision, which is up only 30% over the last 12 months, its PEG ratio is a mere 0.5.  Like I said back in May,

Activision, meanwhile, appears to be rather cheap for its value and has a large chunk of cash that it plans to put to work for investors. I would go for Activision, which still has a lot of room to grow in the digital space as well.

This is still the case for the company, which has a cash-to-price ratio of 27%. I still think Take-Two has some room to go before its turnaround is in full swing. So for now, I'd look to take some Electronic Arts' shares off the table, and potentially redeploy that capital to Activision. 

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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard and Take-Two Interactive . 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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