Can Electronic Arts Survive the Onslaught of Internet Gaming?

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Shares of Electronic Arts (NASDAQ: EA) dropped 8% yesterday as CEO John Riccitiello announced his abrupt departure from the company, which has increasingly come under fire lately for the poor launch of its latest SimCity franchise.

The company also pared its revenue and profit expectations for the current year, at least partially affected by the botched launch of the city-building simulation game, which many users could not play because of server instability.

After the profit warning, analysts at Needham pared the stock’s rating to "hold" from "buy" noting challenges ahead. To be sure, the company’s challenges are far bigger than what can be corrected in a quarter or two. Electronic Arts is faced with more and more gamers shifting to online games that are accessible online or through mobile digital devices such as smartphones, or through social networks such as Facebook.

The last bit is crucial, as its competitors Activision (NASDAQ: ATVI) and Zynga (NASDAQ: ZNGA) have found unprecedented success with the social media platforms.

It is not that Electronic Arts has remained oblivious to the shift but its efforts to boost presence in the online world have been marred by inept planning and technical errors. The problems with the latest game in the SimCity franchise were foreseeable and should have been rectified, as the game was offered in online mode only.

However, inept planning is just part of a bigger problem. The real challenge for the company is to shift most of its games online and from its proprietary platforms to a shared platform such as Facebook. This is easier said than done. Electronic Arts has already invested considerable funds and has achieved some success towards the goal. For the financial year that ended March 2012, the company recorded a 56% jump in online revenues to $1.16 billion. This sounds good, but still made up only 28% of its total revenues for the year.

Meanwhile, Activision – another legacy player – has had better success online. Despite registering a decline of $100 million in 2012, Activision’s revenues from digital online channels represented 32% of its total revenues in the year. The publisher of popular games such as Call of Duty and World of Warcraft is generally recommended as a “buy” by brokerage houses. Simply put, the company has been able to better deliver on its plans and financial performance.

Improved performance has also allowed the company to reward shareholders. This was evident when company CFO Dennis Durkin recently stated more stock repurchases and dividends may be coming shareholders’ way. The company entered the year with nearly $4.4 billion in cash on its books.

The company could return excess cash to shareholders. The stock is trading near its 12-month high levels; however, it would be wrong to assume the upside is limited as a result. On the contrary, continued financial improvement and a dearth of worthy competitors would only increase its attractiveness among investors.

Zynga is another player that has played the social media shift beautifully. In fact, its entire business revolves around developing blockbuster games such as FarmVille and Mafia Wars for Facebook. This is not to suggest that the company is a winner. Quite to the contrary, it has already witnessed pressure on margins and has struggled to make profits, despite cornering the biggest part of Facebook gaming.

After being hailed as the next big thing in the gaming industry, the company has struggled with monetizing its vast and still growing subscriber base. The company has seen more than 73% erosion in its value over the last 12 months due to these concerns, making the stock one of the worst performers.

Overall, the shift to online platforms needs to be watched closely. There are no clear winners in the game yet and while the industry explores monetization strategies, it may be better to consider players with a fair balance of online-offline experience.

Jacob Wolinsky 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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