Can Investors Trust Electronic Arts Again?
Soroush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Oh the joys of being Electronic Arts (NASDAQ: EA). One minute you’re on top of the virtual world, the next you’re being called one of the worst companies in America. Mired in a slump as deep as the Miami Dolphins, shares of EA stock have been in fourth and long territory for the majority of 2012, losing more than 40% since the start of the year. These declines have partially been the result of a bevy of customer service nightmares including: (1) the Mass Effect 3 debacle, (2) EA’s history of tacking on extra fees for downloadable content, (3) acting like Big Brother and scanning your game’s ownership history, (4) closing servers on games released as recently as 2010, and (5) using charities without permission for free advertising, to children.
Quantitatively speaking, the videogame maker is looking like a mixed bag. Revenues and EPS have wilted for three consecutive quarters, but that is expected in an industry as downtrodden as videogaming has been. Since a peak of $21 billion in 2008, aggregate sales have shrunk to the tune of 8% a year. In EA’s case, its top line has declined by just -0.6% a year, giving some solace to the bull’s case.
On July 31st, EA reported its Q1 earnings, delivering underachieving sales numbers while slightly exceeding the Street’s EPS estimates. Regarding the latter, the company amassed earnings of -$0.41 a share, beating analysts’ consensus of -$0.42, though the loss is still not very inspiring. EA’s highest grossing games of the quarter were “Battlefield 3,” and “FIFA Ultimate Team,” in which the latter contributed $30 million to the company’s bottom line. On a negative note, subscribers to “Star Wars: The Old Republic” are down from its release date high of 1.7 million to 1.3 million, which is scary, considering the company’s renewed focus on MMO and RPG games post-recession (see: acquisition of BioWare).
Going forward, official estimates are expecting year-end earnings of $0.63 a share, up 86% from the $0.34 EA reported last year, but current prices show that the markets are remaining slightly cautious for the time being. At its present forward price-to-earnings ratio of 9.6X, EA is trading below the industry average (16.8X) and Activision Blizzard (NASDAQ: ATVI) at 10.0X, but above Changyou Ltd (NASDAQ: CYOU) at 3.6X, and Take-Two Interactive (NASDAQ: TTWO) at 5.6X. When growth is factored into the equation, though, we can see that EA does sport a PEG ratio of 0.5; typically anything below 1.0 signals undervaluation. Moreover, this is also below peers ATVI (3.3) and CYOU (3.1).
From a cash standpoint, EA has grown its operating (45.1%) and free (99.1%) cash flows quite nicely over the past three years, though it still trades at a price-to-cash flow ratio (14.5X) below its own 5-year (31.8X) and 10-year (34.6X) historical averages. In fact, Electronic Arts’ cash hoard has traditionally traded at a 243% premium to those of the S&P 500. This year, they appear much cheaper, trading at just a 62% premium.
If the videogame maker is able to stay on track with analyst estimates, fairly valued shares can eclipse $16, though the aforementioned economic headwinds and public relations snafus remain an obvious risk. WealthLift’s Sentiment Index does rate EA as a hold, with the community’s users split on what the future will bring.
Interestingly, the company does release “Madden 13” on August 28th; ardent investors would be wise to track the game’s sales during its first few weeks on the shelves. Any positive data will give this stock a much-needed dose of optimism, soothing investors’ collective psychologies after a turbulent first half of 2012. For updates on this situation, check back at WealthLift INSIDER.
WealthLift 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.If you have questions about this post or the Fool’s blog network, click here for information.