The video game industry stands on the cusp of great change. The days when customers would line up outside a retail store waiting for the chance to get their hands on a copy of a much-awaited video game are rapidly going away. The modern gamer is more likely to download the desired game from the internet. Electronic Arts (NASDAQ:EA), one of the world’s biggest video game publishers, has stated its intention to eventually shift its operations entirely to the digital domain.  The company’s latest earnings report, released at the end of last month, revealed that it is indeed undergoing a transition.
EA’s digital revenues, earned through its online portals Origin and Play4Free as well as mobile devices such as smartphones and tablets, accounted for 25% of EA’s net revenues in the six months ending September 2011. In 2012, digital revenues increased to nearly 40% of net revenues. Besides extending EA’s customer base to the casual gamer who occasionally uses his or her mobile device to play video games, digital revenues also offer higher margins for the company as manufacturing and distribution costs are not involved.
We believe that the focus on digital growth will benefit the company in the long term. Our recently updated price estimate for Electronic Arts is $17, implying a premium of about 10% to the current market price.
New Consoles To Fuel Growth
EA reported a 19% year-over-year decline in packaged goods revenue in the last quarter. This was not an isolated incident; a 19% decline in software sales was observed throughout the gaming industry.  However this decline may be attributable to the fact that both Microsoft’s (NASDAQ:MSFT) X-Box 360 and Sony’s Playstation are in the waning phase of their product cycles. Both console giants are expected to release their next generation consoles within the next two years and we believe that this will boost console revenues for Electronic Arts.
Sports franchises like FIFA and Madden are big breadwinners for Electronic Arts. The company releases annual editions of its popular titles. FIFA 13, the soccer game for the current year, outdid its predecessors by selling 7.4 million units in the first four weeks of its launch to break the record for the biggest sports videogame launch ever. Madden NFL 13 sold 9% more units in the quarter than Madden NFL 12 did last year. The fact that EA has an exclusive licensing agreement with soccer’s governing body, FIFA, and other regional bodies like the English Premier League give it a big edge over competing titles like Pro Evolution Soccer. The popularity of its sports titles will help the company capitalize on and adapt to the new consoles as they are launched.
Nintendo’s next-generation console, Wii U, has received much fanfare. Video game retailer GameStop (NYSE:GME), which has over 44% of the U.S. software market share, reported over 1.2 billion titles reserved pre-launch and over 500,000 customers in its Wii U reservation wait-list. The console was recently launched successfully in the U.S. We expect the console to help EA arrest the slide in Nintendo platform revenues that it has reported so far this year.
Although some rumors have suggested that the new X0Box 720 might be disc-less,  the company has been mum about the console. Some speculations suggest that a Blu-ray drive might be part of the package.  One thing is certain, however: downloaded games will play a bigger role in the future.
EA management has suggested that its gross margins should improve substantially as digital revenues form a bigger part of the product mix. We expect EA’s margins to increase to about 70% by the end of our forecast period.
- EA exec: We’ll be ’100 percent digital’ eventually, CNET, 3rd July [↩]
- Video Games sales in U.S. October 2012, NPD Group, 9th November, 2012 [↩]
- Microsoft Plans to Release Xbox Next in 2013, Remove Optical Disc Drive – New Report, XbitLabs [↩]
- Xbox 720 to offer Kinect 2.0 and Blu-ray drive, says Xbox World, CNET, 19th November, 2012 [↩]