Electronic Arts Has Huge Potential In The Digital Domain

September 30th, 2013 · by Trefis Team
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Despite being affected by an industry wide decline in video game sales through the first half of the year, Electronic Arts (NASDAQ:EA) has been helped by increasing its focus on high margin digital revenue streams. While non-GAAP publishing packaged goods revenue fell 25% during the June quarter, EA reported a 45% surge in digital revenues leading to a 6% increase in total net revenue for the quarter. The cost of revenue for the digital stream is just around 30% of the net revenue while the cost of revenue for physical sales is around 50%. As a result of increased contribution from these secondary streams, non-GAAP gross margin increased from 61.5% in the first quarter of 2013 to 63.8% for the three months ending June this year. We believe that EA’s strategy can pay off, particularly as the next generation consoles release later this year.

Electronic Arts’ stock has gained 80% since the turn of the year and is now in line with our $18 price estimate.

See our complete analysis of Electronic Arts stock here

[trefis_slideshow ticker=”EA” rhs=”3″]

The Digital Revolution

Digital revenues can be broken down into four categories: mobile revenues, downloadable content (DLC) and free-to-play, full game downloads, and subscriptions and in-game advertising. The DLC stream, which includes purchasable virtual goods and characters, accounts for nearly half of the digital revenues earned by the company while full game downloads account for around 10%.

We believe that EA can leverage the popularity of its titles like FIFA, Madden and Battlefield to grow these two streams. FIFA, the popular soccer based game, accounted for 40% of the DLC revenues earned by the company last quarter. FIFA Online 3 digital revenues increased by 88% over its previous iteration. According to our analysis, FIFA 13 accounted for around 5% of the global game sales last year. [1] The latest edition of the franchise, FIFA 14, was launched this week and has performed well so far. [2] The company is also planning to take the game to China, in collaboration with TenCent and will be looking to capitalize on the popularity of soccer in the country.

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Can EA Compete In The Mobile Domain?

The popularity of smartphones has led to a huge increase in casual gaming, particularly on portable devices like mobile phones and tablets. Electronic Arts has so far been successful in this domain, Real Racing 3, which was the best selling racing title on iOS last quarter with more than 45 million downloads and an average of over 2 million daily active users since its launch in March. The Simpsons: Tapped Out and Plants vs Zombies are two of the best selling mobile games. The company has registered over 22 million mobile users on online digital platform Origin, and also launched FIFA 14 and Madden NFL 25 on mobile.

However, the mobile gaming business is still in its nascent stage and barriers to entry in this stream are very low. Several popular titles like Angry Birds are available for free on the respective mobile markets. To compete, EA has had to launch a free-to-play version of Plants vs Zombies 2. We maintain our forecast for growth but will keep a close eye on future developments to see if EA can maintain the momentum it has built up. While increased digital sales will have a cannibalization effect on physical sales, they will allow margins to increase in the coming years. We expect EA’s gross margin to increase to 68% by the end of the decade.

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Console Revolution

Research group NPD reported that retail sales of console and PC games grew 21% in August, the first positive change in sales since November 2011. [3] This is a positive sign for EA, which has a market share of nearly 12% in the U.S. video game market. [1]  Video game hardware and software sales grew by 60% during the Xbox 360’s first full year in the market while PS3 sales grew by 30%. [4] EA will be hoping for a similar revival this time around. Given that mobile and casual gaming will cut into game sales on consoles, we remain conservative with our forecast, with a 7% increase in EA’s sales through the first full year of the consoles. You can modify the interactive chart below to gauge the effect a change in forecast would have on our price estimate.

[trefis_forecast ticker=”EA” driver=”0091″]

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Notes:
  1. VGChartz [↩] [↩]
  2. EA closes higher as FIFA 14 launches to decent reviews, Seeking Alpha, September 24 [↩]
  3. U.S. Game Sales Show Signs of Turnaround, Wall Street Journal, September 12, 2013 [↩]
  4. GameStop Management Discusses Q2 2013 … – Seeking Alpha [↩]
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