Electronic Arts Still Stuck In The Battlefield 4 Quagmire; Fair Value $28

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After the Battlefield 4 debacle that sent the stock plunging in December, Electronic Arts (NASDAQ:EA) now faces a class action lawsuit alleging that the company made misleading statements to investors regarding the prospects of the first person shooter (FPS). [1] The lawsuit has been filed in United States District Court, Northern District of California by Pomerantz LLP on behalf of all persons who acquired the stock between July 24, 2013 and December 4, 2013.

EA issued strong guidance for fiscal 2014, hoping to capitalize on the launch of the next generation consoles through games such as Battlefield 4, Titanfall and its sports-based franchises FIFA and Madden. The company initially launched four games for the new consoles including established best-sellers FIFA 14, Madden NFL 25 and Need for Speed Rivals. Battlefield 4 was the fourth game launched was expected to compete with Activision Blizzard’s (NASDAQ:ATVI) Call of Duty: Black Ops 2 in the FPS market. However, gamers experienced problems with EA’s games on the new platforms; Battlefield 4 took the brunt of the criticism and EA was forced to halt work on other projects such as Mirror’s Edge and Star Wars: Battlefront to focus on fixing the problems faced by Battlefield 4 players. [2] The stock plummeted following this news release.

Although EA missed an opportunity to gain market share in the FPS market, we still believe that its sports based franchises and digital monetizing strategy will hold it in good stead. Our $28 price estimate for Electronic Arts’ stock implies a premium of 30% to the current market price.

See our complete analysis of Electronic Arts stock here

Public Relations Need To Improve

Electronic Arts has a history of infuriating gamers, highlighted by its undesirable coronation as Consumerist’s Worst Company in America for the last two years. [3] The company has lost a lot of key executives in the last year, the most recent of whom was Vice President Jeff Brown. [4] Mr. Brown handled Public Relations and was regarded as the voice of EA. The exodus of executives under new management might be a cause for concern, but the company’s results have been strong. EA beat its guidance for the last quarter, helped by strong sales of FIFA and Madden as well as sustained growth in the digital domain.

Shift To Digital

Electronic Arts has been focusing on efficiency through the digital domain. The company released 60 titles in fiscal year 2009 and 54 in 2010, primarily stand-alone titles with little or no online support. The revenue earned per title was just around $60 million. Since then, EA has added time-based subscription services and game-related content that needs to be downloaded, increasing the revenue earned per title. The number of titles released by EA in fiscal 2013 was 35 (13 on consoles and PCs and 22 on mobile and internet platforms) while the revenue per game was $108 million.

The digital stream accounted for 65% of the company’s GAAP revenue through the September quarter, and 33% of non-GAAP revenues. For the same period in 2012, the digital contribution was 45% and 29% to GAAP and non-GAAP revenues, respectively. Extra downloadable content is the biggest contributor, accounting for 35% of digital revenues while Mobile phones and tablets account for 30%. Games like The Simpsons: Tapped Out, Real Racing 3, Plants vs. Zombies 2 and Sims FreePlay have driven mobile revenues while content for Ultimate Team, FIFA Online 3 and Star Wars: The Old Republic has helped the DLC stream.

EA has exclusive licensing agreements with the NFL and FIFA, which allow it to maintain a near monopoly in the sports games domain.  EA had a market share of around 14% (in terms of units sold) in the video game market across the world last year, with FIFA accounting for 5% of the global sales. [5] FIFA accounted for 7% of global game sales on the Xbox platform last year, while Madden accounted for 3%. In the U.S., Madden accounted for 4% of total sales while FIFA accounted for 2%. The FIFA World Cup is scheduled to take place in Brazil next year and the fanfare associated with the event should further boost video game sales. FIFA is EA’s strongest offering, accounting for nearly half of the company’s sales last year and is also a big contributor to digital sales. Digital net revenue from the FIFA franchise in the first half of fiscal 2014 went up 25% over the previous year. We expect EA to maintain its push in the digital domain through its sports-based titles in the coming years

Digital growth will also allow for margin expansion. The cost of revenue for physical products sold is about 50% of the net revenue, while the cost of revenue for online and digital services is just 30%. EA’s gross margin improved from 60.1% in the second quarter of fiscal 2012 to 61.7% this year. Management expects to generate over 40% of fiscal year revenues from the digital streams. Going forward, we expect margins to increase to about 68% as digital contribution increases further.

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Notes:
  1. Electronic Arts Inc. : SHAREHOLDER ALERT: Pomerantz Law Firm Announces the Filing of a Class Action Against Electronic Arts, Inc. and Certain Officers – EA []
  2. ‘Battlefield 4′ tech glitches persist, Electronic Arts shares fall, Reuters, December 5, 2013 []
  3. EA Voted Worst Company in America, Again – Forbes []
  4. The master of zinger quotes, EA spokesman Jeff Brown skis off to GoPro, VentureBeat, January 13, 2014 []
  5. VGChartz []
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