Electronic Arts Misses Revenue Guidance But Expands Margins Through Digital Growth

by Trefis Team
-25.50%
Downside
36.25
Market
27.01
Trefis
EA
Electronic Arts
Rate   |   votes   |   Share

Electronic Arts (NASDAQ:EA) reported mixed fiscal third quarter earnings on Tuesday, missing revenue estimates and issuing tepid guidance for the upcoming quarter. Although Non-GAAP revenues of $1.57 billion were up 33% from the prior year, they were below the $1.65 billion guidance earlier issued by the company. Management attributed this shortfall to declining demand for current generation Xbox 360 and Playstation 3 titles. As a result, EA also lowered its full-year revenue guidance to $3.91 billion.

However, the company did post earnings gains, with EPS of $1.26 beating market estimates by 4 cents per share. This was largely driven by margin expansion, as EA continued to shift its product mix towards the digital domain, and also by cost management in research and development and sales and marketing. Non-GAAP digital net revenue increased 27% over the prior year, accounting for one-third of the total revenues. As a result, the company’s gross margins increased from 65.7% to 68.1%.

We believe that EA is well positioned to capitalize on the sales boost resulting from the launch of the next-generation Xbox One and Playstation 4 consoles. The company has so far launched six titles for the new consoles; FIFA 14, Battlefield 4, Madden NFL 25, Need for Speed Rivals, NBA LIVE 14 and Peggle 2. These titles already have a market share of 40% on Playstation 4 consoles and 30% on Xbox One consoles.

Our $28 price estimate for Electronic Arts’ stock implies a premium of about 10% to the current market price.

See our complete analysis of Electronic Arts stock here

Digital Expansion

Electronic Arts is no longer just reliant on product sales, but also gains from support streams like extra downloadable content (DLC) which have allowed it to improve efficiency. The company released 60 titles in fiscal year 2009 and 54 in 2010, primarily standalone titles with little or no online support and earned $60 million per title. In fiscal 2013, EA launched 35 titles (13 on consoles and PCs, and 22 on mobile and Internet platforms) but earned $108 million per title. The DLC stream accounted for 41% of December quarter revenues. Revenues were up 15% over the prior year, driven by FIFA Ultimate Team, FIFA Online 3 and Star Wars: The Old Republic. The company has also launched Ultimate Team services for other sports titles like Madden NFL and NHL with strong positive response.

Mobile phone games – such as The Simpsons: Tapped Out and Real Racing 3 – are the second biggest contributor to digital sales. The company generated $125 million in sales for the quarter, up 26% over the prior year, with over 71 million game downloads on Apple and Android platforms. However, unlike the DLC stream, we expect EA to face strong competition  in the mobile gaming domain. Entry barriers to the field are low and free-to-play games such as Angry Birds have taken the market by storm.

The remaining streams in the digital domain are full game downloads, and subscriptions and advertising. Battlefield 4, despite initial glitches, drove a 157% increase in the former, while the latter was down 16% due to a decline in Star Wars: The Old Republic subscribers. Facing tough competition, EA has launched a free-to-play version of the Star Wars game and will continue to see a migration of paid subscribers.

The cost of revenue for physical products sold is about 50% of net revenue, while the cost of revenue for online and digital services is just 30%. With increased digital contribution, especially from the DLC stream, we expect EA’s margins to expand further to around 68%.

Strong Lineup

While software sales have so far been weak, the Xbox One and Playstation One consoles have seen very strong sales. Research group NPD’s figures indicate that hardware sales increased 28% in December while software sales were down 17% (NPD’s figures do not include digital sales). [1] Strong hardware sales suggest that a software revival is just around the corner. The console product cycle has been refreshed after eight years and it can take some time for consumers to catch up. The Xbox 360 was released in November 2005 and the Playstation 3 was launched in the following year. However, the true impact of the new product cycle was felt only after 2007, the first full year that Xbox 360 and Playstation 3 were in the market, as software sales jumped 43% in 2007. [2]

As we suggested earlier, EA is well-positioned to gain from this trend, as the company has accounted for 35% of game sales on the next-gen platforms so far. The company’s portfolio is strong and it has exclusive licensing agreements with the NFL and FIFA, which allows it to maintain a near monopoly in the sports games domain; the soccer based game was the fourth highest selling game in the world last year, accounting for 4% of the units sold worldwide, while Madden was the third highest game in the U.S. [3] The FIFA World Cup is scheduled to take place in Brazil this year, with over 500,000 fans from all over the world expected to attend the event. [4] Sales of the annual FIFA franchise went up 25% after the last world cup in 2010. We expect a similar trend this time, with additional gains from the DLC stream. [5]

See More at Trefis | View Interactive S&P Capital IQ Analyses (Powered by Trefis)

Notes:
  1. December 2013 NPD: While both supply constrained, Xbox One outsells PlayStation 4, January 16, 2014 []
  2. Nintendo tops video game sales in 2007,NBC News, January 2008 []
  3. VGChartz, 2013 Global Yearly Chart []
  4. Brazil 2014: Four weeks of soccer that impact a lifetime, PWC []
  5. VGChartz, 2010 Global Yearly Chart []
Rate   |   votes   |   Share

Comments

Name (Required)
Email (Required, but never displayed)
Be the first to comment!