VALUATION HIGHLIGHTS

1. Console constitutes 61% of the Trefis price estimate for Electronic Arts's stock.
2. Mobile constitutes 15% of the Trefis price estimate for Electronic Arts's stock.
3. PC/Browser & Others constitute 12% of the Trefis price estimate for Electronic Arts's stock.

WHAT HAS CHANGED?

1. Impact of Covid-19

We see Electronic Arts stock has gained over 22% year-to-date (through Dec 8), ahead of the broader indices, with the S&P 500 up 14%. Gaming companies, such as Electronic Arts, stand to benefit in the current crisis, as the demand for gaming is seeing traction, given that more people are confined to their homes, eschewing more public forms of entertainment. Moreover, with the release of new generation consoles in 2020, the demand for gaming software is also expected to rise, boding well for Electronic Arts.

2. Q2 FY 21 Performance

Electronic Arts' Q2 FY 21 revenues were down 15% to $1.2 billion. This can largely be attributed to year-over-year change in the launch date of the company's FIFA console title from Q2 in last fiscal to Q3 in the current fiscal. Bottom line plunged to $0.64 per share, compared to $2.89 per share in the prior year quarter. However, prior year quarter earnings were higher due to one-time tax related gains.

3. E-Sports Growth

E-Sports has been a huge success for Electronic Arts. For instance, FIFA Ultimate Team has allowed the company to earn from matchmaking services, which refers to connecting players together for online play sessions. The company has launched similar Ultimate Team services for other sports games such as Madden NFL and NHL. Moreover, EA is reaping profits from digital content related to other titles as well. For example, the company has released expansion packs in digital content for its FPS (first person shooter) franchises such as Battlefield. As such, the company is seeing massive growth in its Services segment revenues.

4. Newer Generation Console

Electronic Arts console games sales have grown from $3.0 billion in fiscal 2015 to around $3.8 billion in fiscal 2020. This represents a 5% average annual growth in console revenues, and it can primarily be attributed to the success of its franchises, such as FIFA, and Battlefield. However, newer generation consoles are expected to launch in the second half of 2020, and this should aid the console gaming demand as well, thereby likely aiding Electronic Arts' top line in the coming years.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

Below are key drivers of value that present opportunities for upside or downside to the current Trefis price estimate for Electronic Arts's stock.

Stronger adoption of in-game services

In the changing video game landscape, EA has been focusing on downloadable content, subscriptions, and other supplementary services to generate income. As product costs, warehousing and distribution costs, and manufacturing royalties are not applicable to these streams, they also have higher margins. We expect EA's Console revenue to see a strong growth to $6.1 billion over the course of our forecast period, compared to $3.7 billion in fiscal 2020. However, if this figure increases to $8 billion driven by stronger adoption of in-game services, increased breadth of these services and improved monetization, there can be nearly 20% upside to our price estimate for EA.

BUSINESS SUMMARY

Electronic Arts (EA)

Electronic Arts is an international developer, marketer, publisher, and distributor of games for video game consoles, personal computers, mobile phones, and the Internet. Currently, EA's most successful products are sports games published under its EA Sports label (such as FIFA, Madden NFL, and NHL), games based on popular movies such as Harry Potter, and games from long-running franchises such as Need for Speed and The Sims. The company is gradually entering the First-Person Shooter (FPS) genre led by its Titanfall and Battlefield titles.

Product revenues are primarily generated from the sale of video games. EA also generates revenues from downloadable content, subscriptions, and other services such as in-game advertising.

SOURCES OF VALUE

Console & Mobile Revenue

Over the past few years, the revenue from Mobile platform has seen faster growth compared to the company's other segments. Mobile gaming is seeing increased demand across the globe, with an increase in time spent on smartphones. That said, hardcore gamers usually prefer playing on consoles, which is the largest segment for Electronic Arts in terms of revenues. Therefore, for EA, both these revenue streams are important. Going forward, we expect the console revenue stream to grow at a faster pace compared to Mobile, primarily due to the launch of new generation consoles in the holiday season of 2020.

KEY TRENDS

Gaming Industry's Changing Landscape

The video game landscape has changed significantly over the last few years. Through the last decade, the advent of smartphones and tablets has increased the ease of access to games, leading to the rise of casual gaming. Gamers are no longer restricted to consoles and high-end PCs but can use their smartphones to play games on the go. As a result of this revolution, video game companies have had to change their business model to adapt to the evolving market.

In 2007, the launch of the iPhone and Android based smartphones created a new platform to which the casual gamers, who spent a limited amount of time playing games, started migrating. By 2010, games like Angry Birds and Fruit Ninja were taking away market share from EA’s console based casual games like DeathSpank, Green Day: Rock Band, and Create. The company reacted to this trend by cutting down on the number of titles released, and focusing on secondary service streams such as downloadable content (DLC), subscriptions, matchmaking, and in-game advertising.

Launch Of Next Generation Consoles

Another factor contributing to the sales slump was console fatigue, as the seventh generation consoles had been around for eight years until the XBox One and Playstation 4 were launched in 2013. The next-generation launches refreshed the console cycle, and the initial response to the consoles was strong, though software sales initially lagged behind hardware sales.

The discrepancy between hardware and software sales could be due to a natural lag; gamers might prefer to buy the console first and then move on to buying software. Another factor for the lagging software sales might be the shift towards casual games; core gamers are still buying consoles and software, but casual gamers might not favor the expensive eighth-generation consoles over the smartphone and tablet platforms.

Currently, each Xbox One console sold is accompanied by nearly three games on average. If the difference between software and hardware sales is indeed due to a natural lag, then we might see this figure increase. However a decline in the games to consoles ratio would indicate that casual gaming is eating into the console market.

Changing Trend In Software Sales

The scenario in the gaming industry seems to improve in terms of software sales. Unlike 2014, video game software sales for 2015 were stronger. Even in 2017, the sales were higher. This indicates that unit sales per title have increased over the period, as more gamers made a shift to new generation console platforms.

Growth of Competitive Gaming Market

Although the competitive video gaming sector has been there for a long time, it is just recently that the viewership and participation have picked up in the last five years. Moreover, the prize money and lucrative awards are attracting more professionals to this sector. Since FPS (First-Person Shooter) games are gradually becoming a part of the online competitive gaming landscape, it is the right time for the company to enter this market.