What’s Happening With Electronic Arts Stock?

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[Updated 1/14/2021] Electronic Arts Update

Last month, Electronic Arts (NASDAQ: EA) said that it plans to acquire Codemasters, a UK-based racing game developer, in a deal that is valued at $1.2 billion, outbidding Take Two Interactive’s offer of $973 million. With the  acquisition, Electronic Arts will get access to Codemasters’ racing franchises, including Formula One, and DiRT among others. Electronic Arts has its own racing franchise – Need For Speed – and the company has been successful with its live services offerings and global reach. Under Electronic Arts, Codemasters’ racing games will likely see expansion of live services over the coming years. The acquisition is an all-cash deal and funding is not a concern for Electronic Arts. Currently, it is sitting on cash of around $6 billion and total debt of less than $1 billion. It also generated $439 million in cash from operations in the six months period ending Sep 2020, implying the company has a strong financial position. Electronic Arts expects to close the deal in the first half of 2021.

EA stock has been on a strong run even during the pandemic given an overall increase in gaming demand. EA is up 24% from its pre-Covid levels of around $110 seen in mid February, outperforming the S&P 500, which has gained 12% over the same period. We believe EA stock could continue to trend higher in the near term, especially now that the new generation consoles have hit the market, and the overall demand for games is expected to rise. EA stock is also up 73% since early 2019.

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(Updated 11/20/2020) Electronic Arts Valuation

Electronic Arts’ stock (NYSE: EA) lost more than 18% – dropping from $107 at the beginning of the year to $87 in late March – then jumped 38% to around $120 now. That means it is now up 12% from the levels where it started the year. This marks a slightly better performance compared to the broader markets, with the S&P 500 up 10% year-to-date. Why? Electronic Arts has actually benefited 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. Additionally, while the Covid-19 outbreak and associated lockdowns resulted in an uncertain outlook for the broader markets, the multi-billion-dollar Fed stimulus followed by hopes of availability of vaccine as early as late 2020 has helped the markets stage a strong recovery.

But is this all there is to the story?

Not quite. Despite the recent gains, Trefis estimates Electronic Arts Valuation at about $147 per share, roughly 22% above the current market price based on two key opportunities.

The first opportunity we see is to Electronic Arts Revenue growth over the coming years. Electronic Arts Revenues have seen a 8% growth from around $5.1 billion in fiscal 2018 to $5.5 billion in fiscal 2020 and we expect it to increase 15% to $6.4 billion in fiscal 2022, primarily led by continued growth in its e-sports business, primarily FIFA franchise (the company’s fiscal ends in March). 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 live-offerings, which is a recurring revenue stream.

Furthermore, 2020 marks the launch of new generation consoles from Microsoft and Sony, and the new consoles sales are expected to be high over the coming years. In fact, Xbox sold over 1.2 million units of its new console on the day of its launch, marking its best launch ever. The newer consoles though have backward compatibility, which allows users to play certain games already owned by the user, it will also result in an increased software demand, boding well for gaming companies such as Electronic Arts. Console gaming accounted for 68% of the company’s total sales in fiscal 2020. The company has already announced the games one can play on the new consoles.

The second key opportunity stems from Electronic Arts valuation multiple compared to its peers. The stock now trades at 22x its projected fiscal 2021 adjusted earnings per share of about $5.49. In comparison, to earn close to $5 per year from a bank, you’d have to deposit about $500 in a savings account today (assuming 1% interest rate), so about 100x desired earnings. At Electronic Arts current share price of roughly $120, we are talking about a P/E multiple of around 22x based on expected 2021 adjusted earnings of $5.49, and we think a figure closer to 27x will be appropriate.

The 22x figure compares with figure of 25x for Electronic Arts seen in 2019 as well as in 2017. Some of the other gaming companies, such as Take Two Interactive currently trades at $165, implying 30x its estimated full year earnings of $5.57. With revenue growth driven by new generation consoles, clubbed with margin expansion due to higher contribution of live offerings and cost cutting measures, this will result in strong earnings growth over the coming years. In fact, we estimate the fiscal 2022 Adjusted EPS to be $6.00 per share, and at the current price of $120, EA stock is trading at just 20x fiscal 2022 (expected) earnings, again comparing to levels of over 22x seen over the recent years, implying there is more room for growth.

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