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Electronic Arts (EA)

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WHAT HAS CHANGED?

  1. Q1 FY 20 Performance
Electronic Arts' Q1 FY 20 revenues were up in mid-single-digits to $1.21 billion, driven by sales related to FIFA Ultimate Team, The Sims 4, and Apex Legends. Bottom line grew sharply to $4.75, as compared to $0.95 in the prior year quarter, primarily reflecting the recognition of $1.17 billion deferred tax assets.

  1. 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.

  1. Newer Generation Console

Electronic Arts console games sales have grown from $3.0 billion in fiscal 2015 to around $3.3 billion in fiscal 2019. This represents a 3% 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

EA Services & Other Revenue: 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 services & other revenue to nearly double to $6.6 billion over the course of our forecast period. 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 15% upside to our price estimate for EA.

Unit sales decelerate

EA's product revenue: EA has pulled back in terms of the number of titles it is releasing each year. However, the hit rate, or the percentage of titles that have made it to the list of top hundred titles across the world, has improved. The video game industry is a hit-oriented business, though a title which performs well in one year might not do so in other years. Also, there is an increased push fo digital over physical. The company's older franchises are not seeing much demand. In fact, the recent launch of Battlefield in November 2018 was a miss for the company with sales falling short of expectations. This trend could continue in the coming years, with gamers losing interest in older franchises. As such, we expect EA's product revenue to decline from $1.6 billion in FY2019 to $820 million over the course of our forecast period. However, there can be upside of over 5% if this figure stays around $1.6 billion mark.

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

Product Revenue & Service Revenue

Over the past few years, the revenue earned from in-game services such as downloadable content and in-game purchases, has become nearly equal to the revenue it earns from sales of game titles. Therefore, for EA, both these revenue streams have become equally important. Going forward, we expect the service revenue stream to overtake product revenue stream as the installed base widens. EA is focusing on making the most of its existing franchise titles.

  1. R&D requirements are lower as the games are not developed from scratch. Only incremental changes are made much of the time.
  2. SG&A requirements are lower since the games are already popular among the gaming community.
  3. Lower direct expenses also contribute to higher profit margins for franchise games.

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.

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