Change is hard but inevitable in the video game business. Some companies are weathering the dramatic shift from selling physical goods at retail to digital distribution better than others. THQ (NASDAQ:THQI), once one of the more profitable makers of licensed children’s games, is now trading around 50 cents per share and it’s in danger of being removed from the NASDAQ stock exchange.
Meanwhile Electronic Arts (NASDAQ:EA), one of the industry’s biggest game developers and a business that has struggled since the 2008 crash, is finding new life in digital platforms. Despite its growing success in the field, though, EA’s digital business will never recapture the market dominance the company enjoyed when video games were a retail-store-only business.
How good is EA’s digital business? Digital revenue for 2011 grew 79% year-on-year, coming in over $1 billion. The third quarter (its fiscal year ends in March) was especially strong for the company, with all its digital businesses bringing in $274 million over the holiday quarter, a 40% boost over the same period in 2010. This is in addition to revenue from the company’s subsidiary PopCap, a mobile- and social-games maker that EA acquired in July and isn’t included as part of EA’s quarterly financials.
The origin of Origin
What’s significant about the strong performance of EA’s digital initiatives at the end of 2011 is that it marked a period when EA was aggressively touting its big-budget blockbuster games–typically marketed as games for home gaming consoles like Microsoft‘s (NASDAQ:MSFT) Xbox 360 and Sony‘s (NYSE:SNE) PlayStation 3–as digital downloads on Origin. Origin is the company’s new digital storefront for games–think iTunes or, more appropriately, game developer Valve’s competing service, Steam, which lets users purchase games as they would at a retailer like GameStop (NYSE:GME) or Best Buy (NYSE:BBY) but also offers access to a community for playing games with others online.
Origin opened for business halfway through 2011 and some industry followers worried that EA was splitting the digital market by making some of its games available exclusively as digital products on Origin. EA nonetheless managed to do good business with Origin by the end of the year, pulling in $100 million of the company’s total digital revenue.
More promising for the company and Origin is the early success of the new online role-playing game Star Wars: The Old Republic, a competitor to Activision Blizzard‘s (NASDAQ:ATVI) multibillion-dollar earner World of Warcraft. Released on Dec. 22, Star Wars already has 1.7 million subscribers, and 40% of those sales were made through the Origin service. (There was also some concern that Star Wars wouldn’t yield a return on its $80 million development. Wedbush analyst Michael Pachter, though, said in May that EA only needed between 350,000 and 500,000 subscribers to turn a profit on the game. Goal achieved.)
A digital future, but still a hardcopy present
The company’s digital business is growing and fast. What’s more, EA is transitioning those big-budget titles to its own digital sales platform and making money in the process. It is handling change well. It is not, however, changing fast enough. Total revenue for the fourth quarter is expected to be between $925 and $975 million, meaning that digital still only represents around 28% of EA’s quarterly business.
Sales of physical games like Madden NFL, FIFA, and Battlefield 3 are still what drive EA’s business. Origin is clearly a growing business and the success of titles like Star Wars on the platform prove its viability, but EA’s competition is fierce. Valve doesn’t disclose earnings from its Steam service, but a Forbes report last year suggested that it pulls in about $2.8 billion annually. That was in February 2011. In February 2012, Valve announced that it’s bringing Steam to Apple’s iOS devices and Google‘s (NASDAQ:GOOG) Android handhelds. EA needs more than just a popular Star Wars game to make Origin a Steam challenger.
Investors shouldn’t shy away from EA. The company is doing just fine. As CFO Eric Brown said, the 2011 holiday sales season marked EA’s best cash flow quarter in 31 quarters. Any industry follower expecting EA to be a king of the hill once video games become a purely digital business, though, may be disappointed.