When a company has a profitable product, we often say it has a “cash cow.” The cash cow for Electronic Arts Inc. (NASDAQ:EA) is sports games, titles like Madden NFL and FIFA tied to leagues and sold to fans.
EA is less of a player in games that, like new blockbuster movies, are created out of whole cloth. In this area, too, it goes the licensing route, such as with the “Star Wars” franchise of Walt Disney Co (NYSE:DIS).
This is a conservative strategy that has nonetheless worked well. The shares are up almost 50% so far in 2017, opening Aug. 18 at $116. Its first two quarters this year have been outstanding, the company earning a combined $3.86 per share and bringing about 40% of roughly $3 billion in revenue to the net income line.
What could possibly go wrong?
Is EA Stock a Couch Potato?
There is always a risk that a successful company can get lazy, and there are signs of this happening at EA. Executive vice president Patrick Soderlund admitted being “surprised” by the success of the Nintendo (OTCMKTS:NTDOY) Switch, the year’s hottest new console, but early versions of its sports games on the hybrid-handheld hybrid will lack key features.
That kind of developmental laziness has bears growling. After the company announced just one premium title at the summer’s E3 show, then pushed its delivery date into next year, a short seller publicly predicted the shares will soon fall 20%. That would retrace the current year’s gains, but still leave long-term holders with enormous gains — the shares are up 750% over the last five years.
Our Laura Hoy calls the bear’s bug a feature. Research and marketing costs are low, making margins high. Half of all sales are direct downloads and that percentage is rising, further reducing costs. Its sports games have room to grow as “eSports,” where game players become stars themselves competing for big prizes, and it can quickly bring Virtual Reality to its franchises, making gamers feel they are on the field with their favorite athletes.
Our James Brumley also sees eSports as a gold mine for the company, not only through tournaments but from the incremental sales that come from gamers who watch them.
Better Plays
EA delivered two consecutive quarterly losses as recently as last year, but that turned out to be a platform for its current run, because they were lower than expected and the company then delivered conservative guidance, which it exceeded.
I do have concerns, however. When you’re tied into licensing, you’re vulnerable to the party on the other side of the table walking away, either re-bidding to raise costs or taking the whole project in-house. You’re much better off creating your own intellectual property, games tied to nothing but your own story development.
That is what rivals Activision Blizzard, Inc. (NASDAQ:ATVI) and Take Two Interactive Software Inc (NASDAQ:TTWO) have been doing, and their gains so far in 2017 are even bigger than EA’s. Take Two is the home of the Grand Theft Auto franchise, while Activision Blizzard owns the Call of Duty and Starcraft franchises.
ATVI also has a stronger position in eSports through the assets of the old Major League Gaming organization, as well as ownership of several of the top streamed games according to NewZoo. They know the high end of the market.
So far in 2017 ATVI stock is up 72% and TTWO 87%, numbers that put EA’s 49% gain in the shade. They own the stories behind their titles, and they’re well-positioned on the high-end hardware regular gamers like best. Their margins are lower than EA’s but less vulnerable to disruption.
If I were interested in investing in this business that is where I would go.
Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time, available now at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this article.
