The rumors are true: Electronic Arts (Nasdaq:ERTS) has agreed to purchase PopCap Games. With the deal, the company will get top-notch online games like Bejeweled, Plants Vs. Zombies, and Zuma for platforms like Facebook, smartphones and tablets.
However, the price tag is steep. Assuming various milestones are hit, the deal may amount to as much as $1.3 billion. Keep in mind that PopCap posted about $100 million in revenue in 2010.
But in today’s frothy market, EA had no choice. Apparently, there was a bidding war for PopCap, which involved suitors like red-hot Zynga.
But what about EA’s shareholders, who have seen the stock jump nearly 47% this year? Can the company continue to produce nice returns? Let’s take a look at the pros and cons:
Pros
Survivor. Back in 1982, Trip Hawkins founded Electronic Arts to capitalize on the surging growth of home computers. In fact, the company has since been able to adapt to disruptive changes in the industry. For example, Electronic Arts made the move into the new market for consoles in the 1990s. And now the company is aggressively moving into digital games.
Franchises. Electronic Arts has some of the most well-known gaming titles in the world. They include The Sims, Medal of Honor, Madden NFL, FIFA and Harry Potter. EA has been smart to turn these franchises into ongoing money makers, such as by producing sequels.
Scaled platform. Besides having games for the main consoles – like Sony’s (NYSE:SNE) PlayStation 3, Microsoft’s (Nasdaq:MSFT) Xbox 360 and Nintendo’s Wii – Electronic Arts also has a strong footprint on PCs, mobile devices, Facebook and tablets. This capability has been a huge advantage in terms of maintaining a competitive edge.
Cons
Hits business. Kind of like a movie studio, a gaming company often relies on a few blockbusters. And EA is no exception. If there are a couple duds, the impact can hurt revenue.
Economy. As seen in the recession of 2008-2010, the gaming business is volatile. No doubt, it’s easy for consumers to postpone purchases. Unfortunately, based on some of the latest data, it does look like the U.S. economy is slowing down.
What’s more, the cost of developing games continues to increase. As a result, there has been pressure on margins, especially for console games.
Competition. There are the longtime rivals like Activision Blizzard (Nasdaq:ATVI) and Take-Two Interactive (Nasdaq:TTWO). Of course, with the surge in social media and smartphones, there are a new set of fast-growing competitors. These include Zynga, which has recently filed to go public, as well as Rovio, which is the creator of Angry Birds.
Verdict
In the highly creative business of gaming, it can be tough to pull off acquisitions. But EA has a good track record. It helps that the company understands knows how to provide more freedom yet structure deals that are based on earnouts.
While there will likely be a dropoff in sales from some top games, EA still has a good lineup. For example, there is Battlefield 3 and a multi-player game for Star Wars.
But perhaps the most important factor will be EA’s aggressive actions to improve its digital business. For the current fiscal year, the revenue from this segment may reach $1 billion.
Thus, as the Zynga IPO gets close, EA is likely to get a lift. So, for those shareholders looking for a growth play – and can stomach the volatility – the pros outweigh the cons.
Tom Taulli’s latest book is “All About Short Selling” and he has an upcoming book called “All About Commodities.” You can find him at Twitter account @ttaulli. He does not own a position in any of the stocks named here.
