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Don’t Count on Apex Legends to Save Electronic Arts Stock

EA's new battle royale game is driving big-time optimism, but problems persist

EA stock - Don’t Count on Apex Legends to Save Electronic Arts Stock

Source: Electronic Arts

Electronic Arts (NASDAQ:EA) has desperately needed good news of late. Electronic Arts stock touched a two-year low in December, at which point EA had shed half of its value. Even with some dip-buyers arriving in the past few weeks, EA remained well off its highs.

A third-quarter earnings report that disappointed — as even EA management admitted — sent Electronic Arts shares tumbling again. The success of Epic Games’ Fortnite continued to weigh on EA as well as public rivals Activision Blizzard (NASDAQ:ATVI) and Take-Two Interactive (NASDAQ:TTWO).

But EA finally has received the good news it was looking for. The company’s Apex Legends — a battle royale-style game in the mold of Fortnite — looks like a hit. And it’s done wonders for EA stock.

As of this writing, Electronic Arts stock has bounced 25% in three-and-a-half trading sessions. The strength isn’t coming from the sector — TTWO and ATVI remain at the lows — and it isn’t coming from the rest of the portfolio given the weak fiscal Q3 report. The early strength of Apex Legends simply has driven that much optimism toward EA stock.

Some optimism is merited. But the 25% gain here looks to be too much. It already prices much — if not all — of the game’s potential success. And it ignores the fact that the rest of Electronic Arts’ portfolio has some very real concerns.

Apex Legends Drives EA Stock Higher

To be sure, Apex Legends is a big potential mover for Electronic Arts stock. The game has signed up more customers faster than Fortnite did. Analyst firm Baird estimated potential 2020 revenue of $500 million. Bank of America estimated a high-side case of $600 million.

Against trailing-twelve-month revenue of $5.3 billion, the game could drive an additional 10% in revenue. Considering the high margins on incremental revenue, meanwhile, the profit contribution could be even higher.

Estimating the exact potential of Apex Legends remains a guessing game, but the impact on EA stock could be huge. Fortnite, according to one source, generated $2.4 billion in revenue last year. According to another, Epic Games booked some $3 billion in profit. (That latter figure seems aggressive, however, given a reported valuation of $15 billion for Epic.)

Apex Legends, then, doesn’t have to be the ‘next’ Fortnite to have a material impact on EA financials. Even a second-place standing would provide solid growth against EA’s current totals of about $5.3 billion in revenue and a little over $1 billion in adjusted net income.

Has the Rally Gone Too Far?

That said, the rally of late has incorporated quite a bit of upside from Apex Legends. EA stock has added roughly $5 billion in market value in the last four sessions. There may have been some help from a “dead cat bounce” following the disappointing Q3 report. But whatever the exact figure, the market already has added at least a few billion dollars to EA’s valuation based on the early returns from the game. In other words, a solid second-place standing relative to Fortnite already looks close to priced in.

Meanwhile, “early returns” is the operative figure there. The game itself still has a long way to go. And Electronic Arts itself has to figure out how to monetize the game wisely. That will require some nimble movements, considering that EA undermined consumers’ trust with its ham-handed efforts around Star Wars Battlefront II. EA also has to make sure not to cannibalize Apex Legends with the March launch of the battle royale update for Battlefield V.

At the least, given its experience with Battlefront, EA is likely to go slow in terms of managing in-game monetization. And so investors expecting a big boost to near-term financials from Apex Legends may be disappointed.

The Other Risks to Electronic Arts Stock Persist

After the rally past $100, there is a case for caution here. Apex Legends is a potential hit — but investors have noticed, and bid EA stock up accordingly. And EA still needs to capitalize on the early momentum — and properly manage its revenue and profit potential going forward.

Meanwhile, in the rest of the portfolio, nothing has changed since the Q3 report. Growth concerns persist. FIFA 19 — historically the company’s largest game, at 11% of revenue — sales were below expectations. The sports portfolio on the whole, per the Q3 conference call, is expected to see revenue flat to up 5% in 2020. Battlefield V, too,  has disappointed.

That’s not changing any time soon. Overall, according to the call, bookings are supposed to grow just low single-digits in fiscal 2020. So are earnings. Margin benefits from the shift to digital — as EA sold games direct instead of through retailers like GameStop (NYSE:GME) — are moderating. In-game monetization revenue growth is slowing substantially.

There’s simply not a lot of growth left in the legacy portfolio — which is why investors have punished EA stock over the past few months. And yet EA stock, against current FY20 estimates, trades at 25x this year’s adjusted EPS guidance even backing out net cash.

That’s a multiple that already assigns quite a bit of success to Apex Legends. So does the 25% rally in EA stock. To keep the rally going over the long-term, EA is going to have to succeed with Apex Legends and find more growth elsewhere.

As of this writing, Vince Martin has no positions in any securities mentioned.

Article printed from InvestorPlace Media,

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