Shares of Electronic Arts (NASDAQ:EA) tumbled after the video game publisher reported ugly third-quarter numbers that included a big cut to the company’s full-year revenue and profit guides. EA stock shed more than 10% in response.
You were warned. On InvestorPlace, both Tezcan Gecgil and I warned in separate pieces on back-to-back days that EA’s third-quarter earnings report could bring bad news for EA stock investors. It did. The stock is spiraling. What next?
Now is the time to get bullish on Electronic Arts stock. Bad Q3 numbers and a weak Q4 guide are confirmation of weak near-term trends for EA. But, those weak near-term trends are temporary. In the big picture, this company has staying power in the big video game publishing industry, and that industry is supported by secular growth drivers in digital gaming, eSports and micro-transactions.
This leadership position in a secular growth market means that near-term weakness will eventually pass. It will be replaced by long-term strength. When that happens, EA stock will bounce back in a big way.
After the post-earnings selloff, Electronic Arts stock is both oversold and undervalued. As such, this is a great opportunity to buy a long-term winner at a big discount and at oversold levels. Within the next 12 months, Electronic Arts stock should rise by a lot from here.
Ugly Numbers Confirm Recent Headwinds
As I warned in my earnings preview, EA’s third-quarter numbers were more representative of the company’s recent struggles, than of its long-term strengths.
Notably, the company’s headline release in the quarter, Battlefield V, was delayed by a month and faced stiff competition from Call of Duty: Black Ops 4 and Red Dead Redemption 2. Management also took a misstep by prioritizing single-player mode over battle royale, which was the hottest trend in the video game sector during the holiday season. All together, Battlefield V disappointed in the quarter.
The company’s headline mobile release, Command & Conquer: Rivals, didn’t perform up to par thanks to increasing mobile gaming market concentration, which makes it tougher for new games to break into the market. FIFA also didn’t live up to investor expectations. The Asia market was weak, too.
Overall, digital net bookings in the quarter dropped 3%, and were up just 6% on a trailing twelve-month basis. That’s a sharp departure from what has become the norm for EA over the past several quarters (double-digit digital bookings growth). Indeed, fiscal 2019 is shaping up to be EA’s first down year in terms of net bookings growth in several years.
The decline isn’t small, either. Management is guiding for net bookings to drop more than 8% this year. From 2015 through 2018, net bookings rose by, on average, nearly 7% per year.
Overall, ugly third-quarter numbers and a weak fourth-quarter guide confirm that this is shaping up to be EA’s worst year in recent memory. Some of that is due to the video game industry normalizing after several years of red-hot growth. Some of it has to do with EA’s headline launches not living up to expectations. Overall, it was a bad year for EA. Third-quarter numbers confirm as much, as does the weakness in EA stock.
Those Headwinds Will Pass and EA Stock Will Rise
During rough years, it is often wise to zoom out and look at the big picture. If you do that with EA stock, it becomes clear that this dip is a buying opportunity.
Zooming out, we can see that EA is a leader in the video game industry. Due to its wide portfolio of video game titles with enduring appeal, such as FIFA, Madden NFL, Star Wars, NBA Live, Battlefield and Sims, among others, EA has established long-term staying power for itself in the video game industry. Thus, as goes the video game industry, so goes EA stock.
Right now, the whole video game industry is cooling off after several years of red-hot growth powered by the digital download shift and micro-transactions. Those two tailwinds are cooling off, as almost all games are now digitally downloaded, while micro-transactions are starting to face consumer and regulatory backlash. As such, it has been a tough year for the video game industry.
But, long term, this industry will bounce back. Digital downloads will continue to rise toward 100%. Micro-transactions will continue to be implemented across the entire sector. eSports will turn competitive gaming from a niche pastime, into a mainstream sporting event. Advertising and other eSports league-related revenues will march way higher. Cloud gaming, or streaming games through a Netflix (NASDAQ:NFLX) type service, will unlock an entirely new leg of growth. The widespread emergence of VR/AR technologies also introduces multiple new growth levers.
Overall, the long-term outlook for the video game industry remains healthy. EA is a leader in that industry and it has ample exposure to all the important things that will power growth over the next several years. As such, the long-term outlook for EA stock remains healthy, too.
Bottom Line on Electronic Arts Stock
The post-earnings selloff in EA stock is a gross overreaction to temporarily bad numbers at the company. Eventually, those numbers will get better thanks to secular growth tailwind underpinning the video game industry. When they do, EA stock will take off, considering the stock now trades at just 18X forward earnings, versus a five-year average forward multiple of 23.
All things considered, this dip is a golden buying opportunity into a long-term winner going through a rough patch.
As of this writing, Luke Lango was long EA and NFLX.