One might think that video gaming stocks like Electronic Arts (NASDAQ:EA) would struggle in trading Wednesday. After all, shares of GameStop (NYSE:GME), the largest video game retailer, are plunging. Yet Electronic Arts stock — like its peers — is unaffected. EA stock actually is up modestly in afternoon trading.
The reason is simple. GameStop’s troubles — including a 13% decline in revenue in its fiscal first quarter — aren’t a reflection of video game demand. Rather, those sales declines are a reflection of a shift in where, and how, those games are sold. GameStop’s weakness thus isn’t a problem for Electronic Arts, or for EA stock. In fact, it might be a signal to buy.
Video Gaming Stocks and GameStop
It’s not just Electronic Arts stock that is up on Wednesday. Peers Take-Two Interactive Software (NASDAQ:TTWO) and Activision Blizzard (NASDAQ:ATVI) have risen 1.4% and 2.1%, respectively, as of this writing.
That’s because GameStop’s troubles actually might mean more market share for the developers, not less. Direct digital distribution has been a big part of the bull case for stocks like EA. The potential end of GameStop — and that company increasingly looks like the next Blockbuster Video as Luke Lango detailed in April — thus is good news.
After all, we have a general idea of what video game sales look like, both from earnings reports from video gaming stocks as well as third-party data from sources like NPD Group. Growth hasn’t been great of late, in part due to anticipation of new consoles from Sony (NYSE:SNE) and Microsoft (NASDAQ:MSFT). But GameStop’s numbers don’t change the facts on the ground for the industry as a whole.
Instead, they suggest that physical disc sales are dropping. And that’s a good thing for Electronic Arts stock. Direct sales are higher-margin, as they cut out the middleman. And with in-game revenue an increasingly large portion of total sales, here’s another driver for higher margins — and, eventually, larger profits.
Is Electronic Arts Stock a Buy?
And so the market’s shrug in response to GameStop news makes some sense. Lower revenue is a GameStop-only problem, which is why GME stock is down 37% and its suppliers are up — as odd as that might seem at first glance.
But the question is, even if GameStop’s weakness is modestly good news for EA, does that make EA stock a buy?
On its own, it’s not enough — but EA stock is cheap. It’s not quite as cheap as it was when I recommended it in December, but most stocks have rallied from those lows. Even with nearly 20% gains since then, EA trades at about 18x 2019 EPS estimates, backing out net cash.
In the context of multiple growth drivers — with eSports another tailwind — that multiple seems cheap. But I’m still skeptical it’s cheap enough. I wrote in February, after EA had climbed above $100 thanks to optimism regarding its Apex Legends game, that the rally had gone too far.
Indeed, Apex Legends has stalled out somewhat. Growth expectations for this year remain muted. The industry on the whole continues to struggle in responding to the runaway success of Fortnite from privately owned Epic Games. EA gave back some of its Apex-related gains, and along with ATVI has bounced sideways for the last few months. (TTWO has managed to put together a rally in recent weeks.)
I’m skeptical the news from GameStop really changes the case here, even with Electronic Arts stock back below $100. Digital download growth is helpful, but not that helpful, as the FY20 outlook for modest revenue growth and minimal margin expansion suggests. EA stock needs something more.
The Case for EA Stock
That said, I do see the long-term case that patient investors should buy EA stock here and look at other video gaming stocks as well. The sector remains near the lows. The industry is going to see continued changes over the next few years. At this point, that likely includes the disappearance of GameStop and a shift to a model that is digital-only, or close.
Video game streaming offers another opportunity. Demand from developing countries (notably in Asia) should rise for years. Better games, better demographics (as Gen Xers and millennials keep playing into middle age and beyond) all suggest long-term revenue growth.
It well may be, as EA bulls argue, that investors are focusing on short-term worries (like Fortnite) and ignoring the long-term opportunity. But if years of change are ahead, GameStop wasn’t going to be a part of that change anyway. Wednesday’s news doesn’t necessarily mean those changes are coming any faster.
As of this writing, Vince Martin has no positions in any securities mentioned.