The case for video gaming plays like Electronic Arts (NASDAQ:EA) seems reasonably simple. Gaming demand continues to rise. The transition to digital downloads has bypassed retailers like GameStop (NYSE:GME) and Walmart (NYSE:WMT), presumably boosting margins in the process. For Electronic Arts stock, in particular, dominant sports franchises provide a stable profit baseline – and perhaps a floor to valuation.
The problem at the moment is that the case has held for a few years now. And EA stock has done nothing. In fact, it’s traded down 14% over the last 29 months.
In other words, that bull case doesn’t look like quite enough. Electronic Arts needs to show more. The problem, less than three weeks out from fiscal second-quarter earnings, is that it’s not at all clear what the company can do to surprise investors.
EA Stock Falls Flat
The problem with EA isn’t just a matter of the market’s reaction. Operationally, EA hasn’t performed well. Net bookings actually are down 4%+ over the past twelve months, according to figures from the company’s fiscal Q1 release. That includes just a 5% increase in digital net bookings, the supposed growth driver.
EA doesn’t disclose non-GAAP figures, but it does seem like earnings growth is relatively minimal. Analyst consensus for EPS this year (and the Street usually uses adjusted figures) suggests a roughly 8% increase year-over-year. There’s some help from share buybacks in there as well.
Even at an admittedly reasonable multiple, that doesn’t look quite enough. And it’s with the help from Apex Legends that spiked the stock above $100 earlier this year. I thought those gains were overdone, and that appears to have been the case. Indeed, Electronic Arts stock fell almost 10% in two sessions when Season 2 of Apex began – and hasn’t recovered since.
Electronic Arts Stock Lacks a Driver
So what’s the bull case now? The case for just buying video game stocks seems to have run its course. Indeed, rival Activision Blizzard (NASDAQ:ATVI) similarly has fallen sharply from 2018 highs, though ATVI has rallied in recent weeks.
Take-Two Interactive (NASDAQ:TTWO) did almost get back to last year’s levels before a recent fade, but that’s kind of the point. Unlike EA and Activision Blizzard, Take-Two isn’t just reliant on older franchises. Those franchises – whether it’s Call of Duty or Madden – aren’t driving enough growth. It’s Fortnite, and even social gaming, that look more attractive at the moment.
And so the key question for Electronic Arts is: where is its new franchise? Where is its new growth driver? The company doesn’t have an answer right now, which is why EA stock has traded sideways for most of this year.
The Case for EA Stock
To be fair, what EA can deliver might be enough to drive some upside in Electronic Arts stock. EA is cheap, at a little over 20x fiscal 2020 consensus EPS estimates. Back out the company’s cash hoard (about $14 per share)and the multiple drops to a reasonable 17x.
That’s a multiple that likely only prices in single-digit growth – and that’s what Electronic Arts can deliver. So an investor can perhaps afford to be patient here, hoping for an earnings beat later this month, an acceleration in Apex Legends, or new momentum behind one of the legacy sports franchises.
At the same time, however, that’s not a very compelling bull case. And it leaves the same problem: something here needs to change. The old bull case isn’t working. Electronic Arts needs a new one – but it’s not yet clear what it can be.
As of this writing, Vince Martin has no positions in any securities mentioned.
