Previous Gaming Coverage
You might skip this overview in case you only want to read about Electronic Arts (NASDAQ:EA). Nevertheless, I would like to point out that I have already covered the gaming sector in my few months as an analyst on Seeking Alpha to draw your attention to other potentially interesting articles in the Gaming sector.
- First, there was Nintendo at the end of 2023, which I rated with a positively inclined Hold rating. Over a 6-month period, this played out well, with a positive return in USD but also not outperforming the S&P 500 for example.
- At the beginning of 2024, I covered Take-Two with a negatively inclined Hold rating, which also proved correct with stagnant development and a pronounced underperformance over a short-term 4-month period.
Please note, these ratings reflect my assessments at the respective times of publishing. I have not revisited or re-evaluated them since. However, I feel readers of this EA article could still be interested in following my theses about Nintendo and Take-Two.
And then there was GameStop only two months ago, just a week before the GME craziness returned after a three-year break. You most likely know what is going on there. Funny enough, the very first two bullets of the article’s summary displayed below turned out to be valuable, despite the fundamentally based Sell rating admittedly leading nowhere so far.
Thesis Overview
So much in advance: my conclusion is neutral regarding the gaming giant EA. This time for the following reasons: current operating fundamentals are solid and valuation indicates no red flags, which, taken together, would initially be positive from a purely quantitative perspective. However, a mixed qualitative picture of past strategies with an unpleasant aftertaste, competition, and an unclear long-term perspective are stopping me from issuing a buy rating. In this sector, I prefer Nintendo in the long term, while Microsoft’s Activision might be EA’s most relevant threat.
The Most Hated Company
Electronic Arts is well known for gathering iconic gaming franchises under its umbrella, such as The Sims, Need for Speed, Madden, formerly FIFA, and Battlefield. Beyond that, it has historically also been awarded the undesirable title of most hated company on several occasions and has rightly been criticized for the following questionable aspects, amongst others:
- Drawing the ire of the gaming community over pay-to-win practices instead of skill-based gameplay
- Being insatiable through microtransactions and various pricy expansions beyond the base games
- Even more critically, feeding into gambling with loot boxes. This has been complained about to regulatory authorities multiple times in the past. However, EA has generally gotten off lightly in most cases and to this day rejects any comparison with gambling.
- Releasing undeniably unfinished games
- Acquiring game studios with a high turnover rate – instead of fostering creativity, some were quickly shut down if they did not achieve the desired success.
Current Business
Recent developments in EA’s portfolio are more cosmetic in nature and hardly something to move the needle. Among these is the FIFA rebranding, now called EA Sports FC following a split from FIFA. Additionally, a Sims movie is reportedly in the works under the direction of Margot Robbie’s film studio. With this move, EA follows in the footsteps of Nintendo, which benefited from significant ripple effects following their Super Mario Bros. movie. Whether this could have a similar outcome for EA remains questionable, which I feel is perceived less as a feel-good company compared to Nintendo. The pipeline holds little that is surprising, though College Football 25 is worth mentioning.
EA’s segment Live Services and Other contributes almost three-quarters to the company’s revenue, three times more than actual game sales. In EA’s 10-K Report it says “(…) live services include extra content, subscription offerings and other revenue generated outside of the sale of our full game sales. (…) Our most popular live services are the extra content purchased for the Ultimate Team mode associated with our sports franchises and extra content purchased for our Apex Legends franchise.” (emphasis added)
Catalysts Or Empty Words?
Of course, it is almost a given that EA itself sees great potential in the use of AI, both to shorten development times, create personalized games, and explore additional monetization methods. However, these potential developments apply to all competing gaming companies as well and do not provide EA with a competitive edge. I would even argue that the opposite might be the case, especially since EA now faces one of the most potent publishers, Activision, directly at the source of AI developments following its acquisition from Microsoft.
“We weren’t looking to sell the company, but as we started to see how difficult it was going to be to find the type of specialized talent in AI and machine learning — realizing that we’re competing against big companies like ByteDance, Tencent, Sony, Nintendo — we started to really think about how much of an advantage it would be to be a part of Microsoft,” said Activision CEO Kotick.
Apart from that, what good are extreme efficiency gains and short development cycles if, in the face of competition, potentially weakening discretionary spending, or simply an unattractive pipeline, the latter are the bottlenecks?
On the promising side, the currently ongoing European Football Championship must certainly be mentioned. “Electronic Arts (EA) has benefited in the past from a burst of soccer interest in the U.S. during and following the tournament”, claims SA News Editor Clark Schultz.
Valuation – A Tale Of Stagnation
See below TTM net bookings for three years by quarter, sourced from EA’s self-provided financial model, which I have only adapted to show YoY and QoQ changes and visualizations on the right. This data illustrates lackluster developments over more than two years, with the last significant increases occurring about two years ago, and even some decelerating trends in net bookings.
The company’s outlook for this fiscal year suggests stagnation, although analyst consensus estimates still anticipate growth on the bottom line, while their top-line growth is also almost stagnant. I want to take these consensus forecasts, with just about double-digit earnings and therefore also free cash flow growth until 2027 (6-19 analysts), to foot a quick DCF on, just to get a rough feeling for EA’s intrinsic value. For this, I calculated EA’s WACC at 8.5%, as shown below. You might be wondering why I assume 0% terminal value growth, which is rather unusual. Initially, this was because of free cash flow conversions from adjusted net earnings that were 100% or higher, implying that there is no relevant reinvestment of earnings. That puzzled me and led me to take a closer look at EA’s cash flow statement (while the basis for my DCF approximation are analysts’ forecasts and implied FCF conversions carried forward).
And my observation has proven to be not far-fetched at all. Firstly, EA’s net investment behavior actually indicates no growth trajectory, with depreciation being twice as high as CAPEX, both highlighted below — so no signs of “sowing” there. On the other hand, it is evident that EA uses its cash flow almost entirely for shareholder returns in the form of dividends and, most notably, stock buybacks — “milking”. In recent history, growth in net bookings has also been very sluggish, as mentioned earlier. Therefore, I feel quite comfortable using a terminal growth rate of 0%, which I will, of course, expand via sensitivities next.
Based on this, I arrive at scenarios and ranges that make EA’s stock price appear within a reasonable valuation framework. Specifically, it aligns closely with current consensus estimates, a WACC of 8.5%, and a terminal growth rate of 1.5%. Below, you will find everything summarized. For this reason, I do not see any red flags regarding valuation, which can be interpreted positively and should balance out the largely negative tone of this article. Therefore, I rate EA a Hold.
Too Much For A Sell, Too Little For A Buy
As investors, we want game developers to be profitable and have strong growth, but not at the expense of creativity. Creativity is actually the necessary precondition for the formerly mentioned two financial aspects in the long run. However, I see no sustainable footing in EA’s current business model that goes beyond milking past successes for as long as possible. While profitability is immense, it appears that not behaving like a growing company already plays out in stagnation. Despite still being a solid business, I dislike the almost 100% shareholder return approach and see competitors much better positioned, such as Microsoft with Activision or Nintendo with its iconic franchises (admittedly not necessarily a direct competitor). Profitability and a fair valuation keep me from rating it a Sell. Conversely, a vague strategy — which has often been questionable in terms of quality — and the stagnation prevent me from assigning a Buy rating either. Therefore, it’s a Hold for me – I am not getting involved.
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