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Electronic Arts (ERTS) Down Big on Guidance; Good Value Here

Posted on | October 31, 2008 Time: 3:36 pm |

Video game publisher Electronic Arts just hasn’t been able to find its stride ever since the new game console units came out two years ago. They discounted the marketability of the Wii, leaving R&D woefully behind for the social phenomenon.

And their heralded franchise games (that flat-out print money every year) have failed to make up for the largely flop-ridden new lineup that the company has floated over the past three years. Even the company’s biggest strength in the past - having a bigger piggy bank than all the competitors - has faded as Activision Blizzard (ATVI), Disney, and Microsoft are all throwing money at video game publishing, which is now a bigger market than the global movie business.

An Old Friend

I have been covering this company for many years, and during most of that time felt that Electronic Arts had an aggregate value - including things like franchise strength & branding, distribution power, and upgrade cycles - that was much higher than the market cap of ERTS stock. But shortly after my last bullish piece on the company before Christmas 2007, I started to question just how much of a premium multiple Electronic Arts deserved. Shares have been at P/E’s of 30,40, even 50+ in the past year, and that simply can’t hold up in the face of mediocre growth and a global recession.

Earnings, Guidance Trigger Selloff

Well, the last of the chickens came home to roost this morning, as shares are down 20% in early trading following a weak earnings report, game delays, and a wider net loss. The company now expects to earn about $1.40 in 2008, down from initial guidance as high as $1.70. EA has produced some extraordinary earnings beats over the years, so it’s not crazy to think they may even come in with $1.50 or so for the year. That gets the valuation back down from nosebleed levels to a tidy 15-17x earnings, with strong secular trends, and a historical track record of selling through product well during consumer recessions.

Game-Changing Demographics?

The installed base of XBOX, PS3, and Wii consoles continues to grow; global hardware unit sales for the first half of 2008 totalled more than 12 million, following 30 million units sold in 2007. Sony nearly went broke getting the PS3 to market, so look for the console cycles to slow down measurably from the 3-4 years of the past. This should drive margins lower for the video game publishers in 2009, as well as continued growth in online gameplay and distribution.

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Category: Fundamental Analysis, Gaming/Casinos, Tech Earnings
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