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Alan Hsieh

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William Haddad

ERTS AT A GLANCE

P/E ► -4.59   EV/EBITDA ► -8.63   ROA ► -23.9% AVG ROE ► -39.1% AVG Debt to Equity ► 0.883 AVG Current Ratio ► 1.69 AVG Interest Coverage Ratio ► 264 VERY HIGH

 

 

 

 

 

 

Electronic Arts (EA) is the world's largest publisher of video game software, generating $4.21 billion in net revenue in FY 2009 (ending March 31).^[1] and outpacing rival Activision Blizzard (ATVI), which generated $2.90B in revenues in FY 2008^[2]. As of the end of 2Q10, EA owns 21% market share of the video game industry, including four of the ten best-selling titles in North America and Europe^[3]. EA's major franchises include Need for Speed and a number of EA Sports titles, including John Madden's NFL franchise and FIFA. In FY 2008, EA distributed the new hit, Rock Band on behalf of MTV Games which represented approximately 10% of the company's overall revenues^[4]. In FY2009, ERTS developed and published 132 titles across 7 consoles, with no title accounting for more than 10% of total net revenue^[5].

EA has built its position at the top of the video game industry through acquisitions, both of licensing rights to games (such as the sports games that carry the licensed logos of professional leagues) and top development studios that contribute their titles and talent to EA's portfolio. Purchases have included video game developer Mythic Entertainment in June 2006^[6], the popular role-playing video game giant and Bioware parent company VG Holding Corp. for $810 million in October 2007,^[7], and in November 2009 the leading social networking game site Playfish for $300 million^[8].In an industry where one title can greatly benefit the bottom line, EA must develop mega-hits to stay abreast of the competition. This need has driven the company's multiple attempts to acquire rival Take-Two Interactive Software (TTWO), publisher of the popular Grand Theft Auto franchise.^[9] However, on August 18, 2008, ERTS abandoned its plan to takeover TTWO with an unsolicited bid.^[10] Other opportunities for growth include continued build-out of the casual/mobile/cell phone gaming business, as well as online-gaming. In 2009, ERTS released 35 games for wireless devices.^[11]

Business Overview

EA operates under several publishing labels, and reports revenues separately for a number of other associated business units.

Labels

• EA Games - this label publishes the majority of EA's games that do not fit under any of the other labels.
• EA SPORTS - this label publishes EA's sports affiliated games, which typically have contractual agreements with major leagues for annual titles, such as the Madden NFL franchise.
• The Sims - The success of the Maxis studio developed Sims series has led to a creation of an entire label dedicated to publishing titles for the franchise.
• EA Casual Entertainment - the causal entertainment label handles casual titles for non-hardcore games all across the company's development platforms. Its two major groups are the mobile cell-phone business, and the internet based casual games business.^[12]

Global Publishing

The global publishing unit handles sales and marketing for the company's games, as well as physical distribution of titles. It operates in North America, Europe, and Asia.

Major Titles and Franchises

• Rock Band - Distributed by EA following the success of rival Activision (ATVI) published Guitar Hero, this title contributed 10% of the company's revenues in FY 2008, as mentioned above, the game is published by MTV Games and developed by Harmonix, creators of the Guitar Hero franchise.
• Madden NFL - Published in agreement with the NFL, Madden is the most successful American football software title.^[13]
• Need for Speed - Series of popular arcade-style racing games.
• Command & Conquer - Historically a PC title, the series made its transition to console with the title Command and Conquer III in 2007.^[14]
• Battlefield - This EA series revenue model approximates what EA hopes future titles will become - a revenue model where gamers conduct micro-transactions in the game for personalization, as well as special weapons/vehicles. The next titles in the series, Battlefield Heroes will be free-to-play, pay-for-premium content.
• Pogo.com - The Pogo website hosts EA's casual gaming effort, with card games and board games available for casual users to play
• Spore - A Massively single player online PC game where the player controls all aspects of an organism's evolution, from microbial stages to intergalactic exploration. Player's creatures and civilizations are uploaded to the internet and integrated into other players' games.
• Fifa - Fifa series have been famous since 1993 and hit many times the million units sold. Because Football is the most followed sport in the world, it has been a key market to attract for EA. However, this franchises have faced stiff competition during past few years with another franchise, Pro Evolution Soccer, of the Japanese publisher Konami (KNM).

Business and Financial Metrics

Note that the following analysis is performed on GAAP figures, while EA occasionally reports non-GAAP for press releases, as quoted above. Primary differences lie in revenue recognition as well as how stock based compensation and depreciation are treated in expenses. In addition, EA is on a March 31 fiscal year, so the majority of FY 2008 actually corresponds to CY 2007

^[15]

While EA's revenues have grown more or less with the greater Video Game Industry, its margins have also eroded over FY 2006 - FY 2008. This has been caused by the launch of new consoles, which increased R&D expenses during FY 2006 and FY 2007 by $283MM, or 37%.^[17] In addition, acquisitions of additional studios such as Mythic Entertainment also added more developers to the staff, the primary cause of costs.^[18] Margin's further eroded during FY 2007 to FY 2008 due to one-time costs, such as restructuring fees of $97MM^[19], as well as high sales of Rock Band and other lower margin products. Rock Band is considered a lower margin product because of the many licenses and royalties that need to be paid for the music-related game.^[20]

^[21]

EA's operations are highly diversified, and it collects significant revenues from the mobility platform (cell phones, handhelds, and other mobile devices) compared with its other domestic competitors, such as Activision (ATVI) and Take-Two Interactive Software (TTWO). In addition, the "Other" segment includes licensing profits as well as internet server deals that are affiliated with the games that EA has created. As seen above, the Console platform's now constitutes less than 50% of EA's overall revenues.^[23] While that has been the core business, it will not be EA's future primary growth opportunity.

^[24]

EA's revenues come primarily from North American and European markets, with 53% and 42% revenue contribution respectively in FY 2008.^[26] Asia remains a market with lower penetration, due to lagging popularity of EA titles there. This is partially due to different gaming preferences in the Asian market, which do not favor the American sports titles that EA Games publishes. As a result of this historical lack of presence, EA has a weaker distribution system in that area, further inhibiting a larger revenue contribution.

Trends and Forces

Flawed integration of acquired studios caused ERTS' developer attrition in the past

The company has grown via acquisitions for several decades, acquiring developers along the way. These included Origin Systems in 1992^[27], creators of the Ultima franchise, and Westwood Studios in 1998^[28] , creator of the Command & Conquer franchise. However, the company admitted that its acquisition and integration strategies often ended up demoralizing the acquired studio, leading to staff departures.^[29] For example, Westwood Studios suffered from continuous attrition after its acquisition until the studio was closed in 2003, and no successful Command and Conquer games (the studio's primary franchise) were published until the series was relaunched in 2007 by Command and Conquer 3. EA is now seeking to give its acquired studios more autonomy and more creative freedom, so that they may retain their individual cultures. In the long-run, poor management of developers leads to the employee attrition that the company has already experienced, which in turn causes decreased game quality, which in turn will lose customers.

Poor bets on preferred gaming platform have misaligned the company's game software portfolio

Gamers’ platform preferences are extremely important and not completely predictable. Electronic Arts was forced to shift resources from developing games for the Sony PlayStation 3 to the Nintendo Wii after Sony’s lower-than-expected sales of the PlayStation 3 system. The underallocation of Wii games and overallocation of PS3 games hurt EA's revenues because of the Wii's blockbuster sales and the PS3's poor performance, since console sales aid in game title sales.^[30] Electronic Arts and its competitors want to provide software for platforms which will garner the most users because this translates to more units sold.

Increasing demand for online-publishing an opportunity for revenue growth

EA Mythic is a label set up under the EA Games label specifically for the purpose of developing MMORPGs (Massively Multiplayer Online Roleplaying Games). the studio was first built through the acquisition of Mythic Entertainment, creators of a popular online game Dark Age of Camelot, in 2006.^[31] The company is quite aware of the revenue opportunity in MMOs, seeing the success of competitor Vivendi Games' World of Warcraft, (with a business revenue segment CAGR of 30% between 2004 and 2006^[32]) as well as EA's own equity investment and 19% stake in Chinese MMO operator The9 (NCTY).^[33] The subscription based model of these games allows the publisher to not only generate revenues at point-of-sale, but also through on-going subscription fees to the service. This grows revenues and socially drives more users to the service.

EA games has built out more capacity for mobile gaming development than competitors

EA's mobile gaming division will benefit from the trend of continued market expansion from casual gamers playing games on their phones, and increased numbers of women gamers.^[34] Competitors Take-Two Interactive Software (TTWO), Ubisoft Entertainment SA, and Activision (ATVI), do not have mobile-gaming operations as extensive as EA's, but are attempting to build out studios dedicated to mobile gaming. This includes Ubisoft's purchase of Gameloft India in April of 2008^[35], highlighting the importance of this platform to the competition's projections for growth.

Bid for Take-Two Interactive and its lucrative "Grand Theft Auto" Franchise

EA is seeking to purchase rival developer/publisher Take-Two Interactive Software (TTWO), publisher of the popular Grand Theft Auto franchise. The company was initially rebuffed by the competitor, which argued that the company was undervalued given the pending release of the blockbuster game GTA 4^[36], which ended up selling $500MM its first week in the market.^[37] As of late June, the offer is still pending, open until July 18, 2008.^[38][39]

Competition

In such a dynamic industry where "hits" are what keep the company profitable, Electronic Arts is vulnerable to any company that can take more accurately capture shifting consumer preferences. EA benefits from a wealth of developer talent and financial resources, and its competitors are relatively smaller by revenues, since they typically have smaller game portfolios. However, competitors are still flush with both of these assets, recently launching mega-hits have brought them closer to EA's revenue figures. In particular, Activision (ATVI) and Take-Two (TTWO) have mounted the greatest threats in the past. In late 2007 EA made an offer to buy Take-Two, but was met with other competition in the takeover market. In March 2008 EA raised its bid for Take-Two, offering $2.0 billion in a hostile takeover move.

In the past smaller companies who pose threats to Electronic Arts have been acquired. EA has acquired smaller game developers such as Digital Illusions, Mythic Entertainment, Headgate Studios, Phenomic and SingShot in the past. EA also took a $105 Million stake in Neowiz in order to expand its presence in the online-game market.

Since 2003, Electronic Arts has consistently boasted the highest margins among its competitors, with a trailing 5 year average gross margin of 58.9%^[40], compared with 39.6% for ATVI^[41] and 30.6% for TTWO^[42].

Market Share

Electronic Arts is the industry's largest revenue generator, beating out domestic competitors ranging from Activision and Take-Two, to international competition such as Vivendi Games and Konami. The potential acquisition of Take-Two Interactive Software (TTWO) and its entertainment properties would do well to add to EA's share of the industry's total revenues. Market share becomes even more important as the size of the market decreases. The U.S. video game market contracted significantly in June 2009.^[43] Sales of video game equipment and software fell 31% to $1.17 billion in June 2009 which represented the largest decline since 2000. Software, hardware, and accessory sales decreased 29%, 38%, and 22%, respectively. In addition to the current economic weakness, the declines are thought to be caused by consumers waiting for price reductions before purchasing items. Year to date overall video game sales are down 12%, but those in the industry are expecting the second half to be strong, as there are many big releases planned for the 2nd half. Additionally, in June 2009, Activision Blizzard's "Prototype" was the top selling game, further showing the lack of security in ERTS's spot as industry leader.

References

1. ↑ ERTS 2009 10-K pg. 27  
2. ↑ Activision Press Release, FY 2008 Earnings, May 8, 2008
3. ↑ "EA Reports Record Q2 Non-GAAP Net Revenue of $1.15 Billion" EA Investor Relations, 11/09/09
4. ↑ Electronic Arts FY2008 10-K "Business" pg. 4
5. ↑ ERTS 2009 10-K pg. 3,4  
6. ↑ Electronic Arts Press Release "EA to acquire Mythic Entertainment" June 20, 2006
7. ↑ SFGate The Tech Chronicles "EA buys up two more studios" October 11 2007
8. ↑ "Electronic Arts Acquires Playfish" Electronic Arts investor relations, 11/9/09
9. ↑ Yahoo (Reuters) ""Grand Theft Auto" sales top $500 mln in 1st week" May 7, 2008
10. ↑ ERTS 2009 10-K pg. 5  
11. ↑ ERTS 2009 10-K pg. 3  
12. ↑ Electronic Arts FY 2008 10-K " EA Casual Entertainment Label" pg. 7
13. ↑ Wikipedia.org "Madden NFL"
14. ↑ Wikipedia.org "Command and Conquer 3: Tiberium Wars"
15. ↑ Electronic Arts FY 2008 10-K "Selected Five Year Consolidated Financial Data" pg. 28
16. ↑ Electronic Arts FY 2008 10-K "Selected Five Year Consolidated Financial Data" pg. 28
17. ↑ Electronic Arts FY 2008 10-K "Research and Development" pg. 46
18. ↑ Electronic Arts FY 2008 10-K "Acquisitions and Investments" pg. 32
19. ↑ Electronic Arts FY 2008 10-K "Restructuring Charges" pg. 42
20. ↑ Electronic Arts FY 2008 10-K "Cost of Goods Sold" pg. 39
21. ↑ Electronic Arts FY 2008 10-K "Note 18: Segment Information" pg. 103
22. ↑ Electronic Arts FY 2008 10-K "Note 18: Segment Information" pg. 103
23. ↑ Electronic Arts FY 2008 10-K "Note 18: Segment Information" pg. 103
24. ↑ Electronic Arts FY 2008 10-K "Note 18: Segment Information" pg. 104
25. ↑ Electronic Arts FY 2008 10-K "Note 18: Segment Information" pg. 104
26. ↑ Electronic Arts FY 2008 10-K "Note 18: Segment Information" pg. 104
27. ↑ Software Industry Report "Electronic Arts of San Mateo, Calif., and Origin Systems Inc. have signed a definitive..." September 21, 1992
28. ↑ CNN Money "EA buys Westwood" August 17, 1998
29. ↑ Wired Blog "EA's CEO: How I Learned To Acquire Developers And Not Screw Them Up" February 8, 2008
30. ↑ San Jose Mercury News "EA'S FUMBLE" May 27, 2007
31. ↑ Mythic Entertainment Press Release "EA TO ACQUIRE MYTHIC ENTERTAINMENT" June 20, 2006
32. ↑ Vivendi (EPA: VIV)
33. ↑ Gamasutra "Report: EA To Buy 19% Of Chinese MMO Firm The9" April 9, 2007
34. ↑ Parks Associates Press Release June 29, 2006
35. ↑ Joystiq.com "Ubisoft Buys Gameloft India Studio" April 16, 2000
36. ↑ Dealbook Blog "Bailing Out at Take-Two" March 11, 2008
37. ↑ Yahoo (Reuters) ""Grand Theft Auto" sales top $500 mln in 1st week" May 7, 2008
38. ↑ Dealbook Blog "Electronic Arts Extends Bid for Take-Two Again" May 19, 2008
39. ↑ Dealbook Blog "Whats next for Take-Two" June 18, 2008
40. ↑ MSN MoneyCentral "Electronic Arts Inc: Key Ratios "
41. ↑ MSN MoneyCentral "Activision: Key Ratios "
42. ↑ MSN MoneyCentral "Take-Two Interactive: Key Ratios "
43. ↑ Gabriel Madway (July 16, 2009). U.S. video game sales post largest decline since 2000. Reuters.
44. ↑ Datamonitor Industry Reports "US - Video Game Industry" July 15, 2007