Electronic Arts: Quality Games, Solid Strategy

A PricewaterhouseCoopers report on global entertainment and media for 2008-12 predicts that the global video game industry will reach $68.3 billion by 2012, growing at a compounded rate of 10.3% per year. Console games will grow at a CAGR of 6.9% to $34.7 billion in 2012 and online games at a CAGR of 16.9%. Wireless games will grow the fastest at 19% annually. Analysts expect online game sales to reach $14.4 billion and wireless game sales to reach $13.5 billion in 2012. The video game advertising sector is expected to grow at a CAGR of 16.7% to $2.3 billion in 2012. However, industry observers also expect that PC game sales will likely decline by 1.2% a year to $ 3.6 billion in 2012. Growth in the US will lag global growth, with overall video game revenue growing by 7.9% per year to $17.7 billion in 2012.

Within gaming, online contributes 16.5% of revenues. While consoles might be the largest contributors with a 61% contribution even they are turning online. Microsoft’s Xbox and Sony’s PlayStation have 70% of online gamers with nearly 49% of the population spending at least an hour a week on online gaming. Within online, social gaming is becoming a key contributor to the industry’s growth. In the US alone, 59% of the gaming population is involved in social gaming. Social gaming might currently contribute little to the industry’s  revenues, but it has altered the landscape by making it possible to do away with the big game publishers, such as Electronic Arts (NASDAQ:ERTS), to distribute games.

While these trends might be harbingers of a very bright future for gaming, recent sales aren’t reflecting that. July 2009 was the fifth consecutive month of a year-on-year drop in hardware (down 38%) and software (down 29%) sales. However, the comparison is made difficult by booming sales a year ago.

Against this mixed backdrop, Electronic Arts reported better-than-expected results during their recent quarter. Revenues rose 34% to $816 million over the year driven by the strong sales of the recently released The Sims 3 and EA Sports Active. The company reported a first quarter loss of $0.02 a share compared with a loss of $0.42 a share earned a year ago due to the drastic cost-cutting exercise adopted during the year. Analysts had expected a loss of $0.13 a share on revenues of $729.5 million.

By segment, digital service businesses contributed $124 million in revenues and grew 38% over the year. Subscription revenues of $36 million grew 33% over the year, driven by the success of Warhammer Online. Wireless revenue was $50 million, up 14% from a year ago on revenue generated on the iPhone. During the quarter EA launched 12 games for this platform, including The Sims 3, which became the number one paid game. The company clearly realizes that the future of gaming lies in enabling the same game experience to be available across any gaming platform.

Electronic Arts held four of the top 10 game titles in North America and Europe, with The Sims 3 leading at 3.7 million copies sold in the period. The Sims 3 generated 59% of sales internationally and is expected to outpace the game’s earlier release by nearly 25%.

Electronic Arts is focusing on improving their segment share on the Nintendo Wii platform and remained Wii’s leading third-party publisher in North America and Europe thanks to its content. The company launched EA Sports Active, which sold over 1.8 million copies on the Wii. They are now looking to launch an expansion pack for the holiday season and are using development resources from other teams on the EA SPORTS Active franchise.

Quality remains a priority. Besides The Sims, EA has other games such as Fight Night Round 4, which won “best sports game” at the E3 Expo in June and sold over 1.7 million copies in the last two weeks of the quarter alone. In addition, the Tiger Woods PGA TOUR 10, The Godfather II, and Harry Potter and the Half-Blood Prince each sold over 1 million copies in the quarter.

Traditional gaming is not EA’s only strength: they also launched the FIFA Ultimate Team, which has generated $12 million this year. The module allows players to create their own virtual teams, trade players, and compete head to head.

Later this year, EA plans to launch Madden and FIFA on the Wii, which will be a big effort on the platform as it will have exclusive controls, modes, presentation and packaging. In traditional games they plan to launch FIFA 10, which will feature more realistic shooting, passing and control mechanics, and improved goalkeeper intelligence. Within digital, they are incorporating groundbreaking digital service features such as those in the Madden Online Franchise, which will have real NFL scheduling, live drafts, player transactions and real-time NFL stats. All of these will be manageable via the console, a web browser, or even an Apple mobile app.

EA understands that even with the growing popularity of the iPhone and other handheld devices as a medium for gaming, PC games will remain a major gaming platform as they will continue to evolve.  EA is thus launching Tiger Online, a browser-based game requiring no installation, no disc, and no additional peripherals. This game be monetized by subscriptions and micro-transactions.

For the fiscal year, EA projects revenues of $4.3 billion, up 5% over the year, with non-GAAP EPS guidance of $1.00.

Electronic Arts was sitting at $1.8 billion cash at the end of the quarter and is looking to use some of those funds for smaller-scale acquisitions. The company is considering deals that are valued at less than $ 1 billion and will help them buy franchises or online publishing technologies to expand into the consumer-to-consumer marketplace. A couple of years ago, EA had made an unsuccessful bid for their smaller rival, Take Two Interactive (TTWO). Take Two is in distress right now, and as its price has fallen, it might be the right acquisition target. On the other hand, there are numerous online gaming companies, especially the social and viral ones, that are smaller but extremely successful, and would add to EA’s strategic expansion. Candidates would include Zynga, Social Gaming Network, and several others.

Electronic Arts’ stock is trading at $18.93 with a market capitalization of $6.12 billion.