Electronic Arts: SunTrust Says Buy, But Needham Urges Caution – Barron’s
Shares of Electronic Arts (EA) are down $2.14, or almost 2%, at $115.68, amidst some diverging views today: SunTrust’s Matthew Thornton started the stock at a Buy, with a $133 target, writing that “annuity” revenue from sports games is a big draw, while Needham & Co.’s Laura Martin, although also bullish, warns that the stock tends to trade down from October to as late as the following February.
I his initiation, Thornton notes the company’s sports titles, such as the various “FIFA” soccer games, and the “Madden” NFL title, are leaders in an “oligopoly” of sports video gaming, and that revenue is being helped by trends to “digitally downloaded” games, as well as in-game transactions:
EA’s sports franchises (FIFA, Madden, NHL, etc.) account for well >40% of revenue (across console, PC, mobile), drive annuity-like recurring revenue, and have little-to-no competition given literally hundreds of embedded license agreements (leagues, players, coaches, referees, etc.), many of which go back 20+ years. Further, EA’s Star Wars titles, while less entrenched than sports, generate another well >15% of revenue across platforms with highly differentiated IP. From a margin perspective, secular mix shift to: i) digitally downloaded games (80%+ gross margin) from packaged games sold via physical retail (60%+ gross margin); ii) to in-game content and goods purchased digitally (~90% gross margin); and to a lesser extent iii) to mobile (80%+ gross margin) has been (and will continue to be) a significant driver of margin expansion.
Thornton also calls attention to the rising tide of in-game “micro-transactions”:
We estimate in-game transaction revenue (MTX) to be 30-35% (for non FIFA sports titles) to upwards of ~75% (for FIFA) of full-game sales (attach rate of MTX to game sales) across EA sports titles. Conversely, we estimate the in-game attach rate for key non-sports titles (Battlefield and Battlefront) to be ~15% on a blended basis. The company is on the front end of effectively porting the sports titles’ MTX mechanisms and eSports modes (we believe EA is on the front end of benefitting from competitive gaming including across sports titles) to key non-sports titles. We estimate increasing attach-rate in the non-sports titles from ~15% at current to 35%/75% over time would drive a 7%/21% lift in earnings (this excludes any other/new non-sports IP, e.g. Anthem).
(Note that my college Emily Bary wrote an article on in-game transactions in this week’s Barron’s print magazine.)
Meantime, Needham’s Martin, reiterating a Buy rating and a $130 target, describes herself as a “super fan” of the company, but also thinks “Wall Street is missing that EA often trades down between October and the December-February period of the next year.”
“It’s our view (not popular) that EA trades on its GAAP EPS guidance,” she writes.
“Since EA’s FYE is March 31, EA’s May earnings release date (when management updates forward-year guidance) has been the biggest month for EA shares for the past 2 years.”
“Although past is not always prologue, we suggest caution owing EA through year end 2017.”
Martin notes the next earnings report is October 31st.
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