Electronic Arts Beats Analyst Expectations With Help from Star Wars

Electronic Arts (NASDAQ:EA) has an illustrious past.  A great metaphor, considering EA’s own NBA series of games, is someone like Michael Jordan, who after taking some time off from being a champion with the Chicago Bulls, returned back to the game after an absence.  But the game had changed.  He played for the Washington Wizards, a new franchise team, had a rocky start, but once he’d got his footing, he surprised critics and naysayers by eventually leading the team in points.  Is EA on the same path with their digital revolution?

Similar to MJ, EA has taken a step back from its former glory of 10 years ago, when retail sales were booming and their only concern was how to render Kobe Bryant’s face in a more realistic way to sell millions more copies of their games each successive year.  These days, retail sales are down, and EA is undertaking the difficult journey of regaining their once legendary status in the new world of digital gaming.  And a major move is their release of online MMORPG Star Wars The Old Republic.

If we look at the breakdown of the previous quarter, Q2 FY12, for the 3 months ended October 1st, we can see that EA beat most analyst estimates and their own guidance for the stock.  This growth in sales was driven by a 14% jump in Publishing, a 7% jump in distribution and a huge 30% year over year jump in digital revenues.  This is the key area for Electronic Arts, as they’ve taken the time to invest in social and mobile games whereas their rival, Activision-Blizzard (ATVI) has CEO Bobby Kotick publicly announcing that he’s still unsure whether social games are strongly profitable.  The importance of social games has become something of a hinge upon which stocks like EA, ATVI and the newly public ZNGA rotate.

Street Instincts looked at the breakdown of Electronic Arts’ digital revenue over at Seeking Alpha, and assumed that these digital revenues will continue to grow.  They looked at the breakdown of EA’s digital revenue, and from the chart we can see that both mobile and free-to-play have had steady growth from $219m and $193m in Q2 FY11 to $250m and $335m in Q2 FY12.  That’s a big chunk of overall digital revenues, and their predictions about growth have been correct, as we will look at in a discussion of Q3, whose results were just announced on February 1st, 2012.

Takeover Analyst was worried about Electronic Arts, saying that forward earnings expectations and a price-earnings estimate of 16x would price the stock at $19, and he was right — the stock took a beating after hovering around $22 late last year.  This downwards pressure was a scary proposition for investors, and hurt investors that had been jumping into EA for the course of 2011, hoping to catch some of the profits once Star Wars: The Old Republic (SWTOR) launched.

Unfortunately for investors, there was a glut of uncertain information after SWTOR launched.  People were unsure whether the game had lived up to expectations and sold over 1.5 million units, and while one analyst downgraded based on assumptions, Michael Pachter, a well respected game analyst defended EA and predicted they would hit around 2m units, which they did.  EA sold 2m copies of SWTOR and announced that they had 1.7m game subscribers with at least half of those as paying subscribers.  That puts it at least at 850m paying subscriptions.

World of Warcraft makes about $1.4B a year on 10 million accounts for Activision, so assuming that 850k number continues to grow for EA, it could become a large part of their business.  This does lead into a big question: whether EA’s Star Wars: the Old Republic, a massively multiplayer online role playing game (MMORPG) — developed by all star team Bioware — has what it takes to dethrone Activision-Blizzard’s (ATVI) World of Warcraft (WoW) behemoth.  WoW seems to be a bit susceptible with its latest Cataclysm release being overly criticized by hardcore WoW players, and ATVI announcing in their last earnings report that the World of Warcraft had lost 800,000 subscribers.

Star Wars, abbreviated as SWTOR, has had a strong early critical response.  When the game was launched as a beta, a staggering 2 million players signed up to play.  The reactions typically criticized the old-fashioned graphics and lack of character customization, but then went on to say that the gameplay was surprisingly fun and that the voice acting and story were surprisingly good.  Bioware is an incredible studio, and their past games have always won over fans with their work on story, and it sounds like people are getting the first whiff of that.  Those gamers clearly came on board and are playing the game now, which means this may be a sticky game that continues to grow.

I’ve always felt that while WoW was a great, fun game, the story was scattered and meaningless.  There was no sense of you, as an individual, affecting the course of events in the world, at least until they released the additional packs.  It sounds like Star Wars is coming out of the gate having already done a lot of things right.  Updating character customization abilities is something they can sell as an add-on, and I think players will buy it.

Finally, the power of the Star Wars brand, while diminished by the poor prequel films, is still gargantuan.  WoW has around 11 million subscribers, so the game is very niche.  If the Star Wars game can cross over to a mainstream audience at all, it will mean a lot of possible revenue.  For Warcraft, the game’s monthly cost is $15 per month for each player, and they have approximately 70% of their 11 million subscribers in the U.S.A., giving them around $115 million per month.  These are approximations of course, and it’s taken Blizzard 7 years to get to that user base.  But even if EA can make a dent, the revenue should be very strong.  WoW is around 30% of ATVI’s overall revenue, and that’s 30% of the company who makes those monster Call of Duty: Modern Warfare games.

So what did we see in the latest quarter for the three months ending December 31st 2011?  EA announced revenues of $1.65 Billion, which beat a consensus estimate of $1.62 Billion.  Net income rose to $334 million, or 99 cents per share.  In addition to SWTOR’s performance, digital revenue surged to $377 million for the quarter, a 79% increase over last year and a sign that the company has what it takes to grow in the difficult to address digital realm.  For more information about the latest quarter, check out the Zacks breakdown over at Yahoo Finance.

In essence, we see a series of growth plays for EA.  Their social games division, which is embedded somewhere in their digital revenues, has a lot of potential with The Sims Social becoming the second most popular Facebook game.  As that industry grows, EA will be ready to bring their big brands into the space and cash in, thanks to their acquisition of brilliant social game makers Playfish.  They have SWTOR, and they will continue to push that game as well as release new content — I see this as a long term winner.  They also have a fantastic team over at the EA Mobile division who continue to dominate the Tablet and iOS games space.  Their digital revenues are ballooning and I expect it to continue.

What do you think of EA?

 

 

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