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Are EA games crap? EA loses share - 'questionable' content.
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Fri Nov 16, 2007 8:09 pm Reply and quote this post
The day after Electronic Arts announced its financial results for the second quarter and reorganization plan, analysts weighed in with their opinions on the leading publisher. While most seemed upbeat about EA's prospects, raising or maintaining ratings of "Buy" and "Strong Buy," Deutsche Bank analyst Jeetil Patel was most certainly not.

Deutsche Bank downgraded the stock (ERTS) to "Sell" and issued a price target of $45. Patel commented that while "Electronic Arts delivered 3Q upside... we think that the company still appears to be losing share (on a sellthrough basis) in the video game industry."

Patel added that EA's game quality is a concern: "Our investment thesis on Electronic Arts remains unchanged in that amidst solid growth industrywide, EA's game quality remains questionable, which in turn could translate into ongoing market share losses and limit operating margin expansion to historical levels (seen in the previous cycle). In our opinion, the lack of major outperformance on unit volumes among a majority of EA's titles, especially with a growing fixed R&D expense base, represents the single most important hurdle for the company."

Patel highlighted a number of "major themes" that investors should pay attention to. One is that this particular console cycle has not been as profitable and it's had a detrimental effect on EA.

Quote:
"Despite the market enthusiasm for the shares, the surprise inside EA's numbers is that the company today has not achieved a similar level of profit ... compared to the same time (year 2) of the previous cycle," Patel said. "We estimate EA will generate almost $400mn in operating profit in fiscal 2008, vs. $633mn in year 2 of the last cycle (FY 2003). As the company progress into years 1-3 of the current cycle, it appears profit dollars generated will be much lower in this cycle, underperforming its previous period by an average of $165mn in profits. In other words, the previous cycle was more profitable, yet it does not make sense to us why we are paying a premium for a less profitable business."


Product building up in the channel was another important theme, as EA's titles don't seem to be selling as quickly.

Quote:
"Based on our conversations with folks in the retail channel and other industry participants, it appears as though plenty of EA's titles from the June quarter still remain in the channel. Note that the company shipped in 2mn units each of Command & Conquer and Harry Potter. Assuming a 50/50 int'l./domestic mix split and 50% of C&C on the PC, it may take EA 70-100 weeks to sell-through existing channel inventories on these titles, based on current NPD sell-through vs. units in the channel,"
Patel explained.

Quote:
"Additionally, we highlight that retail pricing for several of the next-gen versions (Xbox 360, PS3, Wii) of the two titles have been already marked down to $30-$40 within 4-6 months of release. We think this could become a more widespread problem considering lackluster product quality, weak sell-through thus far (even on major franchises), and a crowded holiday selling season that should favor a handful of titles (Call of Duty 4, Halo 3, Super Mario, Guitar Hero to name a few)."


Patel also noted that EA's business may be overly dependent on distribution, which carries 15 percent gross margins and operating margins.
Quote:
"Note that Rock Band, Orange Box, Hellgate: London, Crysis among others all represent these lower margin products, which are not owned by EA and cannot be counted upon year-in and year-out,"
Patel said.

Ultimately, Patel sees the world's biggest third-party publisher losing market share: "... we think EA will grow by ~9% in FY08 in the core video game operations. With industry growth of 15% for North America and Europe, the underlying data suggests that the company stands to lose 4-6 points of market share."


What do you think?

Contributed by Editorial Team, Executive Management Team
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