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EA: House of Organic Digital Magic? Or Activision-Copying Relic of a Declining Civilization?


EA's attempt to market itself as a digital-gaming company raises questions.


MINYANVILLE ORIGINAL Video-game giant Electronic Arts (EA) delivered its fiscal fourth-quarter earnings report after the close yesterday, showing a sharp contrast to the blockbuster growth seen at upstart Angry Birds-maker Rovio Entertainment earlier that day. (See: 'Angry Birds' Maker Rovio Reveals Skyrocketing Growth, Highlighting the Increasing Dominance of Smartphone Gaming Platforms.)

So let's go through the boring headline-numbers stuff so we can get to the interesting big-picture stuff:

1) EA reported earnings of $0.17 per share on non-GAAP revenue of $977 million, numbers which were modestly above the Wall Street consensus, and well above guidance.

2) Digital revenue was $425 million, up 83% year-over-year.

3) For the fiscal first-quarter (ending in June), EA is forecasting a loss of $0.40 to $0.45 per share, which is worse than the $0.33 consensus for the loss per share. Likewise, revenue guidance is well below consensus at $500 million.

3) For the full year, EA expects earnings of $1.05 to $1.20 per share, the midpoint of which is basically inline with consensus. Revenue is forecasted at $4.3 billion, or 5% below expectations.

4) Big titles included Mass Effect 3, FIFA Street 4, and SSX. Successful catalog titles included Battlefield 3 and FIFA 12.

5) Subscribers to the Star Wars: The Old Republic MMO came in at 1.3 million, down from 1.7 million last quarter.

Now there's a lot of interesting stuff going on here.

EA's hyper-aggressive investor-relations team is making a huge push for the company to be seen as a high-growth digital-gaming company.

Note that for EA, digital means basically everything that isn't a console or handheld game on a piece of physical media in traditional packaging. So that would encompass smartphone/mobile games, browser-based games, social media-based games, downloadable content, free-to-play games, and full game downloads.

And EA is right: The digital stuff is where the industry is heading, and EA is seeing significant growth in this area. In fact, as I mentioned on Twitter this morning, if EA's business was strictly digital, the stock would probably be trading at a significantly higher earnings multiple, à la Zynga (ZNGA).

However, anyone with half a brain (I've been getting by with three-fourths myself) can see that it's just not moving the needle.

If it was, the company would be forecasting something better than 3% revenue growth this year, right?

It's a simple case of the fast-growing new stuff not growing quite fast enough to offset the declining old stuff.

Additionally, I would also take issue with EA bragging about its "organic" digital revenue, given the fact that it spent billions of dollars acquiring PopCap, PlayFish, BioWare, JAMDAT, and others. I'm not saying these deals don't make sense longer-term, but EA is certainly walking a fine line here.

So to wrap our brief discussion on EA's digital business, it's going well -- but it's just not enough to right the ship.

At the same time, with the benefit of 20/20 hindsight, I suspect that in past years, EA has played it far too safe on the console/PC side. The company has quite correctly cut out a lot of junk titles, but from a new products standpoint, the strategy has seemingly been this: Let's do what Activision (ATVI) is doing!

Remember the good ol' days of Guitar Hero? Activision hit the big time with that franchise, leading EA to partner up with MTV Games for Rock Band.

And when Activision transitioned Call of Duty out of World War II and into present day with 2007's Call of Duty: Modern Warfare, it created the franchise that truly defined this console cycle, at least for serious gamers. EA, taken by surprise, has continually tried to emulate Activision's juggernaut, only coming close with last year's Battlefield 3. (See: Why Strong Sales of "Battlefield 3" Is a Bullish Sign for "Call of Duty.")

Of course, we can't avoid mentioning Star Wars: The Old Republic, which was announced back on October 21, 2008 -- less than a year after Activision merged with Vivendi Games, a deal that brought the genre-defining World of Warcraft under the Activision umbrella.

Now there's nothing wrong with emulating success. But during the current cycle in console/PC gaming, Activision's crack M&A team was continually ahead of the curve, while EA was way, way behind it.

It's easy to sit here on the sidelines in my Captain Obvious costume, saying things like, "They should be more innovative," but it does appear that this copycat strategy hasn't really paid off.

Looking Forward

EA is down huge, but I still don't feel compelled to jump in, because its anemic revenue growth destroys the idea that it's some kind of digital wunderkind. It just still smells like a value trap to me.

Looping back to my title, EA isn't quite a console-era relic... yet. Consoles aren't going anywhere, but they've simply stalled out in terms of growth, and that's bad for incumbent players like EA, Activision, and GameStop (GME) that haven't built their digital businesses up enough to offset the weakness.

I can't stress enough that a good deal of this cycle's growth was driven by casual gamers drawn in by the aforementioned Guitar Hero and Rock Band, as well as the Wii. For the console business to really grow during the next cycle, the industry needs to introduce similarly groundbreaking phenomena with massive crossover appeal.

And that's looking like a challenge when you think about the fact that so many people seem more than satisfied with playing cheap or free games on their Apple (AAPL) iOS and Google (GOOG) Android devices, or on Facebook.

Finally, I'll plagiarize myself and repost yesterday's thoughts on the competitive environment, because I think it sums up just how different this era of gaming really is:

The lesson to take away is that we now live in an era where just about anyone with an imagination can make and distribute a video game to literally hundreds of millions of smartphone users all across the globe, and this has enormous ramifications from a competitive standpoint.

Programming for iOS or Android games is infinitely simpler and less expensive than traditional platforms like Microsoft (MSFT) Xbox 360 or the Sony (SNE) PlayStation 3. It can also be easily outsourced.

And since smartphone games are all digital, distribution is taken care of through uploads to servers.

As far as pricing goes, every game is free or inexpensive, and customers can usually try before they buy, making these games enormously consumer-friendly.

This is a far cry from traditional video games, which are expensive and complex to produce and distribute, and pricey to the end user.

Now, I don't think consoles are going away, but they do appear to have hit a wall in terms of growth.

Going forward, the growth is in smartphones and tablets, and everyone wants in.

However, the publishers will go from competing with less than a dozen peers to a practically infinite number because the barriers to entry are so rapidly disappearing.

Twitter: @MichaelComeau

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