Electronic Arts – A traditional game company poised to break the mold

Electronic Arts ($EA) reported earnings yesterday (7/26/18) and a few peculiar things happened. One, we got to see the company beat earnings, and beat revenue expectations. Two, the stock dropped more than 6%, finally closing at a net loss of 3%. Why did this happen?

Looking at Electronic Arts earnings highlights

Breaking down Q1 results for $EA, we gather the following:

  • Q1 Earnings Per Share was $0.95, beating estimates by a whopping $0.22 a share
  • Q1 revenue was $749 million, beating estimates by $6.58 million
  • FIFA brand was a strong player, due to World Cup activities, and was a leader both on console and mobile platforms
  • Sims 4 player base grew 35% year over year
  • Garnered 60 awards at E3 this year (gaming convention)
  • 2019 guidance for $5.6 billion in net revenue

We suspect the dip in share price was related to a few things, but most notably soft guidance. There won’t really be a major sports event this quarter, with most of the major sports championships happening later on in the year.

Where we see potential with Electronic Arts

Despite weak guidance for 2019, we still see some strong opportunities within investing in EA. The stock does not pay a dividend, but has seen 35%+ growth YTD, and 20% growth this year alone. Even the month of July has seen a net gain of 1.09% in the share price.

The long term potential with Electronic Arts lies not only in the titles and brand licensing it holds, but within its business model. Looking at a 5 YR Discounted Cash Flow EBITDA analysis, we put a price target of a 16% upside to the stock (target price of $164.21 from the 7/26/18 close of $141.90).

A business model shift a la Adobe ($ADBE) and Microsoft ($MSFT) could spell huge returns for investors, and start creating new cash flow for the company. Right now the company sells games one off, with just a few subscription options. Making the shift to a more subscription based model similar to what Adobe did with its Creative Cloud membership, and becoming more like Netflix ($NFLX) for games, EA could start to have less sales pressure for individual titles, and start to reap MASSIVE benefits from base subscription + in-game transactions. This model presents significant opportunity, and we have heard some rumors that this could be a shift in how EA will approach and retain customers.

This shift in business model could see a major bump in the stock price which our model hasn’t accounted for, and could see the stock top $200 in the next few years.

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