EA: “Why Didn’t Wii Focus on Nintendo?”
Note: this post was carried today on Wallstrip
Overview
Make no mistake: EA is a game-creating machine. A techno-behemoth making big-headline games for the Big Three: Microsoft, Sony and Nintendo. But at $58 per share and 43x earnings I would be afraid - very afraid. What was once a company able to focus on harvesting its category-leading franchise is now under siege: high development costs, uncertain platform plays and lofty equity valuation. While EA has deftly navigated the vagaries of the fickle gaming marketplace, it is now facing a competitive landscape unlike any other it has seen in the recent past. Ergo, this is one complex business encountering an array of complex market and business risks. This is not a scenario that makes me terribly comfortable as an equity investor. For a little more insight, read on.
The Business - Like Venture Capital for Gaming
EA creates products for the three major console providers: Microsoft,
Sony, and Nintendo, as well as the PC platform. Success in the game
creation business is all about economies of scale, flat development
costs and luck. Just writing this makes me queasy. Making games is not
just coding - it is internalizing the ethos of Hollywood, leveraging a
hot idea/story to make a big splash that ripples throughout the
addressable market.
In gaming, as in movies, the idea/story can be proprietary or licensed from others. Once an interesting and/or compelling theme is selected, there is the added complexity of choosing a platform for which to adapt your software. If the state of technology is relatively stable, all is well. You pick the platform(s) with the largest installed base(s) and the lowest development costs and code away. This is not much different than a VC spreading bets across multiple early-stage investments, except in gaming-land one is allocating development costs among multiple titles hoping that your hit rate results in an attractive ROI.
However, when a platform technology shift happens (roughly every
five years), game developers encounter a rough patch and need to
increase diversification by making fewer titles across more platforms.
They then wait for the fall-out and watch for the winners to emerge,
after which point they revert back to the original operating model.
While this is a business that has the capacity to mint cash, it also
has the capacity to result in a lot of dry wells. Clearly not a
business for the meek.
EA - Does Success Breed Complacency?
EA has had it easy for the past few years, becoming the biggest, baddest, hottest game creator on the planet. EA has ridden Sony’s PS2 platform to market dominance and an $18 billion market cap - wow!. With PS3 around the corner (and in light of their blue diode supply problems), EA is taking a wait-and-see approach to Sony’s newest platform. They are actively supporting the large installed base of PS2 consoles (100 million strong) while closely monitoring the progress of PS3.
EA has announced and launched three titles so far for the PS3: Madden NFL ‘07, Need for Speed Carbon, and Tiger Woods PGA Tour ‘07. For the Nintendo Wii EA has launched Madden ‘07 and Need for Speed Carbon. For Microsoft’s Xbox 360 EA has delivered 15 games, and all of those mentioned for Wii and Sony are also available for Xbox 360.
One interesting note: EA just pulled NBA ‘07 Live for PS3, shocking both the market and its user base.
Electronic Arts has decided not to pursue its plan to port NBA Live ‘07 to PlayStation 3, deciding instead to focus on the upcoming next-generation version of NBA Street.
That’s according to EA Canada PR Manager David Tinson, who told IGN that the developer is “concentrating [its] efforts on creating a spectacular NBA Street: Homecourt”. That title is due out on PS3 and 360 “early next year”, he added.
In other words, basketball fans will have to wait until the release of NBA Live ‘08 before the series takes its PS3 bow.
That comes as a bit of a surprise, not least because Sony actually had EA demonstrate the game during its E3 2006 press conference, where Live was one of the few games shown off in playable demo form.
Not that the PS3 will suffer from a dearth of EA titles at launch, with Fight Night Round 3, Need For Speed Carbon, Tiger Woods PGA Tour ‘07 and of course Madden NFL ‘07 down for release in the US on 17th November.
More on NBA ‘07 pull-out:
Electronic Arts has canned the PS3 version of ´NBA Live 07´, as IGN reports.
It´s perhaps not too surprising, since IGN lists another three NBA titles as confirmed for the console:
* ´NBA ‘07´ by SCEA (launch)
* ´NBA 2K7 by 2K Sports (launch)
* ´NBA Street Homecourt by Electronic Arts (Q2 2007)Still, that very game was an integral part of Sony´s pre-E3 show, showcasing the console´s power, as the article remarks.
Though PS3-specific features or fixes for the PS3 edition of NBA
Live ‘07 were never announced, the game was used to demonstrate what EA
Sports could do with the system’s hardware during Sony’s onstage
presentation prior to E3. Specifically, the demo focused on NBA Live’s
“Procedural Awareness Technology” and how that would translate into
realistic on-court reactions. Pulling the product neither bodes well
for Sony nor for EA, contributing to concerns over both the competitive
landscape as well as dependence of what has been a historical cash
machine for EA.
PS3 vs. Nintendo: A Celebrity Death-Match in the Making
So if EA continues its emphasis on Sony it is clearly exposed to the degree of adoption (and supply) of new PS3 consoles. If PS3 flops then what? EA will need to identify and milk another future cash cow. They could look to Microsoft’s Xbox 360, with a current installed base approaching 10 million by Dec 31. Not exactly the 100 million installed user base of PS2, but not too shabby nonetheless. However, if the situation evolves such that the Nintendo Wii becomes the rising star, EA may be in trouble. FYI, the French company Ubisoft has lined up nine titles for Nintendo including that exculsive to the Wii: Red Steel.
Ninendo has forecasted up to 4 million units shipped worldwide and with sharply lower development costs than Xbox and PS3: $5-$8 million per title for the Wii vs. the $15-$20 million for Xbox 360/PS3 platforms. This makes the Wii far more attractive (and less risky) for both developers and publishers. If EA sticks to their PS3/Xbox 360 strategy, they may miss the boat on Nintendo, spending too much in development costs while missing what looks to be a home run console in the Wii. This could dent the next several quarters of EA’s earnings, painting a pretty ugly picture for the stock price going forward.
For a little additional reinforcement of this theme read:
WMS: Wii To Double PS3 Game Sales This Xmas?
What are Wii Doing? This Market has Gotten Real Ugly Real Fast
It was only a few years ago that EA owned sports games. This included exclusively licensed content from the major sports leagues: NHL, FIFA, MLB, NFL, and the NCAA. All that changed when a little company called Take2 (being investigated as part of options scandal) came on the scene and decided to compete with EA through a subsidiary called 2k. 2k Sports has been challenging EA on game play, graphics, and “sports-feel.” Continued encroachment on the Sports franchise is the spot to watch for weakness. With the release of Madden ‘07, chinks in the EA armor have appeared. Yes, it is a great selling title and there has historically been no competition due to an exclusive licensing relationship; however, there is a growing discontent with EA among the user base. Check these comments out:
EA’s premium ripoff: football tutorial videos on XBLM
3. Just another example of EA ripping their Madden fans off. The xb360 version 06 was bare bones. having a pay per view early viewing. EA is really pissing me off.
Posted at 3:07PM on Oct 4th 2006 by jonm4. Its a freakin shame that EA has the exclusive NFL license because I would have loved to have seen some competition the last two years. I can still dream of NFL 2K7 on the 360. EA Sucks!
Posted at 3:09PM on Oct 4th 2006 by Dominic8. Did you guys see that there’s also “classic stadiums” available for the Rams and Seahawks for 300 points?! This is ridiculous, this stuff was FREE in all the other games, 300 points for ONE old stadium. I dont even want to know what they’ll charge for each individual alternate and classic team jersey for each team. Makes me sick.
If only they could bring back NFL2K series, the world would be a better place. But then again, they might do it too.
Posted at 3:15PM on Oct 4th 2006 by Mike
Conclusion
EA has some real problems. Historic market dominance, rising
development costs, backing high-end platforms with limited user bases -
none of these factors point to an explosion in valuation in the near
term. And these issues are compounded by EA’s gold rush resulting from
the run-away success of PS2, which does not look to be replicated by
PS3 in light of both production delays and fierce competition from the
lower-priced and highly innovative Wii. As noted by the ‘Net, all ain’t
well. In short, all I can say is: Buyer Beware.
Thanks to Rob Passarella for his passion for gaming and his assistance with this post.
The Author does not hold a position in EA.
Since ERTS reported on Nov. 3 the stock gapped up 10%. That makes ERTS up 36% since the end of June. A little consolidation would be healthy, but the overall picture remains positive.
Are they trading at a premium? Yes. Do they deserve it? Yes.
1) EA officials said they are ready for the new console launches, with eight new titles set to be released in the quarter and more than 30 games in development for all the next-gen systems. EA is pushing aggressively in the next-gen market which is positive.
2) For the key holiday quarter, EA projected revenue to be $1.2 billion to $1.3 billion. Analysts surveyed by Thomson Financial were expecting sales of $1.2 billion.
3) ERTS has a strong balance sheet, with approximately $2.4 billion in cash and short-term investments and over $7 per share.
4) Industry leading margins- For the last 10 years, ERTS has grown its annual sales at a 19% CAGR while gross margins have advanced from 51.1% to 60.0%, higher than all its competitors.
5) ERTS has expensed stock options and increased product development spending in preparation for the next gen consoles; this expense has hit ERTS more quickly than its peers as it expenses, rather than capitalizes, the majority of its development costs. However, investors should expect to see operating margins of approximately 9-11% as increased sales levels should provide leverage.
For the past year, the video game software industry faced slower sales as consumers waited for new game console systems, which are now on sale. If you look at the 2nd and 3rd Q performance, they indicate that the video game market is still healthy.
I'm a fundamentalist first but from a technical perspective, investors need to keep an eye on EA's MACD. If you visit the link below, you will notice the 12-day almost breaching the 26-day MA and OBV pointing toward. Keep an eye on this as it could mean a little pull-back is in play, which would be healthy.
http://stockcharts.com/h-sc/ui?s=ERTS&p=D&b=5&g=0&id=p86997865292
Today in GME's report there were some crucial tidbits for ERTS investors.
"FQ4 SSS should be up 14-18%, driven by PS3 shipments, which are coming in weekly. The small number of PS3s available overall mean that these won't have much impact on quarterly earnings, but the upside heading into the new fiscal year should be strong."
I'd like to point out that for the FY ending March 31 07, EA said it expects revenue of between $2.95 billion and $3.13 billion, up from previous company forecasts of $2.8 billion to $3 billion.
GME was up after-hours on those details quoted above because FY 07 will be good and EA will have enough time for its games to be bought, especially the Madden NFL franchise, as well as The Sims and licensed games, such as The Lord of the Rings. Lastly, ERTS can see some pin-action tomorrow from GME's numbers today.
Posted by: Yaser Anwar | November 21, 2006 at 09:12 PM