EA: Building Up by Being Broken Down

My friend Chris Kohler at Wired Game/Life wrote a little blurb in the wake of EA's recent investor meeting:

In another statement that reconfirms his commitment to getting Electronic Arts back on the right track, new CEO John Riccitiello says to an investors' meeting that they messed up at the beginning of this console cycle:

“Our stock hasn’t moved as much as we’d like,” Riccitello told one investor during a Q&A. He admitted that EA was on the “wrong horse” by concentrating mainly on the PS3 and Xbox 360 while throwing less resources towards the Wii during the console transition.

Yyyyep. To be fair, they've got their bets spread around a little more evenly now.

You said it, John, and right on, Chris. The only point of clarification I'd make is that EA's stock has moved plenty since I first critiqued their strategy in mid-November of last year. Problem is, it has been a great investment for the shorts, having fallen around 14% over the past eight months. Come on, 20%+ annualized, that is a pretty good return! But seriously, Mr. Riccitiello has done a very good job acknowledging EA's problems and taking concrete steps to remedy them. Their strategy which is, as Chris notes, far more diversified, is also less reliant on the core gamer and the legacy platforms that are having serious user-adoption issues. This is most definitely NOT the same EA I wrote about last fall, when their shares were riding high but a reading of the Internet tea leaves indicated trouble on the horizon:

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.

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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.

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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.

Now that EA has their strategy right it boils down to execution. And executing in this increasingly complex marketplace is no easy task, but I think John has the goods and has built depth in EA's senior management ranks that gives it a fighting chance to come out on top.