Author Topic: EA - Electronic Arts, Inc  (Read 10427 times)

griezeman23

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Re: EA - Electronic Arts, Inc
« Reply #20 on: September 18, 2019, 07:06:05 AM »
Just trying to revive the conversation here. Started taking a look at EA this summer and worked out that ~$900mn in earnings in FY19 were due to Sports. Assuming MSD topline growth for FY20 & FY21, Sports should be worth $1bn in earnings in FY21 (GAAP). From there on 300mn shares, that's $3.33 in EPS for FY21. EA has traded (at its highs) 25x FY2 EPS, which I would argue is fair value for Sports given its recurring nature, wide moat, and relatively low risk of license loss. That gives us $83/share. With $600mn debt maturity in 2021, $1bn set aside for acquisitions and $400mn for working capital, that leaves $3bn in "spare cash" or $10/share. I think the other business are worth ~12x earnings (EA sucks at innovating, management of these games is poor and game quality is poor but due bump it slightly since Apex has been a relative success), gives us a valuation of $6bn or $20 per share.

So when EA trades sub-$90, you get sports biz undervalued; with EA in $90-$100 you get sports business fully valued and then  remaining ~$500mn in earnings for free; and over $100 you start assigning value to the other businesses. I'd say then that EA's fair value is ~$120+ with downside limited to $90. Any thoughts? Obviously there are the usual risks: regulatory, gamer backlash, poor management, hits, etc. but I think EA here at sub-20x FY2 earnings, ex-cash, is compelling. Any thoughts?


5xEBITDA

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Re: EA - Electronic Arts, Inc
« Reply #21 on: September 18, 2019, 07:18:18 AM »
How is sports - a product where the consumer has to make a purchase decision every year and make a purchase decision with every microtransaction - in any way recurring revenue?

griezeman23

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Re: EA - Electronic Arts, Inc
« Reply #22 on: September 18, 2019, 07:26:19 AM »
Recurring is probably the incorrect word for MTX - unit sales have a churn rate of ~20%, which one could argue are recurring by the definition. A better word for MTX would be consistent given the consistent nature of UT purchases over the last 5-6 years. Apologies for the mix-up.

Even still, MTX on sports seems to be a relatively consistent stream of revenues - excluding the ethics of loot boxes. Engagement = monetization, and sports continues to keep its core gamers engaged => consistency. Thus, I still think EA's Sports business warrants a relatively high multiple (in-line with its historical highs).


5xEBITDA

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Re: EA - Electronic Arts, Inc
« Reply #23 on: September 18, 2019, 08:39:14 AM »
It is "recurring" only until it isn't. These are not ~3-5 year contracts and consumer purchases are entirely dependent on successful, ongoing R&D. The gaming industry over the last year has proven themselves to be pretty bad at quickly responding to shifting consumer interests, and you can see what happens to the financials / stock prices when they miss a beat. In fact, the guys who got ran over the worst were the ones pitching the IP as "annuity-like".

Schwab711

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Re: EA - Electronic Arts, Inc
« Reply #24 on: September 18, 2019, 09:17:18 AM »
I like the EA Sports-based elevator pitch, Griezeman. I think it make a lot of sense, we might just argue over multiples. I never ended up buying EA at any point and I can't get there now but I like the future a lot.

I agree that non-sports gamers don't appreciate how sticky sports games are relative to the broader video game market. I own the last 20 Maddens and 5 FIFAs. Those 2 + Fortnite are the only games I play. There's a lot of gamers like me. Sports games (due to Ultimate Team modes) are ideal for the 30-60 min gamer. It's frustrating playing against people that spend a lot but EA has done a great job of not making the gap in skill boosts too large. The natural annual reset of the skill inflation is underrated from a video game economics perspective. It lowers the risk of major disruption. Fortnite has done a great job at building in natural resets, so maybe this advantage will become less pronounced. Either way, sports gamers have been trained to expect slow gameplay changes. At least for Madden, the years that had the most gameplay change have been the least liked.

The implementation of betting in Madden microtxns is probably the next leg up for margins in Sports. Madden being close to US-only might end up leading to it surpassing FIFA in EBIT as some point (not sure if it already has but I doubt it given the revenue difference). FIFA is still undermonetized but it's going to take more creativity given the large EU gamer presence there. At some point, EA/TTWO could probably decrease the price of the game without a big hit to the overall economics. I don't play it but 2K probably has the potential of a poor man's FIFA. I think EA Sports has a long runway on margins, though the journey may not be smooth.

griezeman23

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Re: EA - Electronic Arts, Inc
« Reply #25 on: September 18, 2019, 09:20:51 AM »
It is "recurring" only until it isn't. These are not ~3-5 year contracts and consumer purchases are entirely dependent on successful, ongoing R&D. The gaming industry over the last year has proven themselves to be pretty bad at quickly responding to shifting consumer interests, and you can see what happens to the financials / stock prices when they miss a beat. In fact, the guys who got ran over the worst were the ones pitching the IP as "annuity-like".

As I said, in my previous post recurring was not the right word for MTX. Still would argue 80% of customers are repeat purchasers, which is "recurring" by definition. Is it an enterprise software subscription? No, but folks like myself (I bought FIFA blindly for 15 years straight) continue to return to purchase FIFA & Madden because they want the new year's "DLC", the rosters. You can worry about elevated churn due to poor gameplay (Frostbite), but FIFA 18 was EA's best selling FIFA year (24mn+) with its lowest metacritic score, 68. So I think that the risk there is low.

I would agree that EA/ATVI have not responded well to quickly changing customer demands (cough cough Fortnite). Seemingly, EA has reverted to bandwaggoning (Apex) but I'd argue its EA's first good non-sports game in quite sometime. I'd agree with your other points on any non-sports business and hence why I said the rest of earnings should trade in the low DDs. The non-sports gaming community is finicky to say the least and making a good game is not just due to capital allocation (Anthem, Battlefield V, Titanfall 2).

Your point about those pitching annuities is a good one, and one I have thought about for some time. First, I'd argue that I am not getting my faced rip-off like others in the last two years, given EA trades sub-20x now and not 25x like it did in 2017/18. Adjusted for its large cash balance, it trades at around 17x-18x, well below higher valuations seen before (25x+). At $120, it trades at roughly 20x + cash on the balance sheet, which is all I argue for (25x on sports, 12.5x on rest of business). Yes there is volatility potential in earnings, but I think much of this is priced in when EA trades below $100.

Second, I believe your main point of contention is the 25x multiple on the sports business, as the central question is: will UT continue to drive engagement? I don't think that CCG on sports needs to evolve much y/y to continue to grow (UT still growing 11% y/y ex-FX and FY19 struggled most likely as it included Belgium banning the fiat currency sale of FIFA points). I'd argue that FUT has a few more years to live since the EPL hands out FUT player cards along with its POTM awards, so I imagine UT still has at least a couple years of continued engagement. Could see this happen with UCL given the relatively new partnership there. Some academies in the UK are using FUT cards to help kids understand their weaknesses in real life. So I feel comfortable that risks to FUT declining in the very short term are low. There are risks, but I like EA here below 20x.

griezeman23

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Re: EA - Electronic Arts, Inc
« Reply #26 on: September 18, 2019, 09:25:13 AM »
Schwab,

I'd agree that we are likely to squabble over multiples. Obviously, 25x is steep but I agree that sports is still undermonetized and LT growth of MSDs with further OM leverage in the LT (cloud gaming) make me feel like this is a good multiple (particularly, since EA traded that high before but Mr. Market can be wrong). Like you said, margins and growth will most likely be lumpy. Multiple here is just fine for me, not my best idea but I like it nonetheless.

Great point on skill reset.