Playing In The Gaming Industry

Electronic Arts (NASDAQ: EA) saw its stock tank last week, falling as much as 8%, after CEO John Riccitiello announced plans to step down at the end of the month. The company also announced that its fourth quarter results could come in at the low end of its previous earnings guidance of $1.08 billion. But is this just a minor set back for the company?

Despite the stock's pullback on the news, the company is still up nicely year to date:

The push to online gaming

DFC Intelligence estimates that the online video grame market will grow from $19 billion in 2011 to $35 billion in 2017. By 2017 online gaming is expected to account for over 40% of the total video game revenues. Meanwhile, Gartner also has robust estimates for the industry, expecting that consumer spending on online gaming will grow at an annualized rate of 27% through 2015.

The good news is that EA has a strong online presence which presents solid growth opportunities for the company. The digital (online) business is expected to be an important growth driver for the EA as growth in packaged games appears to be declining.

For 2012, the digital business made up 54% of EA's total revenues and grew 47% year over year basis. The other big positive is that EA expects its digital business to grow by an annualized 20% over the next four years.

Activision Blizzard (NASDAQ: ATVI) is another major game maker, with a market cap nearly triple that of EA. Activision has also been making the transition to digital, with 57% of its revenues generated from the segment last quarter. Credit Suisse believes that the company's 4Q earnings beat was a result of higher-quality games -- including its Call of Duty series. The investment firm also believes that high-quality content will continue to be the drivers for long-term company growth. However, I think EA is the better value -- explained later (read about Activision's move to mobile gaming).

Take-Two Interactive Software, Inc. (NASDAQ: TTWO) currently only derives 23% of its revenues from digital. Last quarter, Take-Two posted EPS of $0.67 compared to the $0.27 for the same quarter last year, and beating consensus of $0.56 handily. This was in large part thanks to its NBA 2K13 and Borderlands 2 games. Take-Two should be able to ride the coat tails of is upcoming game releases from its BioShock and Grand Theft Auto series through 2013, but I think the growth potential of Take-Two is not as pronounced as that of EA.

Industry headwinds include the emergence of online games on social networking websites, including Facebook (NASDAQ: FB). Facebook, however, does expect revenues via payments from the games platform to remain subdued. Facebook games are mostly desktop based and declining desktop usage in the developed markets is expected to hurt its top-line growth in 2013. Facebook is instead focused more on monetizing its mobile presence and breaking into the search industry (read about Facebook's search ambitions).

The other side of the coin

If online gaming is one side of the coin for gamings' future, then mobile is the other. Zynga (NASDAQ: ZNGA) has already recognized such a trend. The social gaming company is now transitioning from online gaming and Facebook to a mobile-focused strategy. This should be a big positive for the company as the number of people spending time on smartphones and tablets is rapidly growing.

Mobile will need to lead the future for Zynga, which reported flat revenues year over year last quarter, but a net loss of nearly $50 million and a 15% decline in bookings year over year. Although Zynga is looking to make its move into mobile never fear, EA has quite the presence here (in mobile) too; "EA Mobile is the world's leading publisher of mobile games."

Don't be fooled

EA appears to be one of the best positioned gaming stocks and the recent pull back could be a great opportunity to get into the stock. EA is also the best "value" from a valuation perspective. The company trades at a 1.4 price to sales ratio, compared to Activision's 2.2; meanwhile, their growth rates are very similar. Analysts expect the companies to grow at 14% (EA) and 13% (Activision) over the next five years. I would be remiss if I did not mention Take-Two, which trades at a mere 0.86 times sales. Yet, I think the stock warrants the low valuation multiple given its long-term expected earnings growth rate is only 9%

Electronic Arts (EA) Is In A Deep Shit

“To the executives at EA, from one of your employees

I am deeply embarrassed by the troubled launch of Sim City and I hope you are too. When I walk around our campus and look at the kind of talent we’ve collected, the amenities we have access to and the opportunities working at such a big company affords us, I can’t imagine how for release after release, EA continues to make the same embarrassing, anti-consumer mistakes. We should be better than this. You should not be failing us so badly.

Another thing I see when I walk around our campus are massive banners that display what are said to be our company values. They are on posters on every floor, included in company-wide emails and hanging above the cafeteria in bright colors. You even print them on our coffee mugs so we see them every day. But somehow when planning the launch of Sim City, you threw them all out the window.

Most important of the values you are ignoring is Think Consumers First. What part of the Sim City DRM scheme, which has rendered the game unplayable for hundreds of thousands of fans across the globe, demonstrates that you are thinking about consumers before you are thinking about yourselves? Does “first” mean something different in boardrooms than it does to the rest of us? Does the meaning of that word change when you get the word “executive” in front of your title?

You can’t even pretend that you didn’t know consumers would be angry about this. Common sense aside, consumers complained about this during your public betas. In fact, when one of them posted his criticisms on the forums, he was banned! You tried to silence your critics. The same thing is happening now as users write in to demand refunds. What part of this behavior aligns with our company value to Be Accountable?

What you’ve demonstrated with this launch is that our corporate management does not believe in our core values. They are for the unwashed masses, not for the important people who forced this anti-consumer DRM onto the Sim City team. This DRM scheme is not about the consumers or even about piracy. It’s about covering your own asses. It allows you to hand-wave weak sales or bad reviews and blame outside factors like pirates or server failures in the event the game struggles. You are protecting your own jobs at the expense of consumers. I think this violates the Act With Integrity value I’m looking at on my own coffee mug right now.

On behalf of your other employees, I’d like to ask you to fix this. Allow the Sim City team to patch the game to run offline. If Create Quality and Innovation is still a core value that you believe in, then this shouldn’t be a hard decision. Games that gamers can’t play because of server overload or ISP issues are NOT quality. Be Bold by giving the consumers what they want and take accountability for the mistake.

Finally I’d like to ask you to follow the last company value on the list in the future: Learn and Grow. When you made this mistake with Spore, the company and all your employees suffered for it. You didn’t learn from that mistake and you are making it again with Sim City.

So please, learn from this debacle. Don’t do this again. Grow into better leaders and actually apply our company values when you make decisions. Don’t just use them as tools to motivate your staff. With the money, talent and intellectual property available to EA, we should be leading the industry into a golden age of consumer-focused game publishing. Instead we’re the most reviled game publisher in the world. That’s your fault. Things can only change if you actually start following the company values and apply them to every title we launch.

Sincerely,

A Disappointed But Hopeful Artist at EARS”