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EA: At the Bottom, Looking Up?
Trading near a 52-week low, Electronic Arts could be a buying opportunity.
January 30, 2003: 6:08 PM EST
By Eric Hellweg, CNN/Money Contributing Columnist

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SAN FRANCISCO (CNN/Money) - With the stock market caught between Iraq and a hard place these days, you gotta sift through a lot of silt to find nuggets -- or even just some spare change.

And for every Amazon or eBay, both of which are trading near 52-week highs, several companies struggle at valuations approaching 52-week lows.

But few of the companies I cover have valuations that are as shocking on the downside as that of videogame maker Electronic Arts (ERTS: Research, Estimates). Based in Redwood City, Calif., EA has been trading lately in the high-$40 range, precariously close to its 52-week low of $47.51.

The company reported third-quarter results Thursday, and it showed a profit of $1.69 per share, 84 percent growth year over year. Its previous quarter saw a profit of 34 cents per share -- an increase of 150 percent, compared with the software industry's average growth rate of 27 percent. EA's P/E is 21, while the industry hovers much higher, around 34.

I rarely offer specific stock recommendations, but I'd keep an eye on EA as a potential buying opportunity.

What gives?

Why is EA trading so low? Several reasons -- most of which revolve around Wall Street analysts' worries about the sector's ability to maintain a 20 percent growth rate at a time when the hardware cycle is ebbing and consumer spending is falling fast.

This is a legitimate concern, but ultimately overstated. "There's so much emphasis on maintaining that 20 percent growth rate," explains Schelley Olhava, a program director with IDC. "But even a 10 percent growth in an economic down year is still good. I'd be more concerned if it shrank 10 percent."

Yes, consumer spending is dropping, and yes, console games are starting to enter the downturn of their five-year cycle (which typically occurs two years after a new console is introduced, according to Forrester Research analyst Charlene Li).

But the most recent data from research firm NPD Group shows that the growth rate is still very healthy: EA's December sales were up 18 percent year over year, and the entire gaming sector was up 21 percent for 2002, compared with 2001.

With online gaming growing in step with broadband, companies such as EA -- with games like The Sims -- are best positioned to capitalize on this new market, even though it represents just 2 percent of the company's total revenue.

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The majority (55 percent) comes from console games such as those for the Microsoft Xbox, Nintendo GameCube, and Sony Playstation 2. PC games make up another 18 percent. Even though sales of the consoles themselves are now beginning their cyclical decline, game-unit sales could actually increase, according to Li, since hardware prices will come down. This bodes well for software manufacturers such as EA, which produced 6 of the 20 best-selling titles of 2002.

One last area of concern, however, is the level of insider selling at EA in recent months. In the last year, insiders have sold 1.98 million shares, 1.27 million of those in the last three months alone. Despite this activity, I believe that EA's long-term prospects are strong and that it's being unfairly trammeled in a down market. We'll check back on EA later this year and see how it's faring.

Eric Hellweg is a contributing writer at Business 2.0.

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