Game's on for Electronic Arts
Stock Spotlight: No. 1 video game maker gears up for new consoles from Sony and Nintendo. Wall Street debates whether EA is a good play.
NEW YORK (CNNMoney.com) -- Electronic Arts may be the video game sector's dominant player. But that hasn't made the past year much fun for shareholders.
The company, known for blockbusters such as "The Sims" and the "Madden NFL" series of football games, has been, well, a maddening stock to own.
EA warned in May that earnings for the current fiscal year, which ends in March, would be lower than expected. That sent the stock into a tailspin. Shares hit a new 52-week low in June.
Since then, the stock has roared back and is now trading at about $55, where it was before it warned. So with EA (Charts) set to report its fiscal second-quarter earnings Nov. 2, what's next for the company?
This year is going to be even more important, however, since two new consoles will hit the market next month. Sony's (down $0.61 to $41.69, Charts) high-end PlayStation 3 and Nintendo's more modestly-priced Wii are both due out in November. And Microsoft's (Charts) Xbox 360 is still relatively new as well. It was released late last year.
Analysts say how EA manages the release of games for these new consoles, particularly the PS3, will be critical to the company's success.
EA, which generates more revenue from sales of games for Sony's consoles than for Nintendo's or Microsoft's, has already said it has more than 30 games in development for the PS3. It also has six games in development for the Wii.
If EA is able to quickly get titles for these new consoles in the hands of eager gamers, analysts think the company can increase its market lead. But analysts say the company also needs to be careful and not forget customers who aren't willing to upgrade to new consoles just yet.
Timing is everything
EA suffered such a mishap when Sony released the PS2 in 2000. Michael Pachter, an analyst with Wedbush Morgan Securities, said EA "abandoned" the original PlayStation market in 2000 and that backfired since consumers were slow to adopt the PS2.
This time around, EA is taking more of a wait-and-see approach. EA spokeswoman Tammy Schachter said the company "will continue to support PlayStation 2" this holiday season.
That's encouraging since EA may need to rely on the PS2 for the foreseeable future.
Pachter thinks the price of the new consoles will lead to slow sales at first. He points out that shortly after the PS2, Nintendo Game Cube and Xbox were launched, the average price of these consoles was $183. Their successors will cost an average of $336.
"At twice the price, people who don't have that much money will have to wait," Pachter said.
But producing games for multiple platforms isn't cheap. In addition to developing games for the big three consoles, EA also makes titles for mobile devices such as Nintendo's Game Boy Advance and Sony's PSP as well as cell phones, PCs and the Internet.
Daniel Ernst of Soleil-Hudson Square Research adds that the new consoles are getting more complex, which also drives up expenses.
This worries some investors. Mike Hickey, an analyst with Janco Partners, said fears of high research and development costs along with poor initial sales of Microsoft's Xbox 360 contributed to the sell-off in EA this spring.
Hickey said delays with the PS3 could also present a problem. Sony originally planned to have 4 million consoles available in the U.S. by year's end but now expects to ship just 2 million. "Unquestionably there will be turbulence in the near term," Hickey said.
The shape of games to come
For EA to maintain the top spot in gaming, it needs to do more than dominate the console market. But analysts see promise in some of EA's newer businesses.
For example, EA bought JAMDAT Mobile, a company that makes games for cell phones, earlier this year.
So far, the integration of JAMDAT has not been moving as fast as expected, analysts said. Ernst said many EA titles aren't available on phones yet because it is hard to replicate games with high-end graphics on phones.
But Martin Pyykkonen, an analyst with Global Crown Capital, said in a couple of years, revenue from cell phone games could make up as much as 15 percent of EA's total sales, up from 8 percent currently.
In-game advertising could also be a lucrative market for EA, Pyykkonen said.
EA does already feature ads in some games through product placement. Golfers in EA's "Tiger Woods PGA TOUR 06" wear apparel from Nike and Callaway while in "Fight Night Round 3," players can choose to box the Burger King mascot.
But Pyykkonen said a big opportunity for EA lies with real-time ads in games. The company announced a deal in August with Microsoft subsidiary Massive to incorporate real-time ads in some games for the Xbox 360 and PCs. Pyykkonen thinks within the next few years, sales from ads and other downloaded content could make up about 10 percent of revenue.
Near-term turbulence, long-term growth
EA's stock has bounced around a lot lately and analysts think investors should expect more ups and downs.
The stock has already enjoyed a good run in the past few months and given the concerns about the new consoles, shares could be due for a breather.
What's more, EA's industry-leading position is more than reflected in its stock price. Shares trade at about 42 times estimated earnings for its next fiscal year, ending in 2008, while THQ and Activision trade at 25 and 30 times estimates for their next fiscal year.
Still, it might not be a bad time to consider buying the stock as long as you don't expect much in the next few months. Janco's Hickey points out that EA has $2 billion in cash, no debt, "and a tremendous emphasis to win in the future."
He adds that a key accounting difference makes EA more attractive than its competitors. Activision and THQ capitalize their R&D expenses, meaning these costs don't affect earnings until the game is released.
EA, on the other hand, expenses R&D costs, meaning they come out of earnings as they incur them. So even though EA's profit may take a hit now, Hickey thinks the company will be in a better position than its rivals for great earnings a few years out.
None of the analysts quoted in this story own shares of Electronic Arts. None of the firms have an investment banking relationship with the company.