Electronic Arts: Staying Long

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Last month, I made the argument that Electronic Arts (EA) could be set to see moderating growth, in spite of an overall increase in gaming demand during COVID-19.

Primarily, the risk of a slowdown in discretionary spending due to adverse economic conditions, as well as the possibility of a delay in FIFA 21 as a result of less marketing opportunities due to cancellation of sporting events were cited as two key risks.

Recent Performance

When looking at the most recent earnings quarter, the company still appears to have performed strongly.

For instance, while digital net bookings saw a decline on a quarterly basis – bookings were still up by 9% on a trailing 12-month basis, with particularly impressive growth of 15% across live services:

Source: Electronic Arts Results – FY20 Q4 Earnings Slides

Moreover, the company has reiterated its intention to release the FIFA 21 game title in Q2 FY21 – which still puts the title on schedule.

Potential Risks

In this regard, it does not look as though the gaming company has particularly suffered negative effects as a result of COVID-19 – at least not for the time being.

With that being said, the company does not rule out event cancellations as a risk factor in not being able to promote major game titles, citing potential “continued disruptions, postponements or cancellations of sports seasons and sporting events around which the Company seeks to launch games and provide live services.”

From this standpoint, potentially disappointing sales of the upcoming FIFA 21 gaming title still cannot be ruled out – even if engagement as a whole is on the up.

Moreover, while the gaming industry has evolved to thrive online, the fact that lockdown has closed brick-and-mortar gaming stores will invariably limit revenue potential for the company – even if EA is still seeing growth in revenue and engagement through live services.

Additionally, the gaming industry has undergone big change in the past decade in terms of how consumers choose to access gaming titles, and the success of live services may be a double-edged sword, even if this has proven to be a strong recurring revenue stream.

There is the perception among some gaming enthusiasts that live services simply erode the overall quality of the game – in that games that rely on constant updates rather than being a finished product in their own right simply diminishes the quality of the game – as one Reddit thread alludes to:

Source: reddit.com

In this regard, while live services growth has been impressive, there is always the risk that the company could become overly reliant on such a revenue stream and ultimately see downside if the appetite for the live services model starts to fade.

With that being said, EA is still seeing growth in revenue and engagement overall – which is to be welcomed. Moreover, even with uncertainty regarding the eventual performance of FIFA 21, the company has still demonstrated strong engagement across other gaming titles, with Madden NFL 20 having shown the highest engagement levels in the history of the franchise, along with the number of players for the Sims 4 showing a higher monthly average for every quarter in fiscal 2020 compared to that of the prior year.

Valuation

From a price standpoint, Electronic Arts has significantly outperformed the S&P 500 since the start of 2020:

Source: investing.com

Moreover, even with price rising – it may just be the case that investors are being overcautious on the stock.

For instance, we see that over the past five years, growth in EBITDA has outpaced that of EV to EBITDA:

Source: ycharts.com

However, over the past year, we see that EBITDA has grown by over 20% while EV to EBITDA has declined by just over 10%:

Source: ycharts.com

There is a good possibility that markets are undervaluing the stock. Notwithstanding that risk factors for EA remain, we could also see a strong appreciation in the stock if the macroeconomic situation recovers faster than expected.

Looking at the P/E ratio would seem to further confirm this, where we see the ratio at a five-year low while normalized diluted EPS has been rising significantly since 2019.

Source: ycharts.com

In spite of the risks ahead, I am long EA and am choosing to remain long – the company has shown impressive performance even with the pressures of COVID-19.

Additional disclosure: This article is written on an “as is” basis and without warranty. The content represents my opinion only and in no way constitutes professional investment advice. It is the responsibility of the reader to conduct their due diligence and seek investment advice from a licensed professional before making any investment decisions.

Disclosure: I am/we are long EA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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