Electronic Arts: Participate In The Fast-Growing Games Market
David Koh | Oct 29, 2017 01:11AM ET
Summary
- Electronic Arts (NASDAQ:EA) is a fast-growing video games publisher with strong fundamentals, currently going through a correction due to delays to a new story-based Star Wars game.
- Given that the global gaming market continues to exhibit strong growth prospects going forward, Electronic Arts is well-placed within the industry to benefit from this trend, especially with its promising business model for games.
- Electronic Arts is now trading at a reasonable valuation compared to peers, which provides investors with an opportunity to participate in the fast-growing global games market.
Quality gaming company going through a correction
Electronic Arts (EA) is the 2nd largest video games publisher (by market capitalization) in the United States, with 56% of revenues coming from outside North America. The company owns several household video game titles such as FIFA, NBA,The SIMs and Star Wars and distributes these titles via consoles such as Xbox One & PS4, PCs and even mobile handsets.
In terms of financial health, EA looks to be in very good shape. The company generates a hefty 19.8% return on invested capital as of FY2017, creating value steadily for all capital providers. Balance sheet-wise, EA also maintains a very strong cash buffer, accumulating $3.5 billion worth of net cash, that it may choose to employ at any time to create value for shareholders. Being a games publisher with little to no inventory requirement, EA also exhibits very efficient earnings-to-cash conversion, which shows up in a strong positive free cash flow generation of $1.3 billion as of FY2017.
Recently, EA shares tumbled by almost 3% after it announced a delay for a new story-based Star Wars action-adventure game. Originally, the company was planning to launch the game between April 2018 through to March 2019. However, due to game design issues, EA decided to overhaul the game, which resulted in the closure of one of its studios, Visceral Games. Though investors took this negatively, punishing its share price, it is still important to note that EA did not cancel the production of the Star Wars game. It was merely a delay, which could result in the development of a better-quality game that would generate higher gamer revenues in the future.
Fast growing games market
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According to the Newzoo Q2 2017 Global Games Market Report, 2.2 billion gamers across the globe are expected to generate $108.9 billion in game revenues in 2017. This represents an increase of 7.8% from the year before, and come 2020, projections show that this figure could increase to $128.5 billion. That’s a +6.2% compounded annual growth rate (CAGR) from 2016 to 2020. Electronic Arts, with its household game titles such as FIFA, NBA,The SIMs and Star Wars, operate within this fast-growing market.
On top of being in an expanding market, EA has also adapted to the increasingly changing gaming landscape by turning to a new business model. Instead of the traditional model of having players make one-time purchases, the company now makes mobile free-to-play games and charges for live services such as competitive tournaments, keeping players coming back for more. This model has worked very well for titles such as FIFA Mobile and Star Wars: Galaxy of Heroes, and would allow EA to gain market share in the future.
Valuations reasonable compared to peers
At current prices, Electronic Arts is trading at a valuation of 36.4x FY2017 P/E. Although this might seem expensive at first glance, the company is actually growing at breakneck speeds, with consensus forecasts putting FY2018 EPS at $4.28, representing a projected earnings growth of +35%. And the company seems to be on-track to achieve this target, given that first quarter EPS beats estimates by 16.1% (Q1 EPS at $0.313 versus estimates for $0.270), according to Bloomberg.
On top of fast growth prospects, EA also compares well in terms of relative valuation with its competitors. Fellow game publishers such as Activision Blizzard (NASDAQ:ATVI), Ubisoft (OTC:UBSFF) and Nintendo (OTC:NTDOY) currently have historical P/E multiples of above 40x. Assuming that growth rates are similar across the games publishing industry, Electronic Arts at the current valuation does provide investors with a reasonable price to participate in the fast-growing global games industry.
Disclosure: We have no positions in any stock mentioned above.
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