Fool on Call: EA's New Game Plan

The latest video game console product cycle turned out quite differently from the previous one, in which Sony's (NYSE: SNE  ) PS2 charged ahead of the pack and never looked back. In that cycle, Electronic Arts (Nasdaq: ERTS  ) put its chips down on Sony and focused on producing games for the PlayStation 2. The gamble paid off handsomely.

This time around, Microsoft (Nasdaq: MSFT  ) Xbox 360 got off to an early, fast start. And then Nintendo, which was all but pronounced dead before the new cycle even began, came out of nowhere with a unique experience that captured the imagination of old and new gamers alike.

Electronic Arts was poorly prepared to capitalize on the Wii's success, so it has suffered mightily over the past few quarters. In the third quarter of fiscal 2007, EA's market share was 29%. By the end of fiscal 2007, its share had declined all the way to 20%. Now, in the first quarter of fiscal 2008, EA's market share has fallen even further, to the mid-teens, according to CEO John Riccitiello and the company's most recent earnings conference call.

The good news is that EA is about to go on the offensive. In this edition of "Fool on Call," we look at how Electronic Arts aims to get back to the mid-20-percent range before the end of the calendar year. The plan is simple: bring more big games to the market than the competition. But will this be enough to compel investors to plug into EA?

A combination of old and new franchises
EA's goal got a nice boost when Take-Two Interactive (Nasdaq: TTWO  ) recently announced that it's pushing back the release of Grand Theft Auto IV until after the holiday season. It has been years since I read Sun Tzu's Art of War, but I am sure somewhere in that masterpiece there is sound advice that reads something like this: "When a competing developer delays a major gaming title, thereby giving you a foot of opportunity, take that foot ... and an extra mile, too." Take-Two's loss this holiday season is EA's gain.

Piggybacking off the recent film release Harry Potter and the Order of the Phoenix by Warner Bros. Books, EA's video game version got off to a fast start. The newest Harry Potter launch signals the beginning of EA's resurgence, with a bunch of new and exciting titles along the way.

One of its most anticipated new titles is Rock Band, which gives users the opportunity to shred virtual guitars to 40 licensed songs from five decades of rock 'n' roll, going as far back as The Who and The Ramones to Nirvana and Stone Temple Pilots. To make this possible, EA partnered with Viacom's (NYSE: VIA  ) MTV Networks. Rock Band has a fall release date and is set to debut on both the PS3 and Xbox 360 to compete with Activision (Nasdaq: ATVI  ) and its Guitar Hero franchise. (Read about the battle between Rock Band and Guitar Hero.)

Wii gamers will not be headbanging to Rock Band, but instead can get their groove on to Boogie and its four decades of dance music, ranging from the Jackson 5 to Britney Spears. Riccitiello said of Boogie, "It is innovative and perfect for the casual gamer."

When we account for other new franchises on the way, like Skate and Army of Two, we can see why Chief Financial Officer Warren Jenson is so excited. He says: "We are heading into the sweet spot of our release schedule. We have one of our strongest lineups ever with 10 new properties."

In addition to new franchises, the holiday season should feature one of the strongest seasons ever for EA Sports. NCAA Football 2008, NASCAR 2008, FIFA Soccer 2008, NBA Live 2008, and of course, the grandest of them all, Madden 2008, make up an all-star lineup that likely will gang-tackle the competition.

Big titles lead to big revenue, but ...
Because of the strong lineup, management has upped its fiscal 2008 revenue guidance by $100 million to $3.2 billion to $3.5 billion. However, it's also forecasting a bottom-line loss of $0.10 to $0.63 per diluted share.

The profitability hit is partially blamed on the fact that EA missed the Wii boat and is now playing catch-up with significant investments in upcoming Nintendo titles. In the call, it was said that two other areas can help the company improve profitability: streamlining its cost structure and improving the productivity in research and development. Management didn't elaborate, but hopefully, within the next few quarters we will have better insight. 

Until then, investors are left with the grim reality of declining profitability. This negative trend dampens the enthusiasm we might have had for an otherwise stellar holiday lineup.

Fiscal Year

Earnings Per Diluted Share

Change From Previous Year

2004

$1.87

73.1%

2005

$1.59

(15.0%)

2006

$0.76

(52.2%)

2007

$0.24

(68.4%)

2008

Estimated net loss of $0.10 to $0.63

N/A

*EPS data from Capital IQ, a division of Standard & Poor's.

Until there is significant improvement in profitability, reaching the mid-twenties in market share again won't seem like much of a victory for shareholders. Ideally, Electronic Arts will not only recapture market share but also use its pipeline to pump some profit back into the bottom line. 

Until then, game on your console of choice, Fools. 

For related Foolishness:

Electronic Arts, Nintendo, and Activision are Motley Fool Stock Advisor selections. Microsoft is an Inside Value pick. A free 30-day trial of either newsletter will unlock exciting investing prospects. No, there aren't any hidden passages or levels -- just full access to all the past newsletters, as well as unique online exclusives. 

Fool contributor Jeremy MacNealy has no financial interest in any company mentioned. The Motley Fool has a disclosure policy.


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