Electronic Arts Scores Another Win

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Looks like Electronic Arts (Nasdaq: ERTS  ) racked up another win. The company sold 5 million copies of its latest first-person shooter Battlefield 3, setting a record as the company's fastest-selling game. Although the number is rather small when compared to the 7 million copies of last year's Call of Duty: Black Ops that Activision Blizzard (Nasdaq: ATVI  ) moved on day one, Battlefield's big first week marks another success in a string that make EA a company worth watching.

Racking up achievements
EA's win streak started this summer when it beat out Farmville developer Zynga to acquire PopCap Games, the developer of addictive time-stealers like Bejeweled and Plants Vs. Zombies. The acquisition should help EA fortify its position in the fast-growing casual game market. In the time since the acquisition, the company has had a lot to celebrate:

  • EA launched The Sims Social, which quickly became the second most popular game on Facebook and established EA as Zynga's top competitor.
  • First week sales of Madden 2012 increased 10% year over year to 1.4 million.
  • FIFA 2012 first week sales increased 23% to 3.2 million copies.
  • Second-quarter revenue from smartphone games increased 87% year over year.
  • Over 6 million PC gamers have downloaded Origin, the company's digital game store.

Getting used to the new game map
Overall, I like EA's strategy for navigating the new gaming market. The company plans to transform its major franchises from seasonal blockbusters into year-round money makers. For console titles this means more downloadable content and expansion packs. The company will also launch Star Wars: the Old Republic, a massively multiplayer online role playing game, for the PC in December. If the game is successful, it will give EA a steady revenue stream which should help improve margins in the long run.

It's also good to see the company taking social and mobile gaming seriously. While I still maintain that these new platforms are expanding the gaming market rather recreating it, the opportunities they offer publishers are too big ignore.

Why I'm staying on the sidelines
That being said, I agree with my fellow Fool Anders Bylund. At the moment, EA isn't a buy. In spite of the good news, the company's earnings decreased year over year and cash flow from operations moved further into negative territory. Although I suspect that EA will eventually adapt to the new gaming environment, I think investors might find a better opportunity in a company like Majesco Entertainment (Nasdaq: COOL  ) which is both cheaper and better positioned to benefit from the casual gaming market.

However, I do think it's worth your time to keep an eye on Electronic Arts. Regardless of how the videogame industry changes, the company should remain a major player. And if the company's winning streak continues, it could become a buy. In the meantime, click here to add Electronic Arts to your watchlist and stay up to date on all the latest news and analysis.

The Motley Fool owns shares of Activision Blizzard. The Fool owns shares of and has written calls on Activision Blizzard. Motley Fool newsletter services have recommended buying shares of and creating a synthetic long position in Activision Blizzard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Fool contributor Patrick Martin owns shares of Activision Blizzard. You can follow him on twitter @TMFpcmart03. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (3)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 03, 2011, at 4:54 PM, porkfriedrayrice wrote:

    It doesn't matter about the number of sales EA made.. If you play the game you would notice the glitches and unpolished feel of battlefield 3. sentiment from gamers say this game falls way short of what call of duty can do.. It was a nice try, but maybe u should actually try the product.. Online multiplayer is glitchy and the DICE servers ALWAYS time out when one is in a good game. The games vehicles are the only thing that keeps the game afloat. So play the product don't just look at sales fool.. You have no credibility. On the 8th we will all see who can produce the worlds best first person shooter with even aiming flow and a all round polished game. You will piss your pants on the number of sales cod mw3 will achieve.

  • Report this Comment On November 04, 2011, at 2:19 PM, shovemedia wrote:

    I've been quite enjoying the year's run -- I bought after the '08 crash pushed the price into the teens. My initial price target was ~$20. Might be time for an exit...

  • Report this Comment On November 15, 2011, at 12:53 AM, johnnnyyy2 wrote:

    One Stock I'd Buy Today

    While none of the great, proven blue-chip stocks I listed earlier are cheap enough to buy now, there is a company that's becoming a great business that I recommend you invest in today.

    It didn't qualify for our pantheon of capital efficiency because it was created via a merger in 2008. So it simply doesn't have the pedigree. Also, as a video game publisher, many investors would argue the technology in play in this space is too uncertain. I disagree. Publishing is a business I know well... and I know technology empowers publishers. It allows them to more easily connect with their customers. That's certainly the case with this stock.

    Before I tell you any more about the business, let's review the numbers.

    In the full two years since the merger, this company produced $4.2 billion in gross profit. That's revenues minus the cost of sales – before all operating costs and capital investments. In those same two years, this company distributed $2.1 billion to shareholders in the form of cash dividends and share buybacks. That's a capital efficiency of 50%, which would put it No. 2 on our pantheon above, just behind the tobacco company Lorillard.

    In terms of price, the company's shares trade for an enterprise value of $11 billion. (Enterprise value is market cap plus debt minus cash.) The company generates roughly $1.5 billion a year in cash from operations, which puts its modified P/E at 7.3x. This falls well below our price threshold of 10 times cash earnings.

    Is this a high-quality business? At first glance, you'd say no. Yahoo Finance reports the company's return on assets is only 5.9% – fairly pedestrian. Its return on equity is only 6.15% – nothing to brag about. But these numbers prove you have to do your homework...

    You can't simply rely on databases and computer-generated numbers to define what stocks you buy. Remember... I explained this company is the product of a recent merger. The way merger accounting works, the purchase price of the deal in excess of the net tangible value of the company being acquired gets recorded as "goodwill" on the balance sheet. So when you look at this company, you will find more than $7 billion of goodwill. It's a completely meaningless figure, except that it reduces the recorded returns on assets and equity.

    Simply take out the goodwill number (which is an accounting fiction) and you end up with a company that holds $6 billion in assets (not $13 billion). On these $6 billion in assets, it's earning $1.5 billion in cash each year. That's a return on tangible assets of 25%. And that's a much more accurate representation of its business.

    To summarize, compared to our pantheon of the greatest common stocks in the world, this company has the second-highest capital efficiency, third-highest return on assets, and the lowest price. I hope that explains a lot about what I see in this opportunity. But there's an even bigger reason I like it...

    As a publisher... I know this is a great business. Technology is making video games into active, online communities where people spend hours of leisure time. These communities are growing. And they are powerful, allowing publishers to increase prices and fees. That's a trend I believe will continue at the same time technology allows richer experiences and lower connectivity costs.

    Technology will also allow these publishers to adopt higher-margin distribution models, where players are able to pay the publisher directly, buying the game through subscription, instead of through a retail outlet. These trends are why I'm extremely bullish on the long-term future of the video game business.

    Consider this: In the five days following the company's last major game franchise release, it sold $650 million worth of the title. That's not total sales for the year – that's just five days of sales.

    And finally... for investors... this stock comes with an ace in the hole. Vivendi, the large French media company, owns more than 60% of it. Vivendi made the acquisition during the merger that created this business in 2008. It can only make its money back if the company continues to return capital. And since Vivendi controls the company, you can be certain that's going to happen.

    This majority shareholder situation scares some investors, but not me. I actually prefer to "partner" with large investors that have much more skin in the game. What scares me are reckless management teams, not fellow investors. And when a fellow investor holds more than 60% of the stock, the management team doesn't have much room for error. I like that.

    As you might have figured out by now, the company I've been describing is Activision Blizzard (Nasdaq: ATVI). It's one of the three major video game publishers in the world (along with Electronic Arts and Take-Two Interactive). It has two main franchises. The first is Call of Duty, a "first-person shooter" game. Players take the role of soldiers in various combat situations. The game is massively popular and allows people to play together online. This is the franchise that sold $650 million of product in five days.

    The company's other main franchise is potentially even bigger. It's called World of Warcraft. It is a massively multiplayer online role-playing game (MMORPG). Currently, World of Warcraft has attracted 11 million subscribers, who develop characters in an alternate universe. This is a whole new form of entertainment, something that wouldn't have been possible before the advent of low-cost broadband connectivity.

    And because access to the game is sold via subscription, the margins are incredibly high. In 2010, the company sold $3 billion of products at a cost of $1.3 billion. It sold $1.3 billion of subscriptions at a cost of only $241 million. Product sales as a percentage of total sales are falling as subscription sales continue to grow. And that means the company's gross margins are likely to expand substantially over the next few years. Given the company's extraordinary capital efficiency, most of these extra profits will wind up in the pockets of shareholders.

    Action to take: Buy Activision Blizzard (Nasdaq: ATVI) up to $15. Use a 25% trailing stop loss.

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