If you ask many investors who the top dog is in the gaming business, Activision Blizzard (ATVI) is likely the first name you'll hear. However, there are a few trends that suggest that Electronic Arts (EA 0.79%) could take the throne over the next few years.
A titan of a hit
While one huge hit doesn't mean a company will move up in the ranks in the gaming industry, EA seems to have created quite a stir with Titanfall, and this hit is one of the first reasons EA may be about to take the crown in the gaming business. A good example of what a huge hit can mean to a company's earnings is best shown by the lift Take-Two Interactive Software (TTWO 0.78%) got from sales of Grand Theft Auto V in the last quarter.
Due in large part to the strength of Grand Theft Auto V, Take-Two witnessed a jump in overall non-GAAP revenue of nearly 90%. In addition, the strength of Grand Theft Auto Online caused Take-Two's digital sales to increase by 42%.
In the same way, Activision Blizzard gets a boost in sales from its Call of Duty franchise, as well as refreshes to Skylanders and World of Warcraft. EA's Titanfall is off to a strong start and could be another growth engine for the company.
Strong reviews of the game suggests this title will enhance EA's growth profile. One reviewer's take: "The game is easily one of the most amazing multiplayer shooters I have ever played." Another reviewer: "I cannot remember the last time I had this much fun with a first-person shooter... ." Gamers remember when they find a new hit, and it's extremely likely that EA will expand and refresh this franchise.
If this is the future, EA's future is bright
One of the central themes in the gaming landscape is the move to digital sales. While game discs can be shared and traded, the convenience of digital purchases is hard to pass up. In addition, over time, gaming is likely to follow music and video into the digital realm.
If the future of gaming is digital distribution, EA investors should be very pleased. In fact, EA's strength in digital is the second reason the company could take gaming's top spot. In the current quarter, EA generated 34% of its revenue from digital sales. This performance matched Activision Blizzard's digital receipts at 34%.
Of course, the big difference is that EA doesn't have the benefit of huge online franchises like World of Warcraft or Diablo III like Activision Blizzard does. Instead, EA benefits from multiple console titles that transition well to mobile platforms. With Take-Two getting about 17% of sales from digital, EA leads this company and is matching the performance of the current king of the gaming hill.
Maybe the most important trend of all
One certainty in any technology field is that the company with a higher proportion of research and development will many times outperform its peers. Of these three big players in the field, EA spends relatively more on R&D than its competition.
In the current quarter, EA spent 34% on R&D, compared to 13% at Activision Blizzard, and roughly 4% at Take-Two. While a higher percentage of R&D spending isn't always sustainable, EA also has the cash flow to make this level possible in the future.
In just the last three months, EA generated more than $400 million in core free cash flow. By comparison, on average, Activision Blizzard generated about $260 million, and Take-Two produced about $200 million.
With significant core free cash flow and a high level of R&D, EA is set up continue to produce hits in the future. The company's recent Titanfall success is a good example of productive research spending. EA is tied for digital sales as a percentage of revenue with Activision Blizzard today. However, if Electronic Arts' current trends continue, the company won't be tied with anyone in the future.
