3 Huge Risks Facing Electronic Arts

Is EA still a good investment despite the hurdles it faces?

Jun 17, 2014 at 1:00PM


Source: EA.com

Electronic Arts' (NASDAQ:EA) most recent fiscal report saw the company beat projections and double earnings per share from the previous year. The company has enjoyed a strong debut on new platforms from Sony and Microsoft, evidenced by its titles accounting for 40% of Western game sales on PlayStation 4 and Xbox One in the last fiscal quarter. Even more promising, EA has been leading the games publishing market in terms of diversification.

45% of the company's revenue in the last fiscal year came from high-margin digital transactions, with guidance suggesting that number will climb above 50% in the current year. EA has also been in discussions with Comcast (NASDAQ:CMCSA) to stream games directly to cable boxes. Yet, even with the promising aspects of the company's business firmly in mind, the gaming industry is still volatile. Amidst a transformative period in video games, these three risks threaten EA's long-term outlook.

EA has content problems
Of the large gaming publishers, EA has perhaps the worst reputation in terms of quality control and product innovation. The company has frequently been accused of shipping substandard, bug-ridden games and failing to offer substantial content improvement between franchise installments. While much of this criticism is generated by a vocal minority, there are clear instances where EA has botched high-profile releases.


Source: EA.com

The quality and handling of EA's 2013 release Battlefield 4 prompted consumer outrage and multiple lawsuits, with one case charging that EA intentionally misled investors about the state of the game. There exists concern over whether Battlefield 4 has harmed the broader series and if it will negatively impact this year's Battlefield: Hardline. As one of the companies biggest 2014 releases, a soft performance for Hardline would be a big misfire.

The company has also received substantial criticism for the quality, content, revenue models of recent games such as SimCity, Dragon Age II, Mass Effect 3, Plants vs. Zombies 2, and NBA LIVE 14. The broader properties attached to these games are of considerable importance to EA, but, in many cases, the company has done a less than optimal job delivering on quality and content.

EA may be overly dependent on licenses
As one of the largest publishers in gaming, EA has substantial funds with which to acquire lucrative licenses. The company recently secured exclusive rights for the incredibly popular "FIFA" games until 2022. It has also sured up "Star Wars" until 2023, despite the fact that its last Star Wars game was a big underperformer.

EA also has access to the NFL, NHL, NBA, UFC, and The Simpsons licenses. All of these properties are undeniably strong, but the extent to which EA's performance relies on them creates a plethora of additional variables and risk.

Rumors and evasive comments from EA representatives suggest that EA may no longer have exclusive access to the NFL license, and that Take-Two Interactive (NASDAQ:TTWO) could attempt to position a competitor. The smaller publisher has already beaten EA on the basketball front, with its NBA 2K14 substantially outperforming EA's NBA LIVE 14 both critically and commercially. Take-Two's basketball game has even outperformed the latest Madden on PlayStation 4 and Xbox One, but the company's relatively small cash reserves mean that the NFL license would be a sizable investment. Still, there are other big companies in the gaming industry that could ready a Madden competitor if the license is on the table. With the possibility of increased competition, EA's quality control issues are compounded.

The Internet is uncertain
The possibility of EA teaming up with Comcast to provide streamed content is rife with possibilities, but it could also go terribly wrong. The most recent console hardware cycle has already seen EA back out of a partnership with Nintendo and rework its content strategy after first offering support for the original Xbox One product vision. EA's goal is to shape the progression of online gaming and content distribution, but doing so is a bit of a tightrope act.

Screen Shot

Source: EASports.com

Comcast has already stated that it plans to begin charging consumers based on bandwidth, and the telecom giant's ongoing power struggles with online content providers like Netflix and Google are well-documented. Electronic Arts will eventually face similar pressures if it wants to provide its customers with expedient access to its content and services. Members of EA's digital ecosystem will also likely be paying more money for Internet access and other online content, which has the potential to shrink the available spend pool.

Foolish takeaway...
While there are notable risks facing the company, EA remains an attractive investment option. Large third-party publishers are well-equipped to handle the gaming industry's changing landscape, and EA's diversification efforts are particularly commendable. While shares of fellow publishing giant Activision Blizzard currently hover around an all-time high, Electronic Arts still trades below pre-Financial Crisis prices, a point that suggests the company's valuation will continue to rally. Elements of risk are present, but EA still looks to be one of the best bets in gaming. 

Comcast is merely rearranging the deck chairs on the Titanic
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Keith Noonan has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard. The Motley Fool owns shares of 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.

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