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2 Reasons Electronic Arts Stock Could Soar Over the Next Five Years

By John Ballard - Feb 1, 2020 at 1:45PM

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Management is positioning the business for growth across all platforms, not just the new consoles launching later this year.

Over the last five years, shares of Electronic Arts (EA 1.30%) have doubled in value, and it could double again over the next five. There are a few reasons why I believe Electronic Arts could experience tremendous earnings growth with the new consoles from Sony and Microsoft launching this fall.

Before we get to those reasons, let's first look at how EA performed around the previous console transition six years ago.

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Image source: Getty Images.

Using history as a guide

The launch of the PS4 and Xbox One in 2013 turned out to be enormously beneficial for EA. The stock more than tripled between the end of calendar 2012 and 2014, fueled by strong growth in EA's digital sales, including live services and mobile games. 

Since fiscal 2013, or about six months before the launch of the PS4 and Xbox One, EA revenue has increased only 42% cumulatively. But earnings and free cash flow have soared, which has fueled a rapid rise in the stock price over the past six years. 

The advance on the bottom line was due to margin improvement, as the growing demand for digital game downloads pushed margins higher. Digital sales now make up about three-quarters of EA's business. 

On one hand, an argument can be made that EA's margin improvement story is mostly over, and future earnings growth may not advance as strongly as it did over the past five years, but I think earnings can continue to grow at double-digit rates and fuel another run in the stock price.

Here are two reasons EA can get it done.

1. More platforms to sell games

Market researcher Newzoo expects the video game industry to continue growing through 2022. By that time, mobile and console game sales will comprise 80% of industry sales. 

As it did six years ago, EA is currently working on new experiences in existing franchises, as well as new titles, to capitalize on the upcoming consoles. Management is particularly excited about releasing its next Battlefield title on "a larger installed base" of consoles in the next few years. 

But EA's audience over the next five years will extend well beyond consoles. The game maker has a substantial growth opportunity in building its subscriptions business, which currently generates a small amount of revenue in the company's live services segment

In October, EA announced a partnership with Steam, the widely-used online PC game store, to offer EA Access subscriptions to Steam users. EA also launched EA Access on Playstation 4. This is part of the company's grand strategy, as CEO Andrew Wilson explained during the fiscal second-quarter call, "to reach more platforms in the near future." 

Watch out for cloud gaming. This burgeoning market will allow gamers to play big-budget titles -- typically reserved for consoles -- on any device, which will naturally expand the audience for gaming significantly.

When the technology is ready, EA should be well-positioned with Project Atlas. "As cloud gaming continues to develop, through Project Atlas, we are testing games streamed on public cloud infrastructure to ensure we are at the forefront of this developing space," Wilson told analysts during the company's October call. 

The upcoming rollout of 5G cellular connection speeds could jump-start the adoption of cloud gaming. Analysts expect the market for cloud gaming to grow 30% per year through 2025. 

2. Investing in existing and new games

Nearly six years ago, during the last console transition, EA reported a significant jump in earnings growth for fiscal 2014's fourth quarter. In that case, management credited the depth of its game lineup, its investment in digital services, and ability to keep costs down while still investing in key franchises.

EA is repeating that playbook this year. One of the reasons EA's stock has been moving higher recently is based on the strong momentum in live services, specifically with respect to Ultimate Team and Apex Legends

Apex Legends is a popular battle royale shooter that was released a year ago and has reached a massive player base. "Apex Legends is a major long-term franchise for us," Wilson said during the second-quarter call. He added, "Since launch, we've significantly expanded the team working on the game, and it continues to grow." EA credited strong growth from Apex Legends for its record revenue in live services during the fiscal third quarter. 

The popularity of Apex is so strong that EA is taking advantage of that momentum to spend extra time on Battlefield 6 and the next NBA Live installment. Typically, these two franchises would see a release this year, but management believes the strength from its current lineup will be enough to keep revenue and earnings growing in the near term.

Additionally, EA has "plans for new experiences" that it hasn't announced yet. This includes "new titles and new [intellectual property] for multiple platforms."  

Wilson made it clear that EA will be ready to sell plenty of games to new console buyers this year: "Introducing new games will always be at our core, and we look forward to exciting players with unexpected new titles in fiscal 2021." 

Room to run

The last five years saw in-game spending emerge as a growth driver for EA. The next five years will likely see subscription revenue emerge as a significant contributor to the top line. With the stock still about 25% off its all-time high from 2018, there is plenty of upside for this growth stock

Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. John Ballard owns shares of Electronic Arts and Microsoft. The Motley Fool owns shares of and recommends Microsoft. The Motley Fool recommends Electronic Arts and recommends the following options: short January 2021 $115 calls on Microsoft and long January 2021 $85 calls on Microsoft. The Motley Fool has a disclosure policy.

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