A huge potential opportunity lies ahead for video game companies. This sector has emerged as one of the largest entertainment markets, estimated to be worth around $200 billion annually, and it's expected to grow at a high-single-digit rate over the long term. The growth of mobile gaming is expected to contribute significantly to that growth, especially as 5G connection speeds make playing the most graphically demanding games more immersive and enjoyable.
There is a lot up for grabs for Electronic Arts (EA 1.30%) and Take-Two Interactive (TTWO -0.03%). These companies make some of the most popular titles. But the better stock to buy boils down to each investor's risk tolerance.
If you're looking for the safest stock between these two gaming giants to ride out the bear market while still maintaining exposure to long-term growth in the industry, you might want to consider Electronic Arts. Here's why.
Electronic Arts is outperforming its peers
It's been a tough year for video game stocks. The surge in demand during the stay-at-home environment in 2020 has been followed by slower growth. Total industry sales are expected to grow by just 2% this year, according to market researcher Newzoo. While Take-Two's stock price fell 42% in 2022, Electronic Arts fared better, down only about 3% year to date.
Electronic Arts is known for its best-selling EA Sports titles like Madden and FIFA. These games provide recurring revenue from annual releases. EA also has other best-sellers under its tent, such as The Sims, the Battlefield series, and Apex Legends. Altogether, EA boasts a player base of over 600 million.
EA made a splash last year with the $2 billion acquisition of leading mobile game maker Glu Mobile. Mobile is an attractive growth opportunity, given it is the largest category of game sales, valued at over $100 billion, and is currently the fastest-growing subsector of the industry.
However, mobile is still a small part of EA's business, which is a good thing right now. Mobile games have experienced lower sales of in-app purchases amid the weakening economy.
Most of EA's revenue comes from traditional gaming platforms like PC and console, which tend to attract hardcore gamers that will continue spending money. In the most recent quarter, only 17% of EA's revenue was derived from mobile devices. This is a key distinction from Take-Two's business, which derives significantly more revenue from fickle mobile gamers.
| Fiscal Q2 2022 Revenue by Platform | Electronic Arts | Take-Two Interactive |
|---|---|---|
| Console | 61% | 40% |
| PC and other | 22% | 8% |
| Mobile | 17% | 52% |
Data source: 10-Q filings for the fiscal second quarter ending Sept. 30.
Mobile weakness is a headwind for Take-Two
Take-Two scooped up Zynga, the maker of Words with Friends and Farmville, for about $12 billion earlier this year. Mobile is now half of Take-Two's business, and it's the near-term weakness in mobile that sent the stock down 42% this year, despite strong performance from Take-Two's top console and PC titles like Grand Theft Auto and the NBA 2K series.
Long term, management is targeting a 14% compound annual growth rate in revenue following the Zynga deal, excluding any synergies from the business combination. While I believe Take-Two offers greater long-term upside as it executes against its deep pipeline of scheduled releases, there is something to say about EA's superior record of profitability.
Not only does EA have less exposure to the mobile market, but it is also generating significantly more free cash flow, which helps fund a quarterly dividend to shareholders while providing ample resources to invest in game development. For example, Take-Two generated negative free cash flow of $17 million over the last four quarters, which pales in comparison to EA's $1.6 billion.
EA's greater free cash flow generation led to more investment in research and development (R&D). EA currently spends over 30% of its revenue on R&D, which includes the cost of making games, while Take-Two spends less than 15% of its revenue. EA can easily afford a larger budget, which could prove to be an advantage over the long term.
Electronic Arts is the safer stock
Between the two, Take-Two stock fell the hardest this year, which could lead to greater returns if new game releases drive lots of growth. But new investors looking for a relatively low-risk video game stock should probably stick with EA. EA has a clear financial advantage over its smaller rival, which is a result of owning a greater diversity of best-selling video games.
