"When you think about interactive entertainment today, recognize that it's prime time," Electronic Arts (NASDAQ:ERTS) CFO Warren Jenson said earlier this month.
He was addressing an audience at the Merrill Lynch Media & Entertainment Conference, and his message was to hammer home the significance of being the top dog in entertainment software at a time when investors aren't expecting a whole lot out of the sector despite the evolution of entertainment into an interactive form.
"So what I mean by that is when we think about what is going on in the world," he continued, "it is really we are in the middle of an interactive transformation that is touching everything in every single global market."
Yes, that's a heavy premise for a company in a sector that is presumably out of favor at the moment. Electronic Arts and many of its peers, like Activision (NASDAQ:ATVI) and Take-Two Interactive (NASDAQ:TTWO), have doused investors with profit warnings since late last year. Gamers are holding back on their video game purchases until they see the new PlayStation 3 and Nintendo Wii consoles roll out in the coming weeks. By most accounts, 2006 will be a dud.
Don't get mad, get Madden
Then again, EA has already bucked that trend to some extent. Last month, the company moved 2 million units of Madden 2007 during its first week on the market, a surprisingly robust 12% improvement over the record 1.8 million copies that it had moved last year.
Some can argue that Madden may be a unique property given the annual updates and gamer loyalty. Consumers will play Madden on their PS2 and GameCube consoles today and just snap up Madden 2008 on the PS3 and Wii next year. However, that shouldn't underscore the dramatic achievement here. As Jenson explains, the Madden franchise has recently topped the $2 billion mark in revenues over its 17-year history.
It's not the only property to hit that mark. EA's FIFA soccer series reached it during the World Cup earlier this year, and Need for Speed should get there over the holidays when Need for Speed: Carbon hits retailers.
Yet EA is the top dog in a highly fragmented market. As pervasive as the EA brand may be, the company's domestic market share of the gaming market is just 22% (it is a slightly better 23% slice in Europe). So there is certainly room for upside by gnawing away at market share even if the market doesn't grow, or establishing a larger presence in Asia. But seriously, now, can I get a show of hands from those who don't expect the interactive gaming market to grow?
New streams for bigger dreams
EA has been making inroads in several new markets while expanding existing ones. Jenson points to mobile phone gaming, where EA has a 30% piece of the market after its buyout of JAMDAT. In acquiring Mythic, the company is also a leader in multiplayer online games.
The Internet poses some pretty tantalizing possibilities for a company like EA. Software is already a high margin industry and those margins can only fatten once you don't have to foot the bill for pressing, packaging, and shipping out games.
Half of the Xbox 360 owners are connected to Xbox Live and that opens up new revenue streams for game publishers in the areas of downloads and micropayments. Now that EA has inked deals with in-game advertisers like IGA and Microsoft's (NASDAQ:MSFT) Massive, it stands to receive recurring royalty streams every time a game is played with perpetually updated ads.
In the past, if your game character walked past a theater marquee or you were playing sporting event in a stadium venue, you were stuck with sponsors that can quickly get dated. Now EA is able to deliver ads that are timely (like the latest movie on that marquee, or even targeted spots for the user depending on the time of day, like for a new McDonald's breakfast sandwich).
Sure, the industry is hoping that gamers will be willing to pay $10 more for games on the new consoles, but even if the market balks, developers clearly have other ways to help monetize their future games.
Owning the keys to its future
Jenson also singled out how one of EA's strengths is that 40% of its content is owned by EA. Most of its rivals, like Activision and THQ Interactive (NASDAQ:THQI), rely on licensed properties. There is nothing wrong with cashing in on the character creations of others -- EA does that too. However, the payoff is so much greater when EA is able to expand one of its own properties (either initially developed by EA or ultimately acquired), like it has with The Sims.
So maybe it's to your investing advantage that the developers appear to be in a fiscal rut as we wait for gamers to begin spending their discretionary income toward building up the next generation software libraries with the next batch of hot titles.
There are some pretty cool things going on at the industry in general and EA specifically that will make its earnings power in the future a lot stronger than it is today. That may not be the only way to win the game, but it appears to be the more lucrative.
As far as building out your portfolio with dynamic growth stocks, that's primetime investing right there.
Electronic Arts and Activision are active recommendation in the Stock Advisor newsletter service. With a free 30-day pass you can get access to all of the newsletter's recommendations and services, including a lively subscriber-only discussion board.
Microsoft is an Inside Value selection.
Longtime Fool contributor Rick Munarriz has been a fan of EA's sporting titles dating back to the Earl Weaver baseball franchise and the One-on-One basketball games. Graphics and gameplay have sure come a long way since then. He does not own shares in any of the companies in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.
