The house rules are simple in this weekly column.
- I bash a stock that I think is heading lower.
- I offset the sting by recommending three stocks as portfolio replacements.
Who gets tossed out this week? Come on down, Electronic Arts
Medal of dissed honor
Everyone's chirping about EA's acquiring Chillingo -- the developer behind the wildly popular Angry Birds App Store game. As timely fortune would have it, Chillingo is also the company behind Cut the Rope, which as of last night was the top premium App Store purchase.
EA finally gets it! Social and casual gaming is the future!
Lost in all of this hype is the fact that we're talking about $0.99 games and free ad-supported "lite" versions. Sources tell the Los Angeles Times that the undisclosed deal price is less than $20 million.
That may sound like a great purchase for EA, but it ultimately speaks volumes about the disruptive power of an industry where the barriers to entry are so low that a company can put out two of the hottest games of the year and fetch only a paltry ransom.
Casual games are no match for EA's rich video games, but folks are consumed by the nearly free diversions.
Give EA credit for acknowledging this shift in gamers' tastes. The country's second-largest game publisher also snapped up Facebook diversion creator Playfish last year.
However, there are no points worth awarding when a company's in the right place at the wrong time. The market will still be there for blockbuster releases, but EA's library is filled largely with ho-hum fare and annual sports titles with escalating licensing fees.
When EA reports its fiscal-second-quarter results next week, analysts are braced for a loss on a 29% slide in revenue. The new quarter was supposed to be a winner, but impressive pre-sales for Medal of Honor are likely disintegrating after an initial wave of uninspiring game critic reviews.
The industry is changing, and it's not just the recession that's been keeping the sector down since early last year.
I'm certainly not new to the EA-bashing bandwagon. I singled it out in this weekly column twice last year -- and at much higher price points than today. EA has tanked while the market has generally inched higher.
I don't see that changing. Analysts may see improved earnings off of depressed profit levels, but I think the pros are missing the big picture here. The playing field has been leveled. The days of the $60 console layup are done.
Hooray! EA has Angry Birds. Guess what? It also has angry shareholders.
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.
(Nasdaq: AAPL): If the playing field has been leveled for developers, why not bet on the playing field itself? The ease of developing for Apple's iOS platform has filled its App Store with 300,000 applications -- and counting. Instead of GameStop (NYSE: GME)as the hub for new releases, Apple is the new tastemaker. Last week's blowout quarter may have been initially misinterpreted by worrywarts, but at the end of the day this is a company growing considerably faster than its multiple of 17 times the new fiscal year's projected profitability.
(Nasdaq: TTWO): The company behind the monster Grand Theft Auto franchise delivered an unexpected profit in its latest quarter, but that's not the only reason it's the only traditional video game company I'm offering up as a replacement this week. EA is going to come to grips with its organics shortcomings as it pertains to console titles, and when it does it will have little choice but to revisit its failed buyout attempt of Take-Two.
(Nasdaq: NTES): There is no shortage of cheap online gaming companies in China. Changyou.com (Nasdaq: CYOU)and Shanda Games (Nasdaq: GAME)are trading at a mere 10 times this year's projected net income. However, the class act in this space isn't really all that expensive. NetEase fetches 16 times this year's forecasted earnings and 13 times next year's target. Wall Street is braced for earnings growth of 16% this year, accelerating to 25% in 2011. Why pay 24 times this year's bottom line at EA -- and 18 times next year's estimate -- when a genuine growth stock in a country with ridiculous upside is even cheaper?
I'm sorry, EA. There are better ways to play this game. Please vote in our Motley Poll then scroll down to explain your vote in the comments section.
NetEase.com and Take-Two Interactive Software are Motley Fool Rule Breakers choices. Apple and Electronic Arts are Motley Fool Stock Advisor recommendations. Motley Fool Options has recommended writing covered calls on GameStop. The Fool owns shares of Apple and Take-Two Interactive Software. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.
Longtime Fool contributor Rick Munarriz doesn't mind taking out the garbage every so often. He does not own any of the stocks 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.