Good prospects and solid fundamentals is the name of the game, as EA’s steady performance through the pandemic testifies
Nasdaq-listed Electronic Arts (EA) generated 30.4% in our portfolio last year. We are happy to include this stock in our new portfolio again. The global interactive entertainment company primarily develops, publishes and distributes branded games and software for Internet-connected consoles, mobile devices and personal computers. When it comes to online gaming, EA is a bellwether stock and a well-recognised name in the gaming industry as the company’s gaming titles are very much sought after by gamers worldwide.
EA’s portfolio of games is mainly divided into two main categories. First is its wholly-owned titles which include games such as Need for Speed, Apex Legends and The Sims. The other is titles which it licenses from other developers and these include games like FIFA, Star Wars and Madden NFL.
EA’s business is diversified geographically, where almost 60% of its revenue comes from North America and the rest comes from international sales. It segments its revenue based on the type of devices it sells its titles or offers services to. These include consoles such as the PlayStation and Xbox, computers, and mobile devices.
Our case for EA is that it is a company with strong financials with good growth prospects. It is able to generate medium to high growth with low downside risks. Firstly, the company’s business model is fundamentally good — EA is not solely reliant on licensing rights for its earnings, but also has its own creative portfolio of games to ensure the value of the business grows.
As an example, EA has the rights to publish Star Wars from Disney or FIFA, two wildly popular franchises with hundreds of millions of ardent fans. Yet, it still devotes resources for developing new games on its own, such as Apex Legends which has been a big hit among mobile gamers. We see this as the right way to diversify. By doing so, EA’s earnings stream will not be beholden to franchise owners who could easily parcel the games out to other competitors.
Furthermore, we think EA’s gaming titles are diversified the right way because it covers a wide array of gaming genres — from sci-fi lovers to car enthusiasts through games such as Star Wars and Need for Speed. This denotes that EA is able to tap into other industries for gamers and users, for example soccer fans through FIFA. This implies that as the soccer industry grows in terms of viewership and fan volume, EA is likely to gain as well.
EA has proven to be in the right growth industry — one that is resilient through most economic shocks. The pandemic has mostly been favourable for the online gaming industry as lockdown and social movement orders have caused the volume of online activities such as gaming to surge rapidly. Even if it wasn’t for the pandemic, the growth of the online gaming industry was bound to be strong, given the rapid growth in the gaming industry prior to the pandemic.
Today, with the increasing usage of smartphones, demand for mobile gaming is expected to be a significant contributing factor to the growth of the gaming industry. Other contributing factors for the growth of the gaming industry include the growing viewership of e-sports. Market intelligence reports a growth rate of 12– 13% CAGR over the next three to five years for this industry, which is strong to say the least — and bellwether companies such as EA are expected to grow and perform within these figures as they are at the forefront of gaming.
For its 3QFY2021 ended Dec 31, 2020, EA reported a solid set of results. Some of the company’s financial highlights include delivering record net bookings for the quarter, which is the net amount of products and services sold digitally or physically. These were mostly driven by its live services, which covers extra content, subscription offerings and other revenue generated outside of the sale of EA’s base games. The live services segment has relatively much higher margins compared to other revenue components, which led to the company delivering record cash flow for the period.
The most recent quarter was a windfall period for the company. EA also paid out the first dividend in its history of 17 US cents. Although the amount is relatively minimal, this should be a recurring trend to look forward to, given how well EA is executing its business plan of optimising margins and focusing on more stable and predictable revenue. EA’s management has raised the forecast and guidance for the next quarter and fiscal year is a clear sign how well their strategy is working. Moving forward, EA will continue executing this strategy by focusing on its live services division.
EA’s recently accepted acquisition of Codemasters for US$1.2 billion ($1.6 billion) is strategic and value accretive. Codemasters is a video game developer mainly focused on racing games and is a well-known name among motorsports gaming enthusiasts. Codemasters has a strong reputation, having developed the official Formula 1 game since 2009, and will serve to grow EA’s footprint in racing games, which is expected to grow the company’s margins post-acquisition.
The company’s financials, particularly its cash flow, is stellar — high cash flow margins, and consistent and growing earnings, operating and free cash flow over the past 10 years reaffirms this. Chart 1 illustrates the historical cash flow margins of the company. In terms of yields, the company is relatively attractive compared to the US risk-free-rate of 1.2%. The earnings, operating cash flow and free cash flow yields are 2.9%, 6.1% and 4.7% respectively. Short-term liquidity of the company is excellent with a current ratio of 2.4 times and quick ratio of 2.3 times. Solvency-wise, the company is in a comfortable position with a debt-to-equity ratio of just 16.4% and interest coverage ratio of 32.8 times.
Analysts have given a target price of US$157.44, which offers 11.5% upside potential from its current trading price of US$141.22. Our in-house valuation indicates this company holds at least 15% upside potential over the next 12 months by offering not just value but growth. Good prospects and solid fundamentals is the name of the investment game, and to win it, Electronic Arts is key.
