Electronic Arts – Thanks, Citigroup

Electronic Arts, the publisher/developer of the Madden series and much more, just got a much needed upgrade from Citigroup this morning. You all know the story so I won’t dwell on it too much, but here it is.

  1. There are 3 new video game systems that just came out, therefore
  2. Consumers are going to spend a lot of money on them, therefore
  3. We need a way to make money off of this trend, and game developers seem attractive, so
  4. We look at the four companies (activision, thq, take-two, and ea) and decide which to buy

Investors have pretty much decided that Activision and THQ are the two best companies and EA and TTWO are worse. But I digress. Activision’s success has come as a result of two games: Call of Duty and Guitar Hero. I don’t think that there is much long-term value in either of those games .

EA, on the other hand, has games that will be played on any system in 2, 5, and 10 years from now. They own the exclusive rights to use the NFL team names, and have games like NHL live, NBA live, the Sims, Fight Night, which have long term sustainability. People will always love sports and will always play sports games, especcially EA’s.  The problem with EA is that its release slate is very PS3-focused, and that system is the least popular among the “big 3” (the Wii, Xbox 360, and PS3). The main reasons behind the PS3’s success (or lack thereof)  are a) it’s too expensive and b) there isn’t much supply. The price is a function of supply, so as supply increases, the cost to manufacture each PS3 decreases and Sony will cut prices. Last cycle, when the PS2 was introduced, there was also a delay and Electronic Arts was hit hard. This is what happened then http://news.morningstar.com/article/article.asp?id=7920&_QSBPA=Y

If you switch PS2 to PS3, you have whats happening now. Look at Yahoo! Finance and you’ll see that the stock traded at $18, split adjusted.  You would’ve made almost 300% on your money if you invested on this hugely important, cataclysmic delay.

Turning to valuation for a moment, the stock looks expensive at 86x this year’s earnings. But this is the bottom-of-the-cycle year which always carries the highest P/E. If you let EA grow half as much over the next 3 fiscal years as it did during the 3 years from bottom to top of the last cycle, EA is trading at 13x 2009 earnings, well below its 20% growth rate. I think that bad numbers are priced into this stock and I’m looking to buy on future weakness.

– The Stock Geek

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