Its catalogue includes best-selling franchises such as Battlefield or The Sims, though the prize assets remain the unparalleled EA Sports series, with exclusive rights to design and distribute games for each professional sports leagues (FIFA, NFL, etc.) on a yearly basis.
Some years ago, video gaming companies were universally regarded as poor investments, unless one could find them trading at extremely depressed valuations. On top of a hyper-competitive, fragmented industry, shelf lives were limited and publishers faced difficulties to amortize their ever-inflating development costs.
But the industry underwent consolidation and a few major players — heavyweights such as EA, Activision Blizzard or TakeTwo in the U.S.; Paradox or Ubisoft in Europe; Tencent and Netease in China — now control sanctuarized market shares. Meanwhile, vertical integration from game design to distribution enabled them to achieve meaningful economies of scale.
EA's widely diversified catalogue reduces its dependence upon one or two blockbusters — the traditional hit-or-miss paradigm of the entertainment business — even though the FIFA and Madden series carry most of the freight. The company has scores of financially impressive franchises, some of which have been monetized for decades.
Yet it is true that the company showed unconvincing abilities to invent new genres — unlike TakeTwo or Paradox — somehow lagging in terms of innovation. In addition, several franchises — such as Sim City and Need for Speed — could best be described as undermonetized, although they still enjoy great mindshare among gamers, leaving interesting call options for the future.
Of course, e-sports and the related gambling business are huge avenues for growth if publishers succeed at deploying the right platforms to the right audiences. With its stellar capitalization and sports-oriented IP, EA competes from a position of strength.
So far the EA Sports series have warranted sticky, predictable revenues. As long as the company continues to outbid competitors at securing exclusive licenses, it will maintain its sizable competitive advantage. Here, too, a superior capitalization — doubled with a well-established reputation — comes across as decisive.
Distribution has moved from physical stores to online platforms offering downloadable contents on demand, like EA's Origin modeled after the highly ubiquitous Steam, owned and operated by Valve. Lower distribution costs on top of new opportunities in monetizing plugs-ins and add-ons have produced a huge impact on margins, shelf lives and total revenue streams derived from games.
At EA, a good amount of efforts have been put into optimization over the recent years — in effect adding the "adult supervision" the video games industry had been sluggish to integrate. This is particularly obvious when looking at operating margins, which grew from negative ten years ago to bountiful (20-25%) nowadays.
Besides, the company stopped chasing trends and instead chose to focus on its core assets. Hefty development costs poured into the development of MMO franchises for little earned back are history. As a result, cash-flows have been steadily growing — from $300mil ten years ago to $2bn nowadays — whereas capital expenditures hardly excess $150mil per year.
That leaves comfortable free cash-flows to work with. These operational improvements had a direct effect on financial standing, for EA has a stellar balance sheet and $1.5bn in excess cash. In a bid to take advantage of what management perceives as an unduly low valorization, capital allocation has been firmly oriented towards share buybacks, with $2.5bn spent on the latter endeavor over the two past years.
When mature companies with good businesses find their shares selling below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases. In that respect, *if* earnings keep growing — that is the prequisite — these buybacks will prove highly accretive, in particular because they do not compromise the otherwise rock-solid balance sheet.
In a like manner with the recent investments initiated in our portfolios, EA should benefit from the peculiar current economic environment, for home entertainment products sell well under lockdown. At roughly x30 consolidated earnings — on an enterprise value basis — this is starting to get recognized by the market, though there remains ample room for the positive momentum to continue.
This is precisely the scenario analysts — whose consensus is surveyed in real-time by MarketScreener — are banking on.