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Tuesday, August 01, 2006

Electronic Arts Shares Up in Reaction to Earnings

Stock Tickers: ERTS, THQI, ATVI

Electronic Arts (ERTS) has been a name stuck in limbo for over two-years. The stock closed down 1.25% at $46.52 ahead of earnings, but the shares are now up at about $48.00 in after-hours trading.

Today's earnings and revenues of -$0.12 EPS and about $413 million in revenues were much better on the surface than the street was braced for. The street was expecting -$0.24 EPS and revenues of close to $337 million. The gains were on strong game sales of 2006 FIFA World Cup(TM), Battlefield 2: Modern Combat(TM), Need for Speed(TM) Most Wanted, The Sims(TM) 2 and EA SPORTS(TM) Fight Night Round 3.

They haven't had any gangbuster single genre games that have taken the world by storm in some time and other games such as Everquest, World of Warcraft, Halo2, and Grand Theft Auto: San Andreas have kept millions of gamers occupied. While none of these titles are recent, they did contribute a stead thorn in the company's side. They are considered the KING of Sports games, and they of course have the prized "Sims." But that hasn't brought in a flood of new customers that takes away from everyone else. ERTS has been successful in its Lord of the Rings and armed forces games, but not enough to bring back the "cool" factor.

In 2003, with the culminated launches of Halo2 and GTA occuring in such a short proximity, I speculated that those two games would suck up much of the "available gaming dollars" that gamers would spend in such a short period of time. That is what occurred. But the company hasn't had a new major hit that is sustainable and that has generated a lot of hype. The fact that it took so long for them to settle on the employee overtime issues didn't really help matters with employees calling ERTS Big Brother and The Overlord.

But each time the company has warned or lowered guidance, it has been an opportunity to buy shares and make money. Their recent acquisitions into mobile gaming and into foreign language gaming have positioned it for the years ahead, but there is a long way to go before this really starts adding massively to the top and bottome lines. It looks like the bottom fishers are being rewarded for their gamble.

The initiation of coverage from Prudential with an Underweight rating and $49 price target probably didn't help the video game bulls. The research note said the market premium placed on ERTS over THQI and ATVI is unjustified. One of the things that helped the stock get (a little) off the mat was the better-than-expected June sales data from NPD Group, but that is over 1 month old data. The research note also said that longer-term it would have to double sales to offset higher costs and get its margins back to peak levels. Prudential gave ERTS competitors Activision (ATVI) and THQ (THQI) Overweight ratings as they are smaller and have much lower operating expense ratios than ERTS.

The ESA is the company behind the much famed E3 conference, which has been deemed THE top gaming conference in the world for years. Now even that is changing. E3 will focus on press events and small meetings with media, retail, development, and other key sectors. While there will be opportunities for game demonstrations, E3Expo 2007 will not feature the large trade show environment of previous years. So they are cutting out Joe Consumer and will be saving combined millions of dollars that are required to have a bang-up blow-out show at E3.

The stock has been in a long-term range of what has essentially been set up at $40+ to $60+, and the stock is essentially trading up at over $48.00 in after-hours. The stock had just gotten back over a $45 key level, so it had receovered 15% from its $39.99-40.00 intraday lows over the last 52-weeks.

The company offered the following guidance: $0.00 break-even and $635M to $685M; with annual guidance of $0.35 to $0.65 and $2.8B to $3.0B. The street was looking for break-even to $0.02 next quarter on revenues of $628 million; and Fiscal year March 2007 of $0.53 EPS and revenues of about $2.9 Billion.

The most important note on ERTS here today is that this report was all about the future. This quarterly report seen today is what the video game industry thinks of as "the throw away quarter" with the lowest volume of sales. Nintendo's upcoming launch of its Wii console and Sony's expected November release of PlayStation3 are the next catalysts. Any changes there can obviously create changes in the guidance. So far it looks like ERTS is not nervous at all going into the busy season for the game maker.

Jon C. Ogg
August 1, 2006

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