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Thursday, November 02, 2006

Evaluating Electronic Arts Ahead of Earnings and the Landscape for Gamers (II)

Electronic Arts (ERTS) reports earnings today after the close of the stock market.

Consensus estimates are $0.02 for EPS and $672.25 million in revenues. In August the company forecast a loss of -$0.22 to -$0.28 after items and a break-even result before items on revenues of $635 million to $685 million.

This will essentially be the second throw-away quarter for EA as the bulk of the business is centered around the fourth quarter and first quarter of the calendar. Its "Madden Football" updated game posted sales of more than $100 million its first week out of the chute in August.

So this is the throw-away quarter, and that is a given. Now what we have to worry about is the excessively wide range of estimates that exists for the coming quarter. The street is looking for approximately $0.57 EPS and $1.2 Billion, but the lower and higher ranges are apparently $0.40-0.72 and $1.15B to $1.3B. There is also a discrepancy of consensus estimates from service to service. That means that with the stock back up at the highs, you might have to still worry even if they guide slightly up from mid-points. The other worry is that the company has a history of reporting sporadic results and even more sporadic reactions in stock prices.

With the large Madden numbers you would expect that the revenues were attainable. But in this current quarter we get the release of the two new systems going after Xbox 360's lead. We have the Nintendo Wii and the Sony PS3 coming out within days of each other later this month. Both consoles have sold out as far as pre-orders at GameStop and indications seem to suggest some of the same Best Buy. EA has roughly 30 games under development as of last month. This is actually the second quarter that JamDat has been a subsidiary of the company for mobile operations, so we may have a better grasp of the mobile gaming segment ahead.

NPD gave the following sales figures for the entire industry for U.S. sales of actual video game titles: $446 milllion in September, $397 million in August, and $386.4 million for July. Keep in mind that Electronic Arts also sells outside of the U.S. and these NPD figures are solely inside the U.S.

This stock has gained from $40.00 in June back to over $55.00 in September and October, and it is at the bottom of a more recent $52.00 to $57.00 range over the last 6 weeks. Options traders appear to be braced for a move of up to a range of $2.50 to $2.80 in either direction. Unfortunately options trading in the name has been a bit muted.

Starmine has the following analysts rated as the best for ERTS:
Paul-Jon Mcnealy, American Technology Research, 5 Star Ratings (BUY)
Edward Williams, BMO Capital Markets, 5 Star Ratings (OUTPERFORM)
Elizabeth Osur, Citigroup, 5 Star Ratings (HOLD)
Evan Wilson, Pacific Crest, 5 Star Ratings
Glen Reid, Bear Stearns, 5 Star Ratings (PEER PERFORM)

This is going to be our first real projected result from anyone that can give us what may be broader indications on the new Wii and PS3 sales and how it can look one to three quarters out for game title makers. It isn't the first absolute look because Activision already reported, but it is the most dominant title maker and what it says can ring through to the game sellers. Since this can give us some insight there, we would be very cautious on GameStop (GME) if you have significant profits there. The GME position can be hedged, although the options are a bit pricey at $1.40 per contract for the NOV $50 puts. GME reports earnings on November 21, which is after the November 17 options expiration date.

Take-Two Interactive (TTWO) is probably going to be acting on its own. The company has large exposure to a smaller group of titles and its new Grand Theft Auto doesn't hit shelves until 2007 and its new "Bully" title is deemed an at-risk title because it is essentially getting kids to act as the school bully.

The main game developer title makers to watch in conjunction with ERTS are THQ Interactive (THQI) and Activision (ATVI). Activision already reported last week and actually raised its 2007 outlook. THQI reports earnings the day after ERTS. Secondary impacts could also potentially be seen in Best buy (BBY) and Circuit City (CC) depending on what the company says. There is no real value in trying to peg Atari (ATAR), Majesco (COOL), and Midway (MWY) since those names tend to trade under the radar and more on their own.

Jon C. Ogg
November 2, 2006
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