Value investors typically gravitate toward hated companies.
The more a company is hated, the cheaper its stock and the
better the potential opportunity.
Electronic Arts is hated with a vengeance. The Redwood City,
Californiabased game makers stock is trading at
13-year lows as investors grouse that EAs sales have
stagnated for years and its earnings, though rising, are still
below their 2003 level. A falloff in industrywide sales of
packaged video games down four months in a row,
including an apocalyptic 25 percent drop in March have
added to the rancor. To top it off, EA was recently named the
worst company in America for 2012 by the Consumerist, a blog
operated by the same company that publishes Consumer
Although these might seem like very reasonable concerns,
they really arent.
Stagnant sales. On the surface, it looks
like EAs sales have been in the doldrums for years, but
they havent. The company has been winding down the
distribution of games made by other publishers; this low-margin
revenue declined from more than $600 million annually a
few years ago to about $200 million today, masking healthy
growth in EAs core games business.
The games industry is going out of
business. A four-month decline in packaged-game sales
sends shivers through investors, but it shouldnt. The
bulk of the falloff is happening in handheld devices that have
been losing market share to smartphones (sales of Nintendo
Co.s DS software were down 78 percent in March). Nintendo
Wii sales were down 47 percent; its console has been rapidly
losing market share to Microsoft Corp.s Xbox, which has a
much more powerful processor, more-advanced graphics and a
camera that reads gestures, so theres no need to wave
around the bulky Wii remote. Of course, these statistics cover
only packaged games and dont count those distributed
digitally, a fast-growing segment.
Worst company in America. What did EA do to
be named the worst company in America in a poll of more than
250,000 Consumerist readers? It created Mass Effect 3, a
role-playing game in which players battle to defend the world
in a war against the Reapers. Mass Effect 3 has been a huge
commercial success, but gamers were outraged by the games
ending: Independent of the players decision, the world is
destroyed. EA has promised to release an alternative, happier
ending to Mass Effect 3; in any case, the game maker hardly
compares with the truly villainous companies that topped the
Consumerists list the previous three years: American
International Group, Bank of America Corp. and BP.
Investors are also worried that smartphones will plunge a
dagger into the heart of EAs core business as people
discard their Game Boys and other handheld devices for iPhones.
Wrong! The iPhone and other smartphones have removed the social
stigma of adults playing games in public and in so doing have
created a whole new market for EA. Gaming is not exclusive to
rotten kids, not anymore. Plus, nobody knows whether you are
playing a game, texting or e-mailing when youre using a
Adults are a perfect demographic for games: We do a lot of
waiting, and because the smartphone is always with us, we kill
time playing games. The smartphone gaming industry is still in
its infancy; it has captured only a third of the total
And then there is Facebook, which is arguably the best
time-wasting website known to man (and woman). It presents
another opportunity for game makers, opening up a time slot
that was previously unavailable to most adults: office hours
(when they are supposed to be working). This market was
virtually nonexistent before.
EA will capitalize on both smartphones and Facebook. The
company is no Zynga when it comes to social network games (nor
does it have Zyngas sky-high valuation), but it has an
impressive slate of brands. It bought game makers Playfish and
PopCap, which have expertise in social and casual games and
plenty of hits of their own.
In addition to its exciting new revenue opportunities, EA
can significantly improve its profit margins as consumers
increasingly download games in digital format rather than
purchase packaged software. The companys full-game
downloads doubled over the past year. Digital games come with
profit margins 10 to 25 percentage points higher than those of
packaged games, and their sales are growing at a much faster
rate. Today they represent about 25 percent of EAs sales.
In a few years they should approach 50 percent. The
margin-expansion opportunity is significant for EA, which
recently traded at $15 a share and could earn north of $2.00 a
share within the next few years.
Theres nothing to hate about that.
Vitaliy Katsenelson (email@example.com) is
CIO at Investment Management Associates in Denver and
author of The Little Book of Sideways