Electronic Arts Earnings: Market Recovery Will Lead To Growth Before Console Launches
Electronic Arts ( EA ) is expected to announce its earnings for the second fiscal quarter of 2013 on Tuesday, October 29. We expect strong results from the video game developer as the video game market has surged in the last two months after a year of suppressed sales. In August, research group NPD reported that retail sales of console and PC games increased 21% over the prior year, the first positive change in sales since November 2011. For September, the research group reported sales growth of 27% in the physical retail sector, driven by Grand Theft Auto V video game.
Electronic Arts had three titles in the list of top 10 highest-selling games for September: Madden NFL 25, FIFA 14 and NHL 14. With the much anticipated launch of the next generation Sony Playstation 4 and Microsoft ( MSFT ) Xbox One just around the corner, we believe that EA is well-positioned to gain from the increased sales that the new consoles will bring.
Our $27 price estimate for Electronic Arts' stock is in line with the current market price.
Strong Market Share
According to our analysis, EA had a market share of around 14% (in terms of units sold) in the global video game market last year. FIFA 13 accounted for around 5% of global game sales, while Battlefield 3 and Madden NFL accounted for 2% of global game sales each. Recently released NPD figures list Madden NFL, FIFA 14 and NHL 14 as the second, fifth and eighth highest selling games for September, respectively.
Electronic Arts has exclusive licensing agreements with sports bodies like NFL and FIFA, and launches annual editions of its popular titles, maintaining a near monopoly in the sports video games domain. Given the immense popularity of its titles, we expect EA to make a smooth transition to the next generation of consoles. The company expects a 7% increase in packaged goods and distribution revenues in fiscal 2014, but reported a 30% decline in the same for the three months ending June.
The Shift To Digital
Video game developers have turned to the digital domain in response to growing demand. Global digital game sales grew from $5 billion in 2005 to $42 billion in 2012, accounting for nearly 70% of the video game market. The digital stream includes revenues from extra downloadable content (DLC), full game downloads, mobile sales and subscriptions and in-game advertising. Electronic Arts reported a 42% year-on-year increase in GAAP digital revenue last quarter, and we expect the company to maintain focus on these high-margin secondary streams this quarter.
Half of the company's digital revenues come from the DLC stream, which reported a 35% year-on-year increase in revenues last quarter, driven by FIFA and Star Wars: The Old Republic. FIFA 13 digital revenue increased 92% year-on-year and accounted for 40% of the DLC revenues. FIFA Online 3 digital revenues increased by 88% over the prior year.
Full game downloads also benefited from the popularity of FIFA's titles last quarter, with revenues increasing 12% over the prior year. This stream accounts for 10% of Electronic Arts' digital revenues. On the mobile front, the company has been helped by The Simpsons: Tapped Out and Real Racing 3, which was the best selling racing title on iOS last quarter with more than 45 million downloads and an average of over 2 million daily active users since its launch in March. Mobile revenues accounted for 27% of EA's digital revenues in the June quarter and were up 73% over the prior year. We expect further growth in the DLC and full game downloads streams, but will keep a close eye on the mobile stream to see if EA can maintain its momentum. The barriers to entry are low, and free-to-play games are quite popular with mobile users.
While digital sales can cannibalize physical retail sales, they can also help EA expand margins. The cost of revenue for the digital stream is just around 30% of net revenue while the cost of revenue for physical sales is around 50%. The non-GAAP gross margin increased from 61.5% in the first fiscal quarter of 2013 to 63.8% for the three months ending June this year as digital sales increased. Going forward, we expect margins to rise to about 68% as digital contribution increases further.
Electronic Arts is looking to launch FIFA in China as the government has lifted the ban on sales of video game consoles in the country. Gaming consoles were banned in China in 2000, but the country's gaming market has been booming, with sales increasing 35% year-on-year in 2012 to reach a total of $9.6 billion (60.3 billion Chinese Yuan). EA will try to capitalize on the Chinese market, particularly with its popular sports-based titles, and has announced a collaboration with TenCent to launch FIFA Online 3 in the country.