Don't Punish Electronic Arts Inc For GameStop Corp's Mistakes

Shares of video game publisher Electronic Arts fell after retailer GameStop reported weak third-quarter earnings on Nov 23. GameStop stock plunged as much as 16% that day, while EA stock slid about 6%. It might seem logical to dump a game publisher's stock after a major game retailer misses earnings expectations, but it doesn't really make much sense due to the differences between physical and digital distribution.

Source: GameStop.

How bad was GameStop's quarter?

Last quarter, GameStop's revenue fell 3.6% annually to $2.02 billion and missed estimates by $120 million. Net income fell 11.4% to $57 million, or $0.54 per share, which missed expectations by $0.05. Same-store sales declined 1.1% annually, compared to an increase of 8.1% in the second quarter. Here's how GameStop fared across its six main product categories:

Source: GameStop 3Q earnings report.

At first glance, it looks like sales of consoles and video games are falling across the board. However, console sales were expected to slow down, since the PS4 and Xbox One have both been on the market for two years. Sales of physical software were also expected to fall, due to the growth of digital distribution channels. GameStop's digital games revenue also shouldn't be considered a bellwether for the digital market, since many gamers download games directly from the PlayStation Store, Xbox One Game Store, or Steam.

Simply put, customers buy consoles from GameStop, but they gradually lose touch with the retailer as the hardware ages. These customers then cut GameStop out of the sales loop by buying games through other digital distribution channels. GameStop is trying to counter this trend by offering more digital downloads and diversifying into consumer electronics, but those businesses still generate a small percentage of its overall revenue.

Why EA is different

Unlike GameStop, Electronic Arts has made a fairly smooth transition to the digital gaming model. Last quarter , non-GAAP packaged goods revenue (58% of sales) fell 13% to $666 million, but digital revenues (42% of sales) rose 6% annually to $480 million. Sixteen percent of those digital revenues came from full game downloads, 42% came from extra content like DLCs, 17% came from subscriptions and advertising, and 25% came from mobile games.

EA earned74.5% of its revenues from consoles during the quarter. In addition to selling digital games through the PlayStation and Xbox One Stores, it recently partnered with Comcast to deliver cloud-based games to TVs via its X1 set-top boxes. That partnership enables Xfinity subscribers to use a mobile device as a controller to play EA games streamed over the Internet. Last year, EA introduced EA Access , a subscription-based service which grants Xbox One gamers unlimited access to select titles. These initiatives will ensure that digital revenues flow from living rooms back to EA.

EA Access. Source: EA.

On PCs, EA sells its digital games through Origin, a Steam-like DRM platform which has over 50 million users. By keeping its games within this walled garden, EA maintains tighter control over pricing. It is also reportedly planning an EA Access-like subscription service for Origin. EA's PC/browser revenues accounted for 14.4% of its sales last quarter.

EA's total non-GAAP revenues fell 5.7% annually last quarter to $1.15 billion, which still beat estimates by $50 million. That slowdown wasn't surprising, due to currency headwinds and tough comparisons to last year, when The Sims 4 launched . But looking ahead, EA expects a strong holiday quarter thanks to the launch of Star Wars: Battlefront . For that quarter, EA expects non-GAAP EPS of $1.75 on revenue of $1.78 billion, which exceeds the consensus estimate for EPS of $1.73 on $1.75 billion in revenue.

Comparing apples to oranges

GameStop and EA run on very different business models: Sluggish sales of new hardware and software at GameStop doesn't mean that sales of all games are sliding -- it just means that the distribution model is changing.

This doesn't necessarily mean that EA is an ideal investment at current prices. EA has high expectations for the holiday quarter, but the period could still be rough on margins due to steep discounts and the aggressive bundling of top games with new consoles. However, investors shouldn't sell EA simply because GameStop had a rough quarter.

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The article Don't Punish Electronic Arts Inc For GameStop Corp's Mistakes originally appeared on

Leo Sun has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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