Video game consoles like Sony's Playstation 3 and Microsoft's ( MSFT ) X-Box 360 are in the last stages of their product cycles, and this has led to a decline in sales for video game developers like Electronic Arts ( EA ). EA reported a 19% year-on-year decline in packaged goods revenue in its last earnings announcement. This might be attributed to the fact the EA is waiting for the next generation consoles, Playstation 4 and X-Box 720, to develop video games specifically designed for the platforms. Since the product cycle hasn't refreshed after 2005, the company has decreased the number of games released per year from 36 titles in fiscal 2011 to 22 in 2012, and plans to release just 14 titles in 2013.
While the number of titles and the subsequent sales might increase with the launch of the next generation consoles, we believe that the company might currently be missing out on a big revenue opportunity in Asia. EA earns just 7% of its net revenues from Asia, a surprising fact, given that Japan alone accounts for 15% of the world's video game sales.
How Can Electronic Arts Capitalize on Asia?
According to data compiled by Nintendo, Electronic Arts published the best selling games in Europe and U.S. through the first nine months of 2012, for all platforms. Sports games topped the charts with FIFA 13 for Playstation 3 and X-Box 360 in pole position in Europe, followed by last year's version, FIFA 12 for Playstation 3. In the U.S., Madden NFL 13 was at the top for both major platforms.
However, looking at the chart for Japan, not a single title published by Electronic Arts shows up in the top 20. Japan is a region Electronic Arts should work on tapping, especially by promoting its sports-based games like FIFA 13. Soccer is very popular in the country, and Japan's national team won the last continental competition, the AFC cup, in 2011. English and European soccer leagues are also popular in Asia and has a huge fan base due to extensive television coverage and marketing. Also the fact that Electronic Arts has an exclusive licensing agreement with soccer's governing body, FIFA, and other regional bodies like the English Football Association Premier League Limited, give it a big edge over competing titles like Pro Evolution Soccer.
Electronic Arts is currently trying to promote FIFA Online in Japan and Korea, particularly through its FIFA Online franchise. The company reported a 9% increase in Asia revenues for the six months ending September, but the overall contribution from the region is still small compared to the contribution from North America and Europe. Electronic Arts could boost revenues by as much as 20%, if it is able to bring Asian revenues to even half the level of North American revenues.
Electronic Arts has a gross profit margin close to 60%. However, high research and development costs and selling, general and administrative expenditures lower cash flows. R&D costs are around 30% of revenues for the last four years and SG&A consumed around 25% of the revenues. We expect these figures to remain roughly the same in the coming years. However, gross profit margins might increase due to the fact the Electronic Arts is shifting to an online sales structure. Digital revenues accounted for 33% of Electronic Arts's total net revenues in the September quarter of 2011. In 2012, they accounted for 46%.
While the exact margin for digital revenues is not provided by the company, the management has suggested that they offer higher margins, and we agree with this view. Zynga ( ZNGA ), which is entirely focused on digital revenues, has margins around 70% and can be used as a benchmark for Electronic Arts. We expect gross profit margins to approach 70% by the end of our forecast period.
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