Electronic Arts

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Electronic Arts is a global leader in digital interactive entertainment, developing, marketing, publishing, and distributing games, content, and services across various platforms, including consoles, PCs, mobile phones, and tablets.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: Electronic Arts (EA) operates as a global interactive entertainment company, primarily focused on the development, marketing, publishing, and distribution of games and related content. The company’s portfolio spans across various platforms, including consoles, PCs, mobile phones, and tablets. This diversified approach aims to maximize its reach and engagement with a broad gaming audience.

  • Revenue Streams: EA’s revenues can be broadly categorized as:
    • Full Game Downloads: Digital downloads of their titles that the game was built for. These games are purchased directly by the players. These are the ones that make the biggest revenue contribution to the company.
    • Full Game Mobile: This is the revenue related to the games that are played on mobile devices and tablets.
    • Live Services and Other: Live services provide continuing value to players beyond their initial purchase of the game, and is mostly constituted of the microtransactions done inside the game. This part is important to sustain and create revenue even after the initial hype for the game dies down.
      • Other net revenue is the small revenue that comes from other things, for instance advertising, licensing, sponsorships, and a few other different things.

As of the latest quarter, three-month period ended December 31, 2022, total net revenue grew 5% year-over-year, primarily due to the growth in live service net revenues and the releases of new games. Net revenue increased by 4.6% from prior year (2021) in mobile.

  • Industry Trends:
    • Growth in the industry is driven by global gaming adoption, and digital sales are growing while physical game sales decline. The company has made a big push to shift its sales to digital.
    • A transition to live services and the integration of microtransactions and in-game purchases. Companies are focusing a lot on live services, which creates a reliable source of revenue after the game is released.
    • There is a rise in interest in immersive gaming and metaverse opportunities.
    • Technological advancements in consoles and PCs are also driving the gaming industry.
    • Mobile gaming is becoming more important, therefore is receiving increased importance from companies that aim to take advantage of this trend.
  • Margins:
    • Cost of revenues was $1.344 billion in the nine months period ended December 31, 2022, which represented 28% of its revenue.
    • Operating expenses, which are primarily composed of marketing & sales, R&D and General and administrative expenses, totaled $3.316 billion for the same time period, representing around 70% of the revenues for the same period. This highlights that the major expenses are in making and selling their games and R&D to continue to improve their game portfolio.
    • Net Income for three months ended December 31, 2022, was $359 million. For the nine months ended on the same date, it was $731 million.

EA management is targeting strong operating margins for full year 2024 and expects the operating cash flow to come back up in the later part of the financial year. They expect Q4 to be their most profitable.

  • Competitive Landscape:
    • The gaming industry is highly competitive and fast-paced, featuring companies like Activision Blizzard, Tencent, Take-Two Interactive, and other prominent gaming studios.
    • Competition is especially intense for games with high potential, like sports games and big titles, many companies produce similar titles to gain revenue from such popular genres.
    • Competition is also present in mobile gaming with many new games released on a regular basis, increasing the competition and making it difficult for companies to acquire market share.

To stay ahead of the competition, EA has been aggressively expanding its business via partnerships, acquisitions, and by moving to new geographical locations.

  • What makes the company different:
    • Diverse Portfolio: EA has a vast selection of genres, ranging from sports, FPS, MMOs, and simulation games.
    • Strong Partnerships: EA has close relationships with a variety of companies that help boost their game offerings across several platforms.
    • Emphasis on Live Services: EA continues to focus a lot on live services, which makes their revenue more durable.
    • Technological Strength: EA has been able to make sure they can produce high-quality games across a variety of different platforms.

Financials In Depth: EA’s financial performance indicates a company that has a big focus on growth and profitability with diversified revenues. As of the last quarter for 2023, EA’s balance sheet looks quite healthy. Some points from their financials include:

  • Cash and Cash Equivalents: Has a decent amount of cash, as of December 31, 2022, to a value of $2.45 billion.
  • Total Assets: $11.38 billion, primarily consisting of goodwill, property, plant, and equipment, other assets, and cash.
  • Liabilities and Stockholders’ Equity: $11.38 billion of which $5.3 billion was equity, and remainder is the debt.
  • Positive Free Cash Flow: generated strong and positive operating and free cash flow. For the six months ended September 2023, their CFO confirmed in the earnings call that the company generated a free cash flow of over 2 billion. Their operating expenses are also going down due to cost-cutting. They also stated that they expect a strong free cash flow for the coming quarters.
  • Debt Levels: While not minimal at $4 billion, they are manageable in light of the substantial revenues and cash flow the company brings in.
  • Share Repurchases: EA has an active repurchase program. This shows management’s belief in the company’s long-term prospects.

Recent Concerns / Controversies / Problems:

  • In their Q1 earnings call for 2024, EA lowered their full-year bookings guidance because their game launch sales for Star Wars Jedi: Survivor have been below their expectations, and they also cited challenges within the mobile market as the main cause of their bookings revision.
  • Management mentioned that they plan to cut $650 million in annual expenses, laying off 6% of their workforce to make sure their company is more agile.

Moat Analysis: EA possesses a narrow moat, which is not as strong as companies that can consistently achieve better than industry returns.

  1. Intangible Assets: EA has very strong intellectual property. Games such as FIFA, Madden, Need for Speed, and The Sims create a brand name that has immense value with consistent revenue generation. However, these titles need to be regularly updated and improved to maintain the consumer’s excitement, and competitors can also come up with similar games and compete with them. Therefore, the strength of the moat remains low.
  2. Customer Switching Costs: While the company has a lot of subscribers to their games, it is very easy for the customers to switch and not keep playing their games.
  3. Cost Advantages: There are limited to the infrastructure and expertise required to create games, but in theory, those can easily be recreated by a competitor.
  4. Network Effects: These do not play a big role in EA’s business model.

Based on the aforementioned factors, I would give EA a moat rating of 3 / 5. Although, they do have some defensible characteristics, they are not strong enough to warrant a wide moat.

  • Risks to the Moat and Business Resilience:
    • Intense competition in the gaming market.
    • Technological disruptions that change how games are developed and consumed.
    • Dependence on specific titles for a large proportion of revenues which can be a problem if those titles underperform.
    • Shifting consumer preferences that are difficult to predict.
    • Rising development costs which could reduce the overall profitability and long-term potential.

Despite facing some of the problems mentioned above, EA still possesses pretty strong resilience. With a diversified business model, it does not rely on any single product for a bulk of its revenue, and its strong position in the sports gaming market creates an edge which is difficult to be penetrated by competitors.

Understandability: EA’s operations can be complex, especially when dealing with acquisitions and partnerships. Further, it is hard for a person who is not acquainted with the gaming industry to understand the future revenue trends and predict which games may or may not do well in the future. Therefore, I would give EA a rating of 2/5 on understandability, as for people in the gaming industry, the analysis may not be difficult, but for people with less knowledge of the industry, the valuation may become difficult.

Balance Sheet Health: The company has a pretty strong and healthy balance sheet. The debt level is substantial, but manageable relative to its revenues and strong cash flows. Further the strong cash balances provides the company with a cushion against adverse market events. They also have a share repurchase program in place, highlighting the management’s confidence in future prospects. Therefore I would give EA a balance sheet rating of 4/5.