Electronic Arts Inc. (NASDAQ:EA) stock is struggling at the moment. The EA stock price has pulled back 16% from late August highs.
Two key catalysts have driven this decline. Guidance coming out of the fiscal second-quarter report on Halloween disappointed relative to expectations. And consumer protests regarding the prices of in-game content on Battlefront II have hurt EA’s reputation — and the EA stock price.
But the sell-off has gone too far.
EA stock looks downright cheap. Backing out over $10 per share in net cash, the stock trades at a little over 18 times fiscal year 2019 earnings estimates. In contrast, rival Activision Blizzard, Inc. (NASDAQ:ATVI) trades at nearly 24x calendar year 2018 earnings estimates. Earnings growth remains somewhat muted in the near-term, but ATVI has the same problem, yet trades at a substantial premium and has outperformed EA stock of late.
All told, EA looks too cheap. There are stable, high-margin profits coming from the sports business. Battlefront II will recover. And while EA may be behind Activision Blizzard in e-sports, there’s still plenty of value to be created from Madden tournaments and other offerings. With EA stock just off a seven-month low, there’s a buying opportunity here.
The Star Wars Mess
Admittedly, EA made a mess of its efforts to monetize Battlefront II. As Tom Taulli pointed out last week, Walt Disney Co (NYSE:DIS) CEO Bob Iger had to step in to prevent any damage to one of his company’s flagship brands.
But this too shall pass. The game is good enough to drive that kind of passion, and EA is in the process of fixing the experience. KeyBanc analysts went so far as to argue that EA actually should raise prices, not cut them, pointing out that, per hour, video game entertainment is priced at a substantial discount to movies and other forms of entertainment. (That argument presumably excludes the dirt-cheap price of a Netflix, Inc. (NASDAQ:NFLX) subscription.)
The lowered costs for Battlefront II are a problem — but they’re a short-term, and largely one-time, problem. And they don’t represent a true roadblock to EA’s long-term growth potential.
Relative to other tech stocks, Electronic Arts’ growth is not be that impressive. Revenue rose 10% last year and 11% in the first half of FY 2018, but sales did drop almost 3% in FY 2016. Earnings slipped as well in FY 2017 on a GAAP basis, though guidance suggests a sharp 18% rebound this year.
Still, Activision Blizzard, excluding its acquisition of King Digital Entertainment, actually has posted worse numbers — and, again, it’s valued at a premium to EA stock. So is smaller rival Take-Two Interactive Software, Inc. (NASDAQ:TTWO). And there are growth drivers on the horizon.
EA still is learning how to monetize e-sports, and is building out that business. Demand for the company’s shooter game Battlefield and action game Anthem, from the company’s BioWare studio, should build over the next few quarters. The Street consensus — which uses non-GAAP earnings — predicts 17% year-over-year earnings-per-share growth in FY 2019, yet EA trades at just 18x that figure, excluding its ~$11 per share in net cash.
The EA Stock Price Is Too Cheap
There’s reason to think that the Battlefront II mess will be cleaned up and forgotten soon enough. Gamers aren’t complaining about the game itself, but the payment structure — and that’s a problem that can be fixed. The Star Wars brand remains hugely powerful, and strong enough to bring players back again and again.
If that’s the case, then there really isn’t much, if any, reason for the recent pullback — or for EA to sport an EPS multiple below 20. Even a 21-22 figure — still a discount to ATVI — plus cash, gets the stock back toward $120 and its highs this summer.
That seems a reasonable target, and a level that EA should reach once investors get past the recent developments.
The bad news here is short-term. The good news — strong growth prospects, valuable franchises and a fortress balance sheet — is long-term. Once investors again focus on the good news, the EA stock price will rise.
As of this writing, Vince Martin has no positions in any securities mentioned.
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