Read us and find out if it is a good idea to invest in EA
Electronic Arts is the second largest independent developer of video games in the world.
The Business
We forecast a 3-year revenue CAGR of 14%, as growth decelerates to 11% Y/Y for FY 22 (Mar.) and 10% for ‘23, down from the 18% we project for ‘21. We see 2 main drivers of EA’s top-line growth through ‘23: 1) billions of people sheltering at home due to the resurgent Covid19, boosting overall player engagement and attracting new players; 2) next-gen consoles, Xbox Series X and the PS5, that began shipping in Q4 of calendar 2020. Both consoles feature thoroughly redesigned hardware, not just faster processors, with solid state storage and memory optimized for video games, delivering a stunning jump in visual and audio realism for a more immersive and compelling gaming experience. This is especially true for newly developed games EA plans to release this year, further amplified by virtual reality (VR), which is gaining traction as VR headset prices fall. As digital downloads continue replacing physical media (still ~20% of sales), we see an additional 2% gross margin expansion that, together with the inherent operating leverage of the business, leads to 30% operating margin in ‘23, up from 26% in ‘20 and 20% in ‘19.
Investment Case
Our Buy opinion is based on four key elements: 1) sustained 10%+ Y/Y revenue growth through ‘24, driven by the next-gen consoles and rapidly improving VR tech gaining greater consumer traction as VR headset prices fall; 2) higher engagement and interest in video games due to billions of people continuing to shelter at home; 3) formidable competitive advantages, including iconic brand, large and valuable IP catalog, unique contractual relationships in sports, and strong tech core competencies; 4) attractive valuation and financial resiliency with $5 billion in net cash, about 12% of present market cap. The most salient risk is the ultimate economic impact of a resurgent Covid-19, especially on discretionary spending, offset by higher engagement due to global sheltering at home. Longer term, EA may face unexpected threats as new platforms and modes of play (e.g., mobile, VR/AR) create opportunities for new entrants.
Our $172 target is the product of our EPS forecast for ‘23 of $7.20 and a 23.9x multiple (3-year mean, +5% due to $5.7 billion in net cash, ~12% of market cap, and a 0.5% dividend yield).
Our risk assessment is MEDIUM. Reflects the company’s strong worldwide franchises and market position. This is partially offset by the somewhat unpredictable nature of the hitdriven video game segment. However, a growing percentage of revenue now comes from subscriptions and in-game purchases, which act to lower the volatility of results.
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