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I think EA is an extremely interesting case study for a quality investment idea. It all starts with their shift towards an incredibly powerful new business model.

 

EA is a vertical video game company as they design, market, publish, and distribute all of their own games. Their Origin platform is the closest rival to Steam (though slightly different and less robust) and they have digital and PC offerings with PopCap Games (Bejeweled, Plants Vs. Zombies) and Pogo.com. They also own the Battlefield, The Sims, Need for Speed, Titanfall, and Star Wars: Knight of the Old Republic games. However, it is their sports games that they are synonymous with, publishing under the name EA Sports. They annually release the following sports franchises:

* FIFA (Soccer/European Football) - $625m in revenue

* Madden (American Football) - ~$250m-$325m in revenue (largest y/y rev increase for FY14)

* NHL (Hockey)

* NBA Live (Basketball)

-- EA does not release per game revenue figures. FIFA was easy to determine because it is >10% of total revenue, so it is disclosed. I was able to find the range for Madden by piecing together a few PRs and the 2013 and 2014 Annual Reports. The actual figure is near the high-end since revenue increased 88% (I believe) y/y.

 

EA Sports has been receiving complaints from customers for decades that each new iteration of their sports titles contains an underwhelming amount of gameplay improvements and roster updates. This is the introduction of why their business model (and potentially, their moat) is so great. Like Comcast, EA is able to survive these complaints because they had exclusive rights to create/distribute games for each professional sports leagues. These exclusive agreements generally last for 10-11 years (depending when they are signed), always for an undisclosed amount. Thus, any gamer that wants to play a sports title will almost surely have to purchase an EA Sports game, regardless of their feelings about quality and pace of gameplay improvement. These exclusive agreements have proven to be immune from anti-trust regulation because the agreements are initiated by the professional leagues themselves, thus extending their exemption from anti-trust regulation to EA sports. If you've ever wanted to invest in professional sports to take advantage of the monopoly characteristics and tremendous growth, then I'd wager that EA is the most direct method possible (even more than Liberty or Rogers). *There are several professional FCs (Euro Soccer) with public stocks, but these teams are rarely profitable or extremely overpriced.

 

EA's Moat:

Generally, EA earned revenue from sports games by selling physical copies of their games. Although generally profitable, they would receive money up-front while costs would continue year-round due to customer expectations for patches (as necessary) and roster updates. In 2013, EA changed their online format for their sports games to add a new game mode that would ultimately spell the end for online franchise mode. Ultimate Team uses a Collectible Card Game (CCG) business model where users play in solo challenges or against other users to earn coins. With coins, they can either buy packs with random player cards or buy individual cards/items that are posted in the Auction House (AH - secondary market for trading of any cards a user has). I highly suggest everyone watch the 2 videos on the CCG business model below. It is a succinct explanation of EA's strategy shift while still being highly entertaining (combined they are <15 mins of play time).

 

However, games like FIFA (25% y/y) and Madden (88% y/y) are experiencing accelerating sales because this new CCG model provides EA the opportunity for further monetization of their sports games by allowing users to buy virtual packs with cash. This is a legal way of introducing gambling to sports games and has proven to be highly addictive for serious sports games. For the first time in many years, customers are happy with EA and are significantly more engaged with the game throughout the year (improving EA's ad revenue - a small contribution to total sales). Now sports games retain their historical characteristics where they require very little gameplay tuning year-to-year while selling to customers who are incredibly loyal to their favorite sports games. EA has changed their preferred game mode to incorporate gambling and in-game purchases, an incredibly lucrative combination. It is no surprise that FY14 saw huge spikes in margins, revenue, and profit and I believe it is likely the EA will be able to continue this momentum. The biggest issue that most video game companies run into is their games either become irrelevant (which is not an issue with sports games due to their natural upgrade cycle), or in the case of CCG games, "power creep" alters the game experience to favor long-time players, new players, or some other disruption of competitive equilibrium that eventually forces users to abandon the game. Again, because they create sports games instead of the more common fantasy-style game, player creep fixes itself since players are constantly improving/declining or players retire and new players are drafted. Thus, even if they become too aggressive with player ratings (as has happened in the past with Madden), they merely need to wait a few months for the next iteration to fix their power creep issue. The combination of CCG business model and sports content has the potential to become the largest video game blockbuster in history, each year. This is all going to depend on EA's ability to entice spending without overstimulating their users (and raising expectations of player ratings/gameplay too high). I think this stock has a chance to become a homerun overtime.

 

CCG Business Model Videos: (there's actually a part 3 that I haven't watched yet but I'll include it - their other videos are really good; especially the "Power Creep" one which relates to EA)

Part I:

Part II:

Part III:

 

Any thoughts or has anyone else looked into EA?

 

EA is not cheap so I didn't bother outlining their valuation metrics. They are trading at 28.7x TTM P/E and similar FCF valuation. They have beaten quarterly estimates by >30% each of the last 4 quarters, but you are certainly paying up for the rosy consensus. I think the investment thesis should be focused on business model instead of valuation metrics in this case, which is why I focused on the business model so much.

 

Valuation Metrics (Yahoo! Finance):

http://finance.yahoo.com/q/ks?s=EA+Key+Statistics

http://finance.yahoo.com/q/ks?s=EA+Key+Statistics

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The business model looks great and there is a moat, but I have a serious problem with the valuation for the following reasons:

 

At the end of 2004 Activision released World of Warcraft. By the middle/end of 2005 the stock had run up significantly (like EA now) to discount the success (and future success of this product). Even though WoW was probably the biggest home run (especially financially) in the history of gaming and was followed by another financially impressive franchise (Call of Duty releasing annual iterations at a high pricepoint) for a decade you didn't even get a 2x out of it until the multiple started expanding like crazy over the last 2 years.

 

Why?

 

Because at some point these success stories stop growing and go into steady decline (see ATVI revs over last couple of years). The multiple contracts to what seems appropriate for such a business (10x-12x?). And the sad thing is that something amazing like Hearthstone, whose ratio of revenues/development costs must be ridiculous, can't even stem the bleeding because it is not impactful compared to the cash cows.

 

The bottom line for me is: EA will probably grow its FCF enough that you can survive the multiple contraction without losing any money, but whereas Activision has shown the ability to create amazing new franchises over time, EA has not done the same.

 

They have their sports core, but other than that they have Battlefield (which, ironically, has existed way longer than CoD but they didn't find the value of it until CoD came along), the Sims (timeless, but only iteration and little innovation over the last deacde) and Origin (dominated by Valve's steam, mostly used for EA games exclusively).

 

EA is usually jumping on bandwaggons when they're already rolling. Battlefield tried to play in the CoD market, The Old Republic tried to get a piece of the MMO market after WoW exploded, they also tried to get into "MOBAs" when Tencent's League of Legends and Valve's Dota 2 showed what ungodly amounts of money could be made.

For EA to be really successful they need to stop chasing trends. The amount of money that was poured into the development of MMOs and MOBAs and never earned back is huge - and EA was involved in both.

They need to define new genres, revive abandoned genres and improve accessibility of niche genres by challenging the gaming industry's views about what can and cannot be successful.

 

That is what Activision and Valve have done. Without it, the current surge in EA's stock price will only be a temporary glimmer of hope that this company can actually be a good investment in the long term.

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Nice argument wbr.

I agree they are no Activision or even Take Two Interactive when it comes to innovation (bringing online gameplay to Grand Theft Auto was genius).

But a larger issue for me is that their business model seems to be oriented around actively taking advantage of customers.

Recently, newer games have less content than previous titles and almost force players to purchase downloadable content (DLCs) to make the game playable. For example, Battlefield: Hardline was basically a shell of a game when you purchased the original content and needed the extra purchases to have the semblance of a complete title.

However, the new trend of downloadable content is extending the life of games and the revenue stream derived from them.

 

EA Sports is definitely not the only one to do this, but they are the most notable.

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The business model looks great and there is a moat, but I have a serious problem with the valuation for the following reasons:

 

At the end of 2004 Activision released World of Warcraft. By the middle/end of 2005 the stock had run up significantly (like EA now) to discount the success (and future success of this product). Even though WoW was probably the biggest home run (especially financially) in the history of gaming and was followed by another financially impressive franchise (Call of Duty releasing annual iterations at a high pricepoint) for a decade you didn't even get a 2x out of it until the multiple started expanding like crazy over the last 2 years.

 

Why?

 

Because at some point these success stories stop growing and go into steady decline (see ATVI revs over last couple of years). The multiple contracts to what seems appropriate for such a business (10x-12x?). And the sad thing is that something amazing like Hearthstone, whose ratio of revenues/development costs must be ridiculous, can't even stem the bleeding because it is not impactful compared to the cash cows.

 

The bottom line for me is: EA will probably grow its FCF enough that you can survive the multiple contraction without losing any money, but whereas Activision has shown the ability to create amazing new franchises over time, EA has not done the same.

 

They have their sports core, but other than that they have Battlefield (which, ironically, has existed way longer than CoD but they didn't find the value of it until CoD came along), the Sims (timeless, but only iteration and little innovation over the last deacde) and Origin (dominated by Valve's steam, mostly used for EA games exclusively).

 

EA is usually jumping on bandwaggons when they're already rolling. Battlefield tried to play in the CoD market, The Old Republic tried to get a piece of the MMO market after WoW exploded, they also tried to get into "MOBAs" when Tencent's League of Legends and Valve's Dota 2 showed what ungodly amounts of money could be made.

For EA to be really successful they need to stop chasing trends. The amount of money that was poured into the development of MMOs and MOBAs and never earned back is huge - and EA was involved in both.

They need to define new genres, revive abandoned genres and improve accessibility of niche genres by challenging the gaming industry's views about what can and cannot be successful.

 

That is what Activision and Valve have done. Without it, the current surge in EA's stock price will only be a temporary glimmer of hope that this company can actually be a good investment in the long term.

 

I feel like adding my .02 here could be of value as I am a total competitive gaming nerd and maybe I could offer some insights from inside the machine. I have played League of Legends for the past 5 or 6 years, achieving a best ranking of top 150 and staying in the top 500 for a 6-12 months at that point (out of 450k players in those times), and before that I played counter-strike for a decade. I don't know how long this post will be but don't expect it to be too coherently written or 100% factually accurate so bear with me :)

 

The microtransactions model is nothing new in gaming. What brought it to the forefront is when companies realized they didn't need to sell game power to profit. I'm not sure but I think the first to really get this done was Valve with TF2 (courtesy of Greek's recent finance prime minister AFAIK, cool bit of trivia), followed by Riot Games with LoL.  EA's method is slightly different from the en-vogue method of selling sheer cosmetics by making it a main component of the game ala Hearthstone (aka "collectible card game" model). This is NOT a moat in any way, shape or form. Microtransaction business models have become standard fare in gaming, expect all your favorite titles to include them in some way, shape or form as time goes on. The sports titles thingy is indeed a competitive advantage for EA that gives it some sweet sticky revenue, not sure how durable, but it is a CA for sure. But I repeat myself, using microtransactions of any kind is NOT a moat in gaming. That's like saying that selling soda in cans instead of bottles is a competitive advantage. No.

 

The gaming industry is in the midst of a bubble: Companies are currently shipping out unfinished products and charging customers out the ass in various ways just to get to the finished product (if that). Employees are working in quasi-slave conditions. Coders put in 80 hour weeks and have zero job security as they often get laid off at the end of a title, etc. Companies can get away with it because working for a gaming company is currently cool, but someday that will change and margins will compress. The extent of that compression? No clue. There's all sorts of little things like this happening in gaming that show the industry is bubbling. Which is weird to say because LT there is a huge tailwind for the gaming industry. The thing is, EA is the biggest culprit by a landslide as far as pushing the envelope goes and I'm willing to wager pushing it as hard as they are doing presents FS numbers that are not sustainable long term. It could last like this for a long time, but I'm not willing to take my chances, let alone at that price.

 

The EA sports exclusivity deals are nice, but not enough to make up for the discrepancy in operating quality between EA and the best players in NA: Valve, Activision/Blizzard and Riot Games. Sadly Valve is privately held and Riot is only one of a number of subsidiaries of Tencent making an investment in Riot quite an indirect affair. All of these companies, you will notice, use microtransactions to a certain extent. Riot relies purely on that for revenues. Valve's main titles now use this as main source of revenue. The least usage comes from Blizzard who only has it on Hearthstone (and maybe Destiny? I don't know about this game). They tried to use the system in D3 but the mechanic broke the game, so they removed it.

 

One thing these companies have in common that EA is missing the boat on is they cater (each to different extents) to the competitive side of gaming: e-sports. This is where the true tailwind is at in gaming. In 20-40 years, common folks will recognize Faker, KennyS and Boxer like they recognize LBJ, Tom Brady and Tiger Woods. I won't get into the details of it but that is how it will be, and from now until then is a huge runway for growth for the co's that cater to this. I agree with wbr's assessment  that EA are trend chasers so they might try jumping on that bandwagon, their sports franchises could be a solid platform for competitive gaming (and FIFA is used to a certain extent, but that is despite EA not thanks to it), but by that point it could be too late, plus EA has never acted in a way that would indicate catering to this sublet of the industry successfully would be realistically achievable for them.

 

To summarize my thoughts:

  • Introducing microtransactions does NOT give EA a leg up over its competitors in any way, shape or form.
  • Exclusive sports franchises are indeed a nice competitive advantage for EA
  • A certain % of EA's profits are not sustainable (long-term) due to "egregious behavior". Whole industry partakes, but EA is easy contender for worst offender.
  • E-sports will be big with the upcoming generations, and EA is not positioned to take advantage of this.

 

 

Hope my random ramblings added something of value to you guys. Gaming is a part of me like breathing is, so this topic I am a bit enthusiastic to talk about.

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Schwab711, the following is not pointed at you personally. :)

 

It might be just the situation with market being high, hitting tops. But there is a trend where people propose ideas and nicely justify moats and high valuations. And then you look at the last 10+ years and realize that the company has traded much lower while having all the same qualities they have now. There were times when ADBE, EA, etc. traded much lower, were on sale because Mr. Market and everyone did not believe they had the moat and good business. (There are other examples, but I don't want to turn this thread into "why company X is cheap now even though the multiple is high").

 

I would rather buy a business when it's not loved than when everyone thinks it's the greatest and can do no wrong. Like others above said, the valuations are stretched and might not work out well for current buyers. That's true not just for EA, but for a lot of companies discussed on this site. I don't find much that is cheap right now. Perhaps I am too cheap though. :)

 

Also, when companies fall temporarily, it is hard to buy them then. I am sure people had great reasons not to buy EA when it was really cheap ("PC gaming is passe, sport franchises are tired, no hits, etc"). That's the tough part of investing...

 

Sorry for general and not stock specific comment. :)

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I feel like adding my .02 here could be of value as I am a total competitive gaming nerd and maybe I could offer some insights from inside the machine. I have played League of Legends for the past 5 or 6 years, achieving a best ranking of top 150 and staying in the top 500 for a 6-12 months at that point (out of 450k players in those times), and before that I played counter-strike for a decade. I don't know how long this post will be but don't expect it to be too coherently written or 100% factually accurate so bear with me :)

 

The microtransactions model is nothing new in gaming. What brought it to the forefront is when companies realized they didn't need to sell game power to profit. I'm not sure but I think the first to really get this done was Valve with TF2 (courtesy of Greek's recent finance prime minister AFAIK, cool bit of trivia), followed by Riot Games with LoL.  EA's method is slightly different from the en-vogue method of selling sheer cosmetics by making it a main component of the game ala Hearthstone (aka "collectible card game" model). This is NOT a moat in any way, shape or form. Microtransaction business models have become standard fare in gaming, expect all your favorite titles to include them in some way, shape or form as time goes on. The sports titles thingy is indeed a competitive advantage for EA that gives it some sweet sticky revenue, not sure how durable, but it is a CA for sure. But I repeat myself, using microtransactions of any kind is NOT a moat in gaming. That's like saying that selling soda in cans instead of bottles is a competitive advantage. No.

 

The gaming industry is in the midst of a bubble: Companies are currently shipping out unfinished products and charging customers out the ass in various ways just to get to the finished product (if that). Employees are working in quasi-slave conditions. Coders put in 80 hour weeks and have zero job security as they often get laid off at the end of a title, etc. Companies can get away with it because working for a gaming company is currently cool, but someday that will change and margins will compress. The extent of that compression? No clue. There's all sorts of little things like this happening in gaming that show the industry is bubbling. Which is weird to say because LT there is a huge tailwind for the gaming industry. The thing is, EA is the biggest culprit by a landslide as far as pushing the envelope goes and I'm willing to wager pushing it as hard as they are doing presents FS numbers that are not sustainable long term. It could last like this for a long time, but I'm not willing to take my chances, let alone at that price.

 

The EA sports exclusivity deals are nice, but not enough to make up for the discrepancy in operating quality between EA and the best players in NA: Valve, Activision/Blizzard and Riot Games. Sadly Valve is privately held and Riot is only one of a number of subsidiaries of Tencent making an investment in Riot quite an indirect affair. All of these companies, you will notice, use microtransactions to a certain extent. Riot relies purely on that for revenues. Valve's main titles now use this as main source of revenue. The least usage comes from Blizzard who only has it on Hearthstone (and maybe Destiny? I don't know about this game). They tried to use the system in D3 but the mechanic broke the game, so they removed it.

 

One thing these companies have in common that EA is missing the boat on is they cater (each to different extents) to the competitive side of gaming: e-sports. This is where the true tailwind is at in gaming. In 20-40 years, common folks will recognize Faker, KennyS and Boxer like they recognize LBJ, Tom Brady and Tiger Woods. I won't get into the details of it but that is how it will be, and from now until then is a huge runway for growth for the co's that cater to this. I agree with wbr's assessment  that EA are trend chasers so they might try jumping on that bandwagon, their sports franchises could be a solid platform for competitive gaming (and FIFA is used to a certain extent, but that is despite EA not thanks to it), but by that point it could be too late, plus EA has never acted in a way that would indicate catering to this sublet of the industry successfully would be realistically achievable for them.

 

To summarize my thoughts:

  • Introducing microtransactions does NOT give EA a leg up over its competitors in any way, shape or form.
  • Exclusive sports franchises are indeed a nice competitive advantage for EA
  • A certain % of EA's profits are not sustainable (long-term) due to "egregious behavior". Whole industry partakes, but EA is easy contender for worst offender.
  • E-sports will be big with the upcoming generations, and EA is not positioned to take advantage of this.

 

 

Hope my random ramblings added something of value to you guys. Gaming is a part of me like breathing is, so this topic I am a bit enthusiastic to talk about.

 

I was hoping we'd have a couple competitive gamers on cobf. Thanks for the insight.

 

Couple things:

1) Completely agree about microtxns (in-game txns) spreading to most games over time. Most games use a freemium model (free game, but highly incentivized to engage in microtxns). EA Sports games differ here because they still sell for $60 while also bringing in >50% of game rev from microtxns (incredibly impressive in my view). Best I can describe what they are doing is with the picture below.

2) You are absolutely right that the microtxns do not make a moat in anyway. I tried not to describe EA in that way because I agree. The CA is still the exclusive sports agreements (I could easily expand on why they have an advantage over TTWO in this area were these agreements non-exclusive). The NFL exclusivity will likely expire sometime before Madden 17 is released. I'm guessing they were extend their exclusive agreement for another 10 years and then you will have ~30% of total revenues (and roughly 95% of total profit) locked up with exclusive deals for the next 10 years.

3) You mention the gaming bubble. However, the conditions you mention in support have been true for over a decade. This is an extremely competitive industry, generally with zero-barriers to entry, and roughly 0% aggregate profit margins (majority of games do not make money). EA was one of these companies for many years. Ex-EA Sports is historically break-even or worse. EA Sports has been historically profitable (other than the TTWO price war for a year), but not wildly so. I wouldn't use "bubble" to describe the industry. More so the industry lends itself to rampant speculation like any other commodity business. Instead of an excessively profitable mine, this industry has [temporary] excessively profitable video games.

 

This explains why I am so interested in EA's recent evolution. EA Sports titles are now widely successful because they are still selling $60 games at roughly the same volume because the games are still catered to those that do not engage in microtxns. Sports gamers are generally locked in to their preferred titles. They are an interesting niche within the wider gaming community because they tend to only play sports games instead of the average gamer who jumps around with games every few months. With their microtxns now contributing more than 50% of EA Sports's revenue, they appear to be the first video game company to capture the demand above the equilibrium price! As great as Wow was, everyone paid roughly the same price. Same with CoD. It is hard for CCG games to remain relevant over the years (which is why video game companies are generally terrible investments - see my arguement of why SNMX is a bad investment). However, this is where EA differs from any other CCG. Their sports titles already become irrelevant every year, thus any $ spent on the Ultimate Team (CCG) game mode in a given year will need to be done annually for the same "gaming experience". Unlike any other CCG game, the items you've spent a whole year purchasing or collecting with expire and sports gamers accept this fact with enthusiasm. I really don't think you could find a better type of game for this business model.

 

Ways to Increase Revenue:

* Ultimate Team mode was only released in 2013. There's still a large # of sports gamers who don't play the game mode yet. 2015 marked a huge migration towards the game mode for many long-time franchises players. I imagine just 50% or so of sports gamers play UT. Until this approaches 100% we are likely to see high-growth for EA Sports titles.

* To go with that, <5% of users (according to polls on Reddit specific subs) actually did a microtxn in 2015 for Madden. There is a lot of potential growth for microtxns still.

* EA Sports games are not on the PC (only the 4 consoles). 2017 sports games will only be released for the next-gen consoles (historically has lowered costs without affecting revenue much). There are rumors that 2017 games will also be released for PC (NFL exclusivity contract supposedly affected their decision to stop releasing games for PC). PC represents a huge untapped market for EA Sports.

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nice post patmo. As someone who wants to get in the industry, I wouldn't invest in gaming companies. Maybe only Valve or Naughty dog. But they are both private. And origin is not remotely comparable to Steam. They have lost that battle long ago. This is a nr1 wins type of business, and steam has won it by a landslide.

 

To sum it up, you want to bet on a company in a somewhat shitty industry that is probably somewhat bubbling, and that is known for being a soulless hated creative-less corporation. And all that for 28x earnings?? Im sure there are better picks out there.

 

This company was really interesting at 12$ a few years back though.

 

I mean if they triple profits and multiple normalizes to 15x, that is 61% upside. And your taking some serious risk there to get a measly 60%.

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That's the thing, EA is still being described with certainty and being compared to 3 years ago when their business model and revenue streams have changed substantially each of the last 2 years. There's reason to believe the market is underestimating the profitability of the new business model considering they could have 4 stable and perpetual WoW-like games in their portfolio (they already have at least 2 with FIFA and Madden). WoW averaged $180/year/user (probably less do to indirect sellers and free months). It seems likely that FIFA and Madden have already surpassed this figure and NHL already has or will soon. NBA Live is taking considerable market share from 2K. What made WoW so profitable was their large number of users AND monetizing each user (their revenue/user is higher than most digital games that report revenue/paying user). EA Sports games have these qualities while also restarting "power creep" annually (and thus incentivizing higher annual spending per user). I would also guess that sports games are less likely to go "out-of-style" vs WoW or any other creative game. The CCG conversion (first full year in 2014) increased revenue by 28.5% ($1b increase) and raised profit by $800m (80% FCF yield on operating leverage?!).

 

EA Sports is >50% of total revenue and FIFA is their largest game and double Madden [their #2]. Origin and Pogo are trivial contributions to revenue and aren't really relevant to EA.

 

Let's invert: Why do you (most value investors, I'd guess) avoid investing in video game companies? Would you consider sports games to have similar properties and demo gamers as other games?

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Let me put it like this, you want to pay 28x earnings for this? For a company in a creative industry that was voted most hated company of America? And trust me they haven't changed, I play games semi regularly and they are strangling one old school franchise after the next. In an industry where brand names seem pretty important.

 

And then you want to bank that they will massively increase profits (at least 4-5x) to make a decent return on it when the multiple normalizes. And then hope customers won't figure out soon enough they are getting fucked by a greedy company that sees their customers like idiots that need to be squeezed dry. Trust me there is a lot of backlash here. I like games, and i cannot understand why people would even bother with these micro transactions. They are ruining games. They are not adding value, they are just cheap cash grabs. So I wouldn't want to bet on it long term at 28x earnings.

 

I might be biased because I like games, and they ruined almost all the franchises I played as a kid.

 

But honestly if you look at the value proposition here your comparison with WoW fails. (never played it, but heard this from other people who have) Because with WoW your playing a massive online game that is not possible to offer for free (after initial purchase price). It would be too expensive (servers, the huge world). So you have this huge world, you have the social aspect, and you have new content that actually adds something on a regular basis. So it makes sense to pay monthly, since your actually getting something back in return.  But with sports games it looks to me mostly a cheap money grab? If you read reviews on these things, it often reads like a review on crack cocaine (I hate it but I can't stop doing it, 1 star! Now I must get back to the game!). Who knows, it might even be sustainable? But let's not forget for a second that it usually is a rip off.

 

Edit: to go in a bit more detail, here is usually how they do it. They had a normal game, and cheat codes were added if you want to skip ahead. And usually back in the day, games were made by people who cared about making them as fun and innovative as possible. Now the corporate types have taken over, and they only really care about the bottom line.  So they figured out there is a whole demographic out there prone to addiction. So you could instead offer these 'cheat codes' for money in game. Or you can make desirable items so difficult to get that you are basically forced to buy them with real money. So either the game turns into a boring grind to move up in levels or teams or whatever (done on purpose to force people to buy), or you throw a lot of extra money at it. You can imagine this pisses a lot of people off. I dont think most people really complain about paying for WoW since it buys you something you could otherwise not get for less.

 

And also to add, most people play these sports games on console, since it really is a social game that you don't play on PC. So im not so sure about the size of the market there. And PC gamers tend to be less casual, who dont tolerate micro transactions as much.

 

Seems that out of all the tens of thousands of companies you can choose from, there are better deals out there. I rather buy google before EA. You pay 33x earnings there I think, and you get a company with a massive moat and a much safer growth runway. EA really seems like a 6 feet hurdle.

 

Anyway here you have my biased negative view. GL if you buy the stock  :)

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If you read reviews on these things, it often reads like a review on crack cocaine (I hate it but I can't stop doing it, 1 star! Now I must get back to the game!).

 

My ideal customer! :)

 

Invert: EA was voted worst company in America (7-8 years ago, I believe) which puts them in the same company as Comcast. Probably means they have an incredibly large moat with sports games (I'm probably biased because I'm that sports gamer who has the last 15 Maddens).

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If you read reviews on these things, it often reads like a review on crack cocaine (I hate it but I can't stop doing it, 1 star! Now I must get back to the game!).

 

My ideal customer! :)

 

Invert: EA was voted worst company in America (7-8 years ago, I believe) which puts them in the same company as Comcast. Probably means they have an incredibly large moat with sports games (I'm probably biased because I'm that sports gamer who has the last 15 Maddens).

 

I think they received that title because fans didn't like the ending to Mass Effect 3.  Gamers can be a very "difficult" customer base, especially the hardcore who feel entitled to everything. 

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I've worked in the videogame industry for most of my career, and about 6 years of that time was spent at EA, where I shipped many of the sports titles mentioned in this thread, among others. (I'm actually writing this post on a train packed full of nerds headed to Cologne, where Gamescom is happening this week.)

 

Personally, I would not invest in any videogame company, for reasons already mentioned by others. The closest analog to the games business that I can think of is the biotech industry. It's a massively hit-driven business, and nobody can predict in advance which new IP in development is going to be a blockbuster. (Although lots of people seem to make good livings pretending that they can.) It's only after years of heavy investment that you find out whether or not you have a hit on your hands. (You probably don't. Less than 10% of new IPs even turn a profit). And product development costs are relentlessly rising, while prices are not. This is why all videogame companies are desperately seeking new ways to squeeze more revenue from existing customers with new business models like microtransations. And this is why videogame publishers, like pharmas, tend to lean so heavily on derivative products and product line extensions within successful franchises.

 

So that's what makes the EA Sports business such a uinque jewel. As long as EA can continue to outbid all competitors for those exclusive sports licenses, then they have a durable moat, which is extremely rare in this business. But to be clear, their moat is not in the IP itself, which they don't own. The moat is in EA's ability to pay more for that IP than anyone else. That ability, in turn, is based on years of investment in development tech, process, and infrastructure. The production of these games is about as close to a factory operation as you can get in the games industry, and it would take most competitors a few iterations to match EA's development efficiency and product quality.

 

But you only need to look at what happened to the NBA Live franchise to see how wide EA's moat is without the ability to outbid every competitor. In basketball, EA's NBA license is not exclusive... they have a major competitor in 2K Sports (Take-Two). And in 2010, with just one poorly executed sequel, EA gave up all of its market share in basketball. The NBA Live business was decimated, the development team liquidated, and the franchise relocated from Vancouver to Orlando in hopes of reviving it with fresh blood. (But in the process, much of the investment in development know-how was lost.) Five years later, 2K still dominates basketball.

 

Andrew Wilson is a smart man (and a snappy dresser), and he knows the sports business inside-out (he was running FIFA when I was there). I would not bet against him, but I also wouldn't describe him as particularly shareholder-oriented. Honestly, nobody in the games industry is. It's a business run by enormous egos and self-interest. Within months of becoming CEO in 2007, John Riccitello spent almost a billion dollars of shareholder capital to acquire Pandemic and BioWare, companies in which his former private equity firm had invested $400M. EA wrote-down the Pandemic investment less than 2 years later, closed the studios, and laid-off most of the employees. Also take look at the ongoing shareholder lawsuit against Zynga's executive team, many of whom came from EA.

 

Maybe collectible cards and microtransactions will transform the economics of console sports games for the long-term. Maybe that new value will be captured by EA and will not ultimately flow to the sports leagues who actually own the IP. Maybe EA's management will allocate capital productively and shareholders will realize the benefits. But that's too many maybes for me, especially when I'm being asked to pay up now as if all those things have already happened.

 

Anyways, those are my thoughts. Not trying to poop on anyone's idea. It's just that even without the nosebleed valuation, EA will likely always sit in the "too hard" pile for me.

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If you read reviews on these things, it often reads like a review on crack cocaine (I hate it but I can't stop doing it, 1 star! Now I must get back to the game!).

 

My ideal customer! :)

 

Invert: EA was voted worst company in America (7-8 years ago, I believe) which puts them in the same company as Comcast. Probably means they have an incredibly large moat with sports games (I'm probably biased because I'm that sports gamer who has the last 15 Maddens).

 

I think they received that title because fans didn't like the ending to Mass Effect 3.  Gamers can be a very "difficult" customer base, especially the hardcore who feel entitled to everything.

 

I havent played those games, but they fucked up a lot of franchises. They messed up the hitman franchise, command and conquer franchise, Sim city (that one was really ugly : http://www.metacritic.com/game/pc/simcity), slowly they are ruining battlefield franchise as well. Need for speed is ruined. Just look at the metacritic scores. They are gradually going down over the years. They just don't care about quality it seems.

 

Usually they rip apart the teams what made these franchises great, and turn it into a generate soulless thing. Usually when you read interviews with developers they are completely out of touch what made these games fun to begin with. Often they take out features that were actually present in the last game. If you go on metacritic, you can see for yourself. Only reason they are getting away with it for so long is because game reviewers are often pressured into giving good reviews, and those brand names were strong.

 

Now you could say, well just don't buy them! But it is just sad that most of the money is now going to free to play crap and cheap money grabs. Those microtransaction games are not designed to be fun. They are designed to squeeze you dry. Honestly your better off going to the casino. At least you could potentially win something.

 

And there is no room for any creative risks anymore. It seems in the long run this will cost them.  On the plus side, it prevented me from wasting too much time on this hobby over the past years :) .

 

edit: Another reason why I am pessimistic about companies like EA is that the market is still growing fast. In early 2000's videogames was still something that nerds did. Then sports games and games like Call of duty and mobile games got rid of that stigma for the most part. Playing call of duty for a few hours per day is about as acceptable as watching tv. Plus women are also more catered to now. So the market is rapidly growing with a lot of new customers each year. These new customers don't really care about quality, since they are not used to much. For example they play some generic sequel that was actually worse then the last part and they will sort of enjoy it and not feel ripped off. They don't really check reviews. But as the market matures and growth will halt to only a few % this group will become more picky. Especially if there is no social pressure to buy the game like with online gaming.  They will start reading reviews and demand higher quality. And they will figure out for the most part that these microtransactions are a rip off that offer no value whatsoever. And that games relying on this tend to be worse.

 

Not a problem yet as there are still enough new suckers! But the population in general is barely growing, and the % of older people is actually growing. So at some point the video game market will stall. And those new customers will become seasoned customers. And then they will no longer be satisfied playing the same generic sequel that somehow has less features then the last part. EA will purely rely on their sports franchise then. But the same thing goes for these microtransactions. They will be left making money on a few degenerate addicts, and most people will have moved on knowing this is a rip off.

 

Then there is the problem that these large studios are often horribly inefficient. If you look at that latest witcher game, it was made for a fraction of what a lot of other large games cost. And it was a massive hit, and high quality in every way. Often they hire testers when not needed yet. A lot of people during development spend most of the time twiddling their thumbs due to bad communication and inefficient schedules. It seems like a business that is not easily scalable.

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I've worked in the videogame industry for most of my career, and about 6 years of that time was spent at EA, where I shipped many of the sports titles mentioned in this thread, among others. (I'm actually writing this post on a train packed full of nerds headed to Cologne, where Gamescom is happening this week.)

 

Personally, I would not invest in any videogame company, for reasons already mentioned by others. The closest analog to the games business that I can think of is the biotech industry. It's a massively hit-driven business, and nobody can predict in advance which new IP in development is going to be a blockbuster. (Although lots of people seem to make good livings pretending that they can.) It's only after years of heavy investment that you find out whether or not you have a hit on your hands. (You probably don't. Less than 10% of new IPs even turn a profit). And product development costs are relentlessly rising, while prices are not. This is why all videogame companies are desperately seeking new ways to squeeze more revenue from existing customers with new business models like microtransations. And this is why videogame publishers, like pharmas, tend to lean so heavily on derivative products and product line extensions within successful franchises.

 

So that's what makes the EA Sports business such a uinque jewel. As long as EA can continue to outbid all competitors for those exclusive sports licenses, then they have a durable moat, which is extremely rare in this business. But to be clear, their moat is not in the IP itself, which they don't own. The moat is in EA's ability to pay more for that IP than anyone else. That ability, in turn, is based on years of investment in development tech, process, and infrastructure. The production of these games is about as close to a factory operation as you can get in the games industry, and it would take most competitors a few iterations to match EA's development efficiency and product quality.

 

But you only need to look at what happened to the NBA Live franchise to see how wide EA's moat is without the ability to outbid every competitor. In basketball, EA's NBA license is not exclusive... they have a major competitor in 2K Sports (Take-Two). And in 2010, with just one poorly executed sequel, EA gave up all of its market share in basketball. The NBA Live business was decimated, the development team liquidated, and the franchise relocated from Vancouver to Orlando in hopes of reviving it with fresh blood. (But in the process, much of the investment in development know-how was lost.) Five years later, 2K still dominates basketball.

 

Andrew Wilson is a smart man (and a snappy dresser), and he knows the sports business inside-out (he was running FIFA when I was there). I would not bet against him, but I also wouldn't describe him as particularly shareholder-oriented. Honestly, nobody in the games industry is. It's a business run by enormous egos and self-interest. Within months of becoming CEO in 2007, John Riccitello spent almost a billion dollars of shareholder capital to acquire Pandemic and BioWare, companies in which his former private equity firm had invested $400M. EA wrote-down the Pandemic investment less than 2 years later, closed the studios, and laid-off most of the employees. Also take look at the ongoing shareholder lawsuit against Zynga's executive team, many of whom came from EA.

 

Maybe collectible cards and microtransactions will transform the economics of console sports games for the long-term. Maybe that new value will be captured by EA and will not ultimately flow to the sports leagues who actually own the IP. Maybe EA's management will allocate capital productively and shareholders will realize the benefits. But that's too many maybes for me, especially when I'm being asked to pay up now as if all those things have already happened.

 

Anyways, those are my thoughts. Not trying to poop on anyone's idea. It's just that even without the nosebleed valuation, EA will likely always sit in the "too hard" pile for me.

 

You mentioned my biggest worry to their competitive advantage, what stops the league's from pursuing a stronger negotiating stance. The best estimate I can find on their license expenses for FIFA (FIFA's 2014 budget) is that it is <$40m/yr and likely has a high up-front amount (EA license extensions were signed in 2006 and 2013; rights currently held until end of 2022). I think part of the reason they get the exclusive contracts is due to their commitment to the NFL and realistic accuracy. Competitors can also do these things, but the leagues have a sure bet with EA. I wish I could find the numbers on the NBA, but I'm guessing overall licensing dollars is lower without the exclusive deal (probably a 5%-7% royalty structure; maybe we can figure it out when the 2015 FIFA budget is released).

 

The CCG conversion revenue/profit increase is even more impressive considering I forgot to mention that NCAA Football was completely canceled in 2014 after years of being their 3rd highest selling game.

 

How long can people afford these microtxns is certainly another issue. Right now, those txns are being paid by <10% of gamers (which provides better games for less cost to everyone, as long as you don't engage in these txns). I think it's an interesting shift for video game companies as it creates dynamic pricing for their games, allowing users to pay as much as they will bear instead of what the Econ 101 supply-demand curve may price a game at.

 

Adding pictures I meant to include a few posts ago.

Supply_Demand_Curve_with_Ultimate_Team_Mode.jpg.13327d68d61968c70333c1f6fecb4a85.jpg

FIFA_Video_Game_Licensing_Revenue_Projected_content_costs_for_EA.JPG.52f4ea7735cee4ef97df30f32c15114d.JPG

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How long can people afford these microtxns is certainly another issue. Right now, those txns are being paid by <10% of gamers (which provides better games for less cost to everyone, as long as you don't engage in these txns). I think it's an interesting shift for video game companies as it creates dynamic pricing for their games, allowing users to pay as much as they will bear instead of what the Econ 101 supply-demand curve may price a game at.

 

There are companies/games that do the microtxns the user friendly way and there are ones that completely piss off their user base.

 

I don't know in which camp EA is, since I don't play their games at the moment. (I don't play sports games at all and I play very few other games nowadays).

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I think part of the reason they get the exclusive contracts is due to their commitment to the NFL and realistic accuracy. Competitors can also do these things, but the leagues have a sure bet with EA.

 

I think you're right about that. EA provides the leagues with confidence and security that their brands will be treated well, just based on historical experience and relationships. (E.g. Nobody ever got fired for choosing IBM.) But if 2K came to the table next year with significantly more money than EA, would the NFL or FIFA just turn it down? 2K has also proven its ability to make high-quality sports games, and surely understands the potential value of collectible cards and micro-transactions.

 

The CCG conversion revenue/profit increase is even more impressive considering I forgot to mention that NCAA Football was completely canceled in 2014 after years of being their 3rd highest selling game.

 

Why was NCAA canceled? Seems like an odd decision to suddenly cancel your 3rd highest selling game. Answer that, and you'll see the weakness in EA Sports' moat.

 

Right now, those txns are being paid by <10% of gamers (which provides better games for less cost to everyone, as long as you don't engage in these txns).

 

That is the norm for all micro-transaction games. We call those <10% of people the "whales." In any free-to-play or MTX-based game, the whales provide most of the revenue which keeps the game going for everyone else. Even though 80-90% of the player base never pays a dime, the whales (and the "super-whales") can generate enough revenue to make the game economical. The secret sauce behind all these games is analytics, and much of the effort in analytics is directed to engaging and monetizing whales.

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  • 1 year later...

http://www.usgamer.net/articles/the-bizarre-gaming-culture-of-madden-ultimate-team

 

Cool article that better articulates what I failed to earlier in this thread.

 

EA is still way too expensive for me. I don't think EA is overvalued though. Earnings could reasonably double in 2-3 years. Then you'd have an outstanding collection of assets trading at or below the market multiple at a low opportunity cost (the reason great company at FV works, if you get the "great" part right). I really never pitched this as an investment idea, so I can't take too much credit. I think the wide-moat thesis is playing out well thus far. We'll see in 5-10 years where this stands. At least I can trade my batting average.

 

As an example of the potential, EA should fill the daily fantasy market void by having players by special coins (that cost $USD) as entry to bet on a salary cap-created team that scores points based on real life and/or Madden outcomes. I think the real life DFS game would be popular even  if the "profits" could only be used to purchase finite-lived, virtual prizes (Big Fish did $400m+ in revenue! It's a play-money casino!!). Best part is the govn't can't regulate a fake casino. It would be nearly zero-cost incremental revenue.

 

I think the benefit of micro-txn shift was unusually positive for EA Sports games specifically - I think that is why EA is outperforming peers by such a wide margin. It was perfect for FIFA/Madden game style and player base. As I mentioned before, this is probably the most loyal gaming market. Folks move on from WoW, but they will play sports games for decades.

 

I think there are a lot of way EA could become a $100b+ company due to the incredibly high op lev with FUT/MUT. This is another case  where I think FUT/MUT will end up being worth the majority of the value of EA over time (buried high-quality asset). We'll see in 2026.

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  • 1 year later...

Maybe it's bull market, but Schwab711 had a good call on EA so far.

 

I still think the following:

It might be just the situation with market being high, hitting tops. But there is a trend where people propose ideas and nicely justify moats and high valuations. And then you look at the last 10+ years and realize that the company has traded much lower while having all the same qualities they have now. There were times when ADBE, EA, etc. traded much lower, were on sale because Mr. Market and everyone did not believe they had the moat and good business.

 

<snip>

I would rather buy a business when it's not loved than when everyone thinks it's the greatest and can do no wrong. Like others above said, the valuations are stretched and might not work out well for current buyers. That's true not just for EA, but for a lot of companies discussed on this site. I don't find much that is cheap right now. Perhaps I am too cheap though. :)

 

Also, when companies fall temporarily, it is hard to buy them then. I am sure people had great reasons not to buy EA when it was really cheap ("PC gaming is passe, sport franchises are tired, no hits, etc"). That's the tough part of investing...

 

But OMG it's hard to stick to this when stocks of my examples - and not only of my examples - have moved another 50-100% up.  :-\

 

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  • 2 months later...

 

I think sports games, relative to other game types, are proving to be perfect for this business model. I don't know if all this can go on for decades but smart capital allocation could lead to a great investment (15%+ CAGR ish range). I could see earnings double again from here. They should need to extend both NFL and FIFA soon. It will be interesting to see the new % of rev.

 

I'm thinking of taking a small position.

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  • 1 year later...

Just trying to revive the conversation here. Started taking a look at EA this summer and worked out that ~$900mn in earnings in FY19 were due to Sports. Assuming MSD topline growth for FY20 & FY21, Sports should be worth $1bn in earnings in FY21 (GAAP). From there on 300mn shares, that's $3.33 in EPS for FY21. EA has traded (at its highs) 25x FY2 EPS, which I would argue is fair value for Sports given its recurring nature, wide moat, and relatively low risk of license loss. That gives us $83/share. With $600mn debt maturity in 2021, $1bn set aside for acquisitions and $400mn for working capital, that leaves $3bn in "spare cash" or $10/share. I think the other business are worth ~12x earnings (EA sucks at innovating, management of these games is poor and game quality is poor but due bump it slightly since Apex has been a relative success), gives us a valuation of $6bn or $20 per share.

 

So when EA trades sub-$90, you get sports biz undervalued; with EA in $90-$100 you get sports business fully valued and then  remaining ~$500mn in earnings for free; and over $100 you start assigning value to the other businesses. I'd say then that EA's fair value is ~$120+ with downside limited to $90. Any thoughts? Obviously there are the usual risks: regulatory, gamer backlash, poor management, hits, etc. but I think EA here at sub-20x FY2 earnings, ex-cash, is compelling. Any thoughts?

 

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Recurring is probably the incorrect word for MTX - unit sales have a churn rate of ~20%, which one could argue are recurring by the definition. A better word for MTX would be consistent given the consistent nature of UT purchases over the last 5-6 years. Apologies for the mix-up.

 

Even still, MTX on sports seems to be a relatively consistent stream of revenues - excluding the ethics of loot boxes. Engagement = monetization, and sports continues to keep its core gamers engaged => consistency. Thus, I still think EA's Sports business warrants a relatively high multiple (in-line with its historical highs).

 

 

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It is "recurring" only until it isn't. These are not ~3-5 year contracts and consumer purchases are entirely dependent on successful, ongoing R&D. The gaming industry over the last year has proven themselves to be pretty bad at quickly responding to shifting consumer interests, and you can see what happens to the financials / stock prices when they miss a beat. In fact, the guys who got ran over the worst were the ones pitching the IP as "annuity-like".

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I like the EA Sports-based elevator pitch, Griezeman. I think it make a lot of sense, we might just argue over multiples. I never ended up buying EA at any point and I can't get there now but I like the future a lot.

 

I agree that non-sports gamers don't appreciate how sticky sports games are relative to the broader video game market. I own the last 20 Maddens and 5 FIFAs. Those 2 + Fortnite are the only games I play. There's a lot of gamers like me. Sports games (due to Ultimate Team modes) are ideal for the 30-60 min gamer. It's frustrating playing against people that spend a lot but EA has done a great job of not making the gap in skill boosts too large. The natural annual reset of the skill inflation is underrated from a video game economics perspective. It lowers the risk of major disruption. Fortnite has done a great job at building in natural resets, so maybe this advantage will become less pronounced. Either way, sports gamers have been trained to expect slow gameplay changes. At least for Madden, the years that had the most gameplay change have been the least liked.

 

The implementation of betting in Madden microtxns is probably the next leg up for margins in Sports. Madden being close to US-only might end up leading to it surpassing FIFA in EBIT as some point (not sure if it already has but I doubt it given the revenue difference). FIFA is still undermonetized but it's going to take more creativity given the large EU gamer presence there. At some point, EA/TTWO could probably decrease the price of the game without a big hit to the overall economics. I don't play it but 2K probably has the potential of a poor man's FIFA. I think EA Sports has a long runway on margins, though the journey may not be smooth.

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