EA: Backing the Leaders, Feeling the Pain

Catching up on my feeds this weekend saw me stumble over a story that brought back some memories: from the San Jose Mercury News, “EA’s fumble: Game maker may have misjudged popularity of Nintendo Wii.” This story is, in essence, at least six months old. Even this blogger penned a post over six months ago titled “EA: Why Didn’t Wii Focus on Nintendo?” The interesting thing is that I was going out on a limb back in November when I was calling EA to the mat, back when it’s stock price was $58 and it was trading at 43x earnings. Fast-forward to today: the stock is trading at $48, having dropped 17% from my original post. One of the principal reasons: stagnant revenue growth, skyrocketing development costs. Why? Having to ramp up development for yet another platform, but one that will be absolutely vital to its growth prospects in the near and medium-term: the Wii.

So this is what the Mercury News had to say about EA today:

Some analysts and investors
are beginning to question this upbeat outlook. The biggest problem: the
surprising early dominance of Nintendo’s Wii in the latest round of the
console wars. It’s no coincidence, they say, that EA emerged as the top
game maker at a time when Sony’s PlayStations dominated the game
console market. The threat that  the Wii now poses to Sony’s dominance is bound to affect EA as well, they say.

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EA officials blame the
company’s recent problems on the complexity of the transition. Not only
has the company been developing games for about 11 different platforms
during the transition, but there also are multiple emerging
opportunities in the industry, from the growing market for games in
Asia to in-game advertising to games for mobile phones, said company
spokesman Jeff Brown.

While EA was late to recognize the potential of the Wii and Nintendo’s
DS handheld, it’s been ramping up its development efforts for both,
Brown said. Meanwhile, the company has also been investing in many of
those new areas of the game business, he said.

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In some ways, EA’s
troubles aren’t unexpected. The transition to new generations of game
hardware usually are troublesome for software vendors. That’s because
they typically invest in developing games for the new consoles long
before sales of the machines take off.

But this time, analysts and game makers expected an easier time.
Companies such as EA promised to continue to develop games for outgoing
platforms longer than they had in the previous industry cycle. Sales
from those games as well as for two new handheld systems, Nintendo’s DS
and Sony’s PlayStation Portable, were supposed to help bridge the gap
during the shift from older to newer generations of game consoles.

But things didn’t work out as expected. Sony’s PSP saw limited demand.
Although games for Sony’s older PlayStation 2 continued to sell,
development costs for the new consoles skyrocketed, eating into company
profits. And when the new consoles arrived, fewer than expected made
their way into consumers’ hands because of supply problems, demand
problems or both.

For the industry, the result has been a longer than expected
transition. For EA, it’s meant that sales have grown at an annualized
rate of just 1.5 percent over the last three years, its research and
development costs have more than doubled during that time period, and
its profit has fallen by more than half.

 

Now compare this to what I had written on November 21, 2006. DId these risks of backing the legacy leaders ever come home to roost, or what?!

However, when a platform technology shift happens (roughly every
five years), game developers encounter a rough patch and need to
increase diversification by making fewer titles across more platforms.
They then wait for the fall-out and watch for the winners to emerge,
after which point they revert back to the original operating model.
While this is a business that has the capacity to mint cash, it also
has the capacity to result in a lot of dry wells. Clearly not a
business for the meek.

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So if EA continues its emphasis on Sony it is clearly exposed to the
degree of adoption (and supply) of new PS3 consoles. If PS3 flops then
what? EA will need to identify and milk another future cash cow. They
could look to Microsoft’s Xbox 360, with a current installed base
approaching 10 million by Dec 31. Not exactly the 100 million installed
user base of PS2, but not too shabby nonetheless. However, if the
situation evolves such that the Nintendo Wii becomes the rising star,
EA may be in trouble. FYI, the French company Ubisoft has lined up nine
titles for Nintendo including that exculsive to the Wii: Red Steel.

Ninendo has forecasted up to 4 million units shipped worldwide and
with sharply lower development costs than Xbox and PS3: $5-$8 million
per title for the Wii vs. the $15-$20 million for Xbox 360/PS3
platforms. This makes the Wii far more attractive (and less risky) for
both developers and publishers. If EA sticks to their PS3/Xbox 360
strategy, they may miss the boat on Nintendo, spending too much in
development costs while missing what looks to be a home run console in
the Wii. This could dent the next several quarters of EA’s earnings,
painting a pretty ugly picture for the stock price going forward.

Ok, ok, so I called this one (or, rather, the internet did). But what about Ubisoft, that company that was well ahead of the pack in putting its chips in with Nintendo and the Wii? They just reported blow-out earnings today. Among the big winners in their current product portfolio? Red Steel, exclusively for the Wii, as mentioned in my post above. As I have noted before, game development is akin to trading, where bet distribution and bet sizing are key to winning. And in the case of EA, while they are working dutifully at playing catch-up, they find themselves deep, deep in the hole with a declining pile of chips in front of them. EA has won before and I am sure they’ll win again, but theirs is a tough row to hoe. And it takes time. A. Long. Time.

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COMMENT:

AUTHOR: Chris

EMAIL: mthmchris@gmail.com

URL: 

DATE: 05/30/2007 10:57:44 AM

Here’s the bad news for Ubisoft though: all of their Wii title have been awful flops.  The only company that, so far, has been able to successfully make fun games for the Wii has been Nintendo.  The Ubisofts of the world just don’t have the creativity to launch great games for the Wii, they just tend to port last generation’s ideas onto the new console.

EA can make up alot of ground here if they do their games for the Wii right.  I’m not holding my breath, but IMO the opportunity is still there.

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COMMENT:

AUTHOR: Fab Five

EMAIL: fabfiveinvesting@gmail.com

URL: http://fabfiveinvesting.blogspot.com/

DATE: 05/30/2007 07:40:23 PM

Any thoughts on EA’s recent equity investments in other gaming companies?

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COMMENT:

AUTHOR: Naseer

EMAIL: naseer@tmn.nu

URL: http://tmn.nu/blog

DATE: 05/31/2007 04:13:36 AM

Suprisingly perhaps, I find the best 3rd party Wii game to be made by EA. That being The Godfather: Blackhand Edition.

That said, alot of developers need to crank out original games for the Wii. All the damned ports are tiring.

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COMMENT:

AUTHOR: d

EMAIL: darringosse@gmail.com

URL: 

DATE: 05/31/2007 11:41:08 AM

The problem wasn’t that EA picked the wrong platform, the problem is that their recent games suck.

Ubisoft has done well becaue games like GRAW and Rainbow Six were good games that lots of people wanted.

Resistance and Motorstorm had great sales on the PS3. That’s because they were good games. EA just isn’t making games like that.

Now, EA has some good games on the horizon, but the games from the past year or two have been terrible.

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COMMENT:

AUTHOR: EB

EMAIL: earningsbreakout@gmail.com

URL: http://www.earningsbreakout.com/

DATE: 05/31/2007 07:18:05 PM

Raving Rabbits wasn’t a flop for the Wii.

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