EA Revisited: Playing Catch Up on the Wii, Waking up to the Failure that is PS3
Overview
This is a thread Information Arbitrage (IA) has been actively tracking for the past three months. It has been fascinating to see the process of EA’s coming to the realization that they got their bets dead wrong, and to see how they’ve adjusted strategy in the wake of new information (read: a Wii home-run and a PS3 disappointment). Since my first post, when I interpreted the Internet dialogue around the prospects for the consoles for which EA was developing games, EA has shed $8 in share price and $3 billion in market value. Both posts contained data from the Internet that were sharply negative on EA’s prospects given its lofty valuation, with the thesis derived from the data coming to fruition.
I’d first like to give a little recap of my data-driven position in the earlier posts, and then to present new data to bring IAs readers up-to-date. Bottom line: EA has a lot more work to do in order to keep its profit engine going, posing significant risks to investors considering EA as a vehicle to capitalize on the boom in the console market. Reading between the lines, EA’s recent earnings call showed an increasing emphasis on game development for the Wii and DS platforms while soft-pedaling on their view of demand for the PS3. This is rational and is supported by the data. But are they too late? As I’ve said previously when discussing EA: buyer beware.
From Information Arbitrage 11/21/07: EA: “Why Didn’t Wii Focus on Nintendo?”
Make no mistake: EA is a game-creating machine. A techno-behemoth
making big-headline games for the Big Three: Microsoft, Sony and
Nintendo. But at $58 per share and 43x earnings I would be afraid -
very afraid. What was once a company able to focus on harvesting its
category-leading franchise is now under siege: high development costs,
uncertain platform plays and lofty equity valuation. While EA has
deftly navigated the vagaries of the fickle gaming marketplace, it is
now facing a competitive landscape unlike any other it has seen in the
recent past. Ergo, this is one complex business encountering an array
of complex market and business risks. This is not a scenario that makes
me terribly comfortable as an equity investor. For a little more
insight, read on.********************
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.
From Information Arbitrage 12/7/06: Update on Sony, EA and Nintendo - The Internet Got it Right
And so it goes. The Wii is a happening, plain and simple, and its
fallout is being felt across the gaming landscape. I have written about
Sony quite a bit in the past, and have also penned a post about EA, both of which ran on Wallstrip
as well. The general take in my pieces is that Sony screwed up
massively by mismanaging its supply chain as well as consumer
expectations, particularly as it relates to the blue laser diodes
required for both its PS3 and CD/DVD consoles and its ability to meet
stated delivery targets. Further, I had articulated that EA was missing
the boat by not placing more resources behind the Wii console, choosing
to keep most of its bets along the PS2/PS3 and Microsoft Xbox 360
platforms. Well, what I had hypothesized about appears to being coming
to fruition.********************
The internet conversation has been an incredibly good predictor of the
actual outcomes for Nintendo, EA and Sony. While the game is certainly
not over, it is pretty amazing to consider how directionally correct
all of these online experts and users have been. While Wall Street
analysts often have some good insights, they can’t possibly replicate
the global community brain shared by those who can tap into it
efficiently. And this gets to the post
I authored a few days ago about next generation search. But I’ll keep
you posted on the Sony-Nintendo-EA situation. It is sure to be a wild
ride.
So now you have some context.
The 2/1/07 EA Earnings Call: Whole Lotta Shakin’ Goin’ On
And if I were Larry Probst and Warren Jenson, I would have been shaking, too. These guys should be in politics given the subtle undertones lacing their statements. It takes a Ouija board to really get the bottom of what they’re thinking. But hey, luckily I’ve got one and based on the data here is my read. First up, Warren Jenson, CFO and CAO, when discussing new games for the Wii, from the transcribed earnings call on Seeking Alpha:
So, by the end of this fiscal year, we will have six titles in the
market which other than Ubisoft, we will be most prolific publisher on
the Wii Platform through March. And you can expect to see us ship a
number in the low to mid-teens next year in fiscal ‘08 on both the Wii
Platform and on NDS.
Translation: “We screwed up our handicapping in the console wars and are working like hell to catch up given the wild (and unexpected) success of the Wii. Remember, guys, we bought that studio in Utah specifically devoted to developing games for the Wii, we are keeping up the pressure to catch up with Ubisoft. And hey, while we missed the boat early we are getting on now. After all, we are EA.” Does this sound right to you? Now it’s Larry Probst’s turn, CEO of EA:
With regards to the price change that the question that we would refer
to Sony, looking at the early January results, the trends on the PS3
are good, its selling through at a comfortable clip, again you have to
recall that this is a price point, it is much higher than the PS2. So
when you are setting expectations looking at a PS2 for example, you
would expect that the PS3 would be a bit slower in terms of its ramp,
but we were confident that on the full year number it will be good.
Translation: “Man, that PS3 has screwed the pooch and is killing us. Can you believe nobody in Japan wants it? We have 25 titles lined up - thankfully they can be dual-purposed for PS3 and Xbox 360 - since development costs are a fortune and PS3 is a disappointment. At least Microsoft has this gaming thing going ok. I’m only saying I think PS3 can do 6-7 million units because of the goodwill I need to preserve with Sony given the massive installed base of PS2 users.” So, in a nutshell, PS3 is expensive, is selling poorly, but he’s saying it will pick up because, well, what else is he going to say on his earnings call?
Boy, am I glad I’m not a member of EA management having to answer a bunch of questions at a time like this. You know why? Because they have no freaking idea what is going to happen with PS3, a bet that has already been made. And what they do know is that Wii is kicking butt, and that they have to run like hell to turn chicken shit into chicken salad. And they are behind. And they are EA. This isn’t good.
And Now on the Demand Side
Evidence abounds that regardless of EA and Sony’s contentions, that PS3 is available in abundance while the Wii continues to be in short supply. Further, word on the Internet is that Sony is under pressure to lower prices given slack demand, arising from competition on the low end from Nintendo and on the high end from Microsoft. Neither of these trends bode particularly well for our friends at EA.
From GameDaily:
Japan: Wii Outselling PS3 3-to-1
Say
it with me now: Wiiiiiiii! If Nintendo’s new console can keep up its
current pace, it’ll dominate the market just as the Nintendo DS has.
Lately, the new system has been outselling Sony’s PS3 in the land of
the rising sun by close to a 3-to-1 margin.
The
Japanese love the Nintendo DS and it’s starting to look like that love
may be translating nicely to Nintendo’s new console as well. According
to the latest data from Enterbrain, publisher of Japanese magazine Famitsu,
the Wii has outsold the PlayStation 3 by a margin of nearly
three-to-one in the month of January. Enterbrain’s figures show that
Nintendo sold about 405,000 Wii units last month, while Sony sold
around 148,000 units of the PS3.Life-to-date in Japan Nintendo has sold through 1.4 million Wii units compared to the PS3’s 614,000 units.
All this talk of Sony being outpaced by the competition has once again fueled the idea that a price cut
on the PS3 may be coming sooner than we all think. “There could be a
price cut for the PS3 by the end of the year, and more software titles
will hit the market. I expect the PS3 to be doing better after a
while,” said Enterbrain President Hirokazu Hamamura, according to
Reuters.
However, he then added, “Of course, the Wii will keep running ahead all the while.”Concomitant with Enterbrain’s data, Japan’s other major video game data
source, Media Create, shows that in the most recent weekly chart the
disparity between PS3 and Wii sales is even greater. 83,754 Wii
consoles were sold compared to just 19,996 PS3s. The Xbox 360, as usual
in Japan, trailed behind with 7,365 units.
From Kotaku:
I’ve gotten several emails now from unidentified Toys R Us employees
regarding the availability of Wiis and DS Lites in their stores. It
seems that (once again) a company wide email has gone out telling
employees to hold on to any shipments of the Nintendo consoles that
come in in preparation for a release on February 11.I don’t agree with this kind of mass hoarding and I find it
aggravating that this has become a pattern now for most major
retailers. What is the point? They are still going to sell them whether
they put them out today or next week. It seems a little shady to tell
Grandma that there are no DS Lites for her precious grandbaby’s
birthday when there’s a big pile of them sitting in the back. I think
at this point we can dispense with the forced line waiting and just get
the consoles into the hands of the people who really want them
From Post-Gazette.com:
WHERE IS Wii? Who would have thought, given all the publicity
surrounding the PlayStation 3’s arrival last fall, that the Nintendo
Wii would be the must-have console of the new year? A month after
Christmas, it’s still hard to find a Wii, and crowds are still lining
up in front of electronics stores every time a new shipment is
promised. On eBay, Wiis are still being auctioned off for around $500,
double the console’s list price. It’s even tough to track down Wii
controllers, since most of us who have been able to buy a console are
stocking up on extra “Wiimotes” so the whole family can play.
Meanwhile, Sony’s PS3 is pretty easy to buy. The Web sites for
GameStop, Circuit City and other nationwide retailers have it for sale,
and eBay auctions are starting lower than the $600 list price for the
60-gigabyte model. Several electronics store clerks have told me that
buyers have been returning unopened PS3s after realizing they weren’t
going to make any money selling them on eBay. Serves them right.
From DarkJedi’s Blog:
News around the Internet is saying that Sony is about to lower the prices for their latest attempt at a console, The PlayStation 3 (even though it is not the easiest item to lower the prices on). Already the console is a big expense for Sony’s finances,
but a price cut may be a way to get back into the game. However,
recently the pricetag for the PlayStation 3 in Europe reached retailers
ahead of the European launch in late march - and let me be the first
the say that they are staggering! This should indicate to Microsoft
that they have a good chance at beaten the air out of Sony once again
by competing directly on the price.********************
The game is already on between the two contender for HD gaming on the
next-gen consoles and cost-efficiency is an important factor. Both Sony
and Microsoft knows that improving the manufacturing process is the key
to gaining some better margins - especially if the competitor lowers
prices and you need to follow suit… For this reason the battle for reaching the 65 nm. manufacturing process
is ON! Microsoft is well in the lead and has been since they started a
year before Sony with their launch. They hold the key, both in terms of
price and in terms of game titles! Sony is struggling to get exclusive
titles, especially titles that could prove that the PlayStation 3 is a
more powerful machine than the XBox360. Meanwhile Microsoft can sit
back and wait on Sony to try and lower prices, which they would
immediately meet with lowering prices on the XBox360 or making
good-valued bundles, like they did during the Christmas sales. It isn’t funny being Sony these days!
So what does this all mean? PS3 demand is weaker than expected, Wii demand is greater than expected, and PS3 console pricing is coming under pressure do to the fact that, well, people simply don’t get the value proposition.
So What Does this all Mean to EA? Back to Mr. Jenson
Another tidbit from the 2/1/07 earnings call:
I can speak about it generally — we have single franchise teams that
are approaching each of these businesses. And when we look at the PS3
and the 360, the development of those two platforms is more alike and
has more asset sharing than when you look your current genre or the
Wii, for example. Just given the architecture, the systems, the
multiple processors, the high definition graphics etcetera. So we do
see that that will continue in the future where there will continue to
be 360, PS3 development being mostly the same. We will do some things
on one versus the other to optimize and to make them better, but on the
Wii and the current-gen stuff that still continues to be a different
type of development.
Translation: “Yeah, we’ve got 25 titles going for the PS3 and Xbox 360. We’re amortizing development costs over both platforms. No more exclusives for Sony. If PS3 craps out, we’ll quickly shift resources. We still rock at development and still have a chance to come up with some unique games for the Wii that give us a competitive advantage relative to both Ubisoft and Nintendo’s in-house studio. Developement for the Wii is much cheaper. It’s less risky. And we have to do it.” Mr. Jenson is a good CFO - he’s hedging. What else is EA going to do at this point? They are stuck between a rock and a hard place.
So Sony - Whatcha’ Gonna Do About It?
As referenced in my earlier EA posts, there is huge risk in being a console game developer. It is somewhat simliar to being a venture capitalist, handicapping your odds and spreading bets across a complicated and shifting landscape. Back the wrong consoles, you’ve squandered millions in development costs without the anticipated payoff. Back the right console, you’ve got a potential gravy train for years. In the case of PS3, early failures have sharply increased the risks of development, raising the stakes for those who might consider creating games for the platform. Further, the cost of developing games for the PS3 platform is 2-3x that of the Wii, further upping the stakes. It is in the wake of this unfriendly development environment that Sony has taken some drastic action.
From Igniq.com:
With third-party developers beginning to shy away from PlayStation 3 exclusive titles, Sony’s done the best thing it probably can to ensure its “super computer’s” powers are fully tapped by upcoming game releases.
The company has appointed Ken Kutaragi
as the part-time executive director of a new venture with Namco Bandai.
Dubbed Cellius, the project is meant to create PS3 titles that will
take full advantage of the console’s powers and give it an edge in the
waging war with Nintendo and Microsoft.
The move comes only a few short weeks after Sony named him chairman of Sony Computer Entertainment.
With
Kutaragi being considered the father of the PlayStation, the move could
very well assure that must-have game titles begin to hit store shelves
in the very near future.
As the popularity of the PS3 flounders,
this move is very much needed to make the console stand out against its
competition. While the high price of the PS3 certainly isn’t helping
it, the fact there aren’t a whole lot of impressive games out for it
yet is a real killer in the face of Microsoft exclusive titles like
Halo and Lost Planet and Wii’s quirky party games.
As a PS3
owner, who happens to think Sony really screwed up with its handling of
this console’s release, it is my sincere hope something turns around
soon to really make this console shine.
Oof. And the story just keeps getting uglier.
From PS3CENTER.NET:
It seems that more PlayStation 3 exclusive games are headed over to Microsoft’s camp and the Xbox 360 console.
Sony better start doing some serious damage control if they do not want to fall behind to quickly as it appears that more exclusives on Sony’s PlayStation 3 console may be jumping ship and headed over to the rival Microsoft Xbox 360 console. The first heavily rumored game that will only see the light of day on the Xbox 360 is that of a next-generation version of Killer Instinct, the classic fighting game developed and created by Microsoft owned Rare
********************
It seems that Sony is losing more and more exclusives in a next-generation of consoles where development costs are very high and having a game exclusive to one particular console runs the risk of losing sales and profits which could lead to some financial disasters for game publishers. 2007 should be a very interesting year with the console wars as Sony and Microsoft keep on budding heads with Microsoft maintaining a lead in North America for now…
Sony: “I Know What I’m Going to Do - Deny There’s A Problem”
Lesson #1 in crisis management: admit you have a problem, and clearly describe how you intend on addressing the problem. Sony’s reaction in the midst of crisis: denial. Clearly a sub-optimal response that only reinforces the fact that their culture is seriously broken.
From TECH.BLORGE.com:
Sony US spokesperson, Dave Karraker, has dismissed the Wii as an
“impulse buy”, even as his own company blames the PlayStation 3 for its profit slide, and all indications are that the PlayStation 3 is way behind the Wii in terms of sales and buzz.n an interview with the New York Times, Karraker said that because the PlayStation 3 was much more powerful than the Wii, it did not belong in the same category.
“Wii could be considered an impulse buy more than anything else,” he declared.
Karraker’s theory is that newcomers are buying the Wii, while the
PlayStation 3 is attracting hardcore gamers. He also told the New York
Times that Sony was selling out the 100,000 PlayStation 3s it was
sending to the US every week.Let’s put Karraker’s comments in context.
Nintendo has sold more than 1.1 million Wiis in the US since its launch, while Sony has sold around 700,000 PlayStation 3s.
Given that the PlayStation 2 sold more than 105 million units around
the world, and is the most popular games console of all time, it is
highly unlikely that Sony is purposely pursuing a niche marketing
strategy.To me it sounds like a PR hack trying to put a positive spin on a
situation, which is anything but positive for Sony. I guess that’s what
he’s paid to do.
So what exactly is Mr. Karraker’s point? That sticking one’s head in the sand is the best way to make problems go away? This kind of attitude is neither doing Sony nor its partners - i.e., EA - any favors. Wake up, guys. This is a beautiful example of partnership in reverse.
Microsoft: “Things Aren’t Going So Great Over Here As Well”
As bad as Sony and the PS3 are doing, Microsoft has also had to downscale their volume expectations for Xbox 360 in the face of stiffened pricing and the dramatic success of the Wii.
From MercuryNews.com:
Microsoft reduced its expectations for sales of Xbox 360 consoles by
June 30, targeting 12 million units sold worldwide now instead of its
earlier forecast of 13 million to 15 million. The company said it is
now targeting profitability in its strategy.The days of giveaways are over? This reminds me of the usual dilemma
for a console maker. Ship a lot of units, or make a lot of money. In
some ways, they go together. They need to move a lot of consoles in
order to create the chance for profits from game sales later on. But if
you ship too many consoles too early, you lose a lot of money on the
hardware. You can dig a hole that you never get out of, as when
Microsoft lost $3.8 billion on the first Xbox.********************
Clearly, the PlayStation 3 isn’t taking away sales, as it is still in
short supply and is even starting to accumulate on shelves. If you look
at the Wii’s momentum, it’s threatening. If it continues, you can see
that it’s only a matter of time before Nintendo’s installed base will
grow bigger than the Xbox 360s. Moore says he has great admiration for
what Nintendo has done.*********************
Microsoft’s downsizing of its expectations should be viewed in context
of Nintendo’s continued confidence. Nintendo announced yesterday that
it sold 3.2 million Wii consoles by the end of Dec. 31. That was a far
stronger showing than either Sony or Microsoft had with their
first-season launches. Nintendo missed its 4 million unit target, but
still expects to hit 6 million worldwide by March 31. The DS and
software are selling so well that Nintendo has already hit its 1-year
profit goal in the first nine months of its fiscal year.
With PS3 in extremis and Xbox 360 volume targets down by 10-15%, EA better get its Nintendo strategy right - or else. Even at $50 EA is trading at a massive P/E, one that certainly warrants scrutiny given the near and medium-term risks to their growth prospects.
And a Final Note
From TheStreet.com:
Nintendo’s Wii is a hit.
But more Wii consoles in the hands of consumers during the holiday
season did not necessarily translate into gains for third-party
publishers, many of which are scrambling to profit from the Wii’s
success.The Wii sold more than 3.1 million units as of January, but the bestseller for the platform has been Nintendo’s own title Legend of Zelda: Twilight Princess.
That compares with slightly more than 1 million PS3 units sold since its November launch, and Madden NFL 07 for the PS3, which brought in the big bucks for Electronic Arts (ERTS - Cramer’s Take - Stockpickr - Rating).
“Nintendo has always dominated with games on their platform,”
says Brian O’Rourke, an analyst with the industry research firm
In-Stat. “If you go back to all Nintendo platforms, two-thirds of
software sales have been Nintendo-developed games, while with Microsoft (MSFT - Cramer’s Take - Stockpickr - Rating) and Sony (SNE - Cramer’s Take - Stockpickr - Rating), just a third comes from first-party games.”Still, winners on the Wii platform are likely to be THQ (THQI - Cramer’s Take - Stockpickr - Rating) and Activision (ATVI - Cramer’s Take - Stockpickr - Rating), say analysts, with Electronic Arts facing the greatest challenge, though EA is probably trying hardest to win.
********************
A beneficiary of Wii’s success could be THQ.
The company has shipped more than 3 million units of its best-selling game Cars, based on the Disney/Pixar (DIS - Cramer’s Take - Stockpickr - Rating) movie, for the Wii and Xbox 360. In total, Cars has sold 7 million units.
Also, THQ shipped 1 million units each of its Nickelodeon titles Avatar and SpongeBob SquarePants for the Wii.
THQ’s gross margins for the third quarter
rose 66%, 110 basis points over the prior-year quarter, primarily
because of higher average selling prices for the Wii, DS platforms and
the Xbox 360, said CFO Ed Zinser during the company’s earnings call.“For THQ, the Wii has a bigger impact,” says
Pidgeon. “THQ has always avoided direct competition with top publishers
by going after a niche, and with Wii they have found success.”********************
THQ plans to have 11 Wii titles scheduled for
release in 2008. “We are very bullish on the Wii and the DS and we
think that our product lineup maps very well to both those platforms,”
says Brian Farrell, CEO of THQ. “I think you should think of the Wii as
incrementally more positive to us than the PS3.”Meanwhile, analysts say that EA had been too optimistic about the
success of PS3. For the PS3 launch in the third quarter, EA shipped
four of its more popular games: Madden NFL, Need for Speed: Carbon, Fight Night Round 3 and Tiger Woods PGA Tour, but chose to bring only two of those to the Wii.The Redwood City, Calif.-based market leader among video-game
publishers is now trying to ramp up development on Nintendo systems.********************
In the fourth quarter, said Jenson, EA plans to have four titles for the Wii, three for the PS3 and five for the 360.
Also, EA in December acquired Headgate Studios of Salt Lake City,
Utah, which has been exclusively developing titles for the Wii
platform.“We are redirecting some other resources toward Wii and the
DS,” said Electronic Arts CEO Larry Probst. “By the end of this fiscal
year, we will have six titles in the market — which, other than Ubisoft — will make us the most prolific publisher on the Wii platform through March.”Probst also said that EA is likely to ship “a number in the low to mid-teens” in fiscal 2008, on both the Wii and DS.
The lower cost of game development for the Wii has also given
smaller publishers an opportunity to make games for the platform, says
Pidgeon.Creating a game for Sony’s PlayStation 2, for instance, could
cost anywhere from $10 million to $15 million, and take 18 months to
two years.But with the Wii, the investments are lower — there are fewer
complexities — enabling smaller companies, such as independent
Japanese publisher Capcom, to create games for the platform.“You have to look at the Wii as a new platform, so you can’t
just port stuff from the PS3 to the Xbox 360 to the Wii, though that’s
the EA way,” says Pidgeon.“Companies that do differentiate between the platforms will have the edge because they can write for the platform,” he adds.
That pretty much sums it up. Conclusion Truth be told, IA, or rather the Internet, had it right from the get-go. EA has been riding the PS2 gravy train which has boosted its earnings, bolstered its coffers and provided the resources to become the dominant player in the gaming space. Problem is, you place your bets and sometimes you win, sometimes you lose, and sometimes you are good at managing your risks. I’d say EA is now trying to manage risks after they have become reality, kind of like buying health insurance after you’ve been diagnosed with a terminal illness. Ergo: the cost of insurance is high. The costs of catch-up are significant, whether they manifest themselves in higher costs (such as those required to buy the development shop Headgate or to bring in new development talent to code for the Wii) or lost profits (due to the time between when they could have been selling Wii games and when they’ll actually be able to sell Wii games - and every month that goes buy results in a compounded loss of revenue). EA will still be able to milk PS2 for a while, and Xbox 360 profits will continue to roll in. This will buy them time to get their Nintendo (DS and Wii) strategy right. But this will invariably cause a dent in their lofty P/E, much to the chagrin of current investors. But don’t be surprised. You could have seen this coming. Just listen.
The author does not hold a position in the securities of these companies.
