Zeev, FYI on ERTS...From The Street.com
Electronic Arts May Be Getting Clobbered Unfairly
By Kenneth Li
Senior Writer
01/16/2003 01:07 PM EST
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Shares of video game giant Electronic Arts (ERTS:Nasdaq - news - commentary - research - analysis) slumped to a 52-week low last week, following a slew of bad news in the sector. But some say the selloff is overdone.
The company's shares have tumbled nearly 35% since late October, as investors fled a sector that just a few months ago was hailed as an oasis in the struggling technology market. Yet a growing number of analysts say Electronic Arts shouldn't have been hammered as hard as the rest of the sector. The publisher of hit games such as The Sims met or beat all its earnings and sales targets last year, while other companies came up short. Electronic Arts also has maintained its aggressive industry growth forecasts for 2003.
Furthermore, recent sales data from major game retailer GameStop (GME:NYSE - news - commentary - research - analysis) showed that software sales during the holiday period grew 22% from a year earlier, even though overall revenue declined 1.6%. The company attributed the software gains to a handful of games, including Electronic Arts' Madden NFL 2003.
"This is the first [software sales] number breakout, and there's still pretty decent sales," said Soundview Technology analyst Shawn Milne last week, regarding GameStop's earnings update. "It's a turning point." Soundview has no investment banking relationship with Electronic Arts.
"After an 11.3% decline [in Electronic Arts shares in mid-December] vs. a 0.3% decline in the S&P, we believe shares of ERTS are oversold and the valuation now appears more compelling," said Lehman Brothers leisure analyst Felicia Rae Kantor in a mid-December report, when EA was trading at $56.70. Shares have sunk another 11% since then and now trade at a forward price-to-earnings ratio of 20 times, which analysts consider the lower end of the historical P/E range of 20 times to 35 times. "In our opinion, ERTS is one of our favorite picks within the interactive entertainment group," said Kantor. Lehman Brothers doesn't have an investment banking relationship with Electronic Arts.
Indeed, uncertainties persist. Much of what led to the current game industry backlash hasn't changed. The tech sector shows scant signs of recovery. And three of the seven publicly traded game publishers, THQ(THQI:Nasdaq - news - commentary - research - analysis), Activision (ATVI:Nasdaq - news - commentary - research - analysis) and Midway (MWY:NYSE - news - commentary - research - analysis), warned that sales growth in 2003 would be far less than the expected 20% to 25% forecasts.
Investors, therefore, are concerned about whether EA will continue to affirm its 2003 industrywide sales growth projections of 20%, amid the flood of bad news elsewhere. "EA has been the most bullish of the companies on sector growth, and we believe that these projections may have to be lowered," said Goldman Sachs analyst Chris DeBiase, whose bearish calls in October helped fuel the selloff.
Still, some Wall Street analysts say Electronic Arts will rise above the fray. "We expect Electronic Arts ... to meet or beat expectations," said UBS Warburg analyst Michael Wallace. "We believe ERTS had a good holiday season based on strong sales of key titles." UBS Warburg has an investment banking relationship with the company.
Analysts expect the company's earnings to reach $1.58 a share on $1.14 billion in revenue in the third quarter, according to Thomson Financial/First Call. The company said at the end of the second quarter that it expected earnings per share for the third quarter to be between $1.52 and $1.60 on revenue of $1.076 billion to $1.175 billion.
Recent data released after the holiday season suggest that EA will meet or exceed targets. GameStop's holiday figures were particularly surprising because it was the only retailer to break out software from hardware sales, although few investors noticed. Overall revenue was clipped at the retailer by a shorter holiday shopping season, as well as macroeconomic factors, according to the company. Soundview's Milne also noted that hardware sales, which proceeded at a relatively brisk pace, actually weren't fairly reflected because of steep price cuts among the three hardware console makers -- Sony, Microsoft and Nintendo. These factors helped distort the sales news and fanned investors' wariness of the sector.
Also, the selloff of Electronic Arts shares last week, which was based largely on reports of tepid early sales for the highly anticipated Sims Online game, was misguided. Early sales data furnished by tracking firm NPD counted a total of only two days of sales, since the game shipped weeks later than anticipated. Finance chief Warren Jenson later told analysts at a Morgan Stanley conference that the company sold 90,000 units of the game in the first three weeks.
And, discounting the sales report, nervous investors likely forgot that Sims Online revenue makes up only a small fraction of total sales for Electronic Arts. "The numbers for Sims Online are not all that relevant," said UBS Warburg's Wallace. "It's more of a perception thing than a numbers thing."
Another factor that could give game shares in general a boost: Hardware consoles, such as Sony's PlayStation 2 and Microsoft's Xbox, continue to fly out of retailers' doors, according to sales figures from the companies. Sony said it sold 8.5 million units worldwide during the holidays, representing 27% sales growth from the same period in 2001. In North America alone, the PlayStation 2 console sold 4 million units, a 42% jump on a year-on-year basis. To keep up the growth this year, hardware makers are expected to slash game system prices further this May, say analysts. And more hardware sales naturally lead to more software sales. Close to a third of all PlayStation 2 games are published by Electronic Arts.
Analysts now are looking for Electronic Arts to soothe investor concerns by providing details on holiday sales and shedding some light on projections in its third-quarter earnings report on Jan. 30.
