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Analysis: Why EA Isn't An Acquisition Target (For Now)
by Leigh Alexander [PC, Console/PC, Exclusive]
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October 2, 2009
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[Rumors have been swirling about big media company buys in the games biz -- for example, unfounded talk of a Microsoft takeover of Electronic Arts. Here are six reasons why EA is not a target -- at least not right now.]
Acquisition rumors are a regularity on Wall Street, but all eyes have been on the video game biz in particular recently -- the rapidly-growing, desirable sector finally took some economic hits over the past several months that are believed to be temporary, meaning successful publishers with long term growth prospects are currently trading at more attainable prices.
What's more, the larger entertainment world is realizing that games are here to stay, and many big media groups like Time Warner and Viacom have invested in the biz, more smartly combining internal and external development capacities to leverage their cross-media properties, whereas in the past they might've simply licensed out for a quick game tie-in buck.
Games also look like attractive moves for technology, software and infrastructure companies as the industry increases its digital presence, and as the expanding casual audience means average cable television and Internet users are playing more and more.
Mix it all together and you've got a perfect storm of acquisition rumors surrounding video game publishers. Recently, such whisperings drove up the share value of publisher THQ, based on the argument that the rumored parties of interest -- again, Viacom and Time Warner -- were "interested in the gaming space."
Never mind that most analyst commentary on the rumors neglected the fact that those big media companies are already well into the gaming space.
Viacom is parent of highly successful Rock Band publisher MTV Games, while Time Warner subsidiary Warner Bros. not only has its own interactive entertainment division, but recently completed its acquisition of Mortal Kombat house Midway.
But What About EA?
Perhaps the most frequent subject of such rumors, though, is Electronic Arts. The publisher suffered from last year's crowded holiday and cautious consumer and had to undergo restructuring, and there's been a strain on the share price ever since, as analysts often wonder whether the publisher's future portfolio is any stronger.
Couple this with the buy-friendly climate, and rumors of "big media acquiring EA" are cropping up quite a lot lately. Recently, finance sector buzz pegged Microsoft as ready to snap up the publisher -- a rumor so unfounded and so widely-circulated that Microsoft made the unusual move of publicly stating it had no such intentions.
Cowen Group analyst Doug Creutz is not particularly positive on EA's near-term prospects. Citing weaknesses in the release slate, he recently lowered his expectations for the publisher's earnings from $0.80 to $0.67 per share and said it "has largely missed this console cycle."
Even still, the major publisher is not an acquisition target, says Creutz, and he told Gamasutra why:
It's too expensive. "EA is probably not a seller at a price a major media company would find attractive," says Creutz. "Current management team came in with stock at $50+; to sell at $25 or so would be a major admission of defeat."
It'd make an acquirer look bad on paper. It all has to do with how it reports earnings, versus how its potential acquirers report them. "EA reports earnings on a non-GAAP basis," the analyst explains. "On a GAAP basis, they have been a money-loser for 3 years. Major media companies report on a GAAP basis, so an acquisition would be massively dilutive."
Integration would be too challenging. Big media has generally moved into video games gradually, exploring first partnerships and then nurturing internal businesses before making individual studio buys. But EA is a conglomeration of several kinds of game businesses -- publishing, distribution, online, and a global studio network of variegated developers. This creates "huge integration risk," according to Creutz. "None of these companies have experience running a big video game unit," he notes.
Investors are tired of big buys. "Major media companies have gotten repeatedly pilloried by investors for having done big capital-destroying acquisitions over the past 10-15 years -- think AOL," Creutz explains. "Investors would view this as more of same; managements understand buying EA would likely mean a big haircut to their stock price, as investors would view it as a writedown-in-waiting."
Acquirers don't have the cash on hand. Whether or not one company can afford another comes down to much more than an apples-to-apples comparison of their respective values -- and for many big media companies, the outlook's as uncertain as some analysts find EA's to be. "Several of the media companies don’t really have the capital firepower to do such a big deal right now, as the outlook for their business remains very mixed," Creutz says.
They wouldn't really get much out of it. Acquisitions are about synergies, after all, but the way in which EA allocates its expenses and investments is entirely different from the areas big media currently examines. There are "few cost overlaps, hence few costs to cut, and no real revenue synergy either," says Creutz. "You’re just buying another business, and hoping you can run it better than current management."
In the analyst's opinion, "While EA management hasn’t done a great job, there’s no indication that a major media management team would do a better job -- and more likely the contrary would be the case."
The Bottom Line
Ultimately, says Creutz, a buy of EA would be a massively big -- and unsure -- bet for just about anyone right now. EA may be receiving analyst criticism for its weaknesses, but if its established management can't fix the situation right now, there's no reason to think anyone else could.
"A buyer would be gambling that they can turn around a company that’s been struggling for years despite having little or no expertise in the business," he says.
And for EA, although it's currently trading under $20 for investors who got used to the high $30 and $40 range in days of yore: "The stock only looks cheap compared to where it used to trade -– not on the company’s current earnings power," Creutz concludes.
So according to this analyst, a buyout of EA just doesn't make sense right now. But according to another, Wedbush Morgan's Michael Pachter, it's not that an EA acquisition is illogical -- it's just that the timing is wrong.
"EA has had horrible results for four years in a row, and people like Creutz think that they’re going to disappoint again this year -- I disagree, by the way," Pachter tells Gamasutra. "It would be political suicide for a media head to buy EA and entrust his valuable IP to the EA team if they screw it up."
But Pachter believes that the company is positioned to turn things around -- he believes upcoming Dragon Age, for example, can sell over 3 million units. So lest the company breathe easy, he says the time will come when EA looks attractive to big media again.
"The media guys will be interested in EA once the company proves that it is well-managed," he says. "That means after this year, not during."
Electronic Arts declined to comment on this article.
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As investors often do in this forum, Creutz misses an obvious. EA has a huge established publishing infrastrucutre MSFT would never need. Why would MSFT pay for that? EA would also not get the advantage of multiple platforms for their ROI in that case. That's probably a more important issue for Sr. Mgmt. than selling at $25 a share.
I agree with Pachter on this one. EA is in a healing position. EA was at the top of the hill. Where could they have gone in 2006? They had to fall a few notches. They tweaked their studio and IP model, reacted to purchase trends, and now they are in a better position of rebound, hopefully.
The economy is one of the main culprits for loss these days. Most of the game companies out there are losing money. It's a crucial period now. Those who can bare the current financial climate, while strenghtening their infrasctructures and repertoires, will see better days hopefully. Many won't unfortunately.
And, in so doing, EA would drive those studios into the arms of its competition. How much stronger would Activision, Ubisoft, Sony be if every AAA title which EA is currently publishing that is cross-platform were suddenly in their lineups instead of EA's? Taking EA Xbox-only would sufficiently strengthen EA's competition that it just might ruin EA's ability to compete. It would be suicide for EA, and would ruin the value of MSFT's investment (not to mention thoroughly discredit MSFT's stated commitment to supporting PC game development, with attendant loss of support from anyone to whom PC gaming is important).
MSFT buying EA? Mmmmmaybe. Taking EA Xbox-only? I don't see it happening.
EA is probably better off on their own for now. They're at least half way through the current cycle as well as their re-org plans seem to be working. They also have a stand alone $100M+ business (primarily youth demo) with Pogo. I think it's more likely that EA acquires than becomes acquired.
Btw- @Thomas, do you think that MSFT would pay Nintendo and Sony moneys up front for pressing their IP to compete against themselves? Also, I haven't seen any MSFT games on iTunes lately.
Another barrier to big acquisitions now is tight credit. Most large mergers/acquisitions are funded by the larger corporation getting a huge line of credit.
The next rumor will be Google. Then some Chinese coal mining conglomerate.
Let's assume that by "someone" they mean Microsoft, Sony or Nintendo, and not someone like Activision, Ubisoft, etc. Those contracts signed for all of the sports leagues and movie licenses like Harry Potter are written to guarantee multi-platform development to maximize exposure. To the IP owner, it's not as much about the money from the product as it is the exposure gained by the product. If the product is only released on one platform instead of all of them, they lose a large amount of exposure. The companies will simply take their licenses elsewhere, like the aforementioned Activision or Ubisoft.
Why buy EA only to see Madden, Tiger Woods and Harry Potter "quit?"
I can't believe that wasn't addressed in the article. What major IP's does EA own that would be worth that kind of money for some other company to own? Mass Effect? Dragon Age? Mercenaries? Spore...? Burnout or Need for Speed? EA's games that make them the REAL money are all licensed, from Rock Band to Madden, and those would all go away in a purchase.
Ultimately it would be a far bigger feather in Microsoft's cap to be able to count revenue from their rivals platforms as well as their own.
And who amongst us would have thought Disney would buy Marvel?
I think Ed made some good points about the rumor millin' and the licensing barriers to any acquisition. I disagree about Apple, for now. Maybe they'll compete in cloud or more mobile game stuff but not a new home console IMO.
Leigh: was this article your idea or Creutz's ;)