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Analysts: Game Biz Solid, But EA Poor At Estimating, Managing Cost
by Leigh Alexander [PC, Console/PC]
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January 12, 2010
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Electronic Arts warned investors yesterday that its fiscal 2010 will come in lower than it expected, chalking the estimate miss up to weak retail -- and promising to compensate in the long term with digital business.
But many financial sector game analysts messaging their clients after EA's restatement feel the game business is performing solidly, and that the publisher's problem is mainly that it forecasts poorly.
EA, too, has solid performance potential and strong assets, says Wedbush analyst Michael Pachter, but investors are getting impatient with two straight years of missed estimates and a prolonged restructuring that even CEO John Riccitiello admits is "taking longer" than EA expected. The publisher's stock has plunged 7 percent to $16.98 (as of press time) on the bad news.
"In our view, the company has excellent assets, but continues to spend too much money in creating and marketing them," says Pachter. The analyst says EA's core publishing unit (excepting digital distribution) will earn more revenue than Activision Blizzard's -- but its profits will be only about 35-40 percent of its rival's in that area.
"Some portion of the difference is attributable to the fact that Activision has a blockbuster franchise in Call of Duty: Modern Warfare 2, but a large part of the difference is attributable to EA’s sharply higher cost structure," says Pachter.
So Electronic Arts' misses are less to do with the shape of retail and more to do with its cost structure and management, Pachter claims.
"We think that EA management is somewhat shell-shocked by its second holiday pre-announcement in two years, and think that the negative industry growth forecast was made out of an overdeveloped sense of vigilance about not making the same mistake for three years in a row," he says. "We think that management is just plain wrong about the industry’s growth prospects."
Lazard Capital Markets' Colin Sebastian says that the publisher's oft-stated three-tier strategy -- cost cuts, fewer SKUs at higher quality, and an increased focus on digital business -- should help it drive profitability again. However, Sebastian also thinks it's wise to be conservative on the industry's prospects as a whole.
When it comes to EA's belief that game industry growth will be flat to down 5 percent in 2010, analyst opinions vary. But the prevailing concern regarding the publisher is that investors will too heavily weigh EA's estimate misses and negative opinion of game retail -- something which would impact other publishers.
"Investors are likely to remain skeptical about the industry in general and EA in particular until they see evidence of industry growth and evidence that EA can participate in this growth," says Pachter.
"The industry faces relatively easy comparisons beginning in March, and we expect double-digit sales gains in that month and in each month thereafter through year end," he adds. "EA has demonstrated a poor ability to forecast, so it is not clear that investors will embrace the stock until they see evidence that the company is participating."
In his own note to investors, Cowen's Doug Creutz is less optimistic on Electronic Arts' chances going forward: "We continue to think EA has missed the current hardware cycle and is unlikely return to historical operating income margin levels," he says.
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There is a saying that a farmer can't tug on his crops to make them grow faster. How is that different with games? Like many R&D undertakings, they usually go at the speed they need to go at.
In such a case, probably the best possible strategy is to just minimize burn in all ways possible. This is what the film industry learned - why the big studios maintain little internal infrastructure (which eats up overhead between production cycles). The game industry is just starting to learn this.
There is an enormous lack of imagination in the industry by using such 3D tools and expertise only for games. User interface in Deadspace was awe inspiring. And there are other applications I'd love to game development talent take a crack at making look much slicker in terms of user interface, see the developers of this awesome productivity software like TheBrain.com
It seems like the inverse. The games industry needs to take lessons learned from the more traditional software industry, where the topic of estimating and managing costs has been discussed for about ~50+ years now.
You don't merely focus on managing costs, you find ways to profit off existing assets that you've already invested in. Many game assets are "fire and forget" (not continuously profitable) where as looking towards other industries for more consistent revenue streams would help 1) Keep your people busy and employed 2) expand revenue base 3) give you more flexability since technology to reduce costs and speed up development takes an enormous time to develop, on the order of decades.