Electronic Arts (ERTS) reported a solid FQ4, but its FY09 guidance stunk. Specifically, management guided EPS to a range between $1.30 and 1.70, below the $1.73 analysts were looking for.
In response, a startled Goldman Sachs slashed its F2009 and F2010 non-GAAP EPS estimates to $1.55 and $2.50 to reflect the lowered expectations. It maintained its Buy rating, however:
We maintain our Buy rating and don’t believe the F4Q08 results or initial FY09 EPS targets provide sufficient basis for the incremental investor to either buy or sell the stock. Rather, we think the bulls can point to the 28% yoy incremental implied operating margin, the now 15 (vs. 14) new IP still slated for FY09 with 35 more SKUs yoy, and a step on the path toward the FY’11 operating targets. Bears can, and likely will, point to reduced FY09E EPS, no R&D leverage in FY09, another layer of complexity in analysing the underlying performance (timing shifts) and a shift to the stock being a 2H08 and “show-me” investment story.
We believe the former will outweigh the latter given solid results over time, as market was braced for conservative targets and about $1.50 in FY09 EPS. 1HFY09 losses will be higher vs. previously estimated, but we note that the timing of EA’s revenue simply tracks the title release schedule, which ramps in significantly in F2H09.
Goldman is especially excited about ERTS’ prospects in the international market, where it believes it can gain share:
We believe that Electronic Arts’ increasing international exposure will yield material incremental revenue and operating margins in leveraging top-selling franchises overseas. Given relatively fixed development costs, additional unit sales deliver attractive contribution margins. Ultimately, we believe the company should be able to derive half of its revenue from outside North America versus about 48% in F2008 and 42% in fiscal 2007.
Also, as gamers become more comfortable with micro-transactions online (lower-priced purchases of game updates and upgrades), ERTS’ competitive advantage in connectivity will drive revenue expansion:
Electronic Arts’ exposure to online connected platforms will enable it to realise new revenue opportunities such as online gaming, digital distribution, advertising, and micro-transactions. Although the ultimate size and timing of any impact is debatable, it is difficult to argue with the ultimate ability of these new streams to balance and diversify Electronic Arts’ revenue. Online connectivity has also enabled publishers to engage in smaller-scale digital transactions with gamers. We believe that micro-transactions will continue to gain popularity, driven by purchases of game upgrades, new levels, and personalised features.
GS maintains its BUY rating and $60 price target.
Business Insider Emails & Alerts
Site highlights each day to your inbox.