Electronic Arts – Revenge of the Nerd

Courtesy of Vitaliy Katsenelson.

I wrote article for Institutional Investor Magazine article about Electronic Arts in May 2012.  My monthly column limits me to 800 words (you can read it here), but here is a longer, unabridged version (I forgot to post it here).  I had the pleasure to present EA at the FAME conference in San Francisco in late April, and here is a link to the presentation (we obviously have a position in EA).

Electronic Arts – Revenge of the Nerd

Electronic Arts stock is scratching 52-week lows.  It is unloved, but for some good reasons: its sales have stagnated for years; its earnings, though rising, are still below the 2003 level; and finally, industry-wide sales of packaged video games were down an apocalyptic 25% in March, and they’ve declined four months in a row.  On the surface there are plenty of reasons to hate this stock, but once you start unpiling all the negativity you discover that EA is a compelling growth company trading at a significant discount to its fair value.

EA’s past is ridden with brilliant successes that lead to subsequent arrogance.  It was the largest video-game maker in the world in the 2000s; and, like many successful companies, it started to treat its success as an entitlement, not as a hard-earned victory.  In the mid-2000s it started to make too many games, and the quality of its games drastically declined.  To make things worse, Nintendo came out with Wii, less powerful then Sony’s or Microsoft’s high-definition system, but instead of a joystick it came with motion control.  Since Wii was underpowered, EA did not expect it to be a success and did not develop many titles for it.  When Wii became an overnight success, EA had to catch up.

Over last few years EA regained its focus and cut down the number of games introduced every year from 52 to a dozen.  The quality of EA games improved dramatically.  On the surface it looks like EA’s sales have stagnated for years, but they have not.  EA has been winding down the distribution of games made by other publishers, and so low-margin distribution revenues declined from over $600 million a few years ago to about $200 million today, masking healthy growth in EA’s core games business.

A four-month decline in packaged games sales sends shivers through investors, but it should not.  The bulk of…