“Electronic Arts slashing jobs and closing down several studios. It is reporting its 11th straight quarterly loss. Second quarter loss of $391 million. It expects to turn a profit in both the third and fourth quarters.” — Fox Business Network Imus in the Morning 11/9/2009
Electronic Arts (ERTS), the second largest video game producer, released second quarter earnings after the bell last night that were very disappointing. While revenues grew by about 2%, which was ahead of analysts’ expectations, costs remain a problem and dragged the company to its 11th straight quarterly loss. Excluding one-time items the company made six cents per share but was still below analysts’ expectations. In addition, EA has announced sweeping cost control measures and restructuring efforts in order to attempt to reign in expenses. They will narrow their game offerings by a third in the year ahead, but more importantly there will be a major job cut of 1500 jobs or nearly 17% of the company’s headcount. This is the second major reduction in their workforce in the last 14 months. The company said that they expect restructuring to cost about $150 million next year, but that it will provide $100 million in savings annually.
It is undeniable that the video game industry is in a very tough spot, and retail sales in the U.S. have slid 13% through the first 9 months of the year. The 13% decline year to date was also seen in perhaps EA’s most important game franchise, the Madden series. However, it is no surprise that the holiday shopping season is always a vital one for the industry. At Ockham, we are concerned that the upcoming holiday spending will once again be subdued, even if comparisons to weak sales last year may be favorable. Management guided the market with a wide range of possibilities for the important quarters ahead, saying the company expects fiscal 2010 profits (ending in March) will come in from $.70 to $1. This is clearly a step back from the previous guidance of $1.
The results, released after the bell on Monday, actually sent the stock higher initially in post market action, but on Tuesday the shares are trading down 6.5%. We currently have the stock rated as Fairly Valued because the stock has fallen pretty much as we would expect given the weakening fundamentals. As value investors, we always like to find stocks that have fallen out of favor with the market, but are due to rebound. From a price-to-sales perspective, we see ERTS as moderately attractive as it currently trades below its historically normal price-to-sales range of 3.4x to 6.0x. However, if a company cannot generate profit it has substantially less value to us, and that is really what is holding the stock back in our view. Management did say that they expect to be profitable in the next two quarters, so if you believe that the industry has hit rock bottom it could be a chance to grab this stock for a song. We would wait until the stock dips below $17 before we view this as an attractive buy candidate.