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The Science of Hitting
The Science of Hitting
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Electronic Arts: A Strong Start to Fiscal 2019

A look at the video game company following quarterly results

August 13, 2019 | About:

At the end of July, Electronic Arts (NASDAQ:EA) reported financial results for the first quarter of fiscal 2020.

For the period, net revenues increased 6% to $1.21 billion. Over the trailing 12 months, net revenues were $5.02 billion, an increase of 4%.

Growth in the quarter was led by Live Services, which increased 20% to $731 million. Over the past year, Live Services has grown by 11% to $2.5 billion. The increase in the quarter was led by Apex Legends (helped by the launch of Season 2 in early July), The Sims 4 and a mid-single-digit increase (11% in constant currencies) from FIFA Ultimate Team (FUT). As shown below, the company’s Live Services revenues have increased significantly in the past five years:

As CEO Andrew Wilson discussed on the call, Apex Legends is doing well for Electronic Arts:

“We have a massive global audience continuing to engage in this high-quality free-to-play experience. Apex has tremendous gameplay at its core and we've built it to have longevity as a live service that will continue to drive engagement over time … we're delivering a collection of new content and updates that begin to roll out at the start of each season and continue throughout the course of several weeks and months. We launched Season 2 in early July, including a robust Battle Pass offering, a new character and additions to the environment. And to date, it had outperformed our expectations with significant growth in daily and weekly active players. In each season, there are in-game events that are additional drivers of engagement such as the event coming in the next few weeks that will bring new content and deliver one of the most fan requested features since the launch of Apex. There will be more updates and in-game experiences in the weeks to come for Season 2 and Season 3 is shaping up to be even bigger.

All of these elements, the fantastic core gameplay, seasons of new content and additional in-game events are designed to continually excite and engage the Apex community over the long term. We're also expanding into additional growth opportunities for Apex Legends. Esports will bring new drivers of social interaction and competition to the Apex ecosystem. Interest from teams, broadcast partners and sponsors is strong and we've had great success with our first exhibition event, including a competition at the ESPYS that was broadcast on ESPN and ABC.”

In addition to in-season developments, Electronic Arts is working to bring the free-to-play franchise to China, as well as hold a worldwide mobile launch (both of these are likely to be fiscal 2021 events).

Gross margins expanded by roughly 240 basis points in the quarter, reflecting continued mix shift towards digital downloads (roughly 47% of unit sales over the past year, an improvement of seven points) and a good job controlling costs around services like Apex Legends.

At the end of the quarter, Electronic Arts had 299 million diluted shares – a decrease of 3.5% over the past year. Over the past twelve months, Electronic Arts spent nearly $1.2 billion on repurchases, or 75% of its cash flow from operations. As shown below, repurchases have become a significant use of cash at the company in recent years:

After accounting for capital expenditures, Electronic Arts is likely to generate nearly $1.5 billion in free cash flow in fiscal 2020 (roughly $5 per diluted share).

The company held $5.2 billion in cash and equivalents at quarter end, compared to $1.0 billion in long-term debt. As the business mix continues to shift towards Live Services over the years, management may become more willing to use some of the excess liquidity that they currently hold on the balance sheet. Considering that net cash is currently equal to roughly 15% of the company’s market cap, that could be a nice tailwind for shareholders.

Conclusion

As I noted in June, this is an profitable time for Electronic Arts and the industry. Cloud gaming, subscription services, eSports and free-to-play presents both risks and opportunities.

The double-digit constant currency growth from FUT in the first quarter points to the strength of Electronic Arts' core sports franchises. I do not own the stock currently, but there’s a good chance that will change in the near future.

Disclosure: None. 

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About the author:

The Science of Hitting
I'm a value investor with a long-term focus. My goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio - a handful of equities account for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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