Being a hot games producer one year does not mean you are going to make it the next year. Take Electronic Arts, they have churned out many a hot game but as the games industry takes off they are starting to struggle.
In March 2005, Electronic Arts was at the top of its game. Its stock was at an all-time high, its sales were expected to top $3 billion for the first time, and it was the clear leader in the video game software industry.
Two tough years later, some investors and analysts are wondering when – or even if – the company can return to form. The video game publisher has struggled with stagnant sales, a falling bottom line and a flat stock price.
Investors have banked on EA’s ability to turn its growing research-and-development investment into future gains. They expect EA’s R&D spending to level off while sales increase, sending more money to the bottom line.
EA has been here before. The video game industry is going through one of its regular transitions to a new generation of hardware. The company has struggled in past shifts only to emerge stronger than before, EA’s fans say.
“This transition does seem to be a bit more painful for EA,” said Todd Greenwald, a financial analyst with Nollenberger Capital Partners in San Francisco. But he added, “EA is the 800-pound gorilla. They’re always going to be dominant.”
Some analysts and investors are beginning to question this upbeat outlook. The biggest problem: the surprising early dominance of Nintendo’s Wii in the latest round of the console wars. It’s no coincidence, they say, that EA emerged as the top game maker at a time when Sony’s PlayStations dominated the game console market. The threat that the Wii now poses to Sony’s dominance is bound to affect EA as well, they say.
“It has huge implications,” said one industry consultant, who asked not to be named. “Nintendo will return to its historical position as the No. 1 hardware and software vendor and will leave everyone else fighting for second place.”
EA has to find a way to adapt to that new world, but that’s not easy given the company’s size and its need to change how it develops games to succeed in a Nintendo-dominated world, some analysts say.
“The challenge is it’s such a big ship,” said the industry consultant. “How do they navigate the water quickly?”
EA officials blame the company’s recent problems on the complexity of the transition. Not only has the company been developing games for about 11 different platforms during the transition, but there also are multiple emerging opportunities in the industry, from the growing market for games in Asia to in-game advertising to games for mobile phones, said company spokesman Jeff Brown.
While EA was late to recognize the potential of the Wii and Nintendo’s DS handheld, it’s been ramping up its development efforts for both, Brown said. Meanwhile, the company has also been investing in many of those new areas of the game business, he said.
Company executives seem to recognize that the company needs to change how it does business. Brown said the management team is “discussing organizational changes,” details of which could come as early as this week.
The changes would come some four months EA named John Riccitiello as its new chief executive replacing longtime head Larry Probst, who was named executive chairman. On a recent conference call, Riccitiello indicated that he planned to shake things up at the company, saying he wanted to improve “execution and predictability” and to “align our team for increased accountability, agility and speed to market.”
“No other company in the industry has as many sails up as EA,” said Brown. “When the wind starts filling those sails, you’re going to see us move.”
Transition trouble
In some ways, EA’s troubles aren’t unexpected. The transition to new generations of game hardware usually are troublesome for software vendors. That’s because they typically invest in developing games for the new consoles long before sales of the machines take off.
But this time, analysts and game makers expected an easier time. Companies such as EA promised to continue to develop games for outgoing platforms longer than they had in the previous industry cycle. Sales from those games as well as for two new handheld systems, Nintendo’s DS and Sony’s PlayStation Portable, were supposed to help bridge the gap during the shift from older to newer generations of game consoles.
But things didn’t work out as expected. Sony’s PSP saw limited demand. Although games for Sony’s older PlayStation 2 continued to sell, development costs for the new consoles skyrocketed, eating into company profits. And when the new consoles arrived, fewer than expected made their way into consumers’ hands because of supply problems, demand problems or both.
For the industry, the result has been a longer than expected transition. For EA, it’s meant that sales have grown at an annualized rate of just 1.5 percent over the last three years, its research and development costs have more than doubled during that time period, and its profit has fallen by more than half.
“They have to improve their performance. That’s all there is to it,” said Dan Scalzi, CEO of asset management company Matrix USA, who has a “strong sell” recommendation on EA’s stock.
Few expect immediate improvement. Earlier this month, for instance, Warren Jenson, EA’s chief financial officer, forecast tepid sales growth, a continued rise in research-and-development costs and a worse-than-expected bottom line for the company’s new fiscal year.
EA will probably struggle until the new game consoles are in the hands of a critical mass of consumers, which probably won’t happen for another year at least, analysts say.
But once there’s a large enough user base of the new consoles, EA’s sales should start taking off. And because the company has already paid up-front for developing the basic technology to make games for the new platforms, its costs should decline and earnings should soar.
“I’m disappointed in EA recently,” said Dan Ahrens, who manages the Ladenburg Thalmann Gaming and Casino Fund. But he added, “I’m a big believer in EA for the long term.”
`Madden NFL’
But others have their doubts. EA grew into a powerhouse by developing games such as “Madden NFL” and FIFA soccer that it could update and sell every year and easily transfer to multiple game machines.
It focused on targeting core gamers who want realistic graphics and the latest, greatest games. And many of the new market areas that EA is investing in – such as in-game advertising and add-on content – are those that cater to those gamers.
That strategy may not work so well if the Wii is the dominant console, a distinct possibility as the new Nintendo machine outsells its rivals from Microsoft and Sony.
The games that tend to do well on Nintendo’s machines tend to be quirky, not the ones players can get on any console, analysts say. And while Nintendo has been courting the core gamers, it’s been doing so through offering a different game experience, rather than through mind-blowing graphics.
“This does even the playing field a little bit. Other (game makers) are geared toward the Nintendo platforms,” said Billy Pidgeon, a video game analyst at IDC.
But EA can adapt if consumers continue to favor the Wii, some argue. The company plans to release 10 to 13 games for the Wii this fiscal year, up from six in the last one, Brown said. Already last month, EA’s Wii games outsold those of any other company except Nintendo, Brown said.
“We didn’t anticipate the popularity of the Wii, but we moved very quickly to get into position on that,” he said.
And with sales of the Wii still in their early stages, EA has plenty of time to ramp up for it, said a second industry consultant. But the company’s rebound is going to take just that: time, the consultant said.
“It’s going to happen. None of these things can be done overnight,” the consultant said.
Story written by Troy Wolverton San Jose Mercury
