Source: google images
5 days after we last wrote our Electronic Arts(EA) article in late-January, EA reported its Q3 2019 results and its stock plummeted nearly 20%, in what would be the worst drop since 1999. The catalysts in our article played out perfectly – BFV missed expectations, as expected, and digital sales were significantly lower than expected.
That was the end of it, we thought. However, EA quietly released a new game, Apex Legends, in early February. The success of Apex Legends has caused EA stock to rebound significantly, from near $75 to over $106 at one point.
The problem – Apex Legends had very little to do with EA. EA is still its same old self, as its later release, Anthem shows. Just look at the user scores for its recent games excluding Apex Legends:
We believe investors should run, not walk, away from EA. EA is setting itself up for a massive collapse.
Q3 2019
Q3 2019 was a disaster. Its hard to describe in words how bad this was, so we’ll use charts instead.
Source: EA’s Q2 2019 investor presentation
This was guidance for FY 2019 given in Q2 2019. Revenues were guided to be flat and operating cash flows were guided to be slightly down. It gets a lot worse, however…
Source: EA’s 2019 Q3 investor presentation
This is the guidance given in the most recent earnings call. As you can see, revenues are now guided to be down nearly $300mil from the already low Q2 revenue guidance, with most of the decline being in digital. OCF is also guided to be down about $300mil, or nearly 20%. Most bulls that were expecting solid growth were greatly disappointed.
A disastrous earnings call
The conference call was probably the most interesting part of Q3 2019. Management made many alarming confessions and continued to refuse to take the blame for their actions.
Firstly, management started off on Battlefield V:
Unfortunately, the later release date meant the game launched deeper into a competitive holiday window where heavy price discounting was a big factor. In addition, we also made the decision to prioritize other features, including a single-player experience, at launch over a Battle Royale mode. This year, Battle Royale modes became incredibly popular in shooter games. As a result of these decisions, we struggled to gain momentum and we did not met our sales expectations for the quarter.
All quotes in this segment is from the Q3 earnings call
So instead of admitting that they had made serious marketing and PR mistakes, like Patrick Soderland telling players not to buy the game if they don’t like it, or the fact that they tried to appeal to a small group of social justice warriors while alienating the core fanbase, they blamed it on Battle Royale not being released. I think the ignorance in that statement is astounding. Even random commenters seem to know more than management:
Source: Youtube
This is the most out of touch management we have ever seen in our entire investing career. Despite massive consumer backlash and a sales miss, EA management still refuses to listen to customers. It should come as no surprise that BFV missed sales expectations by a large margin:
As a result, we sold 7.3 million units in the quarter, about 1 million less than comprehended by our Q3 guidance.
We believe investors should avoid companies like EA that have extremely out of touch management who can’t comprehend what their customers want.
Next, management touches on mobile, specifically on the recent launch of “Command and Conquer: Rivals”:
With our latest release, Command & Conquer: Rivals, we had positive soft launch results, but since global release it has not driven installs organically at the levels we anticipated.
For those who don’t know, C & C Rivals used to be an old PC franchise that EA had received after buying Westwood Studios a while back. The series had been stagnant for a while until EA decided to unexpectedly launch a mobile game in 2018. Unsurprisingly, fans of the series were outraged, and one prominent influencer likened it to “defiling a corpse”.
This move seems quite similar to what Activision Blizzard(ATVI) did when they announced “Diablo Immortal”, which caused its stock to drop 7%. Like Diablo Immortal, the trailer for C&C Rivals got significantly more downvotes than upvotes.
Source: EA’s Youtube channel
It should come as no surprise then, that the franchise missed expectations. If gamers don’t want it, they won’t install it.
Next, EA talks about the FIFA franchise, which they mentioned was “robust” despite sales being effectively flat YOY, even with heavy 50% discounts on Black Friday like we mentioned in our last article.
The conversion has been slower than planned, leading to unit sales that were effectively flat year-over-year.
Again, this is a prominent red flag for those who are expecting perpetual growth from EA. If its most robust franchise is flat, what about the less robust franchises?
Management also confessed that mobile, which is one of the strongest growth areas in gaming, will be down:
We entered the year expecting strong Mobile growth, but a combination of a delayed game and underperformance means the business will end the year down.
Mobile delivered net bookings of $142 million, down 22% year on year, with declines across our portfolio. We had made some changes to Madden Mobile in order to broaden its appeal, but monetization fell. We continue to work to turn this around.
Overall, this call just shows that the EA growth story, which is what its premium valuation rests on, may be history. Caveat Emptor.
Anthem – The incoming failure
Those who think that Anthem has learned from Battlefield V’s fiasco may be in for a nasty surprise. Anthem has already copied Battlefield V in one area: A confusing release schedule.
Source: Gamerant
Source: EA
Despite the fact that the Battlefield V release schedule did not drive subscriptions and was a massive source of player backlash, EA added this to Anthem. Clearly EA management needs to rethink their subscription strategy, instead of digging their hole deeper:
Battlefield V drove fewer Origin Access Premier subscriptions than we had hoped, given the difficult launch of the game.
It doesn’t help that EA is already receiving massive criticism from influencers on social media platforms due to this convoluted release schedule.
Source: Youtube
Source: twitter
Instead of increasing subscriptions, many who saw the chart were actually refunding their pre-orders and cancelling subscriptions. EA did issue a response, but we’re doubtful that helped the situation much, considering it only pushed blame to Sony, but did not solve the problem. EA’s terrible release schedule is a classic example of picking up pennies in front of a bulldozer.
After this, EA has also faced controversy surrounding Anthem microtransactions after a picture of a $20 skin was leaked. A Bioware developer did respond, saying that its just an iteration, but again, this caused unnecessary backlash.
EA has stated in the conference call that they expect to sell 5-6mil units, but we highly doubt that they can do it at full price due to multiple reasons we’ll discuss below.
In terms of Anthem outlook, I think I mentioned five to six million units which is consistent with how we thought about it last quarter and we are comfortable with that based on what we’re seeing and outcome of the demo.
Source: Q3 conf call
Now that Anthem has officially been made available to the public, we can get to the juicy details.
So far, every large influencer we view on Youtube has posted negative reviews regarding Anthem. Here are some of the highlights, which in total have garnered millions of views:
Source: Youtube
Note that these reviewers are not average players. They buy the game specifically to play it and review it and are experienced gamers and reviewers. In the case of Anthem, some of these reviewers have played the game for tens of hours before giving their review. Needless to say gamers take these reviewers seriously and may avoid the game if the reviewers give a negative review. These few videos alone probably have cost Anthem tens of thousands lost sales.
Some highlights include:
– The Bioware genius that linked story and gameplay is completely shattered here
– I’ve played 20 years of looter games and I’ve never experienced something as repetitive as this
– Fort Tarsis is one of the most depressing hubs I’ve ever seen in my life
– Avoid this game, it isn’t even worth a fraction of its $60 price tag right now
– Its a damn loading screen simulator
One significant problem pointed out by commentators is that Anthem encourages team gameplay BUT only the person who kills the enemy/opens the chest gets the reward. Seems quite conflicting to us.
Interestingly, even one PAID reviewer by EA gave a negative review of this game. That’s how bad this game is.
Online reviews are not glowing either. The only positive review is from Tech Advisor. The review score from Metacritic is interestingly even lower than Battlefield V’s review, and we all know how that turned out.
Recently, Metacritic reviews have dropped even lower to an astonishing 61% and user reviews are equally dismal at 3.8.
At best, Anthem seems like a mediocre game. If Bioware doesn’t take action and fix the game, this may become the next Fallout 76, a game with significant amounts of bugs and terrible gameplay released last year. 5-6mil is a modest target, but with these kinds of reviews, EA might need to discount Anthem to reach that number.
With plummeting reviews and a disgruntled userbase, Bioware may be at risk of being shut down. Well, this would only be the 15th studio EA has shut down.
Source: google images
The worsening lootbox situation
In our last article, we made the case that lootbox regulation may be about to catch up to EA. At that time, EA was facing a legal battle with Belgium around whether the sale of FIFA points should be banned in Belgium. It seems like EA has lost this battle. FIFA points are used to purchase FIFA card packs, which are essentially randomized lootboxes.
Around the time we published our article, EA released a form 8-K that notified investors that:
After further discussions with the Belgian authorities, we have decided to stop offering FIFA Points for sale in Belgium. We’re working to make these changes effective in our FIFA console and PC games by January 31, 2019. This means that players in Belgium will not be able to purchase points to obtain FIFA Ultimate Team packs.
Source: Form 8-K
Despite EA’s assurances that the impact of this will not be material to their financial performance, there is no doubt that EA’s FIFA Ultimate Team, or FUT, is one of their largest sources of revenue, as disclosed by CFO Blake Jorgensen in a 2017 interview.
We are not law experts, but with this law passing, EA’s FUT revenues around the world could be at risk as more governments consider further banning lootboxes.
Apex Legends – Overhyped
Apex Legends is a game EA released in early February. It was a 3rd person shooter battle royale type game set in the Titanfall universe. It was free-to-play, but even for a F2P game it was quite successful. Today, the game has reportedly reached the 25mil player mark, with close to 2mil concurrent players. Fortnite Battle Royale, which we’ll call Fortnite, in comparison, took 2 weeks to reach that milestones. No doubt investors saw this and came queuing up to buy EA stock, pushing the price up from ~$75 to around $96 as of today, or a ~$6.3bil move up in market cap.
Looking at Fortnite’s revenue, its easy to see why investors were so excited. Fortnite reportedly made ~$2.4bil in revenues last year. If Apex Legends could reach that level, it should be worth ~$11bil using Activision’s revenue multiple of 4.5x revenues.
We believe though, that investors shouldn’t count their chickens before they hatch. Apex legends is already richly valued and is fundamentally different from Fortnite in many ways, which makes us believe it will reap less revenue than Fortnite.
1. Fortnite already is a mature game with great execution – Fortnite has been out for almost a year and has near perfect execution so far. It has outsmarted competitors like PUBG and the deluge of other Battle Royale clones that have entered the market and failed and there’s no reason it can’t outsmart Apex Legends as well. Epic knows its game very well and has more than a year of experience testing and refining the game to please players. Even after a year, millions of people still play Fortnite every day.
2. Fortnite literally appeals to everyone – The bright colors and the inclusion of trends makes Fortnite addictive for adults and children, male and female alike. Apex Legends, meanwhile, looks like a more “adult version” of Fortnite. Although there is major growth at the start, we believe that market saturation will soon be reached as there is no way that Apex will have the same TAM as Fortnite with its darker colors and less family friendly content. Top pic: Apex Legends, Bottom pic: Fortnite
Source: Youtube
3. The Store – Apex Legends and Fortnite both have a cosmetics store, selling different items for game currency that can only be bought with real life cash. Note that Fortnite V Bucks are worth the same as Apex coins.
Source: Youtube
One Forbes writer wrote a scathing review about the store, noting the overpriced items and the limited selection in particular. Another concern was raised about the fact that skins were being sold at around the same price despite the fact that Fortnite players get much more value for their skin compared to Apex Legends skins. This is because Fortnite is a third person shooter where the player gets to see his/her avatar for pretty much the whole game, whereas Apex Legends is a first person shooter where players only see their main character for a few seconds when the player spawns. The 2 pictures below show gameplay of Apex Legends and Fortnite respectively. Note how in Apex Legend, one cannot see his/her own player character. In Fortnite, meanwhile, one can easily see his/her own character, making skins immensely more satisfying to use in Fortnite.
Source: Youtube
EA also seems to have made a major blunder by deliberately using sneaky tactics to get players to spend more, which were easily discovered by influencers. Also, the items high prices are leading to player complaints, like in this reddit thread. The Valentines Day cosmetics, for example, despite including no skins, cost over $10 apiece. Could EA’s greed be leaking into Apex as well?
4. Culture clash – Despite the fact that EA was the owner of Respawn, which developed Apex Legends, EA actually had very little to do with the creation of Apex Legends. According to an interview with a Respawn employee, EA actually had very little to do with the game. In fact, Respawn had to argue with EA’s executives to implement some changes. So for those who are wondering if Apex’s success can be replicated, well, probably not without a major culture change. To make it worse, there is a chance that EA’s executives may, in the search for more money, screw up Apex’s successful launch by interfering with Respawn. Why do we believe this? Firstly, EA has a track record of buying studios and then shutting them down due to internal disagreement. Respawn may be next on the chopping board if Apex monetization comes in below expectations. Secondly, this kind of culture clash has happened before, leading to massive shareholder value destruction. We’re looking at you, Activision Blizzard(ATVI).
So, considering the fact that Apex Legends is priced for perfection, with already a $8bil valuation, and the fact that there’s a high chance it would not be as successful as Fortnite, we believe the move up in the stock price is unwarranted and may be a good opportunity to sell the stock. After all, is Apex Legends really worth 1/4 of Activision Blizzard?
EA’s future pipeline
Other than Anthem, EA has a slate of new updates and IP planning to be released. We’ll give our opinion on all the major ones.
Battlefield V Firestorm – This is Battlefield V’s battle royale mode, going to be released in March. The problem? Apex Legends. The success of Apex Legends will heavily cannibalize this BR gamemode. Combine that with BFV’s terrible reputation and you can see why we’re skeptical that this gamemode will help increase sales significantly.
Star Wars Jedi Fallen Order – Given EA’s track record of EA failures regarding Star Wars games, we’re not too optimistic. Furthermore, since this is a single player game, we’re even less optimistic about the amount of digital revenue growth this can bring.
The competition
While EA is screwing up, its competition has been hot on its heels. One studio, CD Projeckt Red(OTC:OTGLF), is creating a singleplayer RPG named Cyberpunk 2077. The teaser trailer is receiving more views than EA’s Anthem trailer, and is much more widely loved by the gaming community, as you can see from the like:dislike ratio.
Source: Youtube
CD Projekt Red has a stellar reputation among gamers, and it would not be surprising if gamers withheld money from Star Wars Jedi Fallen Order to buy Cyberpunk 2077.
Fortnite is not sitting idly either, recently giving players the chance to earn a free battle pass if they complete challenges. Epic Games has also given out details of its Fortnite World Cup, with an impressive $30mil prize pool. Thats some serious incentive for players to switch back to Fortnite from Apex Legends, which neither has a battle pass nor an esport. As seen from this twitch screenshot, Fortnite is already catching up to Apex in twitch views after at one point being 3x lower than Apex in viewer count.
Source: twitch
Competition in mobile is fierce too, with upstarts like Gluu Mobile(GLUU) releasing hit titles and with incumbents like Activision Blizzard reportedly working on mobile games for all their IPs.
Insider selling continues
Source: Insiderinsights
Ever since the stock rebounded after the earnings call, insiders have continued to sell EA stock. Sales from Feb 12 to Feb 20 are around $5mil so far. Although some commenters believe insider sales are normal now due to the mass granting of stock options, we still see insider sales as a net negative, especially when they occur in these numbers. After all, if EA is going to double in a year, why would insiders sell so much stock?
Recent developments
EA recently laid off 40-50 people at their Australian studio, FireMonkey. Although this number sounds small, it represents a quarter of the studio’s staff. This definitely does not bode well for future growth or the stock price, as Activision’s layoffs have shown.
EA has also won an award! EA’s CEO was featured in an annual overpaid CEOs list after releasing multiple failed games and lowering guidance several times.
Conclusion
EA is honestly not much better off than it was at $75. Apex is definitely not a flop, but we feel confident saying that it won’t be the next Fortnite in terms of revenues. Anthem reviews so far have been below even my low expectations, and competition is just as strong as ever. Insiders continue to sell large amounts of stock, and layoffs only strengthen our point that EA’s growth story is over. EA has been a colossal failure for shareholders and gamers alike, launching an impressive amount of failures in 2018 alone. Avoid EA.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
