AGB 2024.3 - Electronic Arts (EA)
Sports and Licensing Leads to Consistency
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Electronic Arts
“A game is no longer a six-week experience. It's a six year experience. And we're trying to design games that allow people to go deep into things that they love and play them for a very long period of time. And by the way, for $60 you're going to get entertained for the next two years or three years, that's a pretty good deal. I can think of no entertainment medium, like if you go to a movie today, you're going to probably spend $20 to $40 before you buy the popcorn. And that's a short experience compared to the type of experience you're seeing in the games.” – Former CFO, Blake Jorgensen at the Credit Suisse Global TMT Conference Nov 2017
Electronic Arts (EA) is one of the largest developers and publishers of video games. The company owns or licenses some of the largest brands in the industry including Apex Legends, Battlefield, The Sims, EA Sports (Madden NFL, Sports FC, Formula 1, UFC, etc.), Star Wars, Mass Effect, Need for Speed and others. Players access EA’s games on all platforms including console (60% of revenues), PC (23%) and mobile (17%).
The business model for video games has evolved over time, but for the most part it still remains the same at its core. A company hires a team of developers to create a video game in one of the many popular genres like sports, racing, first person shooter, action, platform, role-playing, simulation, fighting, puzzle, adventure, strategy, etc. Then they partner with a publisher to help with marketing and distribution (and sometimes financing) of the game on the various platforms. This was the only viable method for distribution when players could only access games through the purchase of physical disks/cartridges at retailers.
Over the past decade+, the shift to digital has had a significant impact to the industry. First, the distribution model found another avenue to get the game to the player. Whether on the PC or console, players could now download copies of the game directly without having to get the physical copy of the game from a retailer. This was made possible due to improving download speeds and cheaper costs for storage. Digital distribution also allowed for the developer to extend the life of a game by providing additional content after a game’s initial release. Downloadable content or DLC was great for both developers and players because developers could earn more money for little incremental development costs and players could access more content for a game they already liked to play.
Second, digital also allowed for smaller developers to release games that weren’t AAA titles that required large budgets. On any of the online platforms (Xbox Games Store, PlayStation Store, Steam, Epic Games Store, etc.), there are many games for sale that don’t retail at the $60 or $70 price point, and it’s usually made by lesser-known studios. In the past, this was difficult because you had to charge AAA title prices to make a profit due to the distribution model.
Third, digital resulted in much better economics for the developers. Over the past 15 years, the margin profiles for many of the large studios have improved dramatically. This is because retailers have been removed from the value chain and physical copies (and packaging) don’t need to manufactured. It’s estimated that publishers make $7-$10 more in gross profit for each full game download vs. a physical sale. There is usually a platform fee associated with a digital download but you don’t have the retailer, packaging, sales allowances (physical copies usually go on sale quicker due to inventory management) and royalties paid to the console makers. Downloadable content has even better margins than full game downloads because development costs are much lower. It’s estimated that DLC purchases result in operating margins of 60% vs. 20%-45% for full games.
The broader market for video games is fragmented and competitive. This is even more the case when including mobile games. While there has been some industry consolidation in recent years, (Microsoft acquiring Activision, TakeTwo acquiring Zynga, Microsoft acquiring ZeniMax, etc.), the top 10 publishers command just over 30% of the market. Not only do video game developers have to make a good game that players want to play, they also have to compete with other successful game launches and existing games that have long lasting loyal fan bases.
Some might consider the hit driven nature of developing individual titles unappetizing, but this is less pronounced among the larger publishers. This is because existing IP and an established fan base can result in very predictable revenue streams each year, especially ones that come with an annual release schedule like sports. The key is to own a collection of development teams or studios that can produce both the next hit from a popular series of games and create new IP that can add to the developers’ collection. EA owns well renowned studios in the gaming industry such as BioWare (Mass Effect, Dragon Age), Criterion Games (Battlefield, Need for Speed), DICE (Battlefield, Star Wars), Maxis (Sims), Respawn (Titanfall and Apex Legends), and Codemasters (Formula 1). And the company has over 700M registered players (half of which is for EA sports) within their network of games that subscribe to a service.
There are two subtle differences between EA and other large game publishers. The first is that EA focuses more on licensing than other publishers, which allows the company to have the largest sports franchise in the video game industry with Sports FC (formerly FIFA), Madden NFL, UFC, Formula 1, NHL and PGA Tour and Star Wars. Among the top 10 earning PC and console games released in 2023, EA’s games accounted for 3 of them, #5 EA Sports FC 24, #6 Madden NFL 24 and #8 Star Wars Jedi: Survivor. All three are based on licensed IP.
The second difference is that more of EAs annual bookings come from the sports genre, which are released on an annual schedule. While this may go against the idea of digital extending the life cycle of games, EA’s sports titles can almost be considered annual installments to existing games with a few minor upgrades. Usually players pay for the next year’s release to get new features to the games as well as team and roster changes for the game to match what’s actually happened in the sport in the real world. EA has over 400 licenses for its sports franchises.
Sports FC and Madden NFL are the two largest titles in the sports portfolio for EA. The company decided to not renew their license with FIFA in 2023. Instead, EA signed over 300 individual partnerships and licenses across 30 leagues and federations for the game starting with Sports FC 24. Players can access content related to the UEFA Champions League, CONMEBOL Libertadores, the Premier League, Bundesliga, Serie A, LaLiga, and the MLS. The initial response to the game was strong, leading to 14.5M players in the first 4 weeks of its release. Sports FC makes up most of Ultimate Team subscriptions, the live service that provides online multiplayer game play.
Apex Legends is a popular live service game for EA with almost 200M registered players, of which more than 18M are monthly active users. The battle royale themed shooter launched in 2019 in a free to play model. The company monetizes the game through optional characters and items that players can purchase to improve their playing experience. Apex Legends operates in a seasonal model, with each season lasting about 3 months. Each new season provides updated features and new playable characters. The Sims is also a longstanding live service franchise for EA. Sims 4 has over 70M players, which collectively engaged with the game for 1.8B hours in 2023, which was a 30% increase from 2022.
While EA and other North American AAA publishers have established positions within the PC and console end markets, mobile has quickly become the largest end market with other publishers leading the way. The large North American large publishers have recently increased their mobile exposure with Activision’s acquisition of King (maker of Candy Crush) in 2015, TakeTwo’s acquisition of Zynga in 2022, and EA’s acquisitions of Glu Mobile and Playdemic in 2021. Mobile accounts for 17% of revenues for EA. Prior to these acquisitions, the company’s mobile strategy had revolved around releasing mobile versions of its popular franchises like with Apex Mobile and Battlefield Mobile.
Why is it a good business?
As one of the largest publishers of AAA title video games, EA benefits from its intangible assets. The company’s franchise brands allow the company to more effectively sell its new games with less marketing support. This is especially true for its games on annual or biannual release schedules like EA sports titles and Battlefield. This is because these titles already have an established fan base that is likely still playing the last version of the game up until the new one’s release. While transferring progress from year to year may not be allowed in most games, oftentimes achievements and points are transferable. EA sports games account for most of the company’s full game bookings in any given year, and the player base is very loyal. The company has stated that 70% of its player base in sports are repeat buyers of these games.
For many of EA’s franchise titles, engagement from its player base has been increasing over time, which also helps the company earn higher margin revenues. There are two main reasons for this. First, the lengthening of the content cycle with DLC releases and frequent game updates optimize the game for the players over time. For EA’s free to play games like Apex Legends, updated versions of the game are in the form of seasons, which come with new playable characters, items and gameplay. Players can purchase new digital items but for the most part it’s optional. For Apex Legends specifically, it’s important that all players have access to the same version of the game because of the battle royale format, and monetization through optional purchases works for both the players and the developer.
The second reason for longer engagement is the social aspect of many of these franchise games. For Madden NFL or Sports FC, players will typically play a 90 minute session and then jump on a social platform to engage with social content related to the game for 30-45 minutes. The company stated that Sports FC specifically had more than 9 billion hours of engagement from players in 2023, which includes playing, watching and social media. For other titles, the company doesn’t give engagement numbers, but they have stated that about 20% of players are creators, of which half (or 10%) create content that is highly engaged by the player community. And that’s good for EA because engagement and money spent are highly correlated.
The company’s live services business also creates a very sticky and predictable financial profile for the company. EA’s live services makes up almost 75% of the company’s revenues. Ultimate Team for Sports FC, Madden NFL and the other sports titles makes up roughly ~50% of live services revenues. The other ~30% comes from other extra content spend like Apex Legends and the Sims and ~20% from subscriptions. According to the company, about 70%-75% of the players that purchase the sports games join Ultimate Team and half of those players actually spend money on the game.
Allowing players to access the online version of these games through live services extends the lifecycle of the game. Ubisoft has said that revenues for traditional games decline by 87% in the second year as demand wanes without new content. With live service games, revenues only declined by only 48% in the second year. And the most successful live services games have player bases that ramp over many years and then gradually get to a steady state level. TakeTwo’s GTA 5 (released in 2013) and Activision’s World of Warcraft (released in 2004) are two of the most successful live services games in history and they still have significant player bases.
Returns on incremental capital?
Over the past 10 years, EA has spent 6% of its capital on capex, 71% on R&D and 23% on acquisitions. Capex is mainly spent on computer + server equipment and office real estate. Capex spend is generally around 2%-3% of revenues, which could be viewed as high considering this spend doesn’t directly impact growth in value. R&D spend is the company’s largest productive use of capital at ~30% of revenues. About 75% of R&D spend is for the development of games of existing franchises including Sports, Battlefield, Apex Legends, The Sims, etc. Some of these franchise titles have annual or biannual release schedules, which requires large development teams. The other 25% of R&D is spent on creating new IP, of which many don’t make it through full development.
On the M&A front, EA had historically not been very active prior to 2017. This is partly because the company licenses many of its large franchise titles, which means the company doesn’t need to be acquisitive to find the next hit IP. But it could also mean that EA doesn’t take enough risk to venture into new genres or platforms like mobile. However, that changed when the company acquired Respawn in 2017 for $315M. Respawn was founded by the team that developed the Call of Duty series for Activision. EA already had a relationship with Respawn for the Titanfall and Star Wars games. The acquisition led to one of EA’s most popular and profitable titles in Apex Legends.
Then in 2021, EA made 3 large acquisitions of Glu Mobile for $2.4B, Playdemic for $1.4B and Codemasters for $1.2B. Both Glu Mobile and Playdemic improved EA’s position in mobile and gave the company access to a new set of players. There was very little overlap between players of EA’s games and of both of these acquisitions. Glu’s games like Design Home, Covet Fashion and Kim Kardashian: Hollywood attract more casual set of players. Glu Mobile was acquired for $2.1B net of cash or 3.9x revenues and 24x adjusted EBITDA. Playdemic is known for Golf Clash (80M downloads at the time of the deal) and Codemasters is known for its Formula 1 games.
Obviously the Respawn acquisition has been a huge success for EA. Apex Legends was the #10 game in 2023 in terms of monthly active users. (The Sims 4 was #8 and FIFA 23 was #9). However, the acquisitions from 2021 are mixed at best. The deals for the two mobile developers have not yielded great results so far. We know that there has been a pullback on spending for mobile games coming out of the pandemic. But also, the deal values were likely too high for EA to get a good return unless the company can find some tangible revenue synergies. Time will tell if the company can leverage the mobile expertise from these acquisitions to further push its growth into mobile with both existing or new IP. With EA’s scale and distribution, it was likely better to acquire upcoming studios that have potential to create the next franchise IP for the company, rather than acquire a company for its existing player base.
We estimate that EA generated returns on incremental capital between 10%-20% over the past 5 years. Covid related lockdowns had a positive impact EA (as with the rest of the video game industry) in 2020-2021, which increased returns. That was offset by EA’s acquisition spend in fiscal year 2021-2022, which were dilutive to returns given the size of these acquisitions and the high multiples paid. EA hasn’t been as active in M&A in fiscal 2023 and 2024, so the return profile should return to normalized levels going forward.
Reinvestment potential?
The global video game market was $184B in 2023, with mobile accounting for $91B, consoles $53B and PC $40B. Growth in the industry has been led by mobile ever since the launch of smartphones. The player base for mobile games is 3.5B, much higher than console or PC gaming, but the types of games that do well on mobile aren’t necessarily the same as those that attract players on console or PC.
For AAA title publishers like EA, it’s likely going to take more than just creating a mobile version of an existing game that is already popular among console and PC gamers. The brand awareness does help during the launch of the game, but usually the quality and complexity of a PC and console game don’t translate well to the mobile format. EA will likely have to launch brand new IP to successfully compete in mobile and/or acquire existing mobile game studios with popular titles.
Even without success in mobile, the thing that AAA title publishers have going for them is the incredible value that video games provide for most players. On an hours of playtime per cost basis, video games rank very high, especially when considering how interactive and community oriented some games are. Players spend on average 50-100 hours playing the typical AAA game, sometimes spanning over many months for $60-$70 to purchase the game. And players understand this value, increasing their time spent on gaming vs. other forms of leisure activity like TV watching, socializing and reading over the years.
The objective for AAA title publishers is to increase engagement for its titles as well as figure out how to maximize value at the same time. Over the years, the transition to a subscription model and/or free to play games has done exactly this. The players get even more invested in the games and figure spending money for a new character or item is worth it because of the large amount of time spent playing the games. For EA specifically, it’s figuring out that balance (and it’s different for each game) that really is the key to their future success.
With a reinvestment rate between 45%-60% and a return on incremental capital between 10%-20%, we estimate that EA has increased its intrinsic value between 6%-9% over the past 5 years. With many of the large M&A deals being digested from 2021, EA’s return on incremental capital should come back up and its reinvestment rate should come down to normal levels. Looking ahead, EA’s growth in value is likely to remain steady due to its high exposure to sports and licensed titles, which provide a much more predictable cadence for bookings growth.
What else is important?
Microtransactions
Microtransactions are small purchases that can be made within a game to give the player game progression, power-ups or cosmetic upgrades. Microtransactions are usually found in free to play games because the developer needs another way to monetize the game aside from annoying ads placed within the games, which ruins the user experience. Microtransactions have been around since the early 2000s, especially with games coming out of Asia, since that region popularized the free to play model. There are many criticisms of microtransactions with the developer usually being blamed for taking advantage of a key set of players which tend to account for most of the spend in the game.
There are two key issues with microtransactions. First is that players felt that certain transactions resulted the game being “pay to win”, meaning that it was difficult or impossible to compete if you chose not to pay for microtransactions. This either “forced” players to make purchases or quit the game altogether. The second issue was around loot boxes or card packs that some considered as gambling. This could be an issue since many gamers were not of legal gambling age.
While many of these types of microtransactions still exist within some games, the backlash against developers have waned for the most part. This is because many developers have found the right balance of pay vs. free to play for its microtransactions and many have focused more on cosmetic items like costumes, characters and item skins. Players still pay for these cosmetic items because it gives them status within the games and it’s a way for players to support the game without feeling like they’re paying to win. The video game industry is still figuring out the right balance and some developers handle it better than others. EA had a reputation for being very aggressive with microtransactions in the past.
Optionality
Video game developers have lots of optionality built in, especially if they own a collection of studios that focus on different genres. Any new video game IP could turn into a big hit. However, it’s less likely now for something to come out of the blue and take revenue and mind share away from established game franchises. Instead of focusing on creating the next Fortnite, it’s likely better for developers to be on the lookout for new genres or game formats that are taking off and take some of their existing IP to create a new game that fits. Riot Games does that well with its League of Legends IP that has been leveraged to create games like Team Fight Tactics (auto battler) and Valorant (first person shooter).
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Thank you. Similar to AMETEK: May I suggest adding a section to dissect the management incentives (insider ownership, long-term options, RSUs, etc)?
Thank you.