Electronic Arts (EA) shares have lost about 1/4 of their value in the last 30 trading days. On July 26, the company beat earnings/revenue guidance, reaffirmed fiscal year 2019 guidance, and subsequently tanked. Then on August 30, the company reduced FY ’19 guidance and dropped another 10%.

ChartEA data by YCharts

I explained why the company was absurdly valued here on June 20 just as the stock eclipsed $145. I am patting myself on the back even though almost all stocks are absurdly valued right now (read a book).

Even with the 25% haircut, the valuation setup hasn’t changed much. In this piece, I explain why I think the bad news is just getting started and the stock has further to fall. Their goal of becoming the Netflix of gaming carries substantial risk and may ultimately not have the desired effect on earnings.

With identifiable catalysts to the downside, shorting here is reasonable.

Q1 ’19 Results and CC

After listening to the conference call on July 26, you might be inclined to think the stock was headed for new highs. The company reported sales of $1.137B, $57M (5.3%) above guidance. COO/CFO Blake Jorgensen pointed out that diluted EPS came in at $0.95, a whopping $0.31 above guidance! Amazing how the company spent $570M in FY ’18 buying back shares to boost diluted EPS by $0.05 (and more buybacks in the pipeline!). On the other side of the coin, this sales “beat” was 21.6% lower than last year’s revenue of $1.45B…

My favorite quote from the conference call was from Mr. Jorgensen in response to a question about the then upcoming release of EA Origin Access Premier: “We do know though from our EA Access experience and our Origin Access experience for non-frontline titles that we find people play twice as many games for twice as long and spend twice as much money as they did outside or before they joined the subscription.”

Now that’s bullish! Not sure what multiplier to impose on sales/earnings yet, but management clearly believes their new subscription offering is going to be a huge boost!

CEO Andrew Wilson said FIFA Mobile “has quickly become our strongest ever launch in the Chinese market, reaching number one on the top downloads chart for iOS in China and showing best-in-class engagement on the WeChat platform.”

Mr. Jorgensen added the launch of FIFA Mobile in China “delivered one of the highest grossing days ever for any of our mobile titles and hit number one in the iOS download charts.”

One might expect the mobile segment to blow up with the growth from China, and sales to surge with the new subscription product. But one should rein in their excitement because even with the Q1 beat, management only reaffirmed full year guidance of $5.6B in revenue, $5.55B in net bookings, and $1.108B in net income. For the record, that implies YoY growth of 8.7% in revenue and 6.2% in net income.

Mr. Jorgensen complained about the strength of the dollar impacting earnings but luckily did follow it up with: “It should also be noted that there is less risk to the bottom-line because of our hedging strategy.” (thumbs up)

EA Origin Access Premier Released

On July 30, the company launched Origin Access Premier, a new tier in their PC subscription service dubbed EA Origin Access. Mr. Wilson described it as “a first-of-its kind subscription service that will include unlimited access to our newest PC titles.” Rather than paying $60 for a copy of an upcoming game like Battlefield V or FIFA 19, the company is selling subscription access to all of its new and major title releases for $15/month or $100/year.

This is a new and consequentially risky idea. Do people consume games in the same way they watch movies and shows? We are about to find out.

Mr. Wilson thinks so: “We believe strongly in the transformative nature of subscriptions. In a network where subscriptions can reduce friction and help give players ready access to more great content, we are enabling developers from EA and beyond to bring truly amazing and immersive new experiences to a global audience.”

I am skeptical. It seems likely that the base of players will grow as some marginal gamers will consider the new offering, but the ARPU is heading for a cliff. The marginal gamers captured by this offering are not going to be big spenders on the non-essential in-game micro-transactions which the company has notoriously milked of late, as the hardcore gamers are already playing and paying.

I also wonder if perhaps the new subscription model has hamstrung pre-orders for all their upcoming releases…

Battlefield Delayed, Guidance Reduced

On August 30, the company slashed FY ’19 net bookings guidance from $5.55B to $5.2B (down 6.3%). Management decided not to update any of the GAAP operational metrics like revenue or earnings.

The company listed 3 items for why they won’t be achieving the previously sandbagged guidance: “an update to the Battlefield™ V launch date, the continuing impact of foreign exchange rates, and a revised mobile forecast.”

Most folks only saw the part about delaying the launch of Battlefield V, but luckily, FY ’19 does not end until March 31st, so the company will still have the majority of Battlefield V sales in this fiscal year. The 4-week launch delay puts the title’s release on November 20, still in time for the Christmas spending season.

The people that want to sell you the stock would much rather focus on the foreign exchange effects which management estimated to be about a $115M drag on net bookings (sometimes you just can’t get that dang FX market to do what you want!). Remarkably, the majority of the time spent explaining the reduction to guidance focused on how foreign exchange rates can affect a company…

The most important and obviously last item listed did mention a revised mobile forecast. And that’s it… Unfortunately, the quote above is all the color we get about this “revised mobile forecast.” More unfortunate is the fact that management just went over how successful their mobile offerings have been!

Image: Electronic Arts

Battlefield V In Trouble

Some prescient authors here on SA did correctly identify some issues with the game and its launch date. I applaud their efforts and wish I had thunk it up. Read Michael Turner’s piece here and Benjamin Syko’s here.

From the conference call on July 26: “Beginning in late June and into early July, we conducted our first public Alpha test for Battlefield V. The results exceeded our expectations, with high demand leading to three times our planned number of participants joining the test. Feedback was highly positive, with players able to truly feel the advancement that DICE has been focused on in the game play.”

I am confused as to why/how “results exceeded our expectations” and [f]eedback was highly positive” for early Battlefield V reception and then 35 days later, management explained that they would not be meeting expectations and were delaying the launch.

The company fired chief design officer Patrick Söderlund following his comments suggesting players not buy the game if they didn’t like the changes. Read the articles linked above for more specificity on this issue. In any case, this is not the standard backdrop for a blockbuster release…

Implications

So management talked about the momentum across its business segments and then changed its mind 35 calendar days later. They had their best ever mobile launch in China and then revised their mobile sales forecast lower. They explained how great the reception has been for Battlefield V before delaying the launch 4 weeks. They talked up the subscription model and then didn’t even mention it in the business outlook provided in the guidance revision press release.

The revision to guidance suggests no growth in sales this year. That’s especially disappointing considering how big Battlefield V should have been for the company (not to mention R&D spend grew 9.5% last fiscal year). With management neglecting to update guidance for earnings, I’m all but sure we will see a decline in net income this year. This could be our 1st warning sign on the subscription model.

I think we will see some special and “non-recurring” charges (maybe a non-cash tax charge or 2) because FY ’19 is now a tainted year. Management will be unable to resist the temptation to lump as many negative news items together as possible. I don’t hold it against them – shareholders would fire them otherwise.

This means the bear news cycle is just getting started for this stock. I expect more bad news on Battlefield V and dubious results from the subscription model over the next several months. Perhaps we will see some unexpected margin declines. By that I mean gross and operating margins – you will not be asked to look at GAAP net margins.

The stock probably won’t see any support from value investors until it approaches $60, calculated as 20x my projected FY ’19 diluted EPS of about $3.00, which is probably optimistic.

I think this stock is dead money for at least a year. The global economic backdrop and our position in context of the business cycle corroborate. Shorting here is a reasonable idea.

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.