The video game market giant has taken a hit in recent months, but the biggest problem for electronic arts (NASDAQ:EA) shareholders is a title that has not rebounded for 5 years. The company has a rich IP portfolio and powerful content, but the market has likely overvalued these assets until recently. My investment thesis is much more bullish on the stock after a few years of market-level returns and the drop to $125 in the past few weeks.
The best part of EA’s story over the years is that the company has a recurring profit stream. The bigger issue is whether the flow was growing enough to justify the stock valuation.
For FY22, EA reported net bookings of $7.5 billion, up 21% year-over-year. A big part of the increase in bookings was the acquisition of Glu Mobile and an annual booking flow of around $550 million. The company only guided FY23 net bookings from $7.9 billion to $8.1 billion, delivering solid growth of 7%.
EA has a solid track record of growing bookings, and the move to live services leaves the company in a better position for recurring revenue streams. For FY22, live services accounted for 71% of booking flow with full game bookings up last year, but that amount is generally lumpy with FY21 showing low numbers.
While Glu Mobile played a big role in driving bookings growth last year, EA paid around $2 billion in cash for the deal. The company has a large earnings stream to buy growth without diluting shareholders, or to return capital to shareholders through share buybacks and dividends.
For FY22, the company generated operating cash flow of $1.9 billion. EA returned $1.5 billion to shareholders primarily through the buyback of 9.5 million shares for $1.3 billion.
The growth rates are more impressive considering that the company forecasts up to 4 percentage points for net bookings based on the combined headwinds from FX and Russia. EA has key drivers to drive mobile growth in FY23: launch of Apex Legends Mobile; the growth of FIFA Mobile; and the launch of The Lord of the Rings: Heroes of Middle-earth.
Despite these headwinds, EA continues to push the company forward due to the strong content and powerful IP demanded by gamers. The Live Services business now allows the game company to consistently increase revenue without having to create new games every year. Apex Legends kicks off Season 13, providing a path for consistent growth over time by building on existing IP.
The stock is cheap at just 15x forward EPS estimates, but not terribly cheap with the rally back to $125 today. EA is expected to increase earnings near the PE multiple, so the stock is neither cheap nor expensive.
As mentioned above, EA has a consistent path to generating up to $2.0 billion in free cash flow allowing the company to buy companies like Glu Mobile in cash or buy back stock. The company has a net cash balance of $3.0 billion at the start of FY23, but EA has $1.9 billion in debt.
Even if the free cash flow forecast for FY23 drops to $1.45 billion due to the timing of major non-sports launches in the fourth quarter leading to cash-outs in FY24, EA will still have $2.5 billion of net cash to be used for EPS growth. The company has consistent cash flow and earnings growth to make the stock attractive at levels originally seen in 2017. Over that time, EA has consistently seen the market willing to pay multiples of premium for profit flow, providing the opportunity for quick gains in the stock in a more bullish market environment.
The key investor takeaway is that EA is correctly priced for current EPS growth rates of 10-15%. The stock could become cheaper in the event of a market sell-off or further weakness in the games market, but EA is usually rewarded with a more premium multiple due to the valuable intellectual property the company owns.
Investors may want to wait for the next pullback after a rebound of $15 from the lows this week. Ultimately though, EA is a solid investment here at $125 and more on another sale.