Analysts sour on EA

Lazard Capital Market's Colin Sebastian downgrades publisher's stock as industry-watchers take management team to task.


Analysts never like to hear bad financial news from the companies they cover, but yesterday's glum quarterly report from Electronic Arts seems to have hit a nerve. A flurry of investor notes this morning weighed in on the publisher's results, and there was little sympathy to be found, starting with Lazard Capital Markets' Colin Sebastian lowering his rating on the stock from "Buy" to "Hold."

Sebastian noted that EA has been stagnant at a point in the console cycle where it should be ramping up for significant growth. With time running out before publishers have to start investing in software for the next generation of consoles, he noted EA is becoming less likely to generate strong profits before the downturn of the cycle starts. The publisher's recent stated emphasis on quality might not be paying off either, according to Sebastian.

"While we are encouraged by improving quality ratings of several annualized EA Sports titles, as well as recently released Dead Space, we continue to believe the improving product execution is coming at a high cost," Sebastian noted, "and EA's margins are ramping more slowly than we originally expected at the beginning of the year."

Some analysts were clearly frustrated with the publisher's malaise. Pacific Crest Securities' Evan Wilson said the firm had become bored writing investors notes about EA lowering its profit expectations.

"The justification for the delay in profits is always heaped into 'digital investments for the future,'" Wilson wrote. "While it was a different management team singing the tune, the commentary was the same in 2005 as we entered this cycle. The investment needs to be justified eventually, but as of yet it has not been. Today's negative reaction to the delay in profitability is not surprising, but management's continued insensitivity to investors' desire for profit growth in the fourth year of the video game cycle is. ... EA is positioning itself as a victim of its circumstances--that the best is yet to come as the company makes its way through these difficult times. However, we continue to believe that its actions exacerbate the negatives that the videogame industry is facing. EA's results have been mediocre for too long."

In his own investors note, Wedbush Morgan Securities' Michael Pachter was similarly unhappy with management's approach to its quarterly report.

"EA management was somewhat aloof during the earnings call," Pachter said. "With the stock hovering near a seven-year low, management continued its recent history of disappointment, and spent an inordinate amount of time sowing seeds of fear about the potential for a tepid holiday sales season."

Despite lowering his 12-month guidance on EA stock from $53.50 to $38, Pachter retained his "Strong Buy" rating on the publisher. He noted that the company has been producing better games, has been maintaining "robust sales" of new games, and has a number of big releases in the pipe.

"However, management has demonstrated an uncanny ability to snatch defeat from the jaws of victory in the eyes of investors," Pachter wrote, "and we think that these old habits will take a long time to die."

As of press time, EA stock was trading at $22.98, down more than 17 percent from yesterday's pre-quarterly-report closing price of $27.73.

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