We are initiating Electronic Arts Inc. (ERTS) with a Neutral rating and an $18.00 price target. We remain positive on the company’s long-term growth prospects and believe that the current premium valuation is justified. We therefore advise stockholders to wait for a favorable exit point.

Based in California, Electronic Arts is a leading independent developer, marketer, publisher and distributor of interactive games (video game software and content) in over 35 countries.

These games can be played on various consumer platforms, such as video game consoles like Sony’s (SNE) Playstation, Microsoft’s (MSFT) Xbox and Nintendo’s Wii; PCs such as Apple’s (AAPL) Macintosh; handheld devices such as Sony’s PlayStation Portable (PSP) and Nintendo’s DS; and wireless devices such as cellular and smart phones. Key franchises for the company include Madden NFL, FIFA, Need for Speed and The Sims.

Electronic Arts reported better-than-expected second-quarter fiscal 2010 results, with a steep rise in net earnings and growth in revenue. However, the company lowered its earnings guidance for the upcoming quarter due to weakness in the video game industry, a cautious retail sector, pricing issues and increased product development costs. Margins are currently under pressure and cash flow is weak.

We believe the main reason driving the company’s turnaround in fiscal 2011 will be increased focus on cost reduction, a strong balance sheet, a growing presence in digital distribution and most importantly — the Playfish acquisition.

With cash of $2 billion or $6.19 per share and no debt, the company has the necessary liquidity to continue as an industry leader in terms of internal game development. It should also be in a position to make favorable acquisitions.

Electronic Arts forecasted full-year 2010 earnings per share of 70 cents to $1, excluding one-time items. The company also expects to generate profits in the next two quarters. Revenue, adjusted for deferrals is estimated to be $4.2 – $4.4 billion for fiscal 2010.
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