We are upgrading Electronic Arts Inc. (ERTS) to Neutral from our previous Underperform rating, as we believe the stock has bottomed out. We do not expect further fall in share price and believe that the new Sony Corp’s (SNE) ‘Playstation Move’, if released in 2010 may drive sales at EA. 

Going forward, we expect the company to perform in line with the market. Furthermore, we think that the valuation is fair, given the fact that the company’s earnings are expected to grow at 13.8% in the next five years, compared to the peer group’s expected growth rate of 11.8%. We therefore set a price target of $19.50. 

Electronic Arts reported dismal third-quarter results on February 8, 2010. Moreover, weakness in its EA business, poor holiday sales for the overall packaged goods sector in Europe, product mix shifts to lower-margin distribution business in North America, delay in launching new titles, lower restructuring benefits, weak traditional video game sales and the negative impact of foreign exchange led to a disappointing guidance for the upcoming quarters. 

Electronic Arts provided a weak outlook for the video game industry and expects a decline in disc-based games revenue. As a result, the guidance fell short of Wall Street expectations.
With weak third-quarter 2010 results and a conservative outlook for the fourth quarter and fiscal 2011, the company is expecting packaged-goods video game sales to remain relatively weak in 2011.
However, the growth in the digital business and a leaner cost structure may offset some of the decline in packaged goods sales. Moreover, in the long term, an increased focus on cost reduction, a strong balance sheet, a growing presence in digital distribution and the Playfish acquisition should add to growth. 

With cash of $1.78 billion or $5.49 per share and no debt, the company has the necessary liquidity to remain an industry leader in terms of internal game development and also make favorable acquisitions.
Electronic Arts has an impressive new product lineup scheduled for the next fiscal year, which should allow it to generate strong growth through fiscal year 2011. The new game pipeline includes Mass Effect 2, Army of Two and Dante’s Inferno. Electronic Arts recently released new gaming titles such as the Dragon Age: Origins – Awakening and Battlefield Bad Company 2, which are well accepted and will further drive sales.
However, according to the research firm NPD Group, U.S. retail sales of video games (portable, consoles, hardware, software and accessories) generated revenues of $19.66 billion in calendar year 2009, an 8% decline from 2008. According to recent NPD data, video game sales fell 15% in the month of February 2010, following a 13% drop in January. We expect challenges to continue in the near future due to weak video game sales and a cautious retail environment. 

However, we remain positive on the company’s long-term growth prospects and expect it to post profits in 2011. We advise stockholders to wait for a favorable exit point.
Read the full analyst report on “ERTS”
Read the full analyst report on “SNE”
Zacks Investment Research