Although the game publisher’s stock is up in after-hours trading due to the announcement of Riccitiello’s resignation, the departing CEO’s contributions to the company’s turnaround have been enormous.
After taking over the reins in 2007, Riccitiello led the transition from a bloated company that lacked focus to a business focused on its keys to profitability. Namely, the company stopped development on many non-core games and shifted its focus to its hit franchises. Although no longer the growth engines they once were, EA’s Madden franchise and other top games have been key to the company’s profitability over the years. The company became unprofitable when it lost focus on its core revenue drivers and has recovered since resuming focus on its blockbusters.
The New EA is Set to Thrive
With a new set of consoles slated for release in the 2013 holiday season, game publishers will receive a much-needed tailwind from consumers looking to buy the latest games for the new consoles. Electronic Arts’ renewed focus on its key titles affords it significant operating leverage that should boost profitability in the years ahead.
In addition, Electronic Arts Inc. (NASDAQ:EA) is quickly becoming a leader in mobile gaming. The nascent mobile gaming market is gaining steam among casual gamers — a group that Electronic Arts has traditionally failed to court.
However, mobile gaming is unlikely to carry the company into the future. Electronic Arts will ultimately need to develop another blockbuster console-based series in order to provide additional value for shareholders.
Competition is a Virtual Clone
Electronic Arts’ competitors are similar in almost all respects. Like Electronic Arts Inc. (NASDAQ:EA), Activision Blizzard, Inc. (NASDAQ:ATVI) was built upon the success hit franchises. The company’s World of Warcraft franchise has been enormously profitable for the company. On the console front, Call of Duty has proven to be a valuable asset for Activision Blizzard, Inc. (NASDAQ:ATVI).
Meanwhile, Take-Two Interactive Software, Inc. (NASDAQ:TTWO) depends on franchises like Grand Theft Auto and MLB 2k to lead the way to profitable growth. However, Take Two (NASDAQ:TTWO) is significantly smaller than EA and Activision, so it cannot leverage the same scale for higher margins. In addition, Take-Two sells its products at a much smaller gross margin than EA and Activision Blizzard, Inc. (NASDAQ:ATVI).
New CEO Could Lead Company to Higher Profitability
Despite a greater similarity to Activision in both size and price point, Electronic Arts Inc. (NASDAQ:EA)’ operating margins are closer to that of Take-Two than Activision. This is due to a still-bloated cost structure that Riccitiello’s best efforts could not subdue.
However, a new CEO could shake things up at the company and find a way to earn margins closer to that of Activision. If the new CEO can find a way to get EA to a 15% pre-tax margin, then the company would trade for just 9.5x pre-tax earnings based on TTM revenues. However, a 30% pre-tax margin — which matches Activision Blizzard, Inc. (NASDAQ:ATVI)’s margin — would make the stock a no-brainer.
It’s tough to handicap turnarounds, but investors who believe that a new CEO could take Electronic Arts from Take-Two profitability to Activision profitability should buy as much stock as they can get their hands on.
The article CEO Resignation Will Not Derail Game Publisher’s Turnaround originally appeared on Fool.com and is written by Ted Cooper.
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