Electronic Arts Inc. (EA), GameStop Corp. (GME): The Console Wars Are Heating Up…Again

Is the video game console dead? Perhaps Electronic Arts Inc. (NASDAQ:EA) may no longer have the long-term potential with its hard-core video game franchising. Despite the weak performance, I’m a little more optimistic than the rest of the street. Let’s uncover this opportunity?

Earnings highlights

In the first quarter of 2013 Electronic Arts Inc. (NASDAQ:EA) reported a decline in revenue. The company’s revenue declined from $1.368 billion in 2012 to $1.209 billion in 2013. The decline in revenue was driven by the falling demand in anticipation of the console refresh cycle. In classical economic theory, demand for a product goes down in anticipation of future price declines. It has been historically proven that when a console is refreshed with a better version, the older-generation console experiences a significant decline in value. In anticipation of that, it is likely that consumers are saving up to upgrade or are avoiding the purchase of video games in order to buy video games for the PlayStation 4 or Xbox 720.

The company’s decline in revenue wasn’t that terrible of news as the company was able to report strength in its gross profit margin. The gross margin improved from 72.7% to 74.4% and was driven by digital downloads.

The digital media division is projected to report an increase in its revenue. Electronic Arts Inc. (NASDAQ:EA) anticipated $1.7 billion in sales for 2014 (guidance) from digital downloads. The company’s growth in downloads from fiscal year 2012 to 2013 from $1.227 billion to $1.663 billion is what led to the significant increase in its gross margin year-over-year. The improving bottom-line performance is the primary reason for the sudden upwards surge in the valuation of the stock. The company may experience further improvement in gross margin as the next generation of consoles will be switching to a download-only format for purchasing digital content.

Guidance

Guidance was strong; the primary catalyst in the stock price was the operating cash flow improvement. The company anticipates that cash flows will improve to $400 million in fiscal year 2014 from $324 million in fiscal year 2013 (remember the fiscal year 2013 ended on Mar. 31). The company projects its cash flow to grow 23.45% over the next fiscal year. This was what led to the 29.4% rally in the value of the stock. Some of the valuation premium is also attributable to the console refresh cycle along with Electronic Arts Inc. (NASDAQ:EA)’s attempt at growing its market presence in the mobile space.