“Armchair Trader Series” Recommendations
- Week Beginning -
Monday, December 10, 2018

by Ian Harvey

IMPORTANT NOTE: This is a recommendation and individual members can use their own discretion as to when to enter or exit!

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Option Trade – Electronic Arts Inc. (NASDAQ:EA) Puts

Wednesday December 12, 2018

** OPTION TRADE: Buy the EA JAN 18 2019 82.500 PUT at approximately $3.40. Place a pre-determined sell at $6.80.

Also include a protective stop loss of $1.35.

Investors have high hopes for video-game makers as the industry transitions to digital distribution and cloud streaming, but as the holiday season approaches, those hopes are crashing hard.

In order to stay competitive, video-game companies must continually make strong content, which is not an easy thing to do, even for companies with strong game franchises “We don’t think making a larger volume of compelling content in a creative business is simple,” wrote Cowen analyst Doug Creutz. He added, “Quantity is often the enemy of quality.”

While Electronic Arts Inc. (NASDAQ:EA), a game software content and services provider, beat earnings estimates for the most recent quarter, it provided weaker guidance in the report. EA reported earnings of 83 cents per share compared to analysts’ expectations of 58 cents per share, but the weaker guidance prompted analysts to lower their revenue and earnings forecasts for the company. Some technical analysts see another 12% drop in the company’s stock.

Electronic Arts stock started off the year around $110 per share. It soared to as high as $150 in July. But following the recent selloff of tech stocks and the raising of concerns about the launch of the company’s Battlefield V game, EA stock has now plummeted to near $83. That’s more than a 40% decline in just a few months.

Part of the reason for the massive decline of EA was clearly the weakness of the tech sector. The FAANG stocks have been in free-fall, and their retreat is causing many other high-fliers to tumble. But there are some important concerns about Electronic Arts stock. These worries are focused on the recent debut of Battlefield V.

About Electronic Arts…..

EA was listed on the stock market in 2013 when it was voted the worst company in the United States. It also reduced its revenue forecast $350 million for fiscal 2019. However, the stock has risen from $26 in 2013 to an all-time high of $151 earlier this year.

Electronic Arts Inc develops, markets, publishes, and distributes games, content, and services for game consoles, PCs, mobile phones, and tablets worldwide. The company develops and publishes games and services across various genres, such as sports, first-person shooter, action, role-playing, and simulation primarily under the Battlefield, Mass Effect, Need for Speed, The Sims, and Plants v.

Past Performance…..

The video game industry had an extremely impressive month of October. For the month, sales came in at $1.54 billion, representing a massive, 73% gain. Of course, some strong, new game launches that took place that month definitely positively impacted the industry’s sales. Regardless, the $1.54 billion haul is a new record for the month of October, topping the old record of $1.36 billion that was set way back in Oct. 2008.

But even the huge sales figures have done little to prop up video game stocks. In addition to the crushing decline of EA stock, Take Two (NASDAQ:TTWO) and Activision Blizzard (NASDAQ:ATVI) have also fallen.

It’s clear that investors got ahead of themselves with these stocks earlier this year. Yes, the gaming industry is posting excellent sales, but the stocks’ price-earnings ratios had exceeded 30 at one point. That valuation is arguably much too high for cyclical companies that still live or die based on the performances of their new games.

The Battlefield shooter series has long been a cash cow for Electronic Arts. Heading into last week’s release of Battlefield V, the franchise had sold more than 60 million copies.

However, the series’ latest iteration had a major snafu. The game’s trailer featured women in combat. Many players viewed this as an inaccurate depiction because the game is based on World War II.

The trailer racked up dislikes by the hundreds of thousands. EA’s former chief creative officer, Patrick Soderlund, doubled down on EA’s gender controversy, saying “On the [women] in Battlefield, this is something that the development team pushed… The common perception is that there were no women in World War II. There were a ton of women who both fought in World War II and partook in the war.” Soderlund also called those complaining about the depiction “uneducated.”

Although Soderlund soon left Electronic Arts, his departure may have been too late. By making a divisive statement and not immediately walking it back, EA offended a decent chunk of its potential customer base.

Influencing Factors…..

In the wake of the market’s recent brutal selloff, the trailing price-earnings ratio of Electronic Arts stock has fallen to a more reasonable 21. That’s down from its peak of more than 30. But EA stock is fairly valued after its 40% plunge, as it had no business reaching $150 earlier this year.

One other area of concern for owners of EA stock is the company’s stock buybacks. Electronic Arts has been buying back modest amounts of EA stock. However, the company increased the pace of its buybacks this quarter fairly dramatically, as it spent $153 million on buybacks in the third quarter of 2017 and $299 million last quarter. Given the high valuation of Electronic Arts stock last quarter, the share repurchases in Q3 may not have been very well-timed Meanwhile, EA insiders have been selling EA stock throughout the year.

In the past month, investors have witnessed a downward trend in fresh estimates. The consensus estimate has shifted -23.64% due to these changes.

Moving Forward…..

Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift.

Analysts Opinions

In a note to clients recently, KeyBanc Capital Markets analyst Evan Wingren reduced his rating on Electronic Arts from overweight to sector weight, admitting that his team was wrong about the video game maker's growth potential. He contributed his weaker outlook to a "lack of positive catalysts" facing the entertainment company, alongside doubt that Electronic Arts can post results in line with the Street's estimates in the next fiscal year.

“We have been wrong, as it has corrected sharply from its highs and underperformed; despite this correction, visibility remains low, we expect negative estimate revisions, and we have diminished confidence in the pipeline, which is likely to continue to limit valuation expansion in the near term," wrote Wingren.

The KeyBanc analyst is particularly disappointed with the departure of key leaders for games "Battlefield V" and "Anthem." He added that there is "low visibility" on the potential for live services within both mentioned titles.

Several equities analysts have recently commented on the company…..

  • BidaskClub upgraded shares of Electronic Arts from a strong sell rating to a sell rating in a research report released on Tuesday morning.
  • ValuEngine cut shares of Electronic Arts from a hold rating to a sell rating in a research report on Thursday, November 1st.
  • Zacks Investment Research cut shares of Electronic Arts from a hold rating to a sell rating in a research report on Wednesday, September 26th.
  • Credit Suisse Group reduced their target price on shares of Electronic Arts from $155.00 to $146.00 and set an outperform rating for the company in a research report on Friday, August 31st.
  • Finally, Barclays cut their price objective on shares of Electronic Arts from $132.00 to $128.00 and set a buy rating for the company in a research report on Wednesday, October 31st.

Insider news……

CFO Blake J. Jorgensen sold 2,617 shares of Electronic Arts stock in a transaction that occurred on Friday, December 7th. The shares were sold at an average price of $85.02, for a total value of $222,497.34.

Also, General Counsel Jacob J. Schatz sold 1,000 shares of Electronic Arts stock in a transaction that occurred on Thursday, September 20th. The stock was sold at an average price of $113.42, for a total transaction of $113,420.00.

Insiders sold 77,067 shares of company stock valued at $8,148,187 in the last quarter. 2.24% of the stock is owned by insiders.

Summary

But EA still has a lot more to prove, since its long-term track record has been mixed, even though EA stock has been quite strong in recent years. EA’s top line exceeded $4 billion in 2009. Almost a decade later, it’s at $5.2 billion, representing less than 25% growth over that span. That’s not the sort of growth you expect from a company with a high price-earnings ratio.

Electronic Arts has a current ratio of 3.52, a quick ratio of 3.52 and a debt-to-equity ratio of 0.19. The firm has a market cap of $24.93 billion, a price-to-earnings ratio of 24.26, and a P/E/G ratio of 1.42 and a beta of 1.02. Electronic Arts has a 52-week low of $79.50 and a 52-week high of $151.26.






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