A New California Law Is a Tailwind for This Video-Game Giant
Arenas are filling up... to watch people play video games.
Streaming sites like Twitch are helping to transform video gaming into a spectator sport...
Viewers watched more than 9 billion hours of content on Twitch last year – nearly 60% more than in 2017. And the vast majority of that content was video-game streaming.
E-commerce giant Amazon (AMZN) bought Twitch in 2014 for nearly $1 billion. That was a steal, considering the platform's growth over the past few years.
Twitch is also fueling the rise of organized, competitive video gaming (or "esports").
Esport tournaments are attracting mammoth audiences. The 2018 Mid-Season Invitational, an esport tournament featuring the game League of Legends, had around 60 million unique viewers. The 2017 Intel Extreme Masters tournament, which featured a number of games, had around 46 million unique viewers.
The esport movement is exciting for professional gamers and streamers, and bodes well for the future of gaming. Esports are grabbing a lot of attention as high-profile billionaires, entertainers, and athletes like Mark Cuban, Sean "P. Diddy" Combs, and Michael Jordan have invested in esports teams and leagues.
And at the foundation of this esports movement are the video-game publishers.
Today, we're looking at one of the best in the business: Electronic Arts (Nasdaq: EA).
EA owns long-established game franchises whose adoring fans buy their new releases every year. And with its purchase of game developer Respawn Entertainment in late 2017, it now owns one of the hottest new games around – Apex Legends. Respawn has other games in the works that are exciting as well.
And while Respawn produced one of the most popular games out there, EA's other franchises are its cash cow...
In the late 1980s, EA released John Madden Football.
It was a revolutionary game – allowing you to design your own plays. You could pick a formation and then assign passing routes and blocking schemes as you saw fit. The game basically let you pretend you were Hall of Fame coach John Madden.
The game franchise – known simply as "Madden" to its fans – has turned into one of the most prolific in industry history. Each year, EA creates a more realistic game with updated players and rosters. And each year, millions of fans rush out to buy the game.
Despite the success of Madden NFL, the crown jewel of EA's sports franchises is its soccer game...
In 1993, EA released the first FIFA video game. EA has a license agreement with soccer's worldwide governing body that gives the company the exclusive rights to produce FIFA-branded video games.
Each new version of EA's FIFA game is at or near the top of the list of that year's best-sellers.
Rounding out EA's sports franchises are the NBA Live basketball and NHL hockey games. And EA's sports franchise could soon get a huge boost...
A recent decision out of California could bring back one of EA's most popular franchises.
In 2013, EA stopped making college sports games due to "amateurism" restraints. Under "amateurism," student athletes cannot profit off their likenesses.
While the athletes weren't getting paid for their likenesses in the college video-game franchises, EA was.
This brought on a series of lawsuits against EA, which ended with EA no longer making college-sports games, despite the franchises being among EA's most popular.
But this could all be set to change...
In September, California Governor Gavin Newsom signed the "Fair Pay to Play Act." The bill will allow college athletes to profit off their names, images, and likenesses beginning in 2023.
This means athletes can get paid for their likenesses in video games like EA's NCAA Football or NCAA Basketball franchises.
EA's CEO Andrew Wilson told the Wall Street Journal that the company would "jump for the opportunity" to start making college-sports video games again.
If more states follow California's lead, EA's popular college-sports franchises could make a return, boosting EA's "core" franchises.
In addition, EA is a model of capital efficiency. After subtracting all costs, including R&D and sales and marketing, EA has operating margins that range from around 20% to 30%. The median operating margin in the S&P 500 Index is about 15%.
Producing software is a highly scalable, capital-efficient business. It doesn't require a lot of large business investments (capital expenditures or "capex"). EA doesn't need to build factories or maintain expensive industrial equipment.
As a result, EA generates a lot of free cash flow ("FCF") – the amount of cash left over after all expenses and capex. Last fiscal year, EA produced $1.4 billion in FCF. That was the equivalent of about 29% of revenue – this percentage is known as "FCF margin."
With its impressive FCF, EA management has the luxury of being able to return lots of capital to shareholders.
EA doesn't pay a dividend. But it does repurchase stock.
Over the last 12 months, EA bought back $1.1 billion in stock.
EA has a fabulous, capital-efficient business with world-class video-game franchises. And with the addition of Respawn and the new California law, the company has some impressive tailwinds. EA is poised to shine as the video-game industry grows more and more mainstream.
Sometimes investing is simple.