No More Fun and Games for EA?

05/20/2008 12:00 am EST

Focus: STOCKS

Joseph Hargett

Financial Analyst, Schaeffer's Investment Research, Inc.

Joseph Hargett of Schaeffer's Investment Research says a recent critical magazine article of Electronic Arts may indicate sentiment is too negative on the game maker.

A recent Fortune article ("Big Games Don't Mean More Profits for EA," May 13th) details a conundrum for Electronic Arts (Nasdaq: ERTS): The company is selling more video games, but it's not raking in more profit.

ERTS recently reported a $94-million loss in its fiscal fourth quarter compared to a $25-million loss in the same quarter last year. Revenue rose to $1.1 billion from $613 million, an 84% increase. However, chief executive officer John Riccitiello isn't completely satisfied with the results. "We're pleased with our revenue growth, but not yet happy with our profit margins," Riccitiello said in a statement.

After detailing the company's earnings, the article shifts gears to focus on the proposed takeover of Take-Two Interactive Software (Nasdaq: TTWO). Lazard Capital analyst Colin Sebastian has this to say regarding the company's future: "EA has given a fiscal 2011 outlook that shows how it'll do without Take-Two, but more likely than not, they will hammer out a deal with them."

According to the article, Electronic Arts is "trying to buy rival game publisher Take-Two to fuel long-term growth."

There is a negative tone to the article that is hard to quantify in a summary of the piece. The author, and many analysts on Wall Street, are concerned regarding EA's future, and view the TTWO buyout as almost key to the company's long-term growth prospects.

Investor sentiment mirrors this pessimism in the financial media, as the stock's Schaeffer's put/call open interest ratio (SOIR) of 1.28 rests at an annual peak-indicating that options players have not been more negative during the past year. Meanwhile, about 3.6% of the stock's total float is sold short. Analysts are split, with Zacks.com reporting that ERTS earns eight Buys, five Holds, and one Sell.

However, ERTS's technical performance stands in contrast to this wealth of bearish sentiment. Since setting a near-term low of $43.62 in early February, the stock has rallied more than 21% along the support of its ten-day and 20-day moving averages. The equity has even overcome long-term resistance at its 160-week moving average-a common delimiter between intermediate-term up trends and down trends. With ERTS on the mend from January's heavy selling, excess pessimism could unwind in the form of added buying pressure-especially if the company were to ink a deal with TTWO.  (The stock closed above $48 Monday-Editor.)

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