Top News

#1: EA Remains Reliant on Ultimate Team for Revenue Growth

Electronic Arts announced its fourth quarter and FY 2023 results on May 9th, which covers the period that ended March 31, 2023. The California-based video game publisher posted adjusted EPS of $1.20 for the quarter, below Zacks consensus estimates of $1.31. These earnings are adjusted for restructuring costs and stock based compensation. Q4 revenue of $1.87 billion exceeded forecasts which called for sales of $1.73 billion. 

Net bookings, which more accurately evaluates the performance of game publishers as it includes deferred net revenue from online games, rose to a record $1.95 billion. The company reported that FIFA 23 was the most successful in the series to date, and helped contribute to live services revenue of $1.50 billion. Live services now make up more than 80% of EA’s top-line, with full game sales representing a shrinking portion of overall performance. Note that this is dependent on game releases within the quarter, and this proportion can fluctuate. 

Guidance on the other hand was on the softer side, with EA expecting net revenue for FY Q1 2024 to be in the $1.83 billion to $1.93 billion range, with deferred net revenue of approximately -$325 million. This means the company expects bookings, at the midpoint, to arrive at $1.56 billion. This compares with bookings in FY Q1 2023 of $1.30 billion, which represents a 20% increase year-over-year, but measured against soft comparables given the challenges faced by video game companies last year. 

This delta of only a couple hundred million was noted on the earnings call by analyst Andrew Uerkwitz at Jefferies, who pointed out that the quarter would see five games released, whereas a year ago there was only one release. EA noted that live services would continue to drive revenue growth while game sales would not be a large contributor, though the releases, which will include Super Mega Baseball 4 and F1 23, are smaller in scope. The results will also include Star Wars Jedi: Survivor, which launched April 28th to positive console reviews, but middling to negative PC reviews due to performance issues. The outlook may be more conservative than indicated; despite the performance issues, the game is outperforming Star Wars Jedi: Fallen Order on Steam, with a peak concurrent user count 30% higher than its predecessor. 

At the end of March, EA shared an impromptu business update, which was also distributed to employees. CEO Andrew Wilson outlined three strategic priorities for the business, one of which was “amplifying the power of community” within EA’s games, imbuing them with “social and creator tools.” This could mean the company is envisioning some of their future titles becoming “platforms” like Fortnite or Roblox, which would boost engagement but require much more maintenance. Nothing in the immediate pipeline appears to fit this vision, but EA is aware that the most popular games today are trending in this direction.

FIFA 23 has performed exceptionally well as the FIFA Ultimate Team (UT) mode continues to generate a ton of revenue. First introduced in 2012, UT has gamers purchase randomized packs of players with real money, in the hopes of getting high rated footballers like Cristiano Ronaldo or Lionel Messi. These packs are essentially loot boxes, which have been phased out in many other live service games in favor of season passes. Loot boxes are subject to ongoing scrutiny from various jurisdictions, including a recent decision by the courts in Austria which ruled that the loot boxes violated the nation’s gambling laws. Three years ago a similar decision was handed down in the Netherlands which levied EA with a €10 million fine for violating the country's Betting and Gaming Act.

The Ultimate Team mode is also present in the publisher’s Madden / NFL titles. EA stopped revealing revenue from UT starting with last year’s annual report, just as regulators ramped up their oversight of loot boxes. The last disclosure came in FY 2022 when the company earned $1.62 billion from UT across its three sports franchises. From FY 2014 to FY 2021, UT grew at an impressive 23% CAGR, though growth has moderated in recent years. Its contribution to overall live services revenue has tended to range from 40% to 60%. 

Regulatory risk is just one of the factors that can affect UT, and in turn, EA’s high-margin live services revenue. After 30 years, EA’s partnership with FIFA has come to an end, with FIFA 23 representing the last game in the franchise. FIFA is still seeking a new partner for a new soccer game while EA is moving ahead with soccer games under a new moniker, EA Sports FC. This franchise is confirmed to feature real players, stadiums, teams, and leagues, but will likely mean the end of the World Cup, as the tournament is produced by FIFA.

FIFA has inked a handful of smaller partnerships while it waits for a bigger deal that will see it rival EA Sports. Currently the threat to EA remains minimal, but if FIFA ever partnered with a larger publisher that could accommodate a robust live service model, UT revenue could be affected. One potential partner could be Take-Two Interactive, which entered the soccer market two years ago with the $378 million acquisition of Nordeus. The Serbian studio is the developer of the mobile simulator Top Eleven Football Manager, which has been available on iOS and Google Play stores since 2011. 

On the flipside, EA will save on the $150 million annual fee it doles out to FIFA every year for naming rights. Gamers are also entrenched in EA’s ecosystem and are familiar with its games’ mechanics, which remain unmatched by any other publisher. Profits could end up growing if FIFA’s threat never materializes — the $150 million savings would have boosted FY 2023 net income by 19%, from $802 million to $952 million. 

Outside of Ultimate Team, live services were bolstered by Apex Legends, which “delivered net bookings growth in Q4 year-over-year at constant currency.” This implies that other games in the portfolio had shrinking bookings. Apex is currently in its sixteenth season and has seen active players increase by over 20% compared to Season 15. May 9th saw the launch of Season 17, which features a new legend called Ballistic and a new progression system for weapons among other changes. 

Andrew Wilson stated on the earnings call that Apex remains one of EA’s strongest franchises, and the game should be thought of as a platform from which other entertainment could spring from. Wilson compared game IP today to the “comic book IP of 20 to 30 years ago,” adopting a view similar to Nintendo and Naughty Dog who have successfully monetized existing IP in film and television respectively. EA has yet to prove that its franchises can be ported over to other media successfully, but given Wilson’s comments, investors should watch closely for any such tie-ins.

Substantive commentary on mobile was absent from the earnings release. While EA sang the praises of Apex Legends on PC and console, the mobile version of the game was shuttered on May 1st. Despite being one of the highest grossing titles in the company’s mobile portfolio, the game did not live up to EA’s expectations for “quality, quantity, and cadence,” as noted in their press release from January. 

The shutdown of Apex Legends Mobile is not the end of EA’s mobile woes. Earlier this year, the publisher also announced that the development of Battlefield Mobile had been canceled. Battlefield Mobile could have been a pivotal moment for the franchise, whose reception was stained with the lukewarm release of Battlefield 2042 in 2021. EA made the decision to close Industrial Toys, the mobile games studio it acquired in July 2018 that was developing the game.

UT is a large component of live services, and live services constitute the vast majority of EA’s revenue. Going forward, one of the biggest risks to EA will be any upheaval to the model, either regulatory or otherwise, that changes UT from randomized loot boxes to a storefront that allows gamers to directly purchase player cards. Success in future quarters will be reliant on managing these risks while integrating new monetization models in EA’s live service franchises. As for other opportunities, Wilson’s comments about bringing IP like Apex outside of gaming do not yet represent anything concrete. EA has a deep bench to draw from but many of its once popular franchises like Crysis, Mass Effect, and Mirror’s Edge have not seen new installments in years. 

#2: Switch Hardware Cyclicality is a Small Wrinkle in Nintendo’s Grand Strategy

Nintendo’s recent earnings showcased a marked decline in Switch sales, as the device enters its seventh year of life. For the 2023 fiscal year, which covers the period from April 2022 to March 2023, Switch sales fell to 18.0 million from 23.1 million in the year prior. This marks a -22.1% decline in overall hardware sales, with declines accelerating in the recent quarter when sales dropped -25.6% from FY22 Q4.  

Overall, net sales for the fiscal year declined by -5.5% to ¥1.6 trillion, while operating profit declined by 14.9% to ¥504.3 billion. This resulted in operating margins falling from 35.0% to 31.5%, though net profit margins held up better with a 120 basis point fall to 27.0%. These results also include the impact of the favorable exchange rate for the yen, which resulted in an operating profit gain of approximately ¥44.0 billion. Without the depreciation of the yen against the Euro and USD, the decline in operating profit would have been a steeper -22.3%. 

Nintendo provides very granular disclosures across their hardware and software portfolios. Part of the reason sales held up better than indicated by the Switch decline is due to the product mix. The base model Switch sold only 6.1 million units, a decline of -54.7%, while the higher priced OLED model rose 58.8% from 5.8 million units to 9.2 million units. The lowest priced console in the product trio, the Switch Lite, also saw sales fall by -29.2%. Nintendo noted that the global supply chain crisis affected sales during the first half of the period, though it appears some of this demand was not made up in the second half.

The decline in software sales, which are also cyclical, are explainable by the relative lack of hit titles during the fiscal year. Pokémon Scarlet/Violet was the only game to sell more than 20 million units, while Splatoon 3 was the only one to sell more than 10 million. Overall the company turned over 214.0 million units of software in FY 2023, down from 235.1 million in FY 2022. 

Since the launch of the Switch, Nintendo has keyed into the “Annual Playing Users” metric, which represents the number of users that opened software on Nintendo Switch at least once during the year. While console sales fell for a second consecutive year, this metric grew by 11% year-over-year, a notable achievement given the challenging comparables from the peak lockdown periods. Nintendo has increasingly focused on monetizing its users via microtransactions and subscriptions from its vast catalog of first-party titles.

Another recent trend of importance has been digital sales. Sony and Microsoft have weaned gamers off physical distribution for years, contributing to the 90% proportion of video game sales in 2022 that were digital. Nintendo on the other hand only had 48.2% of its software sales come from digital in FY23 (April 2022 - March 2023). This is up 560 basis points from FY22, with the most recent quarter showing acceleration. This is another margin accretive tailwind that should help Nintendo’s profitability in the near future.

Nintendo released a limited edition OLED Switch model themed after The Legend of Zelda: Tears of the Kingdom on April 29th. This may increase OLED sales in the quarter slightly, but is unlikely to move the needle in reversing the overall declining hardware trend. What will help Nintendo though is the new Zelda game itself, which was released on May 12th to critical acclaim. Tears of the Kingdom is currently the highest-rated game of all time on review aggregator OpenCritic, with 100% of critics recommending the game. 

Nintendo disclosed in the quarter that the previous Zelda installment, Breath of the Wild, sold 29.8 million lifetime units. As of May the game has almost certainly eclipsed 30 million units on Switch, which combined with an additional 1.7 million on Wii U as that console’s final game. It is not unreasonable to think that Tears of the Kingdom may sell 40 million units in the next two or three years, which at a $70 sticker price (a first for Nintendo) would result in nearly $3 billion in revenue. This includes a number of assumptions including currency remaining constant across geographies and the game’s price not getting discounted over the period. 

The media flywheel is also in full swing for the Japanese video game giant. The Super Mario Bros. Movie is approaching $1.2 billion at the global box office, and with a break-even point of around $400 million, is a massive success for both Nintendo and its production company Illumination. Nintendo launched its own animation studio last October called Nintendo Pictures, which will be the home of the company’s future films, according to President Shuntaro Furukawa on the latest earnings call. This will allow Nintendo to retain more of the economics around other films based on their franchises, though also means they will underwrite more of the risk. 

Nintendo has several franchises that could be adapted, such as Zelda, Metroid, Kirby, and Star Fox, to name a few, all of which enjoy mass popularity. If the company expands its IP beyond gaming and focuses on higher margin licensing revenue, Nintendo’s results will benefit greatly in the coming years. This also applies to its burgeoning theme park business with Super Nintendo World, which has seen thousands of visitors pay $20 to $30 a day to visit the themed land nestled within Universal Studios. 

These investments in quality IP over the last 40 years are just beginning to pay serious dividends for Nintendo. As a result, the company’s future will be dictated by much more than a five- to seven-year hardware release cycle. While Sony and Microsoft vie for a console-less future in a decade, Nintendo is quietly carving out its own path to the finish line. 

As for the Switch — the console has proven itself as the perfect hybrid of handheld and console gaming. Some gamers were disappointed that the OLED Switch, which was released in October 2021, was not the next major iteration of the console. The next console will probably represent an incremental improvement to the Switch form factor rather than reinventing the wheel. Some updates may include a new chassis for the handheld, 4K resolution, and a new GPU and CPU internally. Given the current Switch is approaching saturation, Nintendo has to make this new console alluring enough to convince gamers to spend another $300-$400 on a similar device.

Top Movers

• For the week ending May 12th, 2023: the average return for gaming companies tracked by Naavik with a market capitalization exceeding $500 million was 0.7%. The S&P 500 returned -0.3% and the Nasdaq-100 returned 0.6%.
• Despite relatively flat index performance, the performance of individual gaming stocks was volatile as many reported earnings. According to the WSJ, this was the sixth consecutive week of moves less than 1% for the S&P 500, the index’s longest streak since 2019.
• AppLovin surged 25.4% last week after reporting earnings that beat expectations. The mobile app technology company reported $715.4 million in revenue for the first quarter, exceeding analyst estimates calling for $695 million. It issued second quarter guidance of $720 million at the midpoint, which was above estimates as well. The stabilization of the mobile advertising market was reflected in Unity’s results, which rose 12.1% after similarly reporting positive earnings.
• Roblox shares rose after the company reported earnings that were in line with expectations. The company reported a loss of -$0.44 per share for the first quarter, more than the -$0.40 EPS estimate from analysts. Revenue was more or less in line at $774 million versus projections of $766 million. What may have contributed to the positive performance was CEO David Baszucki’s guidance for acceleration in bookings growth, and a slowdown in “year-over-year increases in headcount and compensation expenses.”
• IGG Inc. finally brought its winning streak to an end, which saw shares more than double year-to-date on the success of the developer’s mobile game Doomsday. The company reported earnings on April 27th which showed FY 2022 revenue falling -24% from a year prior, driven by a steep drop in revenue from its hit game Lords Mobile.

Most Notable Strategic Investments

• Epic Games and digital fashion company CLO Virtual Fashion “purchased shares in each other,” according to a joint press release on May 11th. The South Korean fashion company offers 3D design software called CLO, which facilitates the creation of virtual garments for a variety of uses. The company released a teaser video in February showing CLO’s workflow within Unreal Engine, which likely put it on Epic’s radar. CEO Simon Kim stated that the company envisions the “digitization of everything,” and “the convergence of fashion with entertainment and the metaverse.” CLO Virtual Fashion was founded in 2009 and has raised a total of ₩6 billion, across a seed round in 2011 and a Series A round in 2014. The terms for the deal with Epic were undisclosed. (Link)
• Keywords Studios acquired Hardsuit Labs, a game development studio in Seattle with over 70 employees. Hardsuit is primarily a contract developer for studios using Unreal Engine, and is currently working with Epic Games on Fortnite: Save the World and Fortnite Creative. Past AAA projects have included engineering support for Gears of War 4 and design work on Call of Duty: Vanguard. Keywords plans on integrating Hardsuit into their Create segment, which has 3,500 employees working on external art services and game development. Keywords CEO Betrand Bodson said that Hardsuit would be their first game development studio in Seattle, complimenting their art, animation, and VFX studio Lakshya Digital in the city. (Link)
• Super League acquired Melon, a company that creates metaverse experiences in Roblox. Melon’s development work includes partnerships with Chipotle, NFL, and Mattel to bring physical experiences to the metaverse. It was also the creative partner for musicians Tai Verdes, and others, bringing their performances into the gaming platform. Melon raised $5 million in seed funding last July, led by musician management company Crush Music. Super League, which is publicly traded on the Nasdaq, plans on turning Melon into an in-house development studio. (Link)

Most Notable Venture Financings

• Gesture recognition technology startup Doublepoint raised $3.3 million in seed funding. Doublepoint has spent three years in stealth creating its patent pending software, which can detect complex touch-based gestures without the need for cameras, like those present on AR and VR headsets. In the demo for the product, CTO Jamin Hu uses a Samsung Galaxy Watch with Doublepoint algorithms to demonstrate hand tracking based on movement alone. The funding will be used to integrate this technology into consumer electronics. The company is based out of Helsinki, but has a total of 11 employees in Finland, Sweden, Germany, and the UK. (Link)

Other News

• FromSoftware’s critically acclaimed open world game Elden Ring topped 20 million unit sales. Bandai Namco’s latest earnings report, released on May 10th, revealed that strong overseas sales propelled Elden Ring to 20.5 million in sales, though the company expects sales to slow down going forward. This puts Elden Ring in rarified air as one of only a few titles this decade to reach this milestone, along with Animal Crossing: New Horizons, FIFA 21, Modern Warfare, and Cyberpunk 2077. (Link)
• Bungie was awarded $6.7 million in damages in a lawsuit against LaviCheats, a developer of cheating software for Destiny 2. This is the latest in successful suits for Bungie after it won $13.5 million in June 2022 from Elite Boss Tech and $12 million from Veterancheats in April 2023. Take-Two Interactive and Epic Games are currently engaged in similar lawsuits, as developers crack down on unauthorized software that allows players to gain an unfair advantage against others, particularly in PvP game modes. (Link)
• The International 2023 will be held in Seattle, near Valve’s hometown of Bellevue, for the first time since 2017. This is the 12th iteration of the tournament, which frequently generates the highest prize pool among esports. Valve stated that TI 12 would have the tournament’s largest audience to date. The event will start in group stages on October 14th before shifting over to the Climate Pledge Arena on October 27th for the actual bracket. (Link)  
• Amazon launched its new service “Amazon Anywhere,” which lets customers purchase physical goods within video games and virtual worlds. The service debuted within Niantic’s new AR pet game Peridot, allowing users to link their Amazon account to purchase merchandise on the same interface where they can also purchase in-game microtransactions. (Link)
• Game Freak, the Japanese video game developer best known for their work on the Pokémon series, announced a new action-adventure game codenamed Project Bloom. The game will be published by Take-Two Interactive’s subsidiary Private Division, which has published titles like Hades and The Outer Worlds. The launch is planned for Take-Two’s 2026 fiscal year, which would be the period from April 1st, 2025 to March 31st, 2026. No consoles have been announced yet for the launch. (Link)

A big thanks to Mario Stefanidis, CFA for writing this update! If Naavik can be of help as you build or fund games, please reach out.