Electronic Arts Can't Shake Risk Factor

The stock rebounds after lowering full-year guidance, but analysts remain cautious.
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Shares of

Electronic Arts

(ERTS)

recovered slightly Wednesday as investors weighed lower guidance against a blowout quarter.

However, uncertainty about the transition to next-generation game consoles prompted one analyst to lower his rating on EA to hold from buy.

Shares of Electronic Arts were recently up 75 cents, or 1.3%, at $59.75 after declining a day earlier by 4.7%.

"People are thinking their

EA's guidance is conservative, not aggressive," said Joe Spiegel, a fund manager with Dalek Capital, which does not hold EA shares.

"I am a little surprised. I thought people would be a little more cautious," Spiegel added. But he noted that there's reason to believe in EA given that the company so widely beat its guidance for the June quarter.

On Tuesday, the Redwood City, Calif.-based video-game software maker said it expected fiscal year 2006 earnings of $1.45 to $1.60 a share -- down 10 cents from prior guidance -- on sales of $3.3 billion to $3.4 billion -- down $100 million. The company blamed delays in its new game based on

The Godfather

movies, whose launch was postponed from the crucial holiday quarter to the company's March quarter.

In addition, the company acknowledged there will be some margin pressure from higher licensing fees paid to football announcer John Madden to keep his face on its market-leading National Football League game.

"They really need to execute really well to overcome the push-out in

The Godfather

and the slight margin reduction likely to come from Madden," Spiegel said. "It's clear to me basically everything else has to go right, and I'm not saying they can't do it but the risk to EA is clearly to the downside."

Wedbush Morgan Securities analyst Michael Pachter also took a more cautious stance on EA Wednesday when he lowered his rating to hold from buy.

"While we expect the company to maintain its market-leadership position, and think that its share price will rebound later in the year, we believe that there is some risk of negative market reaction to several potential negative catalysts," Pachter wrote. Among them: supply issues for current generation consoles, supply and pricing for next generation consoles and the timing of the next-generation launches.

Pachter raised his price target on EA to $61 from $58 based on an enterprise value-to-adjusted income multiple of 30, a 70% premium to the

S&P 500

multiple. He said that premium is warranted because he expects earnings to grow at a rate of 20% compounded annually. However, the upside to his price target is less than 15%, which prompted him to lower his rating.

"We believe that investors should hold shares of Electronic Arts, but we recommend against continued investment at current levels until we have greater visibility into more dramatic earnings growth than we have forecast," he concluded. His firm has not done banking with EA.

Banc of America Securities analyst Gary Cooper suggested there's still a risk that

The Godfather

launch could slip into fiscal 2007, which begins in April. Consequently, he believes EA is at risk of meeting its targets for the fourth quarter of 2006 and fiscal 2006. That said, he still reiterated his buy rating on the stock because he believes the company will produce in the current quarter, achieve his third-quarter estimate and make guidance if

The Godfather

launches in the fourth quarter. BofA has done investment banking with Electronic Arts.

Another possibility, meanwhile, is that management actually gave itself an extra cushion in its guidance in case of further missteps during the remainder of fiscal year 2006, Wells Fargo Securities analyst Yue-shun Ho suggested Wednesday. Ho has a hold rating on EA and his firm has not done banking with EA.

Ho said given that the company actually exceeded the midpoint of its guidance for the just-completed first quarter by $45 million, the $100 million cut in full-year targets actually amounts to a $145 million reduction, with $120 million of it likely coming from

The Godfather

and the remainder from foreign exchange impact.

Indeed, Spiegel noted that EA performed more than 10% better on the top line in the quarter than the company expected. First-quarter sales totaled $365 million, down from $432 million a year ago. But that still handily beat the consensus estimate from Thomson First Call of $326.8 million as well as EA's target of $300 million to $340 million.

"They definitely have some momentum," Spiegel said.

At least one analyst, Tony Gikas of Piper Jaffrey, was bullish about that momentum continuing. Like other analysts, Gikas reduced his fiscal year 2006 and 2007 estimates based on product delays, reduced visibility and transition risks. But he still expects EA earnings to grow nearly 15% during the next video game cycle, which

Microsoft

(MSFT) - Get Report

will kick off in November with its launch of Xbox 360.

"We are advising clients to invest in EA and video-game publishers during the next year and maintain holdings for a period of two years or more," Gikas said. He has an outperform rating on EA; Piper has not done banking with Electronic Arts.