4 Ways an Investor May Play EA Stock

If there's one series to be connected to in the past year, it's Star Wars. Nearly any company that has exposure to the recent blockbuster release from Walt Disney Co. (ticker: DIS) saw some sort of boost from that part of the business. Even Disney, which hasn't performed well of late, saw astounding results from the hit.

Call it the Star Wars effect.

Another company that hopes that impact will serve it for a long time is Electronic Arts (EA). The game producer licensed the rights to launch "Star Wars Battlefront" released late last year, and has a 10-year contract to produced games for the iconic series, including new films currently under development.

A blockbuster would certainly be welcomed by EA stock shareholders, although EA has been on an impressive winning streak, with its stock up 120 percent over the past two years.

Can EA keep its hot streak going?

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Digital provides EA with better margins. One reason for EA's rise is due to the popularity of digital platforms in the gaming space. Having the ability to sell to consumers via consoles, like a Sony Corp. (SNE) PlayStation, allows game producers to hold onto more of the funds when a game is sold. This "gives you more margin," says Michael Pachter, a managing director of equity research at Wedbush Securities.

This can lead to billions in more revenue for EA. For example, if a customer buys an EA game for $60 in a GameStop Corp. (GME) retail store, EA gets about 60 percent of that sale. But if the customer buys it online and downloads the game to a console, EA gets 70 percent of the sale because it pays fewer fees to online platforms than to retailers.

EA is also profiting from the trend of online gaming. Many games -- whether they are bought through a retailer or downloaded online -- offer features that allow players to compete with or against others over an internet connection. EA and other game producers can also sell new features, allowing players to upgrade their purchases.

"That live service keeps (players) engaged," says Chris Merwin, an internet sector analyst at Barclays.

This builds incremental revenue, which EA hopes to increase by $1 billion in the next three to five years.

Trying to create a less cyclical business. The game industry has long been a hit business. Hugely successful games like Activision Blizzard's (ATVI) "Call of Duty," Bethesda Softworks' "Fallout" or Rockstar Games' "Grand Theft Auto" usually means a good year for a game manufacturer. When there's not a hit, the revenue dip is noticeable -- EA has seen annual revenues swing 10 percent to 15 percent in both directions in the last eight years.

But the gaming industry has become "a much more predictable business," Merwin says. EA in particular has taken steps to ensure a more predictable growth strategy, partly with the help its digital sales. And its lineup of successful sports games -- "FIFA Soccer," "NBA Live" and "Madden NFL" -- is updated every year with new rosters and features. Hard-core gamers are eager to buy the updated titles each year, providing EA with a reliable source of revenue, he says.

The Star Wars franchise offers a new opportunity for EA -- more than 15 percent of "Star Wars: Battlefront" players are first-time EA customers, the company says, signaling a bigger audience for EA games.

"The sports franchises are recurring," he says. "But they would love a billion-dollar franchise."

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Mobile offers a way forward, with a stronger strategy. While mobile games grew 9 percent in fiscal year 2016, it's still a small part of the business. For now, EA has kept its mobile strategy similar to its efforts on other digital platforms.

"Their approach is to use existing game franchises and put them on mobile," Pachter says.

But those aren't the type of games that lead to large hits on mobile devices. Instead, it's "Candy Crush Saga" -- Activision bought its creator, King Digital, for $5.9 billion -- and a smartphone. Instead, it's Candy Crush and Zynga's (ZNGA) "FarmVille" that find the most traction on a mobile device.

While Pachter supports many of the EA's management decisions in reshaping the company on digital platforms, he thinks this is one area that it needs to reconsider its strategy.

Although pricey, there are benefits to owning EA stock. Last year, EA announced that it would buy back $1 billion in shares over two years. That program will run through May 31, 2017, but EA has already added more funds for repurchases, announcing in February that it will buy back $500 million more shares.

These repurchases can pay back investors, even if the stock sinks. But Merwin doesn't think that it will happen. He has a price target of $82, based on a 2017 price-earnings ratio of 23. It's a premium to competitors, but it's deserved, he says, because EA's "much more predictable and [has] higher margins."

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It's not a blockbuster hit, but that's OK.

Ryan Derousseau is a journalist with nine years of experience writing about investing and leadership issues. His work has been read in Fortune, Money, CNNMoney and Fast Company, among other publications. You can find more from him on Twitter @ryanderous.