Electronic Arts’ Strong Fourth-Quarter Profits Overshadowed by Star Wars

Console and online game maker Electronic Arts () posted strong fourth-quarter results Monday, with profits surging to $1.20 per share compared to $0.45 per share in the same period a year ago. Revenue also grew 26% compared to last year’s quarter, driven primarily by strong sales of “Mass Effect 3” and “Star Wars: Knights of the Old Republic.” We’d also like to note that “FIFA 2012,” the world’s pre-eminent soccer video game franchise, saw digital downloads and transactions exceed $100 million for fiscal year 2012. The company’s operating margin also more than doubled to 26.7%, in part from leveraging digital downloads and lapping higher research and development expenses.

However, EA forecasted fiscal 2013 non-GAAP earnings per share to be in the range of $1.05 to $1.20 (a disappointment), and the company will be taking several charges including $80 million acquisition expenses, $45 million in restructuring, and $175 million in stock-based compensation. Further, the amount of active subscribers on “Star Wars: Knights of the Old Republic” fell from 1.7 million at the end of EA’s fiscal third quarter, to 1.3 million at the end of its fourth quarter (the most recently reported one). This figure suggests that the company isn’t gaining as much ground on Activision’s (AVTI) “World of WarCraft” which boasts a similar multiplayer online format, along with over 10 million players.

Though EA is giving a tempered forecast, we think “Star Wars” could eventually take some meaningful share away from “World of WarCraft.” Role playing (RPG) gamers are notoriously sticky, and we think it will just take some time for consumers to try the new game. We also think the shift to buy games as digital downloads will help EA’s profitability as it offers them with a slightly lower cost structure.

However, we think EA must stake a claim in the social gaming space, where investors think Zynga (ZNGA) has a slight leg up. Sims Social could end up becoming just as popular as its PC predecessors. Though console gaming is likely not dead, and we may just be waiting for the next console upgrade to boost sales, a new generation of gamers will be consuming games through smartphones, tablets, and Facebook (FB), areas where EA has yet to really compete. At the same time, several console gamers will be reducing gaming time and expenditures, as time allocated to gaming tends to fall as one ages. We aren’t sure how it will play out, but this trend could be a long-term head wind.

In spite of its disappointing forecast, we think shares of EA are starting to look interesting, trading at the lower-end of our fair value range. We wouldn’t be surprised to see some tailwinds from a revamp of Madden, re-launch of the NBA Live franchise, and a new Metal of Honor game. If shares fall further (below the lower end of our margin-of-safety bands), and technical signals start to improve, we may look to open a small position in our Best Ideas portfolio.