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Where Will Electronic Arts Be in 5 Years?

John Ballard, The Motley Fool

Over the last five years, shares of Electronic Arts (NASDAQ: EA) have trounced the broader market, up 141% compared with the S&P 500's return of 51%. That outperformance includes the recent beating EA stock took over the last year, when the share price fell 39%.

Video game stocks can be volatile, but gaming companies still have a lot of growth opportunities. We'll look at three areas EA is focused on to become a more profitable business in the next five years.

A video game controller laying on a table next to a desktop computer with a mouse and keyboard.

Image source: Getty Images.

1. Digital revenue growth

The transition to digital distribution of games has been the central theme of the industry over the last decade. It allows for game companies to build a direct connection to players, and therefore sell more in-game content that keeps players engaged with titles longer. There's also the added bonus of increasing margins.

As we look at the next five years, EA still has a lot of room to expand gross margin. In fiscal 2019 (which ended in March), EA generated 75% of its revenue from digital sales. That left a quarter of its revenue still derived from packaged goods.

Looking specifically at consoles, digital full-game downloads made up only 49% of EA's sales on the Xbox One and PlayStation 4 last year. That percentage has been steadily marching higher. At the rate it's been climbing, EA will likely generate about three-quarters of its console sales through digital channels by 2024, and that should lift gross margin.

EA Gross Profit Margin (TTM) Chart

EA Gross Profit Margin (TTM) data by YCharts.

2. New business models

One of the appealing characteristics of video game companies is their ability to monetize their player bases in a variety of ways. EA believes new distribution channels and business models will continue to emerge, and it's crucial to growing the player base and increasing engagement.  

One new distribution channel that is emerging as a growth opportunity for EA is subscription services, such as EA Access and Origin Access. The company is investing heavily in these services, including a cloud gaming service that management expects could generate billions in annual revenue over time. 

Also, there is still a huge opportunity to grow digital sales through additional in-game content offerings. EA refers to the sale of in-game content as live services revenue, and it made up 40% of its business last year. The most popular live service the company offers is the Ultimate Team digital card game in the Madden NFL and FIFA franchises. 

Revenue from Ultimate Team has been growing steadily, reaching 28% of total revenue last year, up from 21% the year before. It's a $2.4 billion business that grew 10% in fiscal 2019.

3. Esports and mobile games

EA is still in the early innings of developing its esports business into a greater contributor to the top line. Through its competitive gaming division, it is pursuing esports as a way to further monetize its sports franchises with the sale of broadcast rights and advertising, and to stimulate higher engagement. The idea is to get players fired up to play more Madden or FIFA, so they potentially spend more money on Ultimate Team. Revenue from esports is included in live service revenue, which is another reason to keep an eye on the growth of this sales category. 

The other opportunity is in mobile games. Non-GAAP (adjusted) revenue from mobile games declined 13% in fiscal 2019 due to aging titles in its lineup. However, the mobile game market continues to grow, totaling $68 billion, and EA has spent years building a diversified group of mobile studios and franchises, so watch for further growth in this segment. The company expects mobile revenue to grow 12% in fiscal 2020. 

Final thoughts

The video game industry has grown at a steady clip over the years, and it's projected to expand by 9% per year through 2022. With so many different ways to monetize the 500 million players that spend time every month playing its games, I think it's a good bet to expect EA to be a more valuable company in five years than it is today.

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John Ballard owns shares of Electronic Arts. The Motley Fool recommends Electronic Arts. The Motley Fool has a disclosure policy.