Electronic Arts (EA) could have a major growth opportunity in China, but geopolitics is making that difficult to justify.
Shares of the California headquartered video game publisher have slumped along with the broader market on Tuesday, trending towards nearly 2% down just hours before the company's fourth fiscal quarter earnings release.
Aside from the well known issues confronting the company, President Trump's recently more hawkish stance toward China could put a tamp on a significant long term growth opportunity for the company.
Assessing the Market
China is among the most sought after markets for game publishers since the market made multi-billion-dollar monsters out of domestic players like Tencent (TCEHY) , which has recently become an EA partner on Apex Legends.
According to WePC, China continues to dominate the market by global revenue, more than doubling the spend of Japanese gamers, for example.
"China has become one of the largest digital gaming markets in the world and has grown exponentially in the past few years due to the popularity of mobile games and esports in the country," according to a report from Research and Markets, a Dublin-based market data firm. "The China digital gaming market is expected to expand at a compound annual growth rate of 15.4% during 2018-2023, and reach a revenue of $83.79 billion by 2023."
The over 600 million gamers in the region also contribute strongly to in-game purchases that expand the margins of video game producers. According to Newzoo, a video game and esports analytics firm, 94% of players spent real currency on micro purchases in 2018.
By nearly every metric, China is the number one market for each video game publisher.
Despite the significant opportunity, EA's inroads into the lucrative market have lagged.
"Although China is a major growth opportunity for EA off possibilities such as Apex Legends distribution with Tencent, Greater China represents only 3% of EA's current top line," Buckingham Research analyst Matthew Harrigan said.
According to FactSet, mainland China represents about 2.8% of the company's global revenue after falling by about 75% in the course of 2018.
The company has been consistently questioned about the missed opportunity in recent quarters, noting that there are plans in place to attack the massive addressable market.
"China we're being more cautious along with our partner Tencent," CFO Blake Jorgensen said in February. "But some of the regulatory hurdles are starting to get cleared across the industry, which I think will help us speed up that transition."
He added then that while he hoped to be up and running more strongly by the close of the 2018 calendar year, he expected further growth into calendar year 2019.
"We do view that the long-term play there is a positive one, particularly with the growth in soccer in that marketplace," he added.
China is also a well known mobile gaming marketplace, with the lion's share of gamers viewing streaming platforms on mobile devices and increasingly play on phones, not consoles, first.
The number of China's mobile gamers is projected to grow from 601 million in 2018 to more than 700 million by the end of 2021, or more than twice the population of the United States, according to Chinese technology, media, and telecom company KrAsia.
"China is a very particular marketplace," Jorgensen said, noting the trend. "We did a small partnership deal around the Command & Conquer mobile game recently that is performing very, very well in China. We know that the Plants vs. Zombies brand is very strong in China, as is the Need for Speed brand."
The release of a new Plants vs. Zombies game later this year could help kick start growth in this "particular" addressable market.
"Brands like FIFA, brands like Need for Speed, Plants vs. Zombies, Command & Conquer, and potentially The Sims may have tremendous appeal there," Jorgensen concluded. "We are working to plans on how we execute against that over time."
It will be important to hear more from Jorgensen and company executives about how the company is continuing to address the opportunity.
The issue at present regards the company's ability to expand as Chinese consumers are stung by the recently intensified trade war and Chinese regulators that could be less friendly to American companies in its wake.
"Growth in China, especially in the critical mobile business, depends on maintaining a good relationship with Chinese partner Tencent which is also subject to regulatory pressures from Beijing," Buckingham Research's Harrigan noted.
While the risks are real, Harrigan explained that the recent reaction in shares in response to trade war anxieties has been overdone.
"We are retaining our NEUTRAL rating and $103 price target on Electronic Arts but would be opportunistic this week off what we feel was unwarranted negative price action on Friday and a likely reflexive China selloff," he said.
Harrigan added that uncertainty surrounding the earnings is helping leave his rating at "Neutral".
As far as the growth opportunity available, a bullish outlook in China could certainly shift the stock's trajectory. The difficulty will be gaining traction in the currently pessimistic geopolitical picture.