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Analysts: EA Has 'Blow-Out' 2nd Quarter, Cautious on Midway

Following yesterday's earning reports from both Electronic Arts and Midway, analysts from Lazard Capital Markets and Wedbush Morgan cited a 'blow-out' better than expected Q2 as reason to remain bullish on EA, with Wedbush additionally 'cautiously optimis
Following yesterday's earning reports from both Electronic Arts and Midway, analysts from Lazard Capital Markets and Wedbush Morgan cited a 'blow-out' better than expected Q2 as reason to remain bullish on EA, with Wedbush additionally 'cautiously optimistic' on Midway. Both analysts agreed that Electronic Arts, which yesterday posted record second quarter net revenues, up 16 percent over the prior year at $784 million, that the publisher was performing 'substantially higher' than expectations, and expect the industry to grow larger than EA's conservative estimates. Said Michael Pachter of Wedbush Morgan, "Our estimates are at the high end of company guidance, reflecting our belief that management guidance is conservative. In our view, this conservatism is appropriate, given the lack of control that the company can exert over key events such as the timing of launch and available launch quantities for both the Nintendo Wii and the Sony PS3 (though we believe visibility has increased significantly with the launches only two weeks away). He continued: "Company expectations for the Wii and PS3 launch quantities appear reasonable, but we believe that management’s conservatism is more a function of its style than any particular foresight into Nintendo’s and Sony’s manufacturing prospects." He added, "We think that several factors could drive revenues even higher. First, our model presumes only modest contribution from mobile phone games, and EA’s mobile phone business appears to be growing at a rapid rate. Second, we assume no contribution from microtransactions. It is possible that this category could drive revenues significantly higher year-over- year for the next several quarters." Lazard's Colin Sebastian agreed and cited even further 'multiple pieces fitting into EA’s growth puzzle' as reason to remain confident in EA, saying, "We expect that the three next-generation video-game consoles and a healthy handheld market will be the biggest drivers for significantly higher sales at Electronic Arts over the next several years. In addition, the company appears to be more focused on diversifying its portfolio of internally owned franchises for the new console cycle and the PC market. Importantly, EA also focuses on building significant new revenue streams from emerging growth areas such as online subscriptions (e.g., massively multiplayer games and Pogo), in-game advertising, mobile content, and digital downloads/micro-transactions." Sebastian added, "The company’s acquisitions of Jamdat (mobile) and Mythic Entertainment (MMOGs) are obvious cornerstones of this growth strategy; however, recent partnerships with Guangdong Tian Yue in China and advertising facilitators IGA and Massive are also key strategic initiatives, in our opinion. We believe that contributions from emerging businesses should better leverage EA’s wealth of video-game content and could ultimately provide some margin insulation from ongoing higher development and licensing costs in the core console and handheld business." On Midway, which announced continuing losses in its most recent quarterly results, revealing revenues of just $27.4 million and a loss of $22.2 million for the period ended September 30th, Pachter remained cautiously optimistic. "We were encouraged by management’s tone during the conference call," said Pachter. "We believe that the company is investing prudently during this console transition in order to position itself to compete in the next generation console cycle. We are cautiously optimistic that Midway will perform significantly better than it did the previous console cycle. The company expects to release four Wii games at launch with an additional game (Mortal Kombat) in the following quarter. In addition, we expect Stranglehold (PS3, 360) to perform quite well, although we expect the installed base of the next generation consoles to limit upside for the game." "Although we believe that Midway has reached the low point in its turnaround story," he added, "we have no clear visibility as to when it will achieve profitability. Without better clarity and a more imminent path to profitability, we are maintaining our HOLD rating. The company’s cost structure suggests that it can achieve profitability at revenue levels of $300 million annually, and we remain confident that Midway will be able to generate revenues at the $300 – 800 million level over the next several years. However, to achieve this level of revenues, the company must continue to expend resources on growing its development capability."

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