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Electronic Arts goes public.


Now that the stock market has rebounded (perhaps temporarily) from the 1987 Black Monday crash, all kinds of long-deferred initial public offerings seem to be coming off the shelf. Last month, Symantec took the plunge (Soft-letter, 5/1/89); now, Electronic Arts has just put a prospectus of its own into circulation.

The Electronic Arts offering (1,940,000 shares at an anticipated price of $9, equal to about 18 times earnings) offers some interesting insights into the fast-changing entertainment software business. EA, which hauled in $63 million from game titles in its most recent fiscal year, is already the biggest single player in that market. The company's closest rival, Mediagenic, hit $61 million in sales during that same period, but only 54% of Mediagenic's revenues came from true computerbased entertainment software (videogame and productivity titles contributed the balance). Epyx, Sierra On-Line, Microprose, Accolade, Origin Systems, and other game companies are all substantially smaller than Electronic Arts, and most are essentially niche companies that focus on one or two game categories.

Electronic Arts president Trip Hawkins likes to talk about how he's organized his company like a Hollywood film studio, with a group of autonomous "producers' who create and manage "properties." EA has always stressed the high production values of its games and regularly showcases the artists who create these titles; like a major Hollywood studio, it also generates a good chunk of revenues (currently 45%) from "affiliated label" distribution deals with smaller independents. EA's prospectus suggests why the film studio model, with its emphasis on decentralized management, makes sense for an entertainment software company. Electronic Arts currently distributes over 350 titles (more than 100 of its own, plus 250 affiliated labels). A few of these titles can be expected to generate large revenues (EA has broken the million dollar mark about 40 times in seven years of operations), but the average Electronic Arts game generates less than $200,000 in annual revenues. Moreover, turnover rates in entertainment titles tend to be high: Historically, half of EA's annual revenues have come from newlyintroduced products, and the company's product life cycles have averaged six to 18 months. Clearly, entertainment software is a business that demands lots of hands-on, entrepreneurial management.

Even with EA's emphasis on bottom-up management, however, entertainment software remains a tough business. over the past five years, the company's net profit has fluctuated between -7% and 14% of sales--a low return by business software standards, especially for a market leader: (TABLE) Of course, slim margins are an old story to entertainment software companies (during the last two years, Mediagenic netted an average of only 4.4% on aggregate sales of $106 million). But Electronic Arts has added an interesting twist to the discussion--and to its own prospectus--by publicly proclaiming that the entire games software business is on the skids. "Total market demand for floppy disk-based entertainment software," EA's underwriters say, "has been level or declining over the past 12 to 18 months, a trend the Company believes is likely to continue." (Most of EA's rivals would probably agree with this assessment; several are already hard at work diversifying away from entertainment software.)

The chief reason for the market's decline, the prospectus goes on to explain, is the phenomenal success of cartridge-based videogame products, primarily for Nintendo systems (Soft-letter, 4/1/88). Because the videogame business is a volatile boom-or-bust environment controlled by a few large Japanese hardware companies, Electronic Arts has carefully stayed clear of cartridge-based products.

But videogames are where the entertainment dollars are. By the end of this year, the prospectus reports, analysts predict that videogame systems will have penetrated fully 24% of U.S. households. Most of those systems will carry the Nintendo name, but (says the EA prospectus) the market is about to undergo a "technology transition" to 16-bit systems that could open the way to stiffer competition from Sega, Atari, and NEC. If Electronic Arts plays its cards right--and the company does have creative capabilities that outstrip those of most videogame developers-it could emerge from this transition with a very big piece of what is already a billion-dollar market. To be sure, the whole 16-bit videogame scenario is full of risks and lurking demons. But if anybody can make the transition from computer games to videogames, we suspect it's going to be Electronic Arts.
COPYRIGHT 1989 Soft-letter
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1989, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Date:Jul 1, 1989
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