EA shares lowest since '99 - is it now a takeover target?

Electronic Arts has been the rumor mill's favorite grist for years -- but in recent weeks, the company has found itself the subject of even more whispers than usual. Reports that Nexon was planning a bid for the company proved to be a significant misunderstanding by a major news outlet, but with the company's revelation Monday that subscribers to Star Wars: The Old Republic are leaving at an alarming pace and that the future earnings outlook is tepid, those takeover talks may be resurrected. EA shares are taking a hit today on yesterday's revelations -- down some 6 percent (which, admittedly, is better than the 10 percent drop that came in after-hours trading yesterday). Shares opened Tuesday at $14.25, a level the company hasn't seen since July 1999. In the past five years, EA shares have lost nearly 70 percent of their value. A lot of that loss is tied to the broader economic downturn, but there's plenty of blame on EA's side. While it has had its share of hits, it hasn't published a new category-defining title for a long time -- and it has lost several strong members of its management team to companies like Zynga. Meanwhile, the publishing side of the business -- the bread and butter for any traditional game company -- continues to be battered by sluggish retail sales. There are some advantages, though. EA has bet heavily on digital distribution and has expanded its focus into other areas, such as mobile, that are starting to show payoffs. The numbers speak for themselves: In the first fiscal quarter of 2011, EA recorded digital revenue of $209 million. In the second quarter, that jumped to $216 million, then $377 million in the third quarter. And it wrapped up the year with $425 million in digital revenue. That speaks well for Origin, which (with 11 million registered subscribers) is still dwarfed by Steam, but still produces a healthy income (generating $150 million in 10 months). Also, while EA could be pointed at as one of the reasons mobile and social developers are being paid astronomical amounts of cash in today's buyouts, it has finally realized the ridiculousness of those valuations and isn't likely to be jumping into the fray again soon. "We don't need to buy a brand just to get a temporary lead on top of the charts for whatever is hot this quarter," said CEO John Riccitiello on yesterday's earnings call. "That doesn't mean that we would never buy or never invest. We would. But right now, what I'm starting to see is valuation expectations that assume that these things are all hockey stick moving up into the right with no end in sight, and I think those are bad assumptions." So there are definite pros and cons to the company. The question is: Does this make it an attractive target for potential buyers? The answer is yes -- and no. Unlike THQ, EA is a company that has a lot of successful franchises that it owns outright. And, unlike some publishers who largely focus on a single genre, it's diversified, having seen success in sports, action, RPGs and more. Couple that with the depressed stock price and it's virtually impossible to imagine no one is contemplating a bid. Forget other U.S.-based publishers. Only Activision Blizzard would be in a position to even contemplate a bid these days, and even casual observers of this industry know how unlikely that is. Overseas publishers, though, are more cash rich, and could be viable candidates. Adding EA to their holdings would give them a strong U.S. presence and help them expand their properties into North America. But I keep coming back to major entertainment conglomerates as the most likely suitors. Fox is making a new push into gaming as it embraces the transmedia lifestyle, and EA has several IPs that have box office potential. And Disney could easily integrate the other EA Sports franchises into ESPN as thoroughly as it has woven Madden into the network. (Plus, EA's increased digital focus would mesh nicely with Disney Interactive Studio's current mission.) Not everyone agrees, of course. "The major media companies wouldn't touch it with a 10 foot pole, because they don't want to be associated with the volatile earnings of a video game company," says Eric Handler, senior equity analyst for MKM Partners. "They're all going social now, they don't want to deal with console games." The hurdles for the deal, though, are substantial. EA has over 331 million shares outstanding -- meaning any bid would have to be enormous to be seriously considered. It's unlikely the company would seriously entertain anything under $25 (which is about a valuation that's roughly 64 percent over its stock price -- the same premium EA offered Take-Two in 2008). Any takeover would also likely hasten the exodus of senior management. And while it's fun for gamers to take shots at EA, the company has an experienced executive suite -- something that's helpful in a rocky period (even if execution by that team has been spotty at best recently). So is EA a takeover target? In the short term, that's unlikely. The cons outweigh the pros and there are a lot of uncertainties looming in the next couple of years. (Will the next generation consoles help the company rebound? Will the digital initiative continue to bear fruit? Will the increased focus on mobile, social and free to play boost the bottom line?) But EA is a company that has failed to deliver for its shareholders again and again. Analysts are still acting as apologists for it, but even they are showing signs of frustration. With a few key stumbles and another major hit to the stock, EA could find itself fighting to remain in charge of its own destiny.