Electronic Arts (NASDAQ:EA) shares have been under assault over the past two months (and especially the past week), as many of our competitors have opined that the company’s MMO, Star Wars: The Old Republic was tracking well below “consensus” expectations. We believe that these concerns are overblown, and that the company’s revenues are tracking ahead of the high end of guidance for the fiscal year.
We believe that Star Wars: The Old Republic sell-in is tracking in-line with our Q3:12 estimate of 2 million units. EA’s MMO was released on December 20, 2011 in the U.S. and Europe. According to NPD, December U.S. sell-through of physical copies of the game was over 600,000 units, and we estimate that EA’s digital distribution platform Origin likely accounted for 25 – 35% of sales domestically, suggesting that the domestic sales figure was over 800,000 units. In our view, the fan base for Star Wars, MMOs and PC games in general skews slightly more European, meaning international sales, which we estimate to be 900,000 units, exceeded the domestic figure. Our combined sell-through estimate of 1.7 million units worldwide implies sell-in of at least 2 million units shipped during the December quarter, in-line with our expectation.
Star Wars server data can be somewhat misleading. Some investors have expressed concern and confusion about peak user levels that topped out at around 700,000 users, well below unit sales estimates, and their concern is exacerbated as peak user levels appear to have declined over the first few weeks following launch. However, because Star Wars is available in over ten different time zones, peak user levels should be expected to be well below total players at any given time, as many users will be distracted by a variety of necessary activities, such as eating, sleeping, working, or attending school. According to www.swtor.com, peak Star Wars users in a given day are topping out at roughly 500,000 users.
We believe that peak user figures represent fewer than 30% of total users, and imply total users (sell-through) of roughly 1.7 million (500,000 users / 30%). We think it is important to note that in a 168-hour week, the typical MMO player spends 10 – 30 hours playing an MMO, meaning that it is unreasonable to assume peak concurrent usage would ever exceed 30%. Finally, because the game went on sale in late December, early usage data should have been expected to be somewhat higher than it is now, as a large number of users were off work or school during the holiday period.
We strongly disagree with competitors that have suggested Star Wars sell-in and user data are tracking below expectations. In our view, the Q3:12 Star Wars sell-in “consensus” of 3 million units mentioned by some of our competitors is far too high. Activision Blizzard’s World of Warcraft, the most successful MMO of all time, sold 1.5 million units in its first month and an additional 2.5 million units in its first year, representing sales of around 50,000 units per week after the first few weeks.
Some of our competitors have suggested that the “consensus” first quarter sales estimate was 3 million units, or over a million above our own estimate, which we believe is not only unrealistic, but borders on the absurd. We believe that the current 500,000 peak user level reflects solid adoption of the game, and expect peak users to grow by 1 – 3% per week going forward, once peak usage stabilizes following initial euphoria from the early adopters. The Star Wars MMO received solid reviews on www.metacritic.com (an average of 85 points), and we believe that the strength of the brand and the skills of EA’s BioWare team will keep the game fresh and relevant for most users. We expect another million units in sales in
FY:13, and believe that 1 – 1.2 million users will opt to become paying subscribers on January 20 and beyond, when the initial 30 day trial expires. It is important to note that the initial trial is not “free”, as many of our competitors have stated; rather, the trial requires the purchase of the $50 game. As consumers have invested at least $50 in the trial, we think that somewhere between 75 – 90% of initial purchasers will opt to become paying subscribers.
We continue to expect Star Wars to have a meaningful impact on revenue and earnings growth in upcoming quarters. As mentioned previously, we expect sell-in of 2 million units in Q3:12 (with an additional 1 million units next year). However, as users get a 30-day free trial upon purchasing the game, subscription revenues will not begin until the latter half of January (Q4:12). We expect roughly 1 million subscribers by the end of March, with 1.5 million subscribers next year. Therefore, in Q3:12 we expect game sales of $80 million (2 million discs at $40 wholesale price), with subscription revenue of $35 million in Q4:12 (1 million subscribers for 2.333 months at $15/month).
Next year, we expect game sales of $40 million (1 million units at $40), plus an additional $270 million of subscription revenue (1.5 million subscribers for 12 months at $15/month). Based on our previous discussions with both companies about other projects, we believe LucasArts will receive 35% of revenue after EA receives payback on game development and marketing, with EA receiving a long-term operating margin of at least 75% on disc sales. For subscription revenues, EA will likely receive a long-term operation margin of at least 30%, once 35% of revenue is paid to LucasArts and the other 35% is spent on direct operating costs.
Michael Pachter is an analyst at Wedbush Morgan.