Tuesday, June 30, 2009

Electronic Arts (NASDAQ:ERTS): Upgraded to Buy at Merril Lynch/BAM

Merrill Lynch/BAM is upgrading Electronic Arts (NASDAQ:ERTS) to Buy from Neutral following a modest post-E3 sell-off.

According to the analyst the upgrades is based on 1) expected upside to consensus estimates in 1Q and 2Q with company likely tracking at/above their early FY10 internal plan, 2) strength of Sims 3, Active and Need for Speed franchises likely driving improved investor sentiment on EA’s
execution, 3) catalysts and seasonality with the summer period historically giving the best return on EA’s stock and the firm sees several upcoming catalysts. Merrill is $100mn above consensus in F1Q (June) and F2Q and their bias is that Street estimates move higher for FY10/FY11 over next 90 days, as key Active and Sims titles should have catalog and sequel strength.

Multiple catalysts
In addition to 1Q/2Q upside, they see the following catalysts helping drive improved investor sentiment: 1) Strength of key Sims 3 franchise and progress on cost reduction initiatives outlined on 1Q conference call, 2) NPD retail sales data for EA improving with increases in market share reflecting a strong June/Sept Q title slate, 3) Need for Speed release in September, units for this key franchise could be up after several years of declines given easy comps and 4) possible PS3 price cut in August or September helptin drive improved sentiment on HW trends.

Valuation attractive if ests. going up, raising PO to $26
EA valued at 12x ex-cash FY11 (CY10) EPS estimate which is well below its historical average of over 20x. In conjunction with the upgrade to BUY, the firm is raising their PO to $26 from $25, rolling forward basis to FY11 using 17x excash EPS estimate of $1.14, plus $7 in cash (a discount to 20x target for ATVI).

Analyst notes they see upside to their PO at $26 based on 2x P/S if execution improves and EA can sustain 10-15% margins. Reaching 10-15% op. margins could warrant a 2.0x P/S multiple ($34 stock price) as EA traded at 4.5x sales last cycle on peak margins of 27%.

Notablecalls: I like this call as it highlights clear near-term catalysts and notes the $26 price tgt may end up being conservative.

I think ERTS will trade in the $21.50-22.00 range today. I don´t think one will get any fills below the lower end of that range.

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