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Bad Times Get Worse for Electronic Arts

Chris Morris|Special to CNBC.com
Tuesday, 12 Jan 2010 | 1:01 PM ET

Investors are getting impatient with Electronic Arts.

The video game publisher, which has been attempting a turnaround for nearly two years, on Monday warned that its earnings for the December quarter would be significantly lower than expected. Shares, predictably, are under fire today , down nearly 8 percent.

Once the undisputed king of the video game hill, EA has somehow become the gang that can't shoot straight. This is the second holiday season in a row that the company has notably lowered its guidance. Its powerhouse games—including "Madden"—are showing signs of weakening. And though critics have applauded some of the newer franchise efforts, none of those titles has become a true blockbuster.

While EA certainly has its problems, Monday's warning also sounded an alarm for the rest of the industry.

Weak sales in Europe were cited as one of the key reasons for the shortfall. EA was especially vulnerable to this, given its reliance on the "Fifa" franchise, but that retail softness could hit several other publishers as well.

Ubisoft for example, has a strong concentration in the continent. And GameStop, which has locations in 15 countries outside of the U.S. and Canada, has already reported a shortfall from Europe.

"European weakness makes it difficult for any of the video game companies to hit numbers for the December quarter," notes Ben Schachter, an analyst with Broadpoint AmTech.

On a broader scale, the EA warning indicates that—"Modern Warfare 2" aside—video games may not have been as popular this holiday season as many expected they would be. While comments from hardware manufacturers indicate that people were buying systems—like the Nintendo Wii and Sony PlayStation 3, they apparently weren't buying many games to play on them.

Worse still, EA executives were fairly gloomy on the months ahead, saying they expect industry sales in 2010 to be flat to down 5 percent.

That's notable, as the industry has a very strong lineup of games announced for this year—and the comparison to last year's sales numbers is likely to be much easier than 2009 was versus 2008. Some analysts, in fact, feel EA might be overreacting.

"Management made a mistake, in our view, by commenting that the company expects industry sales to be flat or down slightly in 2010," says Michael Pachter of Wedbush Securities. "We think that [the company] is somewhat shell-shocked … [and] the negative industry growth forecast was made out of an overdeveloped sense of vigilance about not making the same mistake for three years in a row. We think that management is just plain wrong."

Source: EA

For EA, the shortfall will likely bring about even more cost-cutting. That's getting tougher, though as over the past two years, the publisher has eliminated roughly 2,500 jobs and consolidated several of its studios. Fewer developers will mean fewer titles—with some franchises likely being put on a shelf for a while, letting demand build for new installments and giving the teams time to actively plan for more dramatic changes between releases.

(A good example of this is the new "Medal of Honor" title due later this year. Once a biennial title, EA kept it on the sidelines in 2009, giving its team more time to hone the game and move it from its traditional World War II setting to modern day Afghanistan. )

It will be interesting, also, to see if the company continues to cultivate relationships with independent development houses as part of its "EA Partners" program. Many of the games published under that branch of the company have been sales hits—such as Valve Software's "Left 4 Dead 2" and the "Rock Band" franchise.

EA gets a cut of those sales, but its own games are being overshadowed in the process. And ultimately, that's not a way for a fallen king to reclaim its crown.

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