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Electronic Arts And AOL in Online Games Deal

Added: (Tue Nov 23 1999)

Pressbox (Press Release) - By Therese Poletti

SAN FRANCISCO (Reuters) - In a bid to become the world's top provider of video games online, Electronic Arts Inc. (NasdaqNM:ERTS - news) agreed to be the sole supplier of games to America Online Inc. (NYSE:AOL - news), the No. 1 Internet service provider.

Redwood City, Calif.-based Electronic Arts, the world's biggest developer of video games, also said it would form a separate online games division that will create a Web site in late summer 2000 allowing consumers to play games on online.

The company will also issue common shares in its new Internet business, in the form of a tracking stock, with an initial public offering planned for late next summer.

"EA is a leading creator of content and our intention is to make all that content available online," John Riccitiello, president and chief executive of Electronic Arts, said in an interview. Riccitieillo will oversee the new Web business.

"This exclusive deal merges the two into what we see as a dream team," said Lise Buyer, a Credit Suisse First Boston analyst. "We think (Electronic Arts) is very well positioned to be the No. 1 supplier of games online. All that was missing was a distribution network. AOL provides that."

While the five-year deal and things like the Web site will boost revenues in the coming years, they will first drag earnings down as the company makes investments in the online games business, its chief financial officer, Stan McKee, said.

Additionally, Electronic Arts also agreed to buy the Kesmai gaming unit of Rupert Murdoch's media conglomerate News Corp.(NCP.AX)(NYSE:NWS - news), for $30 million in cash and stock in a deal that will result in a $7.5 million charge against earnings, probably in the fourth quarter.

Nevertheless, Wall Street analysts responded favorably to the unveiling of the company's long-awaited Internet strategy, which fueled an 18 percent jump in Electronic Arts's stock.

Electronic Arts shares settled $16.25 higher at $108.25 after a session of active trading. AOL added $4.12 at $162.31.

AOL, based in Dulles, Va., said it will purchase 10 percent of the new common stock, and warrants for an additional five percent, while News America will acquire five percent of the new common shares. Both deals are subject to regulatory approval. The remaining shares will be retained by Electronic Arts and its employees.

Between the AOL and Kesmai deals, the new Web site and the other investments, Electronic Arts said it expects earnings dilution of 20 percent in the fiscal year ending in March 2001. First Call/Thomson Financial's latest consensus analysts' estimates predicts the company will earn $2.52 in fiscal 2001. It earned $1.74 in its last fiscal year ended in March 1999.

The company, which is known for its popular titles such as John Madden Football, SimCity, Conquer Tiberian Sun, and many others, plans an initial public offering to coincide with the introduction of the site, sometime by the late summer of 2000.

"We are encouraged to see EA take off its gloves to fight in the dot com world, leveraging its best of breed, content and brands," said Larry Marcus, an analyst at Deutsche Banc Alex. Brown, who raised his price target to $140, from $110.

The deal with America Online spans five years starting in April 2000 and guarantees AOL $81 million.

Electronic Arts will be exclusively responsible for the content on AOL's Games Channel and on its AOL.com Web site, its CompuServe service, ICQ and Netscape properties.

For its part, Electronic Arts plans to spend up to $125 million between now and March 2001 as it builds its online games division. It said it will spend $20 million to $25 million in the current fiscal year ending March 2000, plus another $100 million in the following year.

The money would be spent on fees and shared revenue associated with the AOL deal and on product and infrastructure development and marketing, said McKee, Electronic Arts' CFO.

"This year is a straight investment year," said Riccitiello, the president and CEO, adding that material profitability will come in fiscal 2003.

McKee, the CFO, estimated that revenue from the online division would be $50 million to $70 million next year and in fiscal 2002, revenue is expected to be $175 million to $200 million.

Electronic Arts will retain over 95 percent of subscription revenue and over 70 percent of advertising revenue, he said.

In the next year, Electronic Arts plans to offer 60 games online through AOL and its Web site through a subscription based service. It currently offers one online game, "Ultima Online," for a $9.95-a-month subscription fee.

Regarding plans for the tracking stock for the online gaming division, Electronic Arts said it expects to file a proxy statement with regulators by March 2000. It plans to do the IPO late in the summer of 2000, coinciding with the introduction of the Web site, McKee said.

The company said it is issuing a tracking stock so that investors could have an isolated return on its Internet business, and as additional currency for hiring new staff.

"While we are very good at hiring and recruiting, we need more of the best," Riccitiello said.

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