Electronic Arts (ERTS): M&A And Layoffs Meet At A Crossroad

Electronic Arts (NASDAQ:ERTS) did something today that is almost never seen in the corporate world. It made a big acquisition and fired 1,500 of its workers, 17% of the total staff, on the same day.
EA bought online social media game company Playfish which makes the popular “Pet Society” for $275 million in cash plus bonuses if the company performs well after the transaction. Playfish is only two-years-old. It is not likely that the small firm is making money, at least not enough to make a financial justification for EA to pay such a large price. EA trades for 1.5 time annual revenue so Playfish would have to have revenue of nearly $200 million to have a similar a valuation similar to its new parent. Playfish isn’t that large.

EA’s revenue for the quarter ending September 30 was $778 million down from $894 in the same period a year ago. The company had a net loss of $391 million compared to $310 million last year.

The 1,500 lay-offs at EA will save about $100 million and cause a restructuring charge of $130 million to $150 million. The firm could have decided against buying Playfish and paid for the workers that it fired for two years. But, big businesses are forever chasing rainbows and social media has become essential to the life of the internet , at least in the minds of many, due to the rise of MySpace, Facebook, and Twitter. The fact that none of those three companies does well financially does not seem to matter to EA. It is a company that has to show Wall St. that it can diversify beyond the normal video game console and internet gaming worlds. Perhaps the universe of social networking will bring it a new-found prosperity, even though there is no indications the social networks are a real business yet. EA is a company that is running out of options to improve business, and it shows in the firm’s financial results.

Sprint (NYSE:S) was cutting 2,500 people at about the same time that EA was making its announcement. Sprint said that it would put $1.5 billion along with Intel (NASDAQ:INTC) and Time Warner Cable (NYSE:TWC) into the bank account of its partner in building wireless 4G, WiMax as it is known, Clearwire (NASDAQ:CLWR). Sprint will save about $350 million from its cost cutting. That should nearly cover the money it will invest in Clearwire.

The Sprint and EA news is all about leaving the past behind and hoping that managements’ best guesses about what will make future profits turn out to be true. Sprint believes that if it can get to market with super-fast wireless service that it can take customers from AT&T (NYSE:T) and Verizon Wireless (NYSE:VZ)(NYSE:VOD), something it has not been able to do up until now. EA believes that the video game business is moving online faster and faster and that marketing games through social networks will bring in new revenue.

Playfish and WiMax may never be money-makers, but EA and Sprint are both struggling to find ways to make themselves successful again. The temptation to find the success in technology that is new and untried is tremendous.

Defending the future is easier that defending the past, especially at companies that have not done well.

Douglas A. McIntyre