EVENT: ERTS (20.16) reports fiscal q4 2011 earnings tonight after the close.
-Options market is implying ~7.25% move vs the 8 qtr average of ~7.5%.
PRICE ACTION / SENTIMENT / FUNDAMENTALS:
-stock is up 22% ytd, outperforming the Nasdaq up 7%. Since the stocks ramp from the lows earlier in the year, short interest has picked up meaningfully from ~2% in February to ~7.5% of the float in April.
-In the latest 13f data available for Q4 2010, 14 of the top 20 largest holders added to positions, while only 4 sold some.
-analyst community fairly mixed on the name with 13 Buys, 12 Holds and 2 Sells….avg 12 month price target ~21.00.
-In February, the stock rallied off of near multi-year lows on a tepid earnings beat (they have been hard to come by in the name for sometime) and the announcement of a $600 million stock buy back. Chart below shows ERTS’s massive out-performance to the Nasdaq 100 over the last few months.
-Stock has held the gains from February and has benefited from positive sentiment and raised guidance by GME in late March…..Since GME offered upside revenue guidance on March 24th the stock has rallied a little over 20%.
-ERTS investors expect a beat for fiscal Q4, but the stock will likely trade on the guidance issued for FY2012. There are a few potential uncertainties that could weigh on the company’s ability to offer upside guidance for fy 2012….1. NFL lockout could hurt sales of the Madden franchise, 2. ERTS has high reliance on package product sales, even though the company has shown good growth in digital they will need to continue to make big strides to diversify a bit in path to margin expansion….3. title slate for fy 2012 also very important as pipeline and calendar often drive stock price……
-Valuation is in-line with peers with mid to high teens PE…..ERTS has a strong balance sheet with almost $6 in cash and no debt…..
MY VIEW: With the stock at multi-year highs, it will clearly need a beat and raise quarter to break out to the mid twenties, which at the moment I would be hard pressed to see the company offering overly aggressive guidance in the face of the NFL situation.
-The company has long been rumored as a take-over candidate, either by a large media company or a tech titan like MSFT. The problem here is that there is no sales growth. Company has massive brand value with franchises like EA Sports, but has not of late been able to make any new breakout titles. While the stock is not particularly cheap on most valuation metrics, excluding its almost $2billion in cash, the company could be easily acquired. But per usual that is not a great reason to buy the stock. Even with volatility elevated, I want to resist the desire to overwrite longs or offer structures that would cap gains in this healthy m&a environment.
WITH A LOT OF GOOD NEWS IN THE STOCK, LONG HOLDERS, OR THOSE CONSIDERING NEW LONG POSITIONS MAY CONSIDER STOCK REPLACEMENT/REPLICATION STRATEGIES AS THE COMPANY’S VISABILIY AS A RESULT OF NFL/MADDEN SITUATION MAY HURT THEIR ABILITY TO OFFER UPSIDE GUIDANCE FOR FY2012 EVEN IN THE FACE OF COST REDUCTIONS AND GROWTH OF DIGITAL.
TRADE; ERTS (stock 20.16) BUY THE SEPT 17 /22 Risk Reversal for ~.45
-Sell Sept 17 Put at .50 (~20 delta option at 36.41 vol)
-Buy Sept 22 Call for .95 (~37 delta option at 32.74 vol)
Break-Even on Sept Expiration:
Upside: above 22.45 ( up 11%) you make money, btwn 22 and 22.45 lose up to .45
Downside: bwtn 22 and 17 lose .45, below 17, you are put the stock and lose the .45 premium that you paid, so you have effectively paid 17.45 for the stock, down 13%.
TRADE RATIONALE: Stock has rallied to the high end of the multi-year range on news/guidance that has yet to be validated, this is still a wait and see story……Uncertainty regarding product cycles and the company’s ability to grow sales will be major focus……option market reflects this as Vols are elevated in the name, current implied vol around 37 is trading rich to its 60 day realized vol of ~22 and its 90 day realized of ~32. This structure offers a band in which you can get long on Sept expiration without making the commitment to buying the stock at current levels in front of what will be 2 key earnings events. I chose the 17 strike Put as that is the approximate level of the 200 day moving average. The 22 strike call was chosen as a level that would confirm the break-out above the multi-year range. If the company beats Q4 and offers guidance less than street expectations, but not a disaster calling into question their credibility the stock will likely see a sell off within the implied move……Flip side is if they are able to show digital results that give some clarity to the their longer term goals then could casue shorts to cover and large holders to add sending the stock near term to 22-23.