Electronic Arts, the company behind massively popular sports video games like FIFA and Madden posted a huge revenue miss for their latest quarter and the stock is getting absolutely clobbered as a result.

Analyst consensus for revenues in the holiday quarter (October, November, December 2018) was $1.75 Billion. The actual number came in at $1.61 billion which resulted in a miss by around 8%.

EA made a profit of $262 million on the quarter which translates to $0.86 per share. This was another huge miss as most analysts covering the stock expected earnings per share (EPS) to come in around $1.99.

The stock is tanking in after hours trading, down over 15 percent in a matter of minutes.

Source: Google Finance

A 15% loss in market cap for Electronic Arts equates to a value of over $4 billion dollars wiped out in after hours trading.

This continues a terrible performance from EA over the last year or so. The company has lost almost 50% of it’s value since reaching new highs in July 2018 just before the release of Madden 19.

Source: Google Finance

CEO Andrew Wilson had this to say on the earnings release, ” Q3 was a difficult quarter for Electronic Arts and we did not perform to our expectations. We are now applying the strengths of our company to sharpen our execution and focus on delivering great new games and long-term live services for our players “

There continues to be fan backlash over packs and loot boxes in what gamers often call, “Pay to win.” In the popular Ultimate Team game modes of FIFA, Madden, NBA Live, and NHL gamers can by “packs” which give players a chance to get some of the favorite/best players in the game.

Gamers who do not want to spend money have the option to acquire players for their team in different ways but they generally require spending insane amounts of time doing tasks which many view as tedious. For example, a gamer can complete 128 “solo challenges” which are basically 128 mini-games to earn a good single player.

In general the “solos” get increasingly more difficult as you progress. If you assume that loading screens take a minute on each end, the games themselves take on average 10 minutes, and you never have to restart even one solo (unlikely), you are looking at 25.6 hours of sitting in front of your TV playing boring games against the computer of gaming just to acquire one player.

If you don’t acquire at least semi-good players when you go online to play against others, your team will get destroyed even if you are playing a much lesser skilled player. Using the case of Madden 19, if you take your team out on the field with Nathan Peterman or Blake Bortles at QB you are going to get absolutely destroyed by a team that has Michael Vick or Tom Brady.

The time-consuming nature of these solos and other ways of acquiring players for your team lead players to just spend real money instead to buy “Packs” directly from EA. It’s a very good business model which EA relies heavily on to drive revenue growth and profit.

Again using Madden 19 as an example, the top players found in packs in August when the game first comes out, are no longer the top players in October. The top players in October are no longer the top players in December. That trend continues all the way through until a new game is released the next year when gamers start all the way over from the beginning.

These are virtual players with no real world value. Gamers have to continually spend more and more if they want an elite team that can compete at a high level and then it starts all over the next year.

There are 2 big issues that Electronic Arts is running into now that is putting the business model under pressure.

Fortnite and other games like it – Fortnite, like EA games, has all kinds of microtransactions built into it. The key difference is that they are all purely cosmetic. They do not impact the outcome of matches in any way. You can be a great Fortnite player without ever spending a dime. You just won’t look nearly as cool while playing. Rising prices and lower pack odds – Many people don’t mind spending a little money on their favorite game. The issue is that new gamers who pick up FIFA around Christmas time will go into a match, excited to try out their new game and before the end of the first half be down 5-0. That does not make these new customers want to spend money, it makes them want to give up the game.

The 2nd issue then leads to an even bigger problem that the gaming community hates possibly even more than the “Pay to win” scheme that packs enable. And that is a controversial tactic that many gamers think EA is deploying called, Dynamic Difficulty Adjustment or “DDA.”

For those of you who want to get into the weeds of all DDA is, here is a link to a paper published by some EA Employees.

EA, like any other big gaming company, has a ton of big data. They know what causes a player to stop playing their game and what causes a player to stop spending money on packs.

Using Madden again as an example (but this can be extrapolated to any game, especially sports games) say your team is winning in a very important online game 21-0 in the first quarter. EA knows that your opponent is on a 4 game losing streak and their data says that if they lose a 5th game in a row, they are very likely to quit playing the game for the year.

EA can’t have that because your opponent is a big spender, dropping $500 per month on packs. All of a sudden, as you head into the 2nd quarter your running back fumbles twice in a row and your best receiver drops a wide open touchdown pass. You end up losing 24-21 and you feel cheated.

EA’s big data knows that you will eventually forget about the loss, and attribute it to just bad luck. They also know that your opponent is now happy, feeling like he made a great comeback to win a very important game. That of course will lead to him continuing to spend money on packs.

Obviously the above scenario is 100% made up but the logic behind it makes perfect sense from a business standpoint. It hasn’t been confirmed that the DDA system is even in place but if you talk to hardcore gamers, they all know that something like it is happening with some regularity.

Here is a link to a patent EA filed for Dynamic Difficulty Adjustment. If you’d like you can read the abstract at that link. It is in PHD level language but the real world application is exactly as described above.

All of these things are taking place while gamers are frustrated that many of the yearly release games like Madden, FIFA, and NHL are underfunded and unfinished.

These issues can’t be fixed overnight, but they must be addressed in the future otherwise EA risks an erosion of a large chunk of their fan base and as a result, their revenue.

Next: Why EA Sports games like Madden 19 and FIFA 19 never seem to improve.

DISCLOSURE: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions.