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BioWare, a subdivision of video game developer and publisher Electronic Arts Inc. (EA) recently announced that the free-to-play version of its massively multiplayer online (“MMO”) game Star Wars: The Old Republic is now live.

Players now can access all the eight classes of the MMO up to the 50th level for free. BioWare also released a new game update “HK-51 Activated”, which adds a new companion character. The update also opens up new areas for players to explore, such as the Section X, which gives them a chance to amass new deadly weapons.

Developed by BioWare in partnership with LucasArts, Star Wars: The Old Republic MMO is a story driven game, set a thousand years before the classic Star Wars movies directed by LucasArts founder George Lucas. The MMO is one of the costliest games from EA in terms of game development and promotional expenses.

However, the MMO failed to live up to EA’s growth expectations as its subscriber base steadily declined since its release in the third quarter of fiscal 2012. EA noted that the decline in subscriptions was primarily on account of the exit of gamers playing on a casual or trial basis.

One of the primary reasons for the dwindling number of subscribers of Star Wars can be traced to the emergence of free-to-play MMOs by social game makers like Zynga Inc. (ZNGA - Snapshot Report). Moreover, EA’s expanding portfolio of free-to-play games has also been cannibalizing its own product.

EA believes that the new free-to-play version will provide much needed boost to the game’s customer base going forward. Although free-to-play games do not earn any revenue from customers, EA earns revenues through the sales of in-game items and advertisement. We believe that the popularity of the Star Wars franchise coupled with a new free-to-play version will attract online gamers going forward.

EA expects contribution from free-to-play, casual and social games to increase to approximately 35.0% of worldwide digital revenue by calendar year 2013. We believe that EA’s innovative product pipeline will boost its market share in the online gaming market. Moreover, EA’s strong focus on the digital segment will help it stand out even amid sluggish market conditions going forward.

With increasing consumer spending on free-to-play games, mobile games and social games, we believe that EA’s significant exposure to these segments provide it a competitive edge over traditional peers such as Activision Blizzard Inc. (ATVI - Snapshot Report).

Further, EA’s accretive acquisitions of Klick, PopCap games and Playfish over the last couple of years have bolstered its social free-to-play portfolio to counter strong competition from the likes of Zynga and also offset declining sales of its core packaging division.

However, the highly fragmented video game market continues to witness increased competitive pressures, which are hurting its overall profitability. Further, a soft video game industry outlook in the near term particularly due to weakness in retail sales and lack of visibility around aggressive monetization of social and free-to-play games capable enough to offset this weakness, keep us cautious on the stock. This compels us to remain Neutral on the stock over the long term.

We believe that cancellation of NBA Live and weak customer response to Medal of Honor Warfighter will hurt EA’s top line in the near term. In such a scenario, the loss of revenue due to the free version of Star Wars may further hurt the top line. Currently, EA has a Zacks #3 Rank, which implies a “Hold” rating in the near term.

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