The Market Just doesn’t Get Activision

By Brian Shaw - August 5, 2012 | Tickers: ATVI, EA, TTWO, ZNGA | 0 Comments

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Last week, Activision Blizzard (NASDAQ: ATVI) reported its second quarter earnings, in which the company blew past analyst expectations for revenue and earnings.   Additionally, the company raised guidance for revenue and earnings for the full year.  Sounds great, doesn’t it? 

It is, yet the market rewarded Activision with a 5.5% decline in share price on a day when all major indexes were up solidly.  For the year, Activison’s shares have declined 9% (as of Aug. 3), while the S&P has risen 9% over the same period.

For those readers out there who own shares of Activision, this story should sound familiar.  The company has generated solid results for the past several years, yet the company’s share price has mostly bounced in a narrow range between $10 and $13 per share for the past 3+ years.   

How does Activision Stack up against the Competition?

For those unfamiliar with the company, Activision develops video games and has created some of the most popular franchises in the world.  Examples include Call of Duty, World of Warcraft, Skylanders, Diablo and Starcraft.

Activision CEO Bobby Kotick takes a deliberate approach to developing well-made, profitable games.   If a game or franchise isn’t going to be profitable, Kotick will walk away.  While Activision’s shares have not kept pace with the market, at least the market recognizes that Activision is a much more solid company than competitors such as Electronic Arts (NASDAQ: EA), Zynga (NASDAQ: ZNGA) and Take Two Interactive (NASDAQ: TTWO).  Here’s a comparison of these four companies and the S&P 500 over the past 12 months:

To look a little deeper, here’s a handful of metrics for each of these companies:

Well, that table certainly says a lot!  Activision is the only reliably profitable company on the list, generates significant free cash flow, has no debt and has the financial stability to pay a regular dividend.  Activision has a tremendously strong balance sheet with $3.4 billion in cash and short-term investments. In addition to the dividend, the company has returned capital to shareholders through share repurchases that have reduced total share count (including 4.4 million chases in the most recent quarter).  So with this solid execution, why is Activision lagging the market?

What is Pressuring Activision’s Shares?

First and foremost on analysts’ minds are Activision’s World of Warcraft subscriber numbers, which have fallen from a peak of 12 million in 2010 down to 9.1 million in the most recent quarter.  Is this the beginning of the end for Activision’s dominant massive multiplayer online role playing game (or “MMORPG”) and its extremely profitable recurring revenue stream?

Second on the list is Vivendi SA, a French conglomerate and owner of 61% of Activision.  Vivendi’s recent struggles have forced it to consider divesting assets, potentially including Activision.  Not knowing what form such a divestiture would take (spin-off, sale to third party, dumping shares on the open market, etc.) has led to uncertainty and concern regarding the near-term effects of a potential flood of shares in the market.  Just last week, Vivendi reportedly began to back off this plan.

Competition is a third pressure on Activision.  In the MMORPG space, Electronic Arts has a number of titles that compete with Activision, including Star Wars: The Old Republic, which just recently added a free-to-play option to attract subscribers.  Other MMORPGs, such as Guild Wars 2, have also entered the arena and are competing for a share of gamers’ attention.  Additionally, analysts are constantly criticizing Activision for its lack of offerings in the social gaming genre, which includes games on Facebook, smart phone apps and anywhere else that companies like Zynga can get customers to pay real money to buy virtual chickens and plant virtual vegetables.  Thus far, Activision hasn’t considered this genre to be a profitable business opportunity.  A quick look at Zynga’s financial statements would tend to support that conclusion!

So is this Stock a Bargain or Not?

There are always reasons to find fault with Activision.  A few years ago, the end of the Guitar Hero franchise was deemed to be the beginning of the end for the company.  Was it?  Record revenue and earnings in recent quarters seems to indicate otherwise. 

What if the state of the economy worldwide causes people to stop playing video games?  A $60 video game with deep content and multiplayer options has been repeatedly found to be one of the cheaper forms of entertainment on a dollar per hour basis, yet the doubt continues.  

What if the next big game is a flop?  Always a risk, but the depth of Activision’s brand portfolio is much deeper than most seem to appreciate and is not reliant on any single release.   

Are free mobile games going to eliminate the market for console and computer based games?  Records set by recent Activision titles, including dramatic pre-order counts, clearly show that this threat is not what some expected it to be. 

The point here is that analysts constantly find reasons to doubt Activision, yet the company continues to execute brilliantly.  As you can probably tell, I’m not really buying the bearish arguments and think that the stock is finally ready to breakout of its recent trading range.

In my next post, I’ll explain why and even pull out my crystal ball for a prediction on Activision’s stock for 2013.

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