2013: The Year of the Activision Breakout

By Brian Shaw - August 7, 2012 | Tickers: ATVI, MSFT, NTDOY.PK, SNE | 0 Comments

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In a recent post, I summarized the position of Activision Blizzard (NASDAQ: ATVI), including its record breaking second quarter results and raised full-year guidance.  Despite this great performance, a rock-solid balance sheet with $3.4 billion in cash and short term investments, no debt and a full slate of new titles, Activision’s stock continues to lag the market.  This compelling investment opportunity can’t be ignored forever, so let’s take a look at what the breakout will look like when the market finally appreciates the power of Activision’s brands.

Loaded with Potential

Activision is firing on all cylinders, and its success is broad based and constantly improving:

• World of Warcraft, Activision’s flagship brand and the most-subscribed massive multiplayer online role playing game (or "MMORPG"), still has 9.1 million recurring subscribers over a decade after its initial launch.  While this number has tailed off from the peak of around 12 million in late 2010, the continued success of the franchise has been based on a series of popular expansion packs.  The next expansion pack, World of Warcraft: Mists of Pandaria is scheduled for release during September 2012.
   
• Call of Duty, Activision’s wildly popular first person shooter, leads the industry by a wide margin.  Call of Duty: Elite has reached 12 million online players (and over 2 million premium-paying subscribers) in the most recent quarter.  To continue the momentum built by this franchise, Activision is releasing Call of Duty: Black Ops II later this year. 
   
• In addition top the release of a new Call of Duty game in the second half of the year, Activision recently announced a partnership with Tencent Holdings, which will bring the Call of Duty franchise's multiplayer experience to the Chinese market.  For a sense of scale, China’s online gaming market is estimated at 160 million users, generated $7 billion last year and is expected to grow rapidly in the near future.
   
• Diablo III had a record-breaking introduction in Q2 2012, has already reached 10 million users and was the best selling PC game during the first half of the year despite only being available for a month and a half of that period.
   
• Skylanders: Spyro’s Adventure has been the most successful console and handheld game in the first half of 2012.  Together, the most recent Call of Duty, Diablo and Skylanders releases have been the top three selling video games in 2012.  To follow up on this success, Skylanders Giants will be released later in the year.
   
• This summary of franchises is really just the tip of the iceberg.  In the Starcraft franchise, Starcraft II: Heart of the Swarm is nearing completion and a release date should be announced shortly.  Among other titles currently in Activision’s portfolio are games based on popular entertainment titles such as Transformers, James Bond, X-Men, Spiderman, Wipeout and many others.
   
• What isn’t mentioned often enough is the fact that we’re finally entering a new game console cycle.  Nintendo (NASDAQOTH: NTDOY.PK) will lead things off with the upcoming release of the Wii U.  On the horizon for 2013 are the expected releases of the next generation of Microsoft’s (NASDAQ: MSFT) Xbox and Sony’s (NYSE: SNE) Playstation consoles.  The success of the Wii U will be critical to Nintendo's survival, while Microsoft and Sony have a much larger home entertainment strategy hinging on these new devices.  Given how much emphasis these companies will put into making the next generation consoles a success, there is a huge potential for growth for Activision's industry leading franchises.
   
• There is more on the way!  For example, the Blizzard side of Activision is known to be working on a new MMORPG named Titan, which is in production but far from release.  Based on Blizzard’s history of taking its time and creating high-quality games, the potential of a next generation MMORPG cannot be emphasized enough.  
   
• In the coming year, we’ll hopefully get some clarity on Vivendi’s plan for its 61% stake in Activision.  Will it sell its interest to another company?  Will it spin-off Activision shares?  As long as Vivendi doesn’t dump its shares on the open market, most of the outcomes should unlock value for Activision shareholders.

Valuation, and Why to Expect a Jump in Share Price

In the latest earnings release, Activision increased its estimated non-GAAP EPS guidance to $0.99 per share.   Activision has been known to be conservative in its guidance and has firmly beaten analyst expectations in recent quarters, so it is safe to use the $0.99 as a conservative benchmark for valuing the company.  As we look to 2013, analysts expect EPS of $1.09, which I think is very low based on all of the growth drivers listed above.  Given everything going for Activision in 2012 and 2013, my projection is that 20% growth (i.e., EPS of $1.20) is a better target for Activision in 2013.  Whether it can generate EPS of $1.09 or $1.20, let’s take a look at what this might translate into for Activision shares by the end of next year.

Based on analysts’ estimates for Activision earnings in 2013 and the current market average valuation of a P/E of 15, shares of Activision should jump 47% by the end of 2013.  Since the company has no debt, over a quarter of its market cap is cash and it is generating about $1 billion in cash a year, one could argue that a P/E of 18 is a more reasonable valuation multiple; in that case, analyst expectations would yield an increase in share price of 76% over today’s price.  If Activision can outperform the analysts’ current targets for 2013, that could translate into stock price increases of 62% to 94%. 

This is a very simplified valuation model, so don’t take it to imply a precise target for Activision’s stock.  However, a range from $16.32 to $21.60 is not unreasonable, and any number in that range represents a significant increase from the current price of $11.12.  

What Does My Crystal Ball Say?

Based on a combination of Activision’s recent performance, the slate of new titles and other growth drivers and the expectation that Titan will formally be announced in 2013, I think Activision will be trading around $18 at the end of 2013.  This is of course subject to the whims of Vivendi, but I’m willing to take that chance given just how much upside we’re talking about.  In the meantime, I’ll be happy to collect Activision’s dividend, which I expect will increase to $0.20 (per year) in 2013.

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