Activision's Pipeline: Action-Packed and Ready To Deliver

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Activision Blizzard (NASDAQ: ATVI) boasts a successful track record of industry-leading video game franchises and record-setting video game sales for both PC and consoles. In fact, "Call of Duty: Modern Warfare III" remains the most successful media launch ever, grossing more than $1 billion in its first 16 days. In addition, "Diablo III" checks in as the top selling game (including retail and digital sales) year-to-date. With names like "Call of Duty," "Starcraft," "Modern Warfare," "Diablo," "World of Warcraft," and a plush, action-packed pipeline, Activision is bound to deliver for investors.

The pipeline

The developers of the wildly popular "Halo," a game franchise owned by Microsoft (NASDAQ: MSFT), are hard at work creating Activision's next big hit, code-named project "Destiny." "Destiny" will be a series of at least four MMO (massively multiplier online) titles. It's rumored to be a sci-fi action shooter title to take on "Halo."

Historically, successful new launches represent serious cash for Activision shareholders. Furthermore, Activision has a reputation of breaking its own records as its franchises evolve. For instance, take a look at Activision's internal estimates of its Call of Duty monthly active users (MAU) over the life of its franchise (as of December, 2011):

<img src="/media/images/user_13783/call-of-duty-mau_large.png" />

Tomorrow Activision will launch "Call of Duty Black Ops II." In the Q3 earnings call, Activition claimed that awareness and intent to purchase "Black Ops II" is at an all-time high for the franchise. Furthermore, "Black Ops II" is planned to be its biggest launch of the year, with record pre-orders, 15,000 midnight events, and "huge interest in the launch trailer, with over 18 million YouTube views in one week" (according to the company's Q3 earnings slides).

Don't forget about the likely MMO heir to "World of Warcraft," code named "Titan," that is set to be released sometime in 2014. World of Warcraft was, unfortunately for Sony (NYSE: SNE), an unofficial sequal to the once-popular Everquest. The Everquest user-base, of course, paled in comparison to Activision's extremely successful "WoW." I wouldn't be surprised to see "Titan" trump "WoW" sales and MAU records by large margins, just as WoW walked all over Everquest. As Steve Jobs always said, "It's best to cannibalize your own products before someone else does."

A fundamental powerhouse

Fundamentally, Activision is a cash cow. Its gross margins in Q3 were 72.5%, up 4% from the same quarter a year ago. Even more impressive, operating margins have increased dramatically over the last three years due to increased digital sales and proportionally lower expenses. Digital operating margins are much higher than retail margins, at 50%. So any increase in digital sales has a very large impact on the bottom line. In 2009, 2010, and 2011, revenue from digital sales was $1.23, 1.44, and 1.64 billion, respectively. As a result, the operating margins were 25.8%, 28.5%, and 30.3%, respectively.

With a healthy balance sheet and a reliable dividend, investors can count on Activision's well-planned and well-executed strategies to continue to deliver. Activision carries $2.79 billion in cash & cash equivalents on the balance sheet. Furthermore, its dividend payout ratio is 96%, with $3.1 billion returned to shareholders between 2009 and 2011.

Valuation

Activison's competitors come in several forms: console game publishers, console manufactures, MMO developers, and generalists such as Electronic Arts (NASDAQ: EA) (creator of "Madden," "FIFA," "Battlefield," and "Sims"). So, it's tough to conduct direct valuation comparisons based on common Wall Street methods; but if we look past the easily manipulated earnings to free cash flow (FCF), we can paint a clearer picture of Activision's financial situation and valuation compared with similar companies.

One method I always like to use for valuation is the FCF yield, which shows you what percentage of a company's share price is represented by the cold, hard cash it's churning out. The higher this percentage, the better. Let's see how Activision measures up with Microsoft, Sony, Electronic Arts, and Time Warner (NYSE: TWX).

<img src="http://media.ycharts.com/charts/0031803585f4fb7e7802427d5443ed38.png" />

ATVI Free Cash Flow Yield data by YCharts

Activison falls right smack in the middle. But the chart below displaying FCF growth over the last five years paints quite a different story:

<img src="http://media.ycharts.com/charts/34b9e170f2fc942da0116e479d7f126e.png" />

ATVI Free Cash Flow TTM data by YCharts

A FCF yield of 10% for Activision is extremely generous, given the historical growth of FCF over the last five years shown in the chart above.

Returning to the FCF yield chart, notice that Activision's recent sell-off has resulted in an uptick of the FCF yield. In fact, investors can now buy into Activision's cash flow at a cheaper price than they could at any other time since Activision's merger with Blizzard.

The bottom line

Activison's pipeline is ready to deliver for investors, the stock is cheaper than ever, and its video game franchises are performing better than ever. With a loaded pipeline and exceptional fundamentals, the pull-back on Activision's stock price over the past three months offers a chance for investors to pick up the controller and get in the game.


DanielSparks has no positions in the stocks mentioned above. The Motley Fool owns shares of Activision Blizzard and Microsoft and is short Sony (ADR) and has the following options: long JAN 2013 $22.00 calls on Sony (ADR). Motley Fool newsletter services recommend Activision Blizzard, Electronic Arts, Microsoft, and Time Warner. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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