This Company Will Have Monster Returns
Daniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Who else was that kid growing up? I mean the kid glued to the newest console system, starting with the original Nintendo. A kid in a room loaded with favorite sodas and a mountain of Twinkies or Oreos. Who else was that kid, spending countless sugar highs and outrageous amounts of time with favorite games such as Mario, Teenage Mutant Ninja Turtles and many others? When advised to invest in what you know, my mind first turned to game developers, because I was that kid.
Fast forward 15 years, I devour substantially less Twinkies and sodas, but the thirst to destroy mutants and monsters remains. Since I understand gaming, and now business, it’s time to put that knowledge to good use! The entertainment and gaming industry is constantly evolving with new technology and trends. Below, my research shows a company with an excellent balance sheet and many of the freakishly popular games including Call of Duty, Guitar Hero, World of Warcraft, StarCraft, and Diablo. I’ll point out a few headwinds and decide if they can remain viable with ever changing gaming trends or if it’s game over for Activision (NASDAQ: ATVI).
Groundbreaking idea, Poor execution
Revenue for Activision was up 51% led by strong sales of Diablo III. Activision tried something groundbreaking here. From a business perspective it was a brilliant move, if they could execute properly. On the original Diablo game there was a virtual auction market, where people would trade gold gathered in game for weapons and gear. This became so intense and valuable that people actually spent time efficiently farming gold on the game and selling it. It was a market with untapped potential to create revenue. Activision tried to capitalize on this idea in Diablo III where they created an actual auction house and took a percentage of sales in real dollars. They cashed in on the idea they could further monetize the fanaticism the original Diablo trading market. Did they execute? In my opinion, no, they failed. ATVI needed to create an amazing game to take advantage of the market potential, instead they focused on the market potential and issued a game that wasn’t good enough to create the same market as Diablo III’s predecessor had. Despite the failure to monetize the auction market so far, Diablo III is still the top selling PC game this year.
WoW, what a decline!
The insanely popular and wildly successful Massively Multiplayer Online Role Playing Game (MMORPG), World of Warcraft has watched its subscribers decline from 10.2M at the end of Q1 to 9.2M. That’s definitely a bad sign, but look at this chart showing how ridiculously dominant it was for Activision.
The chart, courtesy of mmodata.net, shows the clear dominance of WoW (not including the recent drop to 9.2M I mentioned previously). Why the recent decline from a game that has captivated the masses for almost a decade? The MMO genre may be in decline and adding to the Warcraft decline is substitute products. Guild Wars 2 hit $1M in pre-purchased copies, and they don't require a monthly subscription which could lure even more gamers from beyond the MMO demographic. On a more broad industry look, revenues could be hurt this year because of the slow recovery causing less spending on discretionary items. Game developers that rely on console systems or PC's have a futuristic battle brewing with low cost mobile game developers. Activision plans on releasing an expansion in September for World of Warcraft, it could have a major impact if it renews interest in the game and generates revenue once again.
A product too far ahead?
That sounds like a crazy concept, my business teacher would smack me, how can you have a product that’s too far ahead? Think of it this way, Sony Corporation (NYSE: SNE) PS3 and Microsoft Corporation (NASDAQ: MSFT) Xbox 360 potential still hasn’t been met by console games! They’re over 7 years old and still aren’t being used up to their full capability. That’s a much longer lifespan than previous consoles had. This has become a problem because revenue sharply increases for game developers such as Activision when new consoles are released. It’s projected that video game console sales will decline between 15-20% this year and Sony and Microsoft aren’t planning on releasing new consoles until late 2013. Revenues for developers across the industry will surely decline for the remainder of 2012, but one thing may save Activision. Call of Duty: Black Ops II, the latest in the extremely popular console game series, is releasing in November. The entire series has been extremely successful and the new release will help boost ATVI revenue in an industry that is struggling.
Vicious re-sale cycle
The market for video game re-sales is growing with companies such as GameStop Corp (NYSE: GME). Activision loves to see the line of hundreds of kids rushing the doors at midnight, lacking only shields and swords, for the release of their games. What they don’t like to see is two weeks later those people bring the game back and allow GameStop to re-sell it, giving no revenue back to Activision. GameStop has its own challenges, but its business model presents a challenge for game developers. The fact is consumers are becoming more budget aware and this focuses more attention to cheaper re-sale games. Re-sale games account for roughly 20% of total video game sales in 2011 numbers and will increase if consumers continue the money saving trend.
Bottom Line
Activision knows how to produce popular games. They have a lot of cash and no debt on the balance sheet. Their Q2 EPS beat estimates and overall, their financials are fantastic. They’re crushing the competition, one look at Electronic Arts (NASDAQ: EA) balance sheet and titles list will be enough to convince you of that.
| Dividend | P/E | Return on Revenue (%) | LTD to Cap (%) | |
| ATVI | 1.5 | 17 | 22.8 | N/A or No Debt |
| EA | 0 | 78 | 1.8 | 18 |
EA also failed to copy Activision’s success in the MMORPG genre with the semi-flop of “Star Wars: The Old Republic”. They’ll be counting on Madden 13, released Aug 28th, to carry the company on revenues. Despite all of the headwinds I mentioned, Activision is really the one bright spot in the home entertainment industry. Their results speak for themselves and if they can adapt to the gaming trends of the future, which will change from console systems, investors could be in store for monster returns. As that kid, I’m biased; I firmly believe video games still offer the best value to price for entertainment. As long as ATVI keeps pumping out insanely popular games that appeal to a multitude of demographics, I believe they’ll be very successful.
dmiller5350 has no positions in the stocks mentioned above. The Motley Fool owns shares of Activision Blizzard, GameStop, 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. 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.
