A Business With Game

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It’s no wonder Activision Blizzard (NASDAQ: ATVI) is so horribly misunderstood. The amount of misinformation being bandied about by market analysts and investors alike is simply mind numbing. Those investors who’ve taken five minutes to Google it may in the past year have allowed themselves to be deluded into believing they have read the definitive word on the subject and worse, may have charged in like bulls in china shops snapping up shares of the so called social gaming company Zynga (NASDAQ: ZNGA). Video games are far more difficult to understand then critics, analysts and a great many of your peers may have you believe. There are many unique styles of games that cannot simply be put into a one size fits all box. A first person shooter, for instance may not at all appeal to a massive multiplayer online role playing gamer, but that’s a whole other article. Though it should be needless to say, clearly it isn’t obvious to everyone that what Zynga brings to the gaming world is not remotely similar to what a company like Activision Blizzard offers.

As a long term holder of ATVI shares I’ve personally witnessed and debated much of this misinformation at my favorite online water cooler. We have a rich community on the Stock Advisor board at The Motley Fool and it’s a perfect microcosm of the investment world at large, comprising rabid long time gamers, our co-founder David Gardner no less, as well as novice gamers and/or investors who don’t know Farmville from Fahrvergnügen. It’s my intention to offer a series of articles that will help even the most inexperienced investor with regard to this industry sift through much of the noise and therefore be prepared to better navigate the potential for such investments going forward. This begins with a basic understanding of the products.

Hard-core Gamers

Hard-core referring to gamers is a word so misused by analysts that I fail to find the appropriate adjectives to describe how horribly, incredibly out to lunch the investment community and most of the public in general are on this subject. Even at The Motley Fool there is a substantial divide in terms of understanding. When I hear an argument that video gamers are migrating to mobile, as well as what are presently accepted as social games of the ilk provided by companies like Zynga or Kabam, this frustrates me a little.

The other day on Motley Fool Money I actually got to listen in on a perfect example of this divide. One analyst clearly understood that there was in fact no such migration going on at all, while the other genuinely believed hard-core gamers were turning in their long held gaming ways in favor of convenient and free to play mobile and social games. 

I can assure you as a long time, rabid gamer myself that any gamer that comes even remotely close to this classification outright scoffs at the notion. What are today called out as social games by the ill-informed as well as games on mobile are truly pitiful in terms of graphics, gameplay, controls and immersion relative to true games of quality. From a page in Bloomberg’s Businessweek discussing a game produced by Kabam, one of the world’s premiere mobile and social gaming companies…

It also shows that the company is making good on its strategy to expand beyond Facebook, the platform where it began its quest to make social games like Kingdoms of Camelot for hardcore gamers.”

Lord love a duck! Take a look for yourself at Kingdoms of Camelot as I along with true gamers everywhere take a moment for an epic smirk at the thought that Kabam was indeed ever on such a quest, let alone that they made good on it. I admit to being a little bit irrationally outraged at the mere suggestion that there is anything, I mean ANYTHING at all hard-core about this game. It is effectively no different from any Farmville, Cityville or Toiletteville out there. However, the researcher who spends a few minutes or maybe even a few hours trying to familiarize themselves with this industry could be led terribly astray. If it’s not absolutely nobody, then at least it’s so nearly nobody that it’s virtually impossible to quantify the number of hard-core gamers that are leaving games they love to play for these backwater offerings. Even suggesting such a move to these free or cheap offerings to a real gamer would be met with condescension and disdain. I assure you that no such migration is happening, at all.

How About We Turn the Notion on its Ears?

Bobby Kotick, CEO at Activision had it right when he said he welcomed the influx of would be gamers into his industry thanks to the likes of Zynga, Gameloft, Kabam and so forth. Zynga recently counted 151 million MUUs (Monthly Unique Users). Were there any threat at all of World of Warcraft, Call of Duty, Diablo 3, Starcraft 2 or Skylanders suffering losses to these games surely they’d have been decimated by the sheer volume of gamers fleeing to free or cheap pastures offered by this company. No such thing happened. World of Warcraft saw number of monthly subscribers swell back over 10 million again in October of this year, while Call of Duty as an example of demand for top dollar quality games did $500 million in revenue in 24 hours, or $1 billion in just 15 days. None of these folks are playing Kingdoms of Camelot, or likely ever will.

Of the 151 million MUUs at Zynga’s games, 2.9 million ponied up any money at all each month. Those are a lot of mouths to feed for very little reward. Why on earth would a company like Activision Blizzard ever want such unprofitable games to cannibalize their remarkably strong business model that serves true and even actual hard-core gamers? To be clear, in the real gaming community hard-core really only applies to the most extreme players who play real top quality games, however here I’ve decided it’s best to designate it as a label for all those who play quality since the likes of Bloomberg have so abused the term that it seems necessary to skew the designation a little away from its true definition to where it represents a genuine divide between types of customers. Suffice it to say, no such thing as hard-core or anything remotely similar applies to any games produced by the likes of Zynga.

What Bobby Kotick was trying to convey was that he welcomed the large volume of gamers, be they of whatever style, regardless of how they were first introduced to any kind of gaming since to Activision Blizzard they represent opportunity. Those 151 million users at Zynga were not playing any of ATVI’s games at all, and though he himself may not be a gamer, those whom he surrounds himself with have assured him of as much. Therefore, Zynga has actually served more than one purpose, first demonstrating a terrible business model that ATVI were wise not to follow aggressively, while competitor Electronic Arts (NASDAQ: EA) presently have been, and secondly introducing total past non-gamers to the whole idea of gaming, often for the first time in their lives. These are potentially one day actual profit generating customers for quality games provided by Activision Blizzard entering or at least hovering around their market now. It’s certainly shown there is an appetite for games out there that is clearly untapped. The potential for success at such conversion as yet is undetermined. Activision Blizzard dipping their toes in with prudence to slowly learn how to best exploit the opportunity is another example of wise stewardship.

But ACTIVISION BLIZZARD’S going nowhere!

The chart below will show divergent paths of the businesses I’ve been discussing above. On our boards in Fooldom it’s been a point of contention that ATVI shares have done nothing for the past four years now. There’s no denying that. Let’s have a look at how the competition has fared.

<img src="http://media.ycharts.com/charts/bb0024833bb4a089726052a43 90adc92.png" />

ATVI data by YCharts

How happy do you think those who listened to pundits telling them Zynga is taking over the gaming world are after their social gaming ride of 2012? Granted, ATVI shares have not lit the world on fire, heck they haven’t even lit a match if I’m to be honest here. There are factors such as Vivendi’s large stake in the company combined with Vivendi’s own problems with most of the rest of their other holdings that have investors hesitant to jump into a position with ATVI today for fear of what Vivendi may do with all those shares.

However, it hasn’t been for lack of progress on the business front at Activision Blizzard. Beginning in 2008 the results of a merger saw Blizzard begin contributing and by all accounts it appears it was a very wise direction Activision decided to go partnering up with the true social gaming giant. Yes, World of Warcraft is a truly, madly, deeply social game. Another partnership with Bungee, of HALO fame, has been formed to the tune of a ten year collaboration now as well and beginning in 2013 we will see that relationship begin to bear fruit. The reality is Activison Blizzard has been doing plenty. It’s also been buying back shares thanks to its phenomenal cash flow at great value while the market has neglected it and it’s grown revenue all the while. I’ll borrow from a post of my own and offer these figures.

2009 Consolidated Net Revenues - $4.279 billion
2010 Consolidated Net Revenues - $4.447 billion (increase of 3.9%) granted not exciting
2011 Consolidated Net Revenues - $4.755 billion (increase of 6.9%)

2009 GAAP earnings per share $.09
2010 GAAP earnings per share $.33 (266% increase)
2011 GAAP earnings per share $.92 (179% increase)

2009 Non-GAAP earnings per share $.69
2010 Non-GAAP earnings per share $.79 (14.49% increase)
2011 Non-GAAP earnings per share $.93 (17.72% increase)

Extending even further back to the first year after the epic merger...

2008 Consolidated Net Revenues - $3.026 billion (3 year increase of 57.13%) from the first full year since the merger to 2011.

None of this has moved the needle in terms of stock price and it’s greatly frustrated a good segment of even our patient Motley community. To borrow a quote from 8martini8, a favorite contributor of mine on our boards…

When one has held a stock long enough, each new day is but a link in the binding chain of expectation.”

Perhaps some folks will be much more fortunate by picking up their first shares of ATVI today, having not waited for acknowledgment from the market of an incredibly well run business for going on five years now, and perhaps, just perhaps their own chain may be a shorter one by comparison as expectation is much more quickly replaced by realization.

Robert Kralj has  positions in ATVI . The Motley Fool owns shares of Activision Blizzard and Google. Motley Fool newsletter services recommend Activision Blizzard and Google. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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