Free at Last: Will Shareholders Really Benefit From a Vivendi-Free Activision?
Jason is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The recent announcement that Activision Blizzard (NASDAQ: ATVI) has entered into an agreement to acquire 429 million shares back from French conglomerate Vivendi for $5.83 billion in cash and debt, along with another 172 million shares being acquired by CEO Bobby Kotick and an investor group that includes Tencent for another $2.34 billion, has come as welcome news and a very big surprise. Shares shot up 15% on the day of the announcement.
The question I have is a simple one: Will this move pay off for investors?
Best player on a really bad team
The video game space is full of poor performers. Once king, Nintendo (NASDAQOTH: NTDOY.PK) has lost its luster as its new Wii U console has failed to gain traction in replacing the successful Wii. Electronic Arts (NASDAQ: EA) has faced a number of challenges over the years, specifically failing to gain traction with its MMORPG titles in efforts to compete with Blizzard's World of Warcraft and its giant margins and cash flow generation. This is best represented by Star Wars: the Old Republic, which failed to gain traction for its paid model, and the company moved to free pay to maintain player interest.
Nobody can argue Take Two Interactive's (NASDAQ: TTWO) ability to create compelling games. However, as the smallest company in the mix with annual sales that have a bizarre elliptical orbit around $1 billion, its inability to manage the high costs of development in between hit games leaves the company with very lumpy revenues that make it difficult to consistently stop losses, much less generate regular income.
Activision, however, has been the one consistent operator over the years. It creates compelling, entertaining games that hold large followings, and is also the best operator in the segment by far, consistently generating a growing stream of income for shareholders. With that said, there are many (yours truly included) that have long thought that the company's performance hasn't been fairly reflected in its share price, in part due to its association with such poor performing peers. Toss in the recent clamoring for the Zyngas of the world and the supposed vast opportunity in social games, and investor interest was surely affected to the negative.
But wait! There's more!
Vivendi has been like a French gorilla on Activision's back since the merger with Blizzard in 2008.
Soon after the merger the worldwide economy began crumbling, weighing heavily on Vivendi and its other operating businesses, which primarily operate in Europe. As Europe has remained in a state of stagnation, Vivendi's growing debt and majority ownership of the profitable Activision have put pressure on Activision. From last year's rumblings that Vivendi was looking for a suitor to buy its controlling interest in the company, to recent rumors of the board (which is controlled by Vivendi to a large extent) forcing a massive dividend to pay down debt, this controlling stake has surely had a negative impact on both share prices, and to some extent, on management's ability to follow a path completely of its own choosing.
Price of freedom
Frankly, it doesn't really look like Activision, in the short term, is gaining any additional advantage by this move. To the contrary, with a TTM net income of about $1.25 billion, the cost of servicing the debt, minus the tax benefit, minus the saved dividends no longer paid on the shares bought back, could be as much as 10% of this net income depending on how cheaply it can attain the short- and long-term debt. However, with the share count being reduced by more than 25% through this transaction, EPS will actually increase, hence the market's response so far.
But until we have more info about the cost of the debt, and if there are any immediate benefits to the company's ability to grow earnings (which I don't see,) it's hard to form an opinion as to what we have gained as investors. But what we do know is that there's little doubt that being a wholly independent company will result, over time, in a more competitive, better Activision. But there's just not any "right here, right now" advantage to this move.
Foolish bottom line
Nintendo is in a state of disarray. And as a maker of consoles as well as content, it could take years for the company to fully recover. Revenue has fallen over 60% in the past five years, while the share price is down 55%. And while sales have started flattening, they are still heading down. Until the company decides which direction it will go, and shows a return to sales and profit growth, I'd stay far away.
Electronic Arts, like Take Two, tends to have very lumpy revenues on both the seasonality of its games, and the periods in between big hits. Simply put, I'd lump them together. The day that both companies show they can be consistently profitable is a good day to consider investing, but not a day before. A compelling product alone isn't enough.
Activision has shown us that both consistent profitability and compelling products are possible, and it remains the best investment in this segment. Breaking free of Vivendi is just a bonus.
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Jason Hall owns shares of Activision Blizzard. The Motley Fool recommends Activision Blizzard and Take-Two Interactive . The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!