This Company Isn't Playing
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I've written in the past, that Activision Blizzard (NASDAQ: ATVI) has essentially ended the gaming war. In years past, one might have made the argument that Electronic Arts (NASDAQ: EA) could be a legitimate competitor to the current king of gaming. More recently, some might point to companies like Zynga (NASDAQ: ZNGA) or even international gaming companies like Perfect World (NASDAQ: PWRD) as the future of the gaming industry. While it's true that digital content and web games are changing the face of the industry, it seems likely that Activision Blizzard will still be the king of the hill at the end of the day.
If there is any question about the earnings power of Activision, investors only need look at the company's current earnings to realize just how impressive this company is. In the last quarter, net revenues on a non-GAAP basis grew over 50% and EPS on the same basis also increased 50%. For investors concerned about the increase in digital gaming, consider that Activision's digital channels revenue represented 47% of the company's total in the last quarter. As proof that the company dominates the industry, consider that the top three most popular games in North America and Europe were all sold by Activision. Specifically, Diablo III was the number one best-selling PC game in the first six months of the year.
The Future is Bright:
In the next few months, the company expects to release Skylanders Giants, Call of Duty: Black Ops II, and World of Warcraft: Mists of Pandaria. All three games are either extensions or sequels to existing popular titles. In addition, the company is bringing its popular Call of Duty franchise to the massive Chinese gaming market through an agreement with Tencent, a leading Internet services provider. It's clear that Activision understands international gaming, as they plan Call of Duty to be a free to play game monetized through in game items. In the Chinese market free to play games dominate the industry. For Activision to bring their most popular title and change the concept to match players taste in the country is the right move. Last but not least, the company's World of Warcraft franchise still leads the on-line gaming segment with over 9 million subscribers. While some might worry about the decline in on-line subscribers, the new Mists of Pandaria is a highly anticipated release and should improve subscriber numbers.
Strong Financials & Outlook:
Investors have to be impressed with Activision's strong financials and future outlook. The company repurchased 4.4 million shares at an average price of $12.27 in the most recent quarter. In addition, the company still has almost $3.2 billion in cash and investments. In both the third-quarter and full-year, Activision is projecting revenues and EPS just barely below the average analyst expectations. However, the company has beaten estimates each of the last four quarters by an average of better than 94%. Based on these past results, it seems very likely that Activision's guidance could be artificially low, setting the company up for yet another earnings beat.
Though it's true that Activision faces numerous competitors, none seem to offer the type of stability and growth potential. Electronic Arts is expected to show 18% earnings growth over the next few years, but the company seems to always be playing catch-up to its larger rival. Though strong brands like Madden and the NCAA franchises will likely keep console gamers coming back, the company's biggest online game Star Wars: The Old Republic is getting crushed by Activision's World of Warcraft game. In a recent update EA said that The Old Republic has "well over 500,000 subscribers", but that is down drastically compared to the over 1.7 million subscribers nearer to its launch. The company's acquisition of PopCap games and moves into casual and social gaming with its Sims franchise and others is a positive move, but casual gaming is anything but a sure path to profits as investors in Zynga have found out.
Zynga has some of the leading on-line games like Words With Friends, Farmville, and Cityville, but the stock is priced as such. Analysts are calling for better than 25% EPS growth, but investors in Zynga have already bid up the shares to nearly 42 times full-year earnings. Zynga is heavily reliant on the popularity of Facebook and its system to gain new users as evidenced by the fact that Zynga represents about 12% of Facebook's payments revenue. Zynga also reversed a pattern of being free cash flow positive in the most recent quarter by reporting $67 million in operating cash flow versus over $270 million in capital expenditures. While the company's popular core games may allow it to do well in the future, the company has less than half of the net cash and investments of Activision, and if the company can't continue to develop attractive games, the stock could deteriorate further. On the international front, there is a company that could challenge Activision for investors dollars, but its hidden dividend is all but unknown.
Perfect World is a Chinese based on-line gaming company that specializes in massive on-line multi-player titles. However, this investment is more speculation on future dividends than a consistent growth story. The company is in a bit of a lull with game releases, but expects to have future hits Legend of Condor Heroes and Return of Condor Heroes released in the 2nd and 4th quarters of next year respectively. Each of these games is based on the popular Chinese author Louis Cha's martial arts novels. The company expects the familiarity with these works to drive heavy adoption of the game and its sequel. While these newer games are still several quarters away, the company is sitting on over $500 million in cash and investments. In an often overlooked change to the company's dividend policy, Perfect World said it expects to now distribute dividends on an annual basis. In April 2012, the company paid a dividend of $98 million. With five times this amount in cash and investments, a substantial dividend next April seems very likely. With about 48 million outstanding shares, a similar dividend next April would represent a yield at current prices of over 18%. With hit titles lined up for next year and the potential for a huge annual dividend, investors need to give Perfect World more credit. The shares also sell for just 5 times forward estimates, which is yet another argument to consider this company.
However, of all these companies only Activision pays a regular dividend, shows consistent growth, and is priced reasonably. While I personally own Perfect World for the potential hidden dividend, I can certainly see the attractiveness of Activision. I've been a console gamer since the Atari 2600 (yes I just dated myself), and that isn't going to change soon. I do play casual games as well, but that is in a different setting than when I play on my console. I believe this is a change that benefits Activision as well. Casual gamers can easily also be console gamers. The two are not necessarily independent of each other. With the all-important holiday selling season coming up, and three popular titles being released in the next few months, Activision should do quite well.
MHenage owns shares of Perfect World. The Motley Fool owns shares of Activision Blizzard. 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.