Call of Duty, Warcraft, Starcraft: What's Not to Love About This Company?

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

World of Warcraft, Call of Duty, Starcraft. What do these names have in common? They are all best selling video games, and they are all produced by Activision Blizzard (NASDAQ: ATVI). The company was formed by a merger between Activision Entertainment and Vivendi Games in 2008. It was a merger between the primary developer of PC games and the primary developer of console games. 

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Financial overview

The company has been hugely profitable since the merger. Since 2009, its revenue has grown from $4.3 billion to $5 billion in the trailing twelve months, while its net income has grown from $0.11 billion to $1.22 billion in the same time period. 

It has a P/E ratio of 13.17x due to its trailing diluted earnings per share of $1.09. The earnings multiple is far below the industry average of 22.2 and at first glance, this would suggest that the stock is undervalued.

A look at Activision's balance sheet reveals some impressive statistics. The company has no debt and $4.6 billion in cash & cash equivalents. It also has a strong net working capital of $3.9 billion, and a net working capital ratio of 3.06. This number is very large as almost all companies have ratios of between 1 and 2 and is indicative of Activision's strong financial position and large degree of operating leverage. 

Activision's margins are far larger than its competition. It has a trailing operating margin of 30.5% vs. the industry average of 3.3%. It also has a trailing net margin of 24.4%, also much higher than the industry average of 8.3%. The company also has a return on assets TTM of 9.3% and a return on equity TTM of 11.1%. Both of these figures demonstrate the company's continuing resolve to return value to its shareholders. These key statistics also show how Activision is very focused and is producing games which are profitable and provide strong revenue streams.

Electronics Arts (NASDAQ: EA) is Activision's closest competitor. EA recently released Star Wars: The Old Republic, which has been very successful to date, while the company has also raked in the cash from its Need for Speed, Madden, and The Sims titles. It is also on the verge of releasing Battlefield 4 and Titanfield, which, based on pre-orders and early reviews, looks ready for success.

Nintendo is another competitor, and has found it very hard to compete against the other companies, recording negative operating income the last two years, as its previous position in the console market has collapsed.

Why invest?

Activision Blizzard has several attractive factors. Its subscription service for World of Warcraft continues to generate free cash flow, and it is expanding this service into Call of Duty with its Beachhead service. The new MMO, Titan, looks like it will follow this trend of subscription service. Its strong and loyal customer base also allows it to offer expansion packs for its games, which also see strong demand.

Its map packs and additional characters for games have also seen profitable demand. The company's Skylander franchise also seems set to develop into a longstanding success for Activision and should appeal to the company's young audience.

Activision also has made significant strides in developing intellectual property which appeals to the consumer. It has started to penetrate the developing markets and already has a strong network in both Asia and Latin America. The company's management seems to have secured the future of Activision as its operating leverage and net income looks set to continue to grow rapidly over the next few years, providing increased return to shareholders. 

The numbers clearly speak for themselves for Activision. It is miles ahead of its competition in terms of successfully generating profit out of its games while appealing to a wide audience. However, it is also important to put these numbers in perspective. A quick comparative analysis allows us to measure the financial performance of Activision versus its main competitors. 

To find the enterprise value, we add the market cap of ~$16.05 billion to the total debt of $0 and then subtract the cash & cash equivalents of $4.6 billion. Therefore, Activision's EV (enterprise value) is ~$11.4 billion. It reported EBITDA TTM of $1.7 billion, therefore, it has a trailing EV/EBITDA of 6.7x.

<table> <tbody> <tr> <td> </td> <td>Enterprise Value ($bn)</td> <td>EBITDA ($bn)</td> <td>EV/EBITDA TTM</td> </tr> <tr> <td>Activision Blizzard</td> <td> 11.4</td> <td> 1.7</td> <td> 6.7x</td> </tr> <tr> <td>Electronic Arts</td> <td> 5.9</td> <td> 0.41 </td> <td> 14.4x</td> </tr> <tr> <td>Sega</td> <td> 606.1 (JPY)</td> <td> 46.8 (JPY)</td> <td> 12.9x</td> </tr> <tr> <td>Nintendo</td> <td> 744.3 (JPY)</td> <td> -23.7 (JPY)</td> <td> N/A</td> </tr> </tbody> </table>

Perhaps, the best comparison is with Electronic Arts, as Electronic Arts is a firm that competes with both the Activision aspect of the company and the Blizzard part (Vivendi Games' side). Activision Blizzard is clearly undervalued compared to Electronic Arts. With the exception of EA, its competitors are unprofitable and seem unable to present a threat to Activision. Therefore, with strong cash flow and a solid gamer base, Activision seems well positioned to grow and gain market share. 

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Rupert Nicholson owns shares of Activision Blizzard. The Motley Fool recommends Activision Blizzard. 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!

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