You Should Start Playing Activision Blizzard

By Ser Jing Chong - August 25, 2012 | Tickers: ATVI, AAPL, EA, GOOG, ZNGA | 0 Comments

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Activision Blizzard (NASDAQ: ATVI) has been an interesting company for investors who have held on to the stock since August of 2009. The stock went from $11.80 per share on Aug. 1, 2009, to $11.80 per share on Aug. 22, 2012… Hey wait a minute, the stock went nowhere!

Looking at just the stock price alone, you might think the company has flat-lined and that investors are looking at a no-growth company that will languish into perpetuity. Take a deeper dive and a different story emerges. The chart below shows the revenue and cash flow for the company in Fiscal Year (FY) 2008 to 2011. Notice the growth here – not spectacular, but certainly no slouch either.

What is often overlooked, however, is the fact that ATVI has a pretty robust economic moat that can be seen from its financial statements. Warren Buffett often talks about companies having an economic moat. He likens an economic moat to a castle surrounded by deep waters that make it hard for enemies to conquer the castle. In Buffett’s famous annual Berkshire shareholder letters, he actually gave us a glimpse of how he interprets the numbers of a company to discern the evidence of an economic moat. Essentially, Buffett looks for considerable after-tax earnings on net tangible assets. If a company was able to grow its Returns on Net Tangible Assets (RNTA) over the years without seriously deteriorating its balance sheet, chances are the company has a rather strong economic moat. Let’s take a look at a table showing ATVI’s after-tax earnings compared to its net tangible assets from FY 2005 to 2011.

Table 1 - ATVI's Financials (numbers in millions)

Sure, the RNTA looks lumpy, but it shows a gradual increase which is a good thing and actually highlights the fact that ATVI might have a significant economic moat with RNTA of 38% in FY2011. The numbers look nice, but does it tell a complete story? Let’s take a look at some of ATVI’s strongest franchises. The few franchise names that come to mind would be World of Warcraft, Diablo, Starcraft and Call of Duty. World of Warcraft is a Massive Multiplayer Online Role Playing Game (MMORPG) with 9.2 million paying subscribers worldwide. The game is almost 8 years old and yet still manages to capture the attention of millions of players. In comparison, one of ATVI’s strongest competitor, EA’s MMORPG effort, Star Wars: The Old Republic, started out with the same paying-subscribers concept but has since reverted to a free-to-play model after 8 months (yes, months). The longevity of World of Warcraft certainly alludes to the presence of very strong customer loyalty for ATVI. The first Diablo game was released in December 1996 and has enchanted gamers ever since. The third installment in the Diablo franchise was released in May 2012 and became the fastest-selling PC game of all time, with 3.5 million copies sold in the first 24 hours of its release. The Starcraft series have displayed similar successes with the Republic of Korea having professional Starcraft Leagues where the gamers are treated like bona-fide celebrities.

All these look impressive right? Let’s move on the Call of Duty series. The Call of Duty series had record-shattering sales for a number of installments. The most impressive of which would be the November 2011 launch of Call of Duty: Modern Warfare 3. It holds the record for the biggest entertainment launch of any medium with sales of $400 million within 24 hours. Are these signs of extremely strong brand recognition and being the Top-Dog in the gaming industry? You tell me.

A look at ATVI’s competitors will highlight a significant difference in the presence of an economic moat judging from their financial numbers over the years. ATVI’s biggest competitor within the same industry would be Electronic Arts (NASDAQ: EA). Its cousin in the social-gaming industry would be Zynga (NASDAQ: ZNGA) (I would argue that ZNGA cannot really be considered in the same category as ATVI, but that would be another story for another day). The numbers are presented in Tables 2 and 3. Notice how ATVI has a much better showing in the RNTA row compared to ZNGA and EA over the years.

Table 2 - EA's Financials (numbers in millions)

Table 3 - ZNGA's Financials (numbers in millions)

I would also throw in tech heavyweights Google's (NASDAQ: GOOG) and Apple's (NASDAQ: AAPL) financials for FY2011 as a comparison for their RNTA.  The reason for doing so is that within the technology industry, AAPL and GOOG are commonly the ones considered to have considerable economic moats (and rightfully so, in my humble opinion) and their numbers do showcase that fact. We can compare their numbers to ATVI’s to get a sense of how strong ATVI’s moat is within the gaming industry and if you compare the RNTA rows for Tables 1, 4 and 5, you can see that ATVI compares favorably with these two tech giants.

Table 4 - GOOG's Financials (numbers in millions)

Table 5 - AAPL's Financials (numbers in millions)

Of course, numbers alone can never tell us a complete story of a company’s investment merits. But just looking at ATVI’s relatively low current TTM P/E ratio of 17, significant product pipelines (World of Warcraft Expansion set: Mists of Pandoria, Skylanders Pyro, Call of Duty: Black Ops II, etc.) and the quantitative and qualitative presence of an economic moat all suggest to me that ATVI will be a good investment opportunity in the next few years.

I recognize the fact that ATVI’s share price has remain stuck in the doldrums for a good number of years, but as investors, we have to realize that the markets can persist with significant undervaluation of companies for years. I am going to place a "market beating" CAPS call for ATVI and even though I might be wrong on this particular company’s stock price movement, I maintain confidence in the business performance of ATVI. After all, having a good process in picking strong companies for investment opportunities can help individual investors better their odds at investment success. Even if I am ultimately proven wrong, I will learn from it – nobody gets it right all the time.

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