The End of the World (of Warcraft) Spells Trouble for Blizzard

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

In my opinion, the greatest video game of all time was classic World of Warcraft, the first one that came out. That game was, and still is in my mind, the best MMORPG ever. Whether it was questing or raiding a dungeon, there was always something to do in the world of Azeroth. So what if you spent endless hours on a game that provided almost no practical benefits. It was fun.

But developers at Activision Blizzard (NASDAQ: ATVI) just kept tweaking and tweaking the game. Many who once loved World of Warcraft think the game isn't worth playing anymore. The current version of WoW, while probably a decent game, is nowhere near the greatest video game of all time. 

Decline of the cash cow

As an investor you need to know how the decline of the company's cash cow will affect the bottom line. In terms of subscribers, WoW reached its peak of 12 million back in 2010. During the first quarter of this year alone, the game lost 1.3 million subscribers. That brings the current amount to roughly 8 million, a 33% decline from the peak.

How has the decline of Blizzard's cash cow affected the bottom line? To get an idea of that, I'm going to compare recent results with those between 2003-2010, we'll call those years WoW's heyday.

During WoW's heydey, revenue grew at a 27.6% compound annual growth rate, or CAGR, while net income grew at an astounding CAGR of 41.3%. The game was good, and the company and stock succeeded mightily.

How has growth been since the end of WoW's heyday? During the 2010-2012 period revenues and profits grew at the much less impressive rates of 4.5% and 24.3%. Alright so net income growing by 24.3% compounded is still good. But I don't expect that to continue for long if revenue growth continues to be lackluster.

Rewarding a CEO for a mediocre job

World of Warcraft probably had a longer reign as the world's most popular video game than any game ever has. But patching in constant fixes to a game that wasn't broken ruined Activision Blizzard's cash cow.

And what does the company do to reward the CEO for overseeing this recent period of unimpressive growth? Increase his pay eight-fold, and make him the fourth highest paid CEO in America! That massive raise cannot possibly be justified by the companies recent performance.

Other gaming companies don't look much better

Activision Blizzard, of course, makes money selling other games besides WoW. The company also owns the Tony Hawk and Call of Duty Franchises. However shareholders will be disappointed to know that pre-orders for Battlefield 4, a product from rival Electronic Arts (NASDAQ: EA) outsold those for Call of Duty: Ghost. 

Despite having a solid franchise in Battlefield, things over at Electronic Arts don't look great either. The company recently lost its contract with the NCAA to produce college sports games under that title. 

Shareholder's equity has declined in each of the past three years and currently stands at $2.26 billion. The company's most profitable year in the last decade was 2004. While Electronic Arts generates more revenue now than it did nine years ago, its operating expenses have more than doubled.

In 2012, EA generated $76 million in net income. For the company's fiscal 2013 that number was $98 million. Call me crazy, but I would never pay $7.2 billion for net income like that.

A non-traditional gaming company

Another gaming company out there is Zynga (NASDAQ: ZNGA). While I realize they don't compete in the same industry as Activision Blizzard or Electronic Arts, Zynga still is a gaming company. And I figured if the companies making games for major consoles like the Xbox aren't worth buying, maybe a company that designs games on another platform is.

Maybe there is a video gaming company out there that deserves to be invested in, but it sure isn't Zynga. How is the company whose crowning achievement is Farmville worth $2.7 billion dollars?

The company posted massive losses in 2011 and 2012. To try and reverse its fortunes Zynga recently replaced former CEO Mark Pincus with Don Mattrick, the former head of interactive entertainment at Microsoft

In my eyes there's almost no way Mattrick could bring changes that will justify buying the company at its current price. When your most productive assets are Facebook games, its almost impossible to justify a multi-billion dollar valuation.

One potentially major catalyst for Zynga could be the widespread legalization of online gambling. But personally I have no idea when, or if that will occur. And I won't invest my money on the hope that online gambling becomes legal soon.

Final foolish thoughts

Thanks to one of the greatest video games of all-time, shares of Activision Blizzard performed marvelously for investors who got in early enough. But by constantly trying to patch up something that wasn't broken, the company ruined its cash cow. 

Electronic Arts faces problems similar to Activision Blizzard. One of the biggest being the threat posed by free games. Video games are about as far from a necessity as you can get. When individual gamers need to save money, odds are pay-to-play video games are one of the first things they'll cut.

And as for Zynga, well, that company strikes me as honestly being a joke. Somehow the aggregate value of a bunch of silly little Facebook games is $2.7 billion? A potentially major catalyst exists for the company in the field of online gaming. But personally I wouldn't invest if that was my only reason.

Perhaps there is a great gaming stock out there worth buying right now. But in my opinion it isn't any of these three companies.

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Fool blogger Ryan Palmer has no position in any of the stocks mentioned. 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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