King of The Hill: WarCraft Edition

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

I love video games. They keep hoodlums off the streets. They provide entertainment and an outlet for countless amazing writers. They are also big business, and can be lucrative if the company knows what they are doing. Public companies tend to be publishers, though they might have in-house development teams. They also contract and acquire numerous developers and keep them more or less intact to churn out games from valuable IPs.

These relationships are important in evaluating a publisher. The developers under them determine the quality of the games and the creation of new IPs. An IP is intellectual property. In terms of a game an IP can keep on giving. Think of it as the premise or universe of the game. Each individual game utilizes the IP, but an IP is indefinite because it is just an idea at its very core. For example, try releasing a game in the StarCraft universe and see how quickly the lawyers come knocking. Next try releasing a game set in World War 2 with different mechanics from Call of Duty, and there won't be a lawyer in site. So IPs can be utterly unique, or they can just be a brand with some familiar components between games. The publishers you want are those with quality developers and amazing IPs.

Quality and Depth - The King of the Hill

Activision-Blizzard, Inc. (NASDAQ: ATVI) is my favorite in the video game industry. Being over-exposed to video games is not my idea of being smart. Activision has a quicker turnaround and some solid if sometimes run-of-the-mill IPs. Call of Duty is a massively successful series. I would not say it is the most innovative of series, since it only makes incremental changes to the first person shooter genre. This is probably by design, because each game is very successful as long as it is quality. Activision knows that its audience wants a good first person shooter not one that tries complex new game mechanics.

The Blizzard side of business has some of the most iconic IPs in gaming. WarCraft, StarCraft, and Diablo are extremely old. StarCraft is the newest one of the group, and fans of the first game waited over a decade to scoop up the second. During that entire time the internet was buzzing with news and rumors. The same with the recently released Diablo 3. WarCraft was the same before World of WarCraft. That game started the MMORPG proliferation that created a lot of garbage, but through it all World of WarCraft stayed solid. Only recently has that game started to see cracks in its facade. Hopefully, Blizzard can continue the series with a new game or try new projects.

So Activision-Blizzard has two sides to its business. One is fast and the other is slow. Both have longevity but Blizzard's IPs command a greater loyalty. Keeping strong fans for over a decade is an almost unheard of loyalty among my generation where yesterday's news may as well never have happened. This duality makes me think that Activision-Blizzard has a solid business that is worth a long-term investment. They also started giving a dividend the last few years showing that the video game industry has matured.

Activision-Blizzard is not undervalued. The price to book and price to earnings are all fair. My favorite part of Activision-Blizzard's fundamentals are the monstrous cash balance of $3.192B with no long-term debt. It has a good profit margin, though I would want that to grow a bit since this is a software company at its core. Revenue is high, but flat.

I have loved this company since I first started looking into stocks. I know its products and have personally contributed to that cash balance. The lack of debt is also a great sign. The company can scoop up developers and IPs in order to expand earnings. Activision takes new IPs, like Prototype which is just a few years old and defunct as of the second game. Blizzard is left to work on its legacy IPs. I know the cash pile is being put to work. It does not take much to finance development at a small time studio and offer a revenue sharing agreement. Once the game takes out it does not take much to buy them up, because publishers typically own all the distribution rights of that IP. That means that Activision-Blizzard has exceptional flexibility in expanding its portfolio of games, and that means more potential revenue and profit.

The current levels are a good place to take a position. It pays a dividend, which you can collect while waiting for it to appreciate. It moves extremely slow and seems to decline back to where it was on even an inkling of bad news for it or the economy. All that means is that you can write covered calls to write yourself a bigger check in addition to the dividend.

Indiscriminate Breadth - King of the Mole Hill

I wanted to talk about Ubisoft here, but they are traded only in France. Therefore I have to turn to Electronic Arts (NASDAQ: EA). It is not my favorite company, but they have a large number of titles and some are amazing. A few years ago it only really had good sports games, but since then it has improved its portfolio drastically. Having so many titles and IPs can lead the company down paths that only waste cash and manpower. Although, some of those IPs are big hits, such as Crysis, Dead Space, and Command and Conquer. The lack of focus from Electronic Arts is what makes them second place in my eyes.

Cash is about three times long-term debt, which is not bad. The debt to equity ratio is 0.2132, which is low enough. The profit margin is good at around 20%, which is the level I want Activision-Blizzard to have. The price-to-equity ratio is a bit high at around 68. Electronic Arts needs to improve its earnings and profitability in absolute terms. The margin is there now it just needs the bottom line to increase. Revenue is in line with Activision-Blizzard but net income lags quite a bit.

I do not want to discuss Electronic Arts as much as I did Activision-Blizzard, because I think only one video game company needs to be in a portfolio right now. Electronic Arts would be better if it had better earnings. If it can lean out operations and stop going down so many dead-ends on games, then it would be much better. The Activision side of Activision-Blizzard has similar problems, but on a far smaller scale. I would not even hazard a position in Electronic Arts until I see some good quarters and hear the conference calls.

Conclusion

Activision-Blizzard is my favorite video game company. I like the concept of keeping two powerhouses separate. It walks a thin line as an organization. Keeping the two extremely related organizations separate, but that allows them to keep their separate cultures. I think that will make Activision-Blizzard an amazing company for years to come, and I would hold onto it for a while. I don't know how long, but it is a consistently solid company. When that changes I'll reassess.


TheArchivist has no positions in the stocks mentioned above. 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.

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