E ATVI: There's One Born Every Minute

Recommendation Summary

 

*Source: Bloomberg

After a 41% drop in October last year, ATVI’s stock has been in a literal stagnation for 10 months until recently, so is there value to be had in the coming years?

The company does seem to be cheap at first glance, but after a deeper look at the fundamentals I do not find the company fairly valued compared to its market price today. I have found the company to be overvalued by ~30%, I believe the market has underemphasized the big disruptions going on in Activision’s latest acquisition, Blizzard and the loot box controversies stirring up talk of possible legislation.

Catalysts to decrease the price in the next 6-12 months include the continued ban of loot boxes in more countries, possible economic slowdown and the possible failure of the GaaS model.

Some of the risks included in this analysis include the release of the new Warcraft Reforged later this year or beginning of next which the market could overreact to and an increase in market share in mobile gaming.

Company Background and Overview

 

Activision Blizzard (ATVI) is an American video game and film holding company. It has several companies underneath it, including Treyarch, Infinity Ward, High Moon Studios and Toys for Bob. Some of the major games produced by the company include Call of Duty, Guitar Hero, Tony Hawk's, and Spyro through Activision's studios, World of Warcraft, StarCraft, Diablo, Hearthstone, and Overwatch through Blizzard Entertainment, and mobile titles including Candy Crush Saga through King.

In the last 3 years (including TTM) the company has experienced a modest increase in revenues at an average of around 4% per year mostly fueled by an increase in subscription and loot box revenues. This coupled with implementing the “games as a service” business model and cost-cutting measures like employee layoffs and shuttering Heroes of the Storm esports segment has made ATVI continue increasing profits throughout the last year, but I do not find this to be sustainable in the long-term.

Below you can find the main revenue segments broken down:

*Source: Company filings and author’s own estimates

Investment Thesis

Currently, I believe the market sees ATVI as one of the leaders in the PC gaming market fueling this is the latest Black Ops 4 release which outdid sales of the previous Black Ops 3 title in 2015 and the new Crash Team Racing: Nitro Fueled which in June came in at number-one as the best-selling game in the UK. 

However in the long run I think the stock could continue experiencing a downfall because of the reasons listed below:

Blizzard acquisition still weighing heavy

*Source: Company filings and author’s own estimates

Blizzard is considered to be a unique company bringing in exclusive value to the gaming market. Despite being slow in its development cycles Blizzard has solidified its market position by releasing hit and memorable franchises like Diablo, Warcraft, Starcraft, World of Warcraft and Hearthstone. 

Instead of Activision building on the success of the company mentioned above, we have seen disruptions within Blizzard causing some of the older creative staff leaving the company. Bellow you will find a list of the people who left Blizzard after the Activision acquisition:

• Mike Morhaime – CEO, Co-Founder and President

• Amrita Ahuja – CFO – 8 years with the company

• Nate Nanzer – Overwatch League commissioner – 4 years with the company

• Mar Pierce - Co-founder

• Kim Phan – Global Product Director Of Blizzard Esports – 13 years with the company

• Brian Stolz - Chief People Officer

 

Instead of the acquisition solidifying the company’s position I have seen it causing more disruption than synergy. With some of the staff leaving the company and operating margin experiencing a downwards trend I do not find Blizzards acquisition bringing the expected results.

Considering all this I find that there is significantly more downside to the Blizzard acquisition than the market has priced in. I expect Activision to continue struggling with Blizzard’s established company culture, thus not optimizing the company’s full potential in the future.

With an average revenue decline of 5% in the last 3 years combined with the lack of political synergy between Activision and Blizzard and the economic slowdown, I have lowered the expectation of Blizzards future performance for the next 5 years. I expect an overall average of 0.9% revenue growth per year in the next 5 years and then returning to a 2.5% terminal value in year 10 and beyond.  I also expect the lack of optimization I mentioned above, to weigh in on operating margins in the future. With the assumptions mentioned above I got to an equity value for Blizzard of $5,752 million:

*Source: Author’s own estimates

Games as a service

The GaaS model revolves around giving games a long or indefinite stream of monetized new content over time to encourage players paying to support the game. More and more companies have their operating margins and revenue growth determined by the effectiveness of their GaaS model and ATVI is no exclusion.  The main idea behind the GaaS model is to concentrate the company’s resources into one blockbuster of a game in order to make the game profitable in a longer period of time, thus increasing company margins overall. I see this model falling flat in the long term as games like Destiny 2, Anthem and Battlefront exposed the models flaws, by having buggy releases and lacking content therefore not meeting sales expectations. As sales of Destiny 2 disappointed, so did its retention rate and at the end ATVI broke up with the developers of the game, Bungie. 

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Disclosure:

I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I have no ...

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