Over the past decade, the video game industry has experienced much of an industry renaissance. From increased internet options to more immersive playing formats, this has been one exciting industry to follow, despite recent losses in shareholder value. I expect the industry to continue to reinvent itself over the next few years and buoy up the price of Activision Blizzard (ATVI) in the process. With modest EPS expectations but a "strong buy" rating on Wall Street, the game-maker has a lot to prove in its increasingly competitive field.
Activision specializes in making online, computer, handheld, console, and mobile games, focusing on largely (although, to its benefit, not completely) a younger male market. It has done a stellar job in creating a loyal fan base and continues to penetrate the market with relentless product development.
The company recently announced that online-RPG "Diablo III" will be released in early 2012, which disappoints me since I would have much preferred a competitive launch alongside Electronics Arts (ERTS) "Star Wars: The Old Republic". I believe that a late 2011 release of "Diablo III" would have resulted in the game producer eating away market share from its competitor, especially given the lowered income of holiday shoppers.
Bear in mind though that a popular strategy in the industry is to delay a product's release so as to create demand. Activision is also releasing some popular games that will prove to be value-drivers, including expansions to "Starcraft 2: Heart of the Swarm" and "World of Warcraft". I am particularly excited about the game-makers revenue plan for "Call of Duty: Elite".
Activision will offer some free services--including a Facebook friend feature and player stats--and a premium service for $50/year that gives consumers access to DLC over a nine month period. This game will have tremendous revenue synergies for "Modern Warfare 3" and "Black Ops" in a way that takes away heat from EA's "Battlefield 3".
While I find the company's current fundamentals strong, the market continues to underappreciate the industry's potential as a whole. I am referring specifically to the increased demand that follows the release of a new console.
PlayStation (Sony SNE) and Xbox (Microsoft MSFT)are both more likely to unveil a new system sooner due to the announcement of Nintendo's Wii U (NTDOY.PK). Although the Wii U was criticized by analysts as being "out of touch" with modern-day gaming, the reality is that management knows its market best and, accordingly, the stock took an unnecessary hit in my view.
Even still, of the 3 major consoles, Nintendo Wii games made up the lowest percentage of Activision's revenue at just less than 18%. What this means for Activision is that the company is more safe than what the market expects and can thus benefit from higher risk-adjusted returns. The unveiling of a new Sony or Microsoft system will similarly benefit the stock.
Massively multiplayer online role-playing games ((MMORPG)) continue to be strong performers and make up the largest portion of Activision's revenue. The company has sort of carved out a loyal niche in this market, although an aging population can only work to the game-maker's disadvantage. The stock currently trades at 22.8x and 13.5x past and forward earnings, respectively, while offering a dividend yield of 1.32%. For comparison, its competitors Electronic Arts and Take-Two (TTWO) trade at a respective 19.6x and 5.8x forward earnings while offering no dividend yields.
Finally, as a matter of wealth security, I believe that Activision is the safest industry bet. Since 2008, the stock weathered the recession the best and only fell by 14.4% while Electronic Arts fell by 61.5%, Take-Two by 26.6%, Microsoft by 25.7%, Sony by 66.5% and Nintendo by 73.9%. This is a staggering loss of shareholder value and underscores the importance of evaluating industry exposure to a recession before making an investment decision.
Consensus estimates for EPS are that it will be flat for 2011 at $0.79 and then rise by 17.7% and 15.1% in the following two years. My model predicts EBITDA declining by 5.7% to $1.5B, and then increasing by 25.1% and 6% in the following two years. Although the stock has tremendous risk, strong game developments and a loyal market complemented by console releases will, in my belief, improve the company's competitive position and help it regain lost shareholder value.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
