Buy, Sell, or Hold Activision Blizzard?

For much of the two years since Activision and Vivendi Games merged to form Activision Blizzard (Nasdaq: ATVI  ) , the stock price has done pretty much nothing, hovering between $10 and $12. Yet the merger created the largest and, arguably, the most powerful video game publisher in the industry with several apparent strengths. Should investors be worried about the health of the company and industry? Are the growth prospects better with competitors Electronic Arts (Nasdaq: ERTS  ) or Take-Two Interactive Software (Nasdaq: TTWO  ) ? Or should they abandon the whole sector as doomed? In other words, should investors buy, sell, or hold? Here's a quick look at arguments for each.

Buy

  • Games: Activision has some of the most popular games around and is releasing eagerly anticipated updates and new versions. The long-awaited StarCraft II is being released later this month, and an expansion to World of Warcraft is due out later this year, along with one for Call of Duty. Plus, the company owns several different studios that develop the games and recently signed an agreement with Bungie, the developer of the smash hit Halo (at least it's a smash hit here at Fool HQ).
  • Financial strength: Activision Blizzard generated more than $1 billion in free cash over the past four quarters. With more than $3.3 billion in cash (18.5 times what Take-Two has) and no debt, the balance sheet is rock-solid. Put these traits together and it translates into a company that can afford to reinvest in game development, buy back shares, and pay the dividend, with cash left over.

Sell

  • Angry developers: With the defection of a large number of employees of Infinity Ward -- the studio that is responsible for Call of Duty: Modern Warfare 2, which grossed $1 billion in the first two months after release -- there is concern over Activision's interactions with its studios. Plus, the former heads of Infinity Ward formed a new studio and promptly signed on with Activision rival Electronic Arts.
  • Game sales declining: The year 2009 brought an 8% decrease in industrywide game sales, despite the contribution from Modern Warfare 2 at the end of the year. The trend continued in May and last month's numbers are expected to be disappointing as well. Any turnaround won't show up until later this year.

Hold

  • New franchises: Despite the expected good numbers from StarCraft II, several of the other franchises are getting long in the tooth. Guitar Hero has been saturated and Tony Hawk is aging. The new releases this year should give the company time to come up with something new, but until there's more visibility, hang on.
  • The economy: Activision has shown the ability to sell during a recession, but if the economy slips back into a double-dip recession, the company could continue treading water. The potential for growth is there and it probably won't decline -- the balance sheet protects against that -- but which way it goes isn't clear quite yet.

The final call
I have to go with the buy position. Yes, the company's share price has spent quite awhile at the current level, but Activision has shown that it can survive, even prosper, during a recession. When consumer wallets loosen up a little, sales and earnings will grow. Plus, the company has enough creative talent, and can sign on more, to generate new, successful franchises over the next several years.

Finally, my risk analysis shows that the company itself exhibits only a moderately low risk level. It may take a couple of years as earnings and free cash flow grow before the market recognizes this, but an enterprise value-to-free cash multiple of 10.6 is too low for a company of this quality to keep for too long.

Take-Two is a Motley Fool Rule Breakers pick. Activision Blizzard and Electronic Arts are Stock Advisor recommendations. Motley Fool Options has recommended a synthetic long position on Activision Blizzard and the Fool owns shares of Activision Blizzard. Try any of our Foolish newsletters today, free for 30 days.

Fool analyst Jim Mueller owns shares of and has a synthetic long on Activision. He works with the Stock Advisor newsletter. The Motley Fool has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 15, 2010, at 12:02 PM, dandles2020 wrote:

    Don't forget, they are coming out with another MMORPG, which might very well be announced at Blizzcon in October.

  • Report this Comment On July 15, 2010, at 12:27 PM, Borbality wrote:

    I guess there's no way to know, but what happens to the World of Warcraft business model in the future? I read an interview with the Blizzard CEO recently and he said they plan to upgrade the game continuously and expect millions to still be playing it in 10 years (I think). I think there's no guarantee people will still be playing a version of this same game in 10 years. They have more than just Warcraft, but they will need to fill that gap someday, right? I would bet they have what it takes to create WoW's replacement, though.

    I am holding and have not owned shares for long.

  • Report this Comment On July 19, 2010, at 11:16 AM, spadeknight wrote:

    I agree that people should buy whatever amount they can afford in this company. At less than 12 dollars a share its a great bargain considering they have no debt and are about to release another call of duty game in november. If the economy turns around with a republican victory in november investors and consumers will feel more confident about spending money which will translate into bigger sales in the future. I see activision as a solid buy with very little risk involved. fool on!

  • Report this Comment On July 19, 2010, at 6:23 PM, EvilPhD wrote:

    I am surprised that there is no mention of the possible implications of Real ID - Facebook requirement on everything connected to BattleNet 2.0. Yes, they nixed the idea on the FORMS "for now". It will still be required to have any social interaction in the game. This still is a huge hypocrisy in the gaming / privacy world. I, for one, will no longer purchase ANY game published by Activision until they rescind this.

    There is making a buck (which they will make and have made without Real ID), and then there is blatant greed and deception.

    Many people have been royally pissed off at this company for it's 180 "screw the user" policies. I have dumped my shares of ATVI and doing what anyone can do and voting with my wallet.

    SELL.

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