Is Activision Blizzard Built to Last?

With a stable of popular video game titles, Activision Blizzard (Nasdaq: ATVI  ) is one of the most popular stocks in Fooldom. But does the company have a wide enough moat to keep competitors at bay for the long haul?

The stuff moats are made of
Warren Buffett coined the term "economic moat" to describe the strength of a company's competitive advantages. Many factors confer short-term competitive advantages, but in his excellent The Little Book That Builds Wealth, Morningstar's Pat Dorsey convincingly argues that only four factors create an enduring economic moat. Let's use Dorsey's criteria to see what Activision's moat is made of, and just how sustainable it is.

1. Intellectual property rights
Moat-building intellectual property includes intangible assets like patents, licenses, and brands. Any company can have a brand, but truly moat-widening brands must increase a consumer's willingness to pay for a product.

Moat source: Slight
They key here isn't popular brands, it's sustainably popular brands. While the Call of Duty franchise is red hot today, we can't be confident this will continue in the future (look at what happened to poor Tony Hawk). However, the brands from the Blizzard side of the business like World of Warcraft and Starcraft have demonstrated much greater staying power.

2. Customer switching costs
Products that are tightly integrated with a customer's business or lifestyle make it difficult for that customer to switch to a competitor's product.

Moat source: Yes
The stories you hear about Warcraft addictions are troubling, but they're also a testament to the game's stickiness. WoW is much more than a game, which explains why 11.5 million members are willing to pay a fee every month to keep playing.

3. The network effect
The value of some services increases in direct proportion to the number of people using them. For example, Facebook offers a much richer experience with 500 million users than it did with a handful of undergraduate dorm-mates.

Moat source: Yes
The real appeal of WoW and Call of Duty is the ability to interact with (or slaughter) members of a massive online community. Each new player improves the multiplayer experience for every user – which makes it even tougher for competitors' games to gain traction.

4. Cost advantages
Finally, lower costs can create lasting competitive advantages. The benefits of operational efficiencies and smart processes inevitably erode over time. A truly sustainable cost advantage, like economies of scale or a superior geographic location, simply can't be copied.

Moat Source: Yes
As the 800-lb. gorilla of the video game industry, Activision Blizzard has no problem attracting top talent. The gaming community was concerned about the fate of the Call of Duty franchise after key development talent fled Activision's Infinity Ward studio, but according to COO Thomas Tippl, Activision received roughly 5,000 job applications from developers eager to take their place.

Numbers don't lie
To determine whether a company enjoys a sustainable competitive advantage, examine its return on invested capital (ROIC) over time. Returns consistently exceeding a company's cost of capital suggest that it possesses a nice moat. Here's how Activision Blizzard's ROIC stacks up next to competitors such as Electronic Arts (Nasdaq: ERTS  ) and Take-Two Interactive (Nasdaq: TTWO  ) :

Company

FY2009

Activision Blizzard

28.4%

Electronic Arts

(0.2%)

Take-Two

(42.9%)

Source: CapitalIQ, a division of Standard & Poor's, author's calculations.

Activision Blizzard's fiscal year ends on December 31. Prior year data is not meaningful due to the reverse merger with Vivendi Games in July 2008. Comparable trailing-12-month periods are used in comparing to other companies.

Survey says: Narrow moat!
Activision has a strong moat today, but it's largely based on the stickiness of a few key gaming franchises. To maintain its competitive advantage, the company must stay on top of changing trends in technology and consumer preferences.

Ready to buy?
Not so fast, my Foolish friends! Although we've demonstrated that Activision has an attractive moat, that doesn't automatically make it a smart buy. While competitive advantage is critical, it's also essential for investors to have a strong understanding of a company's management, finances, and valuation – and to always buy at a significant margin of safety.

That's the strategy our team at Motley Fool Inside Value employs. You can read all of the team's research reports, and see their best buys for new money now, with a 30-day free trial.

Rich Greifner and The Motley Fool own shares of Activision Blizzard. Activision Blizzard and Electronic Arts are Motley Fool Stock Advisor selections. Take-Two Interactive is a Motley Fool Rule Breakers recommendation. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (17) | Recommend This Article (10)

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  • Report this Comment On August 18, 2010, at 11:24 AM, Feurbach wrote:

    Activision's moat is going to narrow considerably over the coming 12 to 18 months.

    While this will likely be a dismal year for Electronic

    Arts, who apparently aren't even trying to compete with Microsoft (Halo: Reach, Fable 3) and Activision Blizzard (WoW: Cataclysm, CoD: Spec Ops) this holiday season, next year they're releasing a slew of products with the apparent aim of challenging Activision's dominance in the FPS (Bulletproof, Crysis 2) and MMORPG (Star Wars: the Old Republic) spaces. In fact, the latter title will likely be a game changer within that space - very conservative projections are for $500MM in operating income the first year alone - which will significantly erode Activision's market share as well as usher in a large number of players new to MMORPGs. As evidence, I encourage you to poke around the official SWTOR boards - where there are already literally millions of posts from fans across the globe, even though the release is still 10 months from now - and see what fans are saying. From my survey of the forums, it looks like a large number of fans are already disentangling themselves from their lives within WoW in preparation for the release, while many others have never played an MMORPG before.

    That said, I susepct EA stock is going to skyrocket in the second half of next year. In the short-term, however, Activision is a much better bet. The new WoW and CoD titles will be top sellers this holiday season - especially with the marked lack of serious competition outside of Microsoft (who, with the games mentioned above as well as Kinect, looks incredibly cheap right now). But unless something changes I'd only play Activision on the short-term, given their insipid 2011 pipeline, their inability to get Blizzard developers to commit to dates (Diablo 3? In development for 5 years, with no end in sight), and EA's coming market dominance in the MMORPG space.

  • Report this Comment On August 18, 2010, at 11:42 AM, revrurik wrote:

    Feurbach wrote: "Activision's moat is going to narrow considerably over the coming 12 to 18 months.

    Really? I see just the opposite, due to the impending, yet unreleased juggernaut "Diablo 3," and the latest WoW expansion pack ("Cataclysm") being released soon. I'd also draw your attention to the "Halo" developers who joined Activision's stable of talent recently. I'm very curious to know what they're up to under the new Activision umbrella, considering their past victories. Things may not "jump" in the next year, but I'm long on Activision and doubt that the 'moat' will be narrowing any time soon.

  • Report this Comment On August 18, 2010, at 11:52 AM, dandles2020 wrote:

    Hello? Blizzard is developing a second MMORPG, which they very well might finally announce details on at Blizzcon this year. That doesn't mean it will automatically succeed, but people who play these games, especially their 11.5 million WOW subscribers, might very well be interested in. And it will help them keep those subscribers in the fold.

    I play WOW, and I've never, NEVER heard one person express an interest in SWOTR or talk about leaving WOW to play that game. The only thing I have noticed is that people have left wow to play Starcraft (myself included).

    That being said, WOW will grow old and their new MMORPG might not catch on. The next 12 months will tell a lot.

  • Report this Comment On August 18, 2010, at 12:12 PM, Feurbach wrote:

    Revrurik, Dandles -

    I never said that Activision will fail - only that it's "moat" - by which I (as well as the author of the original article) mean its various competitive advantages - is going to narrow. For that reason, I'm bullish on Activision in the short-term (where their moat is quite strong) and bearish on Activision over the long term. It would be mighty foolish to think that a MMORPG, developed by Bioware, and concerning one of the most beloved and longest lasting sci-fi franchises doesn't threaten to significantly disrupt the MMORPG market, and a very significant portion of Activision's present success relies on the continued revenue stream generated by their only entrant (to my knowledge) in that space.

    Dandles - I apologize that what I've read on the forums differs from your own experience. I don't play WoW (nor will I likely play SWTOR); I merely research them.

  • Report this Comment On August 18, 2010, at 12:19 PM, gaucho420 wrote:

    The PEG ratio for ATVI is a paltry 1.05, while ERTS's currently sits above 1.50. Traditionally, that means ATVI is undervalued and ERTS is rightly priced.

    However, COD's sales estimates maybe overblown, but the stock may rise in anticipation of its release, only to sell once that happens.

    I wonder if COD and the new Medal of Honor will split the FPS market in the fall, as gamers will not have the money to buy both and most will choose one over the other. I'm not worried about Halo, because typically the Halo market and the COD market do not crossover. I personally don't know too many people who play both, even in good economic times.

    ERTS has certainly improved its games, and the announced released of Mass Effect II on the PS3 is positive, but I feel that all these companies will not grow consistently when youth and young men unemployment is at historic highs, which forces gamers to pick and choose their games or to simply wait for the now inevitable price cuts that follows most releases, even the AAA titles (Alan Wake for $39.99?).

    I still beleive that pound for pound, the highest quality titles are put out by TTWO, but unfortunatly, the costs at that joint need to come under control. If I had to pick between ATVI and ERTS, I'd say ATVI short term and then ERTS is a gamble in the long term, as the stock's price is already correct in my opinon.

    BBY maybe a better play at this point, especially with a further pullback in the price of the stock. I also think KNM (Konami) is a cheap levels today.

  • Report this Comment On August 18, 2010, at 12:22 PM, gaucho420 wrote:

    I will add that I beleive Diablo III is coming out much sooner than people think. I could be wrong, but my sources tell me otherwise...but that's just rumours on the net via this comment box, right?! :-)

  • Report this Comment On August 18, 2010, at 12:54 PM, gatorstew wrote:

    You'd be surprised at the amount of crossover between games. When I was gaming more, 90% of my friends list were flip-flopping on what they were playing (Halo 3 and CoD 4). When you log into Xbox Live it gives a list of all of your friends and what they're playing I found that each of them would have different clans that played each game thus the flip-flopping. Obviously the future is downloadable content and ATVI will definitely push that with their developers. CoD: Blackops will surely have them and you can bet everything that the title(s) that Bungie releases over the 10-year agreement with ATVI will be loaded with DL content (i.e. moneymakers).

  • Report this Comment On August 18, 2010, at 1:03 PM, Feurbach wrote:

    PEG ratios are far too dependent on market forecasts - remember, they use anywhere from a 1 to 5 year growth rate - to be particularly useful for evaluating this industry. PEG is great for businesses with predictable demand, but can wildly miss the mark when drivers for revenue and consumption are more difficult to model.

    I agree that the unemployment levels in the US (which is the single largest market for these companies) is having an effect on sales - I'm just not sure if its positive or negative. The fact that the summer releases have been (with the exception of Starcraft) pretty lackluster points, to me, to a problem with the industry, and not demand. Video game sales were pretty solid this winter, when unemployment in the States was also high. Furthermore, they're very cheap forms of entertainment - $40 - $60 for 20+ hours of value.

    That said, I agree with gaucho that consumers are becoming a lot more savvy with how they invest their money in a new game. A glut of recent, high-quality releases have set the bar pretty high, and publishers have responded by shifting their strategy away from market saturation (the "Hollywood" tactic) and towards fewer, higher-quality releases.

  • Report this Comment On August 18, 2010, at 1:10 PM, reeshau wrote:

    I also own ATVI, and ROIC is one of my key metrics when considering and investment. But this article loses a lot of its punch when the comparison companies are also recommendations...

    "Rich Greifner and The Motley Fool own shares of Activision Blizzard. Activision Blizzard and Electronic Arts are Motley Fool Stock Advisor selections. Take-Two Interactive is a Motley Fool Rule Breakers recommendation."

    So, what weight does ROIC hold in the newsletters' recommendations? Does this indicate some disagreement among staff? If this were a scientific proof to correlate ROIC and a recommendation for investing, the conclusion would be there is no correlation.

  • Report this Comment On August 18, 2010, at 3:53 PM, dandles2020 wrote:

    Feurbach:

    I probably should have phrased my comments a bit differently, and included the part where I agree with your assessment overall. I'm skeptical about the Star Wars MMORPG, just because it seems like no one has been able to crack that niche in the way Blizzard has. However, I think the Star Wars game has the best chance to succeed out of anything I've seen. I'm going to check out their forums to see what people are saying.

    I bought some ATVI because I think Cataclysm and Starcraft will bring good results in the near future, but I don't plan to hold onto it for very long UNLESS they announce that second MMORPG at Blizzcon and it looks like a winner.

    Regarding unemployment, for what it's worth, when I've played Wow I noticed that there were lots of unemployed people playing the game, or at least more than a few times players would mention being out of work. I feel like that game in particular was cheap entertainment, even though it was a 15 dollars a month subscription fee, and that it was the last thing people would cut from their budget because of all the hours of entertainment it would provide. Again, take that for what it's worth.

  • Report this Comment On August 18, 2010, at 4:27 PM, Feurbach wrote:

    I'm rather curious about StarCraft's sales figures, especially since they're not included in the monthly NPD report. Other than the initial release of 1.5MM boxes, has anyone seen any additional sales figures tossed around (particularly in the China market)?

  • Report this Comment On August 19, 2010, at 11:03 AM, galtline wrote:

    What is encouraging to me is how ATVI is run...and THAT is what makes them consistently trample over the competition...not to mention that they are sitting on cash.

    I'm curious what you consider to be "short term investment" though....for investors, ATVI has done little but run sideways for the past couple years.

  • Report this Comment On August 19, 2010, at 1:30 PM, Feurbach wrote:

    Kotick manages to keep ATVI's business results pretty predictable in a volatile industry - and that's one of the key's to the company's success (though his ruthlessnes has done little to win the hearts and minds of fans). It also helps that, outside of Microsoft, Activision's competitors are excessively top-heavy (look at EA's SG&A costs - it's structured like a $6B company) and financially irresponsible, often investing excessively in failures (not to pick on EA, but the acquisition of Playfish seems pretty ill-conceived).

    galtline - by short-term, I mean the next six months or so. I see ATVI gaining some ground this holiday season with CoD and Cataclysm. However, and even if they deliver Diablo 3, I see little evidence of any sort of game-changing releases next year - at least, anything that will be able to compete with SWTOR, and the attention it will draw from the street. Should have a better idea after Blizzcon in October, though, as Dandles rightly pointed out above.

  • Report this Comment On August 19, 2010, at 8:09 PM, 1caflash wrote:

    Rich, thanks for an informative article. First, I need to make amends. A while ago commenting on a MF writing, I tried starting a "Secret Stock" contest. This was my imagination going haywire. There is no such contest on my behalf endorsed by Motley Fool or anyone else. If there was, then it is Bogus because there is always someone who knows about a particular equity. Now, perhaps I can mention an investment I have that I believe offers a great growth opportunity, has fewer shares than some Gaming companies, has been paying dividends since the mid-1980's and is International: Konami Corporation [KNM-ADR]. Read about it.

  • Report this Comment On August 20, 2010, at 12:50 PM, lsickler wrote:

    I think ATVI's days of dominance are soon to be over. Looking at thier slate over the last 6 months and into next year I see the following:

    1) Although a lot of people say SCII is a very pretty game (very polished) almost everyone says it was uninspired and they are generally disappointed that Blizzard did not have anything new to bring to the table. It sold a lot out of the gate but we will have to see what the long tail does and overall I think $60.00 is just to much unless your really a fan of the franchise. A lot of my friends have passed on it util it hits the sale table.

    2) WoW/Cataclyism.....I have played wow since it realeased and I have to be honest I think people are hanging on with WoW becuase they are just waiting for something better, seriously I have never seen people so indifferent towards the other 2 expansions. SW:TOR and GW2 are going to take HUGE chunks of sub's from WoW. It's going to happen over night just like Facebook did to MySpace and there is absolutly nothing they can do about it.

    2 things are appearent to me, first off ERTS is getting thier feet under them and listening to Bioware. Dragon Age was a hit, Mass Effect II was a hit, they have decent revenue from all the Sports stuff and they are going to absolutly kill with SW:TOR you put that kind of re-occuring revenue under ERTS and that stock is going to take off.

    Secondly ATVI is currently the "house that WoW built" almost almost everything else they have done has been a disaster (DJ Hero, Prototype, Tony Hawk Ride, Band Hero) except for COD/MW2 which they are working hard to screw up by toying with multiplayer sub fee's. By late Q2 early Q3 2011 I see WoW having lost 3-4 million sub's and that is going to hurt the balance sheet.

    I do totally agree that Diablo III and possibly a new MMO could be huge but given thier past delivery of games I would not look for Diablo III until 2012 and thier is no possible way that your seeing the new MMO util 2013 or 2014. So in the short run your looking at a dramatic drop in revenue plus thier console games are not doing that well and I really expect MW/BO to do less well then COD/MWII.

    For full disclosure I own some ATVI (which I will be trading out of soon) and a lot of ERTS for the long haul.

  • Report this Comment On August 23, 2010, at 1:34 PM, RushenWind wrote:

    A good number of the community I play games with play both Halo and CODMW, they feel very interchangable as each game is released. Also Diablo III will be wildly successfull, even if it was to be considered dry like SCII has been called, because of the fan following. Even with some down reviews for SCII they are releasing two expansions in the following years that will sell copies. As long as the Halo tag sticks to shooters and doesn't try any more RTS it will sell. COD is a game I and others just have to buy and play even if it only lasts a few months and as far as charging for multiplayer I think EA was talking about charging for madden online, it may have been just a one time fee. On top of all this ATVI has WOW pulling in a monthly subscription fee and they still seem to get no respect. They are sitting on top of a mound of cash that is being used to expand beyond RTS, Shooters and the MMO. With ATVI already in place MMO support another MMO should be a hit. After playing alot of MMO's, one of my biggest pet peeves is glitches and bugs that persist for months after a game is released. I think long run as long as they keep hiring new minds and putting out name titles and new ones they will be ahead of EA and TTWO

  • Report this Comment On August 23, 2010, at 1:59 PM, 1badmonkey wrote:

    What is the point of owning ATVI or EA? What have they done for share holders in the last two years? Each has strong products, each has products in the pipeline, but what have these products and potential porducts done for stock price in the last two years?

    Each is sitting on a ton of cash but do they know how to use it?

    Compare them to MCD over the last two years.

    Disclosure, I own ATVI, what was I thinking.

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