Watch stocks you care about
The single, easiest way to keep track of all the stocks that matter...
Your own personalized stock watchlist!
It's a 100% FREE Motley Fool service...
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 ) :
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.