Press Start on Activision Blizzard

This article is part of our Rising Star Portfolios series.

I admit I'm not totally up to speed with today's video games. For me, it pretty much starts with Galaga and ends with Donkey Kong (and Ms. Pac-Man fits in there somewhere). Don't get me wrong, I enjoy playing video games. I even have a PlayStation 2 at home. Granted, I haven't put many miles on it since my stint in the coldest regions of Kazakhstan, but I still have it.

However, if you're a Fool, you know Activision Blizzard (Nasdaq: ATVI  ) . If you're not a Fool, you still probably know Activision Blizzard. We're talking about one of the world's largest video game publishers. And you know what? I think it's just getting started.

The business
Formed by the merger of Activision and Vivendi in 2008, Activision Blizzard is a market leader in video game publishing, covering everything from Guitar Hero to the world's No. 1 subscription-based MMORPG (massively multi-player online role-playing game) World of Warcraft. Activision Blizzard produces games in-house as well as with third-party developers to reach multiple platforms while attracting the largest audience possible.

The business is easiest viewed as the two pieces that make up the whole. The Activision segment produces games primarily for consoles (think PlayStation and Xbox) and its two most popular games are Call of Duty and Guitar Hero. The Blizzard segment produces games geared toward the MMORPG audience. Its most popular game, World of Warcraft, is played around the world and has built up a current subscriber base of 11.5 million enthusiasts.

Why buy?
The merger in 2008 formed a global powerhouse. And I love companies that shape industries. The third-party developer model gives them flexibility in developing the core content that die-hard fans love and compelling fresh content for new audiences. Take, for example, the new 10-year agreement with Bungie. Known best for its popular Halo series, Bungie will now partner with Activision Blizzard to develop and publish the "next big action game universe." To me, this looks like the beginning of a beautiful friendship.

Like Blinky chasing after Pac-Man, the move to digital is unavoidable. To be sure, Activision Blizzard just saw its first quarter where sales from online channels were higher than retail sales. Activision recognized this trend early on, which is actually what prompted the merger with Vivendi. It saw the success of Vivendi's World of Warcraft subscription-based model and realized the costs and difficulty involved with building such a service. Thus the merger and the rest, as they say, is history. With a truly global reach and a management team ready to take on all comers, I see a lot of growth ahead for this superstar.

What's it worth?
It is tough to put a valuation on companies that make their hay from intellectual property. Games have a shelf life, so they need to keep putting out killer content. Digital distribution is going to be a key driver as there are about 5 billion people in the world still without Internet access. With margins trending upward over time due to lower distribution costs, I see shares being reasonably worth around $13 today. With close to $3 billion in cash and short-term investments and zero debt on the balance sheet, I'm excited to buy into this company at today's prices. I am plunking down $1,000 on this gamer with the confidence that it will be worth a lot more years from now.

Risks
A key risk with this company is the power of substitutes: There is a lot of competition out there these days for our entertainment dollars. Companies like Netflix (Nasdaq: NFLX  ) and Google (Nasdaq: GOOG  ) are looking for every possible way to distribute new content to gain audience share, and Activision is dependent on the success of a few key hit franchises. It will need to continue developing cutting-edge content to keep its audiences growing. This is also an extremely competitive industry, and lower development costs should open up the field to new players.

My Foolish bottom line
It took me a little while to come around, but enough digging has convinced me of gaming's staying power. And after looking at all the players, there's only one I want to put my money on. I am going to enjoy following this one, for sure. Now, if I can just figure out what I did with my copy of Donkey Kong.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. Click here to see all of our Rising Star analysts (and their portfolios).

Stock Advisor analyst Jason Moser owns no shares of any companies mentioned. Google is a Motley Fool Inside Value recommendation. Google is a Motley Fool Rule Breakers choice. Activision Blizzard and Netflix are Motley Fool Stock Advisor recommendations. Motley Fool Options has recommended a synthetic long position on Activision Blizzard. The Fool owns shares of Activision Blizzard and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (23) | Recommend This Article (38)

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 November 01, 2010, at 10:40 AM, TMFJMo wrote:

    Hey Fools,

    Hope you enjoy the slew of information coming your way with all of our Rising Stars. It is truly a fantastic opportunity and a great addition to our Foolish community.

    This was a fun first pick. Any questions? Join me over on the discussion board:

    http://boards.fool.com/rs-jason-moser-119864.aspx?mid=288590...

    Fool on!

    Jason

  • Report this Comment On November 01, 2010, at 10:53 AM, QwertyHero wrote:

    By my calculations - if you drop $1,000 on ATVI today - and the stock climbs to $13.00 as you predit - you will net a little under $50.00... Before trading commissions and taxes.

    That can't even buy you one of their games...

  • Report this Comment On November 01, 2010, at 10:59 AM, QwertyHero wrote:

    And by $50.00, I mean $120.00.

    My calulator needs new batteries...

  • Report this Comment On November 01, 2010, at 11:03 AM, letsvotethemout wrote:

    I was in the gym the other day and the teenage kids in there were all raving about "Black Ops" which I was told is a new release to come out of Activision. If experience has told me anything, its when the kids are all excited pre-release, then the cash register will spin when they do put the game on the market.

  • Report this Comment On November 01, 2010, at 11:44 AM, TMFJMo wrote:

    @QwertyHero,

    The problem with your assumption there is that you think I am buying ATVI today to realize a $13 value and then sell it.

    Actually, the $13 price tag is what I see the stock being worth today, so at $11 and change, it is slightly undervalued by my estimation. Further, I believe that ATVI is a well-run company with a management team in place that will help it grow over time...significantly.

    I plan on holding this stock for years. As such, I see today's price as cheap. I would be a fool (note the little "f") to tell you what the stock will be worth in 5 years because I just don't know. But I do believe that it will be worth significantly more than it is today. And worth even more in 10 years (yep, I can see holding it that long too).

    Could I be wrong? Absolutely. But I see enough of a margin of safety for this market leader to put down real money on the conviction.

    Hope to see you on the boards!

    Best,

    Jason

  • Report this Comment On November 01, 2010, at 11:52 AM, MyunderratedLife wrote:

    @ qwerty,

    Not to condescend, but I didn't need a calculator to figure out a $50 profit was off... $50 before fees implies 5%... $11.40 ---> $13

    Can't you tell at a glance it's more than 10%??

    ------------------

    @ Letsvote

    They did the same thing before the latest Bungie release, and we all know how that ended. I wouldn't read too much into it.

    -----------------

    That said, I do hold a position larger than 1k, and I can tell you this, despite being deep in the green, the position is far underperforming.

  • Report this Comment On November 01, 2010, at 5:44 PM, CPACAPitalist wrote:

    Underestimate the money making power of video games at your own right. And its not just for those "darn kids" anymore either, a whole generation of us 20-30 year olds who grew up on games will keep playing long into "adulthood". The only difference will be we don't have to mow the lawn or beg mom for $50 bucks to get them anymore.

    I'm really interested to see where Microsoft's Kinect takes us, I think it could be a break through in consumer technology ala the Ipod (insert Softy hating Apple lovers scoff here).

  • Report this Comment On November 01, 2010, at 5:46 PM, 102971 wrote:

    I also bought Activision some time ago and it has been an underperformer. Out of 39 stocks in my portfolio this is one of only w that are in the red. However, I still have faith and will continue to hold it but not add to it. Incidentally, I've never played a video game in my life, I just liked their balance sheet.

  • Report this Comment On November 01, 2010, at 5:47 PM, 102971 wrote:

    I meant to say "one of only two".

  • Report this Comment On November 01, 2010, at 6:11 PM, Storme33 wrote:

    I agree with Jason's comments back to QwertyHero that right now ATVI is undervalued. I started buying shares in early Dec '09, in which I have 335 shares @ an average of $10.69 per share now. I’m at about 5.86% gain at close today – nothing to write home about, but I am up.

    I only invest in companies I believe in and it has been a sit and wait situation with this stock, but I believe in the company. I believe in them enough that I will continue to hold it for several years to come.

    My boys LOVE video games and I do to for that matter, but for some reason they haven't been too excited about Black OPS or even asked me to get it for them when it releases. That doesn’t really tell you what revenue the game will bring in though. Heck look at Saw 3D, I never thought that would sell that many tickets in its opening weekend.

    With that said, I still feel that ATVI will continue to put out products/games that the majority will want and buy. For some reason the market just isn't giving ATVI the respect it deserves, but when everyone finally does catch on - I know I got mine.

    Fool on!

  • Report this Comment On November 01, 2010, at 6:44 PM, Borbality wrote:

    I haven't seen anything mentioned lately about ATVI's 40+ P/E. How does it need to perform to keep up this kind of valuation?

  • Report this Comment On November 01, 2010, at 9:12 PM, aleax wrote:

    @Borbality, from previous analysis (on SA, I believe) I got the impression that the earnings are artificially lowered by the amortization of the Blizzard merger goodwill (as a videogame company will always have low tangible assets, high goodwill in this case doesn't mean they overpaid!-). The Price/Book ratio of only 1.33 would seem to suggest this: not an overvalued company, but artificially-depressed earnings. As e.g. http://seekingalpha.com/instablog/561070-connor-haley/84778-... puts it: "Don’t be fooled by the high P/E multiple of 48. Instead, you should looking at the company’s Price/ Free Cash Flow, a more accurate measurement of a company’s value. The cash machine that is Activision Blizzard is currently only trading at about 11x free cash flow, a very good value for a company expected to grow at a rate of 14% over the next five years".

  • Report this Comment On November 01, 2010, at 9:41 PM, FrugalDave wrote:

    I bought 100 shares of ATVI on MF's recommendation about 2 yrs ago at $13.85 per share; needless to say I'm still in the red. I haven't sold it on hopes that it will eventually go up. I should have listened to my wife-she told me to buy Apple back then. Oops.

  • Report this Comment On November 01, 2010, at 10:27 PM, gdf55 wrote:

    I love the games they've produced. I like the company less. I think their inability to grow the value of their stock comes down to the fact that the mergers haven't really produced any real synergies - and believe me, I hate that word. Call of Duty is an example of a problem child - there are two developer teams working on it, and they each produce a new product every two years (so the company can release one update each year), and one of the teams seems to be better than the other, and it isn't practical to talk about combining them because it still takes about 2 years to produce a new version, no matter how many videogame design whizzes work on it.

    Yes, I know the previous sentence should be taken out and shot. But it's emblematic of the problem ATVI faces - producing their product is HARD work and a big investment in personnel. Meanwhile ERTS is cranking out mindless lookalike football/soccer/basketball/etc videogames every year which are just as successful (if not moreso) because, frankly, electronic gaming is a mindless activity.

    I'm holding onto my ATVI, but they've got 6 more months before my patience runs out.

  • Report this Comment On November 02, 2010, at 2:57 AM, tdiaczok wrote:

    The shares have to be going up, they're releasing the next iteration of my favourite game - Diablo 3 in April next year !!! An example of continuing to roll out quality software. Ive been waiting 18 months for the release. Interestingly, Blizzard only have one major release a year so they don't compete with themselves, if you know what I mean. This would tend to have a evening effecvt on their profit gradient ??

  • Report this Comment On November 02, 2010, at 8:32 AM, mikecart1 wrote:

    As an ex-shareholder of ATVI from $9 range to a sell of $12+, I am highly against ATVI. Their stock price DOES NOT correlate with their revenue or performance. Their game releases DOES NOT correlate to any speculation or share price increase. Any news at all DOES NOT correlate to anything with the share price up or down. If you ask me, ATVI was my worst stock purchase of 2009 and will not buy it again. Oh yeah, and that 1 time dividend was a joke. I should have bought SIRI instead and took a risk.

    2 thumbs DOWN!

  • Report this Comment On November 02, 2010, at 9:54 AM, reeshau wrote:

    Jason,

    A couple of points from your original article:

    1) WoW now has 12 million subscribers, as announced in October

    2) Blizzard does not focus solely on MMO's. Starcraft and Diablo are still very big franchises.

    Black Ops is going to be very big. The presales are leading MW2's from last year. Why does the world need another modern military game? Here are some details:

    --will be released in 3D, as 3D TV sets are ramping up. I don't expect this will drive big sales, but expect Best Buy to have display areas with gaming, rather than just movies. This will drive a lot of hype

    --the "wager match" mode will be very popular with online gamers. Nothing like putting something on the line to motivate you. Although it is only "points," these have value in-game to allow you to unlock items. A lot of heavy gamers predict this will become a standard feature in all such games, and this is sight unseen!

    --Medal of Honor has not proven to be a big hit, so the competition for Christmas dollars will not be heavy.

    Diablo III will be a great hit next year, and help to build Battle.Net as Starcraft did. The only reason these two won't get the attention they deserve is that they are serving the "hardcore" gamer community, not expanding into casual gamers like Kinect. Still, millions of sales, high-margin digitally distributed PC sales rather than consoles, are money in the bank.

    The dividend was declared as an annual dividend, not one-time. It is implicitly a declaration that WoW is a stable source of income.

    I have held Activision since before the merger, and have bought at dips below $10. I think the company needs to hatch its second MMO for the stock to have a big breakaway. The video game business, like the movie business, is a hit driven business otherwise. Even successful franchises can be loved to death. (Guitar Hero) To gather more shareholders like the industry has gathered more gamers, they will have to prove they are predictably profitable for the long term--even Activision and Electronic Arts, which have been around since nearly the beginning.

  • Report this Comment On November 02, 2010, at 1:09 PM, Borbality wrote:

    @aleax, thanks for the info. I too have been impressed with the free cash flow and the other ratios, but the P/E seems to scare the market out of pricing the stock higher, which is frustrating. I have shares of ATVI and plan to keep them, but all my other picks (not with actual money) are outperforming. It's a little frustrating but I will be patient.

    I think ATVI, or Blizzard at least, is treading a fine line between making games more profitable long term (WoW) and alienating hardcore gamers. I have Starcraft 2, and it's the only game I've paid for new in almost 10 years. I really don't know what I'd do if I had to pay to play it. I might get pretty angry. But the MMO crowd could be different. I just wonder what the company plans to do, because a gamer like me might buy all three installments of Starcraft but never buy another ATVI or Blizzard game ever again. I could be playing Starcraft for 10 years and not put another penny into it. And of course, ATVI must be frustrated to not get a cut of the xbox live revenue it generates thanks to Call of Duty alone. It's a tough revenue model they've got. I think some of these issues (besides the impending WoW replacement) are partially what keep the stock down. It needs to prove itself for real, and then we might be rewarded.

  • Report this Comment On November 02, 2010, at 4:53 PM, FracturedVision wrote:

    If ATVI stays under $13 by New Year's Day, I'm giving up on it and that's saying a lot since I'm a huge fan. I can think of at least 5 better stocks towards which that $1000 can be used and you'll net more in the end - this one is a non-performer.

  • Report this Comment On November 02, 2010, at 10:34 PM, TMFJMo wrote:

    @FracturedVision

    While I appreciate what you are saying, it is actually that very apathy that I am counting on. Yep, people are fed up with it and it hasn't done a whole lot. Truth be told it is pretty much where it was 3 years ago. That's OK though, I have time on my side here, so I am in no rush.

    Some great posts here for sure. Thanks to everyone for the interest. Swing on by the board anytime to chat it up. I will be dropping some watch list ideas real soon!

    http://boards.fool.com/rs-jason-moser-119864.aspx?mid=288459...

    Fool on!

    Jason

  • Report this Comment On November 04, 2010, at 1:10 PM, EvilPhD wrote:

    I don't like ATVI. More so I don't like their management.

    I remember what made great games great. Something this generation hasn't had the taste of, which is regretting.

    Tribes, Unreal Tournament, Starcraft 1, Age of Empires.

    I'm talking about custom taunts, user generated maps, endless game play. All that fun and creativity made by the fan base is what made the gaming community great.

    ATVI's management saw how this was giving extended life to games - people were having too much fun with them and not buying more games.

    So ATVI has slowly, methodically chipped away bit by bit, piece by peace the fun out of their games.

    Think of any other product you buy. You can do whatever you want with it. Customize it, paint it, bling it up, resell it whatever. ATVI has purposefully said SCREW YOU to the consumer because the consumer was enjoying the product too much.

    To me, that is bad business, and a terrible model. I'm staying away from this company.

  • Report this Comment On November 07, 2010, at 1:29 AM, ikkyu2 wrote:

    I don't like a dead money investment. I've been bullish on this company and this stock, for the reasons stated in your article, for 5 years - and the stock has not moved.

    I don't really understand why, but I don't need to. There are greener pastures elsewhere.

  • Report this Comment On November 08, 2010, at 5:27 PM, ob3y wrote:

    On one hand, Blizzard has made, and continues to make some of the best games out there.

    On the other, Bobby Kotick is ruining games by trying to suck every possible penny out of consumers. Good for business, bad for gamers.

    Just in the last year, Kotick has already had two quotes that almost caused a coup de grâce in the gaming communities;

    "The goal that I had in bringing a lot of the packaged goods folks into Activision about 10 years ago was to take all the fun out of making video games."

    http://kotaku.com/5359567/bobby-kotick-wanted-to-take-all-th...

    “And Tony, you know if it was left to me, I would raise the prices even further.”

    http://seanmalstrom.wordpress.com/2009/08/09/dont-bother-try...

    Video game fans (the ones with expendable income) tend to be very counter culture when it comes to this stuff, so when Blizzard quits being the cash cow it is (ie when World of Warcraft gets replaced, either by ATVI or someone else) they’re next piece of IP will never make the money that WoW did, simply because Kotick (and the rest of the Activision side)is ruining the reputation that Blizzard spent a decade building.

    I don’t believe this stock will ever trade above 14 consistently, unless they sign Valve or some other big names out there to get the taste of Kotick out of consumers mouths.

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