Activision Blizzard Treads Water as "Warcraft" Burns

The Azeroth exodus continues for Activision Blizzard (Nasdaq: ATVI  ) . The company's flagship MMO franchise, World of Warcraft, suffered its steepest subscriber drop to date, plummeting all the way to 9.1 million subscribers from the 10.2 million players the company claimed at the end of its last quarter.

That orc-sodus from the lands of Azeroth was offset by three huge first-half releases, including the record-breaking Diablo III, which hit the market this May. Skylanders was also a huge success for Activision, claiming the crown as the best-selling console and hand-held game over the first half. Skylanders, which uses RFID-enabled collectible figurines as a form of memory storage, also trounced the action-figure market, taking first place in action-figure sales for the same period. And, of course, the latest Call of Duty game also sold phenomenally well.

Let's take a look at Activision's latest information to figure out how the company's changing to cope with WoW's decline, and if it can continue to charge forward in the future.

What the numbers tell you
The combined effect of new hits and WoW attrition adds up to an unremarkable quarter. Activision beat analyst expectations on both top and bottom lines, but those expectations ($837 million in revenue) were rather tepid for a company that regularly posts a billion dollars in sales. Both results were lower than the year-ago quarter, though free cash flow improved:

Sources: Morningstar and company earnings report.

Sources: Morningstar and company earnings report.

Activision's upcoming quarters are where the real magic happens. The rest of the year has Activision brass' thumbs up, as it bumped full-year GAAP revenue guidance to $4.33 billion from $4.20 billion while also nudging earnings-per-share estimates to $0.69, a $0.04 increase. But that's not necessarily a positive trend -- 2011's revenues clocked in at $4.76 billion, and EPS for that year were $0.92.

Looking to the future
Second-half drivers will be expansion packs for both WoW and Skylanders, as well as a new Call of Duty release, Black Ops II. With a projected 16 weeks to release, Black Ops II has scored 508,000 Xbox 360 pre-orders, according to games-industry research site VGChartz. The last Call of Duty game had 604,000 Xbox 360 pre-orders at the same 16-week pre-release point. Unless interest suddenly spikes, Activision's latest shoot-'em-up blockbuster may be the first to underperform its predecessor.

The biggest story here continues to be WoW's long-running decline. Since its 12 million subscriber high-water mark, reached during the third quarter of 2010, World of Warcraft has lost a quarter of its players. It's taken a lot longer to shed that much of its subscriber base than Electronic Arts' (Nasdaq: EA  ) competing Star Wars MMO --a single quarter slashed a quarter of EA's subs -- but Activision's just lost nearly as many subscribers as EA has in total.

Here's what I said in a comment on Evan Niu's fourth-quarter Activision earnings recap, earlier this year when WoW's subscriber losses seemed to have evened out:

I'm not surprised WoW [subscribers] didn't drop much in the fourth quarter. Blizzard released the final boss patch of the expansion at the end of November, and [Star Wars] didn't come out until the end of December, if I recall. WoW's next big subscriber drop might not come until the second quarter, in the lull between beating the final boss and the release of the Kung Fu Panda expansion, which I honestly don't expect to stem the tide by much.

Activision bulls may claim that the next WoW expansion will add new subscribers, but history's already proved that argument very wrong. Remember, that 12-million-subscriber peak occurred before the current Cataclysm expansion came out in 2010's fourth quarter. It's been a long slide downhill since. The game is now nearly eight years old and has proved remarkably resilient, but its glory days are over. Chinese partner NetEase.com (Nasdaq: NTES  ) has also suffered through consecutive declines in its WoW-based revenue, so investors shouldn't be relying on the Middle Kingdom to keep WoW afloat.

Skylanders has done very well, but it seems to have merely supplanted the monthly fees of lost WoW subscribers. The lower preorder numbers for Black Ops 2 (though PS3 pre-orders are in line with the last game) are also a big red flag, since these are the company's two biggest cash cows. Diablo III, which has sold more than 10 million copies, will help keep Activision moving forward -- but blaming that game on WoW's decline, as Blizzard CEO Mike Morhaime did in the company's earnings call, doesn't mean those subscribers will return when they tire of Diablo's click-happy gameplay.

Putting it all together
The huge drop in WoW subscribers, regardless of any new game initiatives, should give investors serious pause before they claim that Activision can grow in the future. The company's games are certainly far stickier than Zynga's (Nasdaq: ZNGA  ) and aren't likely to lose players to FarmVille or CityVille or WhateverVille. But Skylanders is Activision's only new game, and it's merely replacing lost earnings from games on the decline rather than adding to the growing revenues of fresh blockbusters. Other big hits are sequels that don't generate the same steady monthly income streams as WoW's dedicated (but dwindling) fan base.

Activision isn't likely to decline anywhere as precipitously as Zynga and EA have this year, but a flat stock isn't the best place for your money -- and Activision, despite its continued dominance, has been more or less a flat company, as you can see in that chart. Do you believe I'm wrong? Will Activision's upcoming product slate overcome WoW's decline? I'd love to hear your opinion, so please let me know with a comment.

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Fool contributor Alex Planes holds no financial position in any company mentioned here. Add him on Google+ or follow him on Twitter, @TMFBiggles, for more news and insights.

The Motley Fool owns shares of Activision Blizzard. Motley Fool newsletter services have recommended buying shares of Activision Blizzard and NetEaseand creating a synthetic long position in Activision Blizzard. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


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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 August 03, 2012, at 11:25 PM, TMFBiggles wrote:

    "Kung Fu Panda" is not the actual name of the expansion, by the way. Just wanted to clear that up.

  • Report this Comment On August 03, 2012, at 11:45 PM, Valorale wrote:

    Another aspect to take into consideration is the new MMO that Blizzard has been working on; Titan. The top talent responsible for WoW were pulled from that project and have been working rather quietly on this fresh title that will expand the Blizzard universe.

    Clearly the brass over at Blizzard recognize that WoW couldnt go on forever and that without a new product to excite the fanbase they would experience the same peak and decline that Sony endured with Everquest following its downward from its peak during Planes of Power.

    So the question is not will Titan enjoy a successful launch and large playerbase. That answer is obviously Yes, it will. The question is can the $15 a month subscription model currently used in WoW survive another generation? That I am unsure of.

    With the rise of advertisement supported games that allow you to acquire ingame items using real cash; older MMOs are rapidly adopting these revenue streams to support a free-to-play model.

    My guess is that Activision/Blizzard will attempt to retain the lucrative $15/m waterfall if they have a large enough playerbase and will switch to the free-to-play model as a last resort.

  • Report this Comment On August 05, 2012, at 10:45 AM, FoolSolo wrote:

    For nearly 5 years I've been hearing the same tired arguments from ATVI bulls, and for 5 years ATVI just bounces around in a range between $10 and $13, 20% plus below my entry point.

    I have lost my confidence in ATVI doing what it takes to move the needle. The execs have been getting nice big paychecks, lining their own pockets, while the stock languishes. The fact is consumer sentiment in hard-core gaming is shifting as the technology platform (consoles, PCs) ages. People have way more options these days than before, there's more than one game in town. Even a relative nobody like Minecraft can come out of nowhere with a homebuilt game and take a giant chunk of market. That is to say nothing about online video streaming and home entertainment options vying for same consumer spend.

    The era of the big-production, hard-core games, has peaked, and likely won't ever return to its former glory unless some major new technical or experience breakthrough happens soon - like maybe 3D virtual reality and holographic projection. But that is very unlikely. I think ATVI has to find a way to diversify or get better at returning cash to investors, otherwise it will just continue its slow and imminent slide until it fades into a memory.

  • Report this Comment On August 16, 2012, at 11:42 AM, inquiryTY wrote:

    This article had such potential but is spoiled by clear opinion and bias of the journalist. Sarcasm laden commentary (ie.g Kung Fu Panda) and too many "I think" "I suppose" statements make this more of an Op-Ed than factual statements. Sure there are some good facts in here... but dang. So much conjecture and opinion.

    Not much here except doomsaying, littered with barely researched facts.

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