Activision Blizzard (NASDAQ: ATVI) unlocked tremendous value for shareholders when it gained its independence from Vivendi during the fourth quarter. With this independence, Activision obtained significant flexibility with respect to its ability to make strategic decisions that are in the interest of the company's independent shareholders. However, this independence came at a cost of $4.75 billion in newly issued debt. For investors, it is important to understand whether this debt limits the company's decision-making just as Vivendi did prior to the transactions.
Activision's balance sheet remains strong
Following the Vivendi transactions, Activision's balance sheet remains remarkably strong. When the transactions closed in October, Activision retained $3.35 billion in cash and issued $4.75 billion in debt, resulting in net debt of just $1.4 billion. With $1.7 billion in EBITDA generated over the past year, Activision's leverage ratio is just 0.8 times EBITDA following the transaction; that is hardly "levering up" the way most companies have to in order to complete such a transformative transaction.
Activision retained balance sheet flexibility by borrowing $4.75 billion with a mix of seven-year secured loans, eight-year notes, and 10-year notes. With these notes' maturities of seven years or more, Activision has plenty of time to repay the debt. With the ability to partially prepay the debt, Activision can also choose to deleverage sooner if it chooses.
As a result of Activision's remaining cash and extended debt maturities, the company did not limit its financial flexibility while purchasing its shares from Vivendi.
Activision can repay debt quickly
While $4.75 billion is a lot of debt, particularly in the choppy world of video game publishing, Activision has demonstrated an ability to generate consistent cash flows that is unmatched in the industry. While competitors such as Electronic Arts (NASDAQ:EA) and Take-Two Interactive (NASDAQ:TTWO) struggle to generate stable profits, Activision has reported steady free cash flow. Activision generated $1.3 billion in free cash flow over the past year and has averaged $1.1 billion in free cash flow over the past four years. With this free cash flow, Activision could reach zero net debt in just over a year and repay its entire debt balance in roughly four years if it chose to do so.
Activision has a strong pipeline
Activision has already announced a strong lineup of titles for 2014. In the past week, the company announced that it will be releasing four downloadable expansion packs for its best-selling Call of Duty: Ghosts franchise. As with past Call of Duty content releases, management has already created strong demand thanks to prudent marketing and loyal fans.
In addition to Call of Duty, 2014 will mark the release of Destiny, a long-awaited title by the creators of Halo. If Destiny can become half the success that Halo has been, then this title can drive success for the company beyond current expectations.
Additional content for popular franchises such as Skylanders, Diablo, and World of Warcraft will also help guide the company to another year of success.
Additionally, Activision is getting some inadvertent help from its competitors. EA's Battlefield, a rival franchise to Call of Duty, has experienced prolonged issues that have helped further Call of Duty's lead over the competition.
Activision maintains flexibility
With $3.35 billion in cash, strong free cash flow, and a leverage ratio of just 0.8 times, Activision retains the flexibility to allow management to invest in the company and take advantage of growth opportunities. These opportunities could take many forms, including investment in future game franchises or the acquisition of other companies. Activision has invested heavily in franchises including Destiny, which will debut in 2014, and Titan, which is still in the early phases of development. On the opposite end of the spectrum, Activision could easily acquire capabilities that could complement the company's existing strengths.
Acquisitions by Activision could take many forms. The company has not placed tremendous focus on mobile gaming thus far, given the unproven profitability of "freemium" games, but the acquisition of one or more mobile gaming specialists could change this instantly. With mobile games like Candy Crush and EA's The Simpsons: Tapped Out proving that mobile apps can be profitable, this would be an excellent opportunity for Activision to gain a more substantial foothold in a rapidly growing market.
On the opposite end of the spectrum, Activision could continue to invest in gaming franchises by acquiring Take-Two; with a market capitalization of less than $1.5 billion, Activision could acquire established franchises like Grand Theft Auto without issuing additional shares or debt.
Activision remains a top stock
While rival EA has struggled with both profitability and game quality issues, Activision continues to execute its strategy. Following its independence from Vivendi, Activision has a comfortable cash position and manageable debt; this enviable situation will allow the company to continue to make prudent decisions that are in the best interest of the company's long term growth. As a result, Activision remains a Top 10 Stock even after the tremendous market outperformance of 2013.
Fool contributor Brian Shaw owns shares of Activision Blizzard. The Motley Fool recommends Activision Blizzard and Take-Two Interactive. The Motley Fool owns shares of Activision Blizzard. 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.