3 Huge Risks Facing Activision-Blizzard, Inc.

Activision-Blizzard is known for its ultra-popular video game franchises, but weakness in its key games, coupled with a risky $500 million bet on a new one, could cause trouble for the company's bottom line.

Jul 9, 2014 at 12:00PM

Video game publisher Activision-Blizzard (NASDAQ:ATVI) is known for some of the most successful video game franchises of all time, including Call of Duty and World of Warcraft. Activision has grown over the past decade into a wildly profitable company, with an operating margin of nearly 30% in 2013, owing to the immense popularity of the company's games. But there are three major threats to Activision's business that could have severe negative effects for investors going forward.

World of Warcraft is under siege
It's old news that World of Warcraft, Activision's decade-old online role playing game, is losing subscribers. In 2010, there were 12 million players paying the company a monthly fee to play the game, but this number has since tumbled to 7.6 million. World of Warcraft is still the most popular subscription-based game in its genre, but new competition could cause subscriber numbers to fall even further.

The Elder Scrolls Online, an online multiplayer version of the Elder Scrolls series of role-playing games, traditionally a single-player affair, launched in April of this year. The game got mediocre reviews, and as it stands, it's certainly no World of Warcraft killer. But given that subscription games like this have long lifespans, The Elder Scrolls Online can certainly improve over time, picking up World of Warcraft subscribers along the way.

Eso

Screenshot from The Elder Scrolls Online. Source: Zenimax Online.

Whether this happens or not is anyone's guess, but with World of Warcraft being nearly 10 years old, it's only a matter of time before something comes along and takes its place. Whether this ends up being a follow-up game from Activision or a game from another company remains to be seen, but it's clear from the subscriber numbers that World of Warcraft fatigue is very real. With online subscriptions bringing in $912 million of revenue in 2013, down from $1.357 billion in 2011, continued subscriber defections pose a serious threat to the bottom line.

An enormous investment in Destiny
Activision is investing a record-breaking $500 million in the highly anticipated Destiny, a game that combines the online role-playing genre with the first-person shooter genre. Destiny is being created by Bungie, known for the Halo series, and Activision has signed a 10-year deal with the company giving the publisher significant control over the franchise. Activision's management has stated that it plans for Destiny to be the next billion-dollar franchise for the company.

Destiny

Screenshot from Destiny. Source: Bungie.

This $500 million investment includes costs beyond developing the game, such as marketing and infrastructure. Still, Destiny is by far the most expensive video game ever made, dwarfing the $260 million spent to develop and market Grand Theft Auto V. Of course, if Destiny sells tens of millions of copies and spawns successful sequels, the $500 million price tag will be well worth it. But given that Destiny is not only a new franchise, unlike GTA V, but it also combines two genres that together are largely unproven, there's a very real risk that the game will fail to live up to expectations.

Even Activision's own Call of Duty didn't become a megafranchise until the fourth game in the series, and the boldness of Activision's $500 million bet shows either an incredible amount of confidence or desperation in the face of its other franchises slowly declining. Either way, if Destiny fails, there will be a great deal of damage done to Activision.

Skylanders is no longer the only game in town
Activision's Skylanders, a series of games that interact with physical toys, has proven to be extremely lucrative for the company. Not only have the games sold well, but over 175 million toys have been sold as well, and the Skylanders franchise has grossed over $2 billion since 2011.

Skylanders

Screenshot from Skylanders. Source: Activision.

But the tremendous growth Activision has achieved so far might not continue. Disney (NYSE:DIS) entered the market in late 2013 with its own game, Infinity, and the company has pointed out that its franchise has been outselling Skylanders since it launched. Disney has the benefit of having well-known characters, including superheroes from the Marvel universe, at its disposal, and that gives it a significant advantage over Activision. This is potentially a multi-billion opportunity for Disney.

Another company entering the fray is Nintendo (NASDAQOTH:NTDOY), which is set to launch its own line of interactive toys that work with its Wii U console and a variety of games. Nintendo also has a cast of well-known characters, and with plans to allow the toys to work with popular titles like Mario Kart 8 and the upcoming Super Smash Bros, the versatility of Nintendo's toys may be enough to win considerable market share. With both Disney and Nintendo wanting a piece of the action, it's clear Activision's Skylanders isn't the only game in town anymore.

The bottom line
Activision relies on a small number of megafranchises for most of its revenue, with Call of Duty, World of Warcraft, and Skylanders making up 80% of the company's revenue in 2013, and a significantly higher percentage of the operating profit, according to Activision's annual report. Weakness in any of these franchises could have dire results for Activision investors, and the $500 million investment in Destiny is an enormous risk to take for a new franchise. Activision's empire seems to be a fragile one, and its sky-high margins may not be sustainable in the long term.

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Timothy Green has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard, Apple, and Walt Disney. The Motley Fool owns shares of Activision Blizzard, Apple, and Walt Disney. 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.

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