For the last several years, Activision Blizzard's (ATVI) management has been gradually shifting to a digital distribution strategy in order to smooth out the company's revenue and cash flow throughout the year. This shift started with the acquisition of Blizzard Entertainment in 2008, which brought to Activision a recurring, monthly stream of revenue from subscriptions stemming from gamers playing World of Warcraft.
Since 2014 management has accelerated this strategy with a flurry of new game franchises that sell additional content after players buy the game. We'll analyze the seasonality of Activision Blizzard's financial results in recent years to see how management has progressed with its goal to create more balanced, year-round, revenue opportunities.
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Revenue seasonality
Try searching for "digital" in Activision's 2008 annual report and you won't find a single mention of the word, which is remarkable given that digital revenue performance has become a key financial measure of all video game companies these days. Game makers are increasingly reliant on the digital delivery of games and add-on content distributed through online channels to generate revenue and profits, whereas 10 years ago revenue was dependent on sales of packaged games.
In calendar 2007, Activision generated 57% of its revenue during the holiday quarter largely from new game sales driven by the fall release of the best-selling Call of Duty franchise. Over the next few years, Blizzard's subscription-based revenue, along with revenue generated from Call of Duty's online content helped grow digital revenue to 34% of Activision Blizzard's total revenue in 2011.
Activision Blizzard's revenue generation began to spread out more evenly throughout the year, largely thanks to Blizzard. The company generated only 30% of revenue in the fourth quarter of 2011, with 70% generated through the first nine months of the year, which hasn't changed much since then.
| Year | 2016 | 2015 | 2014 | 2013 | 2012 | 2011 |
|---|---|---|---|---|---|---|
| % of annual revenue generated through first three-quarters |
70% |
71% | 64% | 67% | 64% | 70% |
| % of annual revenue generated in first quarter | 22% | 27% | 25% | 29% | 24% | 30% |
Data source: SEC 10-Q and 10-K filings.
There was still a problem in that the company remained dependent on game sales in the fourth quarter to drive full-year profits based on cash flows, which is reported on a company's cash flow statement and shows the actual amount of cash a company receives and spends over a given time period. In 2011, only 11% of Activision's annual cash flow was generated by the end of the third quarter, leaving 89% of full year cash flow generated in the fourth quarter.
| Year | 2016 | 2015 | 2014 | 2013 | 2012 | 2011 |
|---|---|---|---|---|---|---|
| % of annual cash flow generated through first three-quarters | 60% | 13% | 7% | 30% | 27% | 11% |
| % of annual cash flow generated in the first quarter* | 14% | 17% | 10% | 25% | 11% | 14% |
Data source: SEC 10-Q and 10-K filings. *First quarter portion is broken out to show the distribution of cash flow over the full year.
The obvious first step to fix this was to spread out game releases between the first half and second half of the year. In 2012, Diablo 3 released in the first half of that year and was a best-seller. Again, in 2013, the company released a console version of Diablo 3 in the third quarter. Also, a significant new expansion for Starcraft 2 called Heart of the Swarm was released in the first quarter of 2013. This helped the company generate more cash flow earlier in the year, with 30% of its full year cash flow earned through the first three-quarters. But that still left the bulk of cash flow to be had in the fourth quarter.
Management goes all-in on digital distribution
The ball really got rolling down the digital distribution path in 2014 with the releases of Destiny and Hearthstone. That year, digital revenue reached 43% of total revenue, up from 34% in 2013. The release of Heroes of the Storm followed in 2015, with Overwatch in 2016. The company went all-in on digital when it acquired mobile game maker King Digital Entertainment in early 2016 for $5.8 billion.
Now, the company had several franchises that were all designed to take advantage of gamers' appetite for additional content purchased in-game via micro-transactions. Digital revenue reached 74% of total revenue in 2016 driven by the mentioned game releases, as well as the addition of King's mobile game portfolio, which also generates revenue from in-game content.
| Year | 2016 | 2015 | 2014 | 2013 | 2012 | 2011 |
|---|---|---|---|---|---|---|
| Digital revenue as % of annual revenue | 74% | 54% | 43% | 34% | 32% | 34% |
Data source: SEC 10-K.
Seasonality has dramatically declined over the last 10 years
Activision Blizzard's strategy to create year-round player engagement opportunities has completely transformed the company over the last 10 years. The company has progressed from depending on holiday sales of packaged games for virtually all of its annual cash flow to generating most of its annual cash flow before the fourth quarter even arrives. This creates greater visibility for future cash flows, allows management greater flexibility and planning with future projects, and should give investors greater confidence in Activision Blizzard's ability to pump out profits year to year.
