Is This Activision Blizzard’s Biggest Weakness?

On the surface, Activision Blizzard (ATVI) has had a good year so far, with record revenue and earnings generated through the first half of 2018. But there's one metric that's coming up short: monthly active users (MAUs), which is the company's way of measuring its audience reach with its games.

Over the last two years, the game maker's MAUs have fallen by 36%. That works out to 196 million users who are no longer playing Activision Blizzard's games, and this could hurt its ability to grow revenue over the long term unless this slide reverses.

Let's look at recent trends causing this slide and what they mean for investors.

Image source: Getty Images.

A steady decline

Activision defines monthly active users as "the number of individuals who accessed a particular game in a given month." One of Activision's long-term goals is to build a big audience around its franchises. The more people who play its games, the more opportunities Activision has to make money from selling additional content updates, which players purchase within a game. In-game spending is a key source of revenue, accounting for 56% of Activision's annual revenue.

The 36% decline in MAUs over the last few years is largely due to the King segment (mobile games), which has experienced a substantial loss of 204 million MAUs since the third quarter of 2015. Management attributes King's decline to less-engaged players leaving the base, which makes sense given that King's revenue grew 5% year over year in the second quarter. Clearly, if those were engaged players leaving the base -- the kind who regularly spend money on in-game content -- King likely wouldn't have grown its top line.

Data source: Activision Blizzard.

The Activision segment (which creates big console titles like Call of Duty and Destiny) ended the second quarter with 45 million MAUs, which is fairly stable against the year-ago quarter's 47 million. Management reported that Call of Duty: WWII (2017) is experiencing higher MAUs over the previous version in the best-selling series. 

The most concerning trend is within the Blizzard segment (the maker of Overwatch), which saw MAUs decline by 9 million over the past year to 37 million in the second quarter. Management attributed Blizzard's MAU decline to player losses in Heroes of the Storm and Overwatch. 

Overwatch's weakness is disappointing. It's one of four franchises that make up two-thirds of the organization's annual revenue. The company's new esports league based on the game, Overwatch League, has been a big success, and Activision has been able to sell teams at steep prices while attracting big-brand sponsors. With the esports excitement surrounding the game, you would think it would be gaining players instead of losing them.

Why are players leaving the base?

The main culprit seems to be the surging popularity of battle royale games. One of these, Fortnite, has simply gone viral in the gaming community this year. On the popular Twitch game-streaming site, viewers spent an average of 131 million hours per month watching others play the game during the second quarter. In comparison, viewers spent an average of 28 million hours per month watching others play Overwatch.

Fortnite has grown at a blistering pace, reaching 125 million registered players in less than a year since its launch. In comparison, it took Overwatch almost two years to reach 40 million registered players.

When asked about the impact these battle royale games are having on Activision Blizzard's core franchises, CFO Spencer Neumann said, "I mentioned on our last call, and it continues to be the case, that we believe we're seeing some impact across certain franchises, primarily on engagement, including players that seem to be splitting some of their time between our games and trying something new."

Is this a weakness?

The MAU losses for King don't appear to be hurting that segment, given the 5% year-over-year growth in revenue for the Candy Crush maker in the most recent quarter. King has maintained stable quarterly revenue (over $500 million) and operating income (over $150 million) during the last year.  But Blizzard's losses seem to have hurt that segment.

Along with Blizzard's loss of 9 million users over the last year, segment revenue fell 13.6% year over year in the second quarter. Operating income was down 41% to $133 million, but some of the decline in profitability was due to increased operating expenses to get Overwatch League up and running.  

The Blizzard segment could get a boost in the third quarter from the new World of Warcraft: Battle for Azeroth expansion out this month -- it's already sold more than 3.4 million copies. Based on strong sales expectations for the Warcraft expansion, Call of Duty: Black Ops 4, and other content to be released this fall, the company anticipates that total revenue will grow 4.8% this year to $7.355 billion, and that non-GAAP earnings per share will climb 11.3% to $2.46. Both targets, if achieved, would represent new highs for the company.

But at some point, investors need to see stabilization in MAUs. Obviously, the company can't afford to bleed users forever, especially when Activision stock trades at a relatively high forward-earnings multiple of 29 times expected earnings for 2018. The multiple implies high growth expectations from esports, and continued high engagement with core (and possibly new) franchises. 

Until the decline in monthly active users reverses its trend, this is a weakness for Activision Blizzard which shareholders should monitor.