Activision Blizzard (ATVI +0.00%) designs games for mobile, PC, and console systems, with noteworthy franchises including World of Warcraft, Diablo, StarCraft, Call of Duty, Overwatch, and Candy Crush. It is the largest pure-play gaming company listed on major U.S. exchanges, though it competes globally with gaming giants including Tencent, Nintendo, Sony, and Microsoft. Activision is estimated to hold a 4% market share of the $150 billion global gaming industry.
Global video game industry market dynamics illustrate compelling opportunities for Activision Blizzard. Growing middle classes spur entertainment technology adoption, and the continued development of countries such as India will add to the demand for gaming. Improving mobile computing power, along with the rollout of 5G, will enable more immersive gaming experiences that broaden the base of interested gamers. The global industry expanded by almost 10% in 2019, and industry forecasts call for 9% annual growth through 2026.
Activision Blizzard has experienced a challenging period of competition
Identifying and analyzing company-specific trends in the gaming industry can be difficult because game launch schedules create volatile financial results. Rapidly shifting consumer tastes also complicate analyses, because in-game revenues can change abruptly as a result. Both elements have been relevant to Activision Blizzard over the past two years — the company had a slower release schedule combined with extreme competition from rival games like Fortnite.
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The company responded to these challenges by focusing on its successful core offering. To reduce fixed overhead, Activision reduced its headcount by 20% and turned its attention to creating more content and augmenting user engagement in flagship franchises. The company is also hoping to build upon the success of its Overwatch Esports league that launched in 2018. These leagues are useful for brand and engagement building on existing titles, but they also create opportunities to stream content that generates advertising dollars. Rather than burning cash on development that may fail to capture public interest, Activision Blizzard is exploring new ways to monetize its existing properties.
Operating and valuation metrics indicate upside opportunity
Activision Blizzard's expense reduction efforts have resulted in a great 28.3% operating margin, which is superior to that of rivals Electronic Arts, Sea, Take-Two Interactive, and Zynga. Despite this superior operating performance, the company's 11.5% return on invested capital (ROIC) actually trails the industry average by 230 basis points. This lag suggests that peers EA and Take-Two are more efficient stewards of working capital, each using its respective resources more effectively to generate financial returns. Nonetheless, the gap between Activision and the industry leaders in efficiency metrics is relatively minor when compared to the numerous gaming companies that are unable to deliver sustained profits. Ample liquidity and very manageable financial leverage also bode well for Activision Blizzard's ability to navigate protracted lean periods or make large, strategic moves to improve the company's fundamental outlook.
After a volatile two years, Activision Blizzard's valuation metrics place it firmly in line with industry averages. The stock trades at a 23.3 forward price-to-earnings multiple, just above the industry average of 20.5. Its price-to-free cash flow ratio at 23.3 is similarly above the average of 20.5, while its EV/EBITDA of 14.1 is actually below the peer group average of 15.0. Activision is the only member of its peer group that pays a dividend. The 0.68% dividend is not exactly a difference-maker for income investors, but it does offer some extra upside.
Activision Blizzard has weathered a storm since 2018, and it seems to have become a leaner, more focused player as a result. The stock does not provide the cheapest exposure to the gaming industry, and the industry itself is not the highest growth opportunity in the global economy. However, Activision is somewhat of a blue-chip within its niche. The company owns several extremely popular franchises across console, PC, and mobile gaming factors, with geographically diversified revenues in a market with rather predictable growth that approaches double digits.
It seems that the tech stock underwent a healthy price adjustment following serious competitive threats. Its more rational valuation now allows investors to gain exposure to the financial opportunities associated with Activision's upcoming releases, growing mobile presence, and opportunities related to esports and sponsorship deals. Any major franchise losing momentum could obviously jeopardize this stock, but this is still an attractive opportunity to gain exposure to the growing global market of gaming.
