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Why Activision's Deal for King Digital Was a Home Run

By Luis Sanchez CFA - Feb 5, 2020 at 11:16AM

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Management has demonstrated skill in negotiating and running a vibrant gaming business.

Activision Blizzard (ATVI -0.79%) is one of the world's largest video game publishers, but historically the company has been almost exclusively focused on making games for the hardcore PC and console markets.

That is, until Activision acquired King Digital in 2016. King owned Candy Crush, the highest-grossing mobile game of all time in the United States, which gave Activision a foothold in the market for smartphone games. Nearly four years later, it's clear that Activision's acquisition was a home run for shareholders.

Activision paid a good price

Activision agreed to pay $5.9 billion in cash for King Digital. This was the company's largest acquisition since its merger with Blizzard back in 2008 and ranks as one of the largest-ever acquisitions of a gaming company.

Despite the relatively large price, Activision got a good deal. King generated $682 million in EBITDA for 2015, which translates into an 8.7 times enterprise value/EBITDA purchase multiple. To put that valuation into context, Activision currently trades for roughly 20 times its estimated 2019 EBITDA.

The deal immediately resulted in earnings-per-share growth because the company was able to finance the purchase with cheap debt and avoid issuing stock. The average interest rate on Activision's debt today is below 4%. It is hard to go wrong when you can borrow at low rates to buy highly productive assets!

Man with a focused face on a subway train car holding a smart phone

Image Source: Getty Images.

Activision has improved King's monetization

Activision was able to buy King cheaply because investors no longer believed in the sustainability of King's underlying business. It went public in 2014 at $22.50 per share but saw its stock decline over its two-year life as a public company.

King's business was dominated by just a handful of mobile games. The Candy Crush mobile game has always been King's biggest earnings driver, and after several years on the mark 

But under Activision's ownership, King has had a renaissance of sorts. Activision has been able to increase King's overall revenue and earnings. To accomplish this, Activision expanded the game studio's resources, which enabled King to roll out new games in the Candy Crush universe and release new features in the existing games. For example, King released a sequel to Candy Crush called Candy Crush Friends Saga in 2018, which helped increase the number of active users. And generally speaking, more users equal more revenue for a mobile game.

King Segment Financials 2016 2017 2018
Segment revenue $1.586 billion $1.998 billion $2.086 billion
Segment operating income $537 million $700 million $750 million

Note: 2016 King segment financials only reflects from March to December due to the King acquisition closing in late February. Data source: Activision and Capital IQ.

There is still an opportunity for Candy Crush to make even more money by introducing advertising. Historically, King games have primarily been monetized by enabling users to make in-game purchases to skip levels or unlock features. But with an audience of over 200 million monthly active users, Activision believes it can unlock value by selling those eyeballs to advertisers. The company started selling Candy Crush advertising spots in the last year and is already on track to deliver $100 million in annual advertising revenue.

A strong management team

In 2018, the King business segment generated $750 million in operating profit before taxes and is on track to do a similar amount for 2019. This level of earnings implies a very good return on investment for Activision based on what it paid to acquire the company.

The King case study shows the talent of Activision management for structuring attractive deals and operating extremely well to make the acquired assets more valuable. While it's not uncommon to find a management team with acumen in executing deals or running a business, it's rare to see one that is skilled at both. Shareholders should take great comfort in this, and hope that Activision can find more acquisitions like King.

Activision is a standout technology company that investors should consider adding to their portfolio for exposure to the growing video game industry.

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