Two entertainment leaders are Walt Disney (DIS -0.04%) and video game maker Activision Blizzard (ATVI). There are key similarities between these companies, but only one can be the better buy.
Disney's stock is down 54% from its all-time high. The main culprit is lower profits due to heavy expenditures on streaming content. But Activision also looks attractive after falling 26% from its previous highs. In fact, Warren Buffett's Berkshire Hathaway acquired a small stake in the company in the fourth quarter of 2021, before Microsoft offered to buy the whole company for $68.7 billion early last year.
There's a lot of skepticism that Microsoft's offer will pass the regulatory process. The European Union recently gave approval for the acquisition, but the U.S. Federal Trade Commission (FTC) has sued to block the deal. A U.K competition authority also moved to block it last month. At this point, it's best to consider buying Activision stock intending to hold it long term.
Activision serves a gaming industry that is estimated around $200 billion, which makes it the largest form of entertainment. It has an installed base of millions of players across several best-selling franchises, including Call of Duty and World of Warcraft.
While Disney owns a deep well of entertainment properties going back a century, there are three reasons I would buy Activision Blizzard right now.
1. Activision has been more consistent during economic uncertainty
Investors want all stocks they buy to go up over the long term. Ideally, investors want shares they own to hold up well in the near term, too.
Over the last three years, investors have seen some of the most volatile markets and economic conditions in recent history. But unlike Disney, Activision continued to generate steady free cash flow and revenue from more than 350 million monthly active users across its games on console, PC, and mobile.
Over the last year, Activision generated $2 billion in free cash flow on $8.1 billion in revenue. And the business continued to generate healthy levels of revenue and profitability during the pandemic in 2020.
Data by YCharts
Video game producers have a unique advantage over other entertainment companies. Activision maintains a direct connection with its customers, who spend money throughout the year online on game content while playing. This is why the company drove strong growth even when the economy was shut down during 2020. About two-thirds of Activision's business comes from in-game spending.
On the other hand, nearly a third of Disney's business (theme parks) was shut down during the pandemic. This caused a collapse in revenue and Disney to suspend its dividend. And even as the parks recovered, Disney has seen profits deteriorate over content spending to drive growth in streaming.
Over the last four quarters, Disney generated only $94 million in free cash flow on $84 billion in revenue.
Data by YCharts
Disney more than doubled its free cash flow in the last quarter, so it's making progress to turn things around. But investors should place a higher value on Activision's consistency. Companies that can generate steady financial results through economic uncertainty are worth owning over businesses that stumble.
2. Activision is growing faster
Across Disney's entire business, revenue grew 13% year over year in the most recent quarter. This was driven by double-digit revenue growth in the direct-to-consumer segment, and strong growth in the parks, experiences, and products business.
However, Activision got off to a strong start in 2023 following new releases in the fourth quarter. First-quarter bookings grew 25% over the year-ago quarter, with adjusted earnings per share nearly doubling. Management credited broad growth across its five largest titles: Call of Duty, Candy Crush, Warcraft, Overwatch, and Diablo.
Activision said presales for the next installment in the Diablo franchise, which will be released on June 6, are strong. Analysts expect Activision to report full-year bookings growth of 24% and 15% next year.
On the other side, Disney is lacking near-term growth catalysts. Instead, it's in the process of cutting costs to shore up the bottom line. Analysts expect Disney to grow the top line by 7% this year and 6% next year. Even factoring in management's cost savings to grow earnings, Disney stock still trades at a higher valuation than Activision on a forward price-to-earnings basis.
Data by YCharts
3. Activision offers long-term upside from emerging new platforms
A final reason to buy Activision is that there are growth opportunities emerging that the market is not fully accounting for. The video game industry has a long history of bringing new people in as new technology emerges. Over the next decade, there are three catalysts to watch: cloud gaming, virtual/augmented reality gaming, and development of the metaverse. These emerging opportunities play to Activision's strengths.
Goldman Sachs previously estimated the metaverse to grow into an $800 billion addressable market across retail, education, and entertainment. This favors Activision's capabilities at creating the graphically demanding software and applications required to make these virtual 3D worlds a reality.
The biggest growth driver right now for Disney is streaming, which is losing money. Activision's consistent operating performance through a difficult economy is not fully appreciated by the market. The stock is undervalued compared to Disney's valuation and should be a rewarding investment over the long term.
