For much of the two years since Activision and Vivendi Games merged to form Activision Blizzard
- Games: Activision has some of the most popular games around and is releasing eagerly anticipated updates and new versions. The long-awaited StarCraft II is being released later this month, and an expansion to World of Warcraft is due out later this year, along with one for Call of Duty. Plus, the company owns several different studios that develop the games and recently signed an agreement with Bungie, the developer of the smash hit Halo (at least it's a smash hit here at Fool HQ).
- Financial strength: Activision Blizzard generated more than $1 billion in free cash over the past four quarters. With more than $3.3 billion in cash (18.5 times what Take-Two has) and no debt, the balance sheet is rock-solid. Put these traits together and it translates into a company that can afford to reinvest in game development, buy back shares, and pay the dividend, with cash left over.
- Angry developers: With the defection of a large number of employees of Infinity Ward -- the studio that is responsible for Call of Duty: Modern Warfare 2, which grossed $1 billion in the first two months after release -- there is concern over Activision's interactions with its studios. Plus, the former heads of Infinity Ward formed a new studio and promptly signed on with Activision rival Electronic Arts.
- Game sales declining: The year 2009 brought an 8% decrease in industrywide game sales, despite the contribution from Modern Warfare 2 at the end of the year. The trend continued in May and last month's numbers are expected to be disappointing as well. Any turnaround won't show up until later this year.
- New franchises: Despite the expected good numbers from StarCraft II, several of the other franchises are getting long in the tooth. Guitar Hero has been saturated and Tony Hawk is aging. The new releases this year should give the company time to come up with something new, but until there's more visibility, hang on.
- The economy: Activision has shown the ability to sell during a recession, but if the economy slips back into a double-dip recession, the company could continue treading water. The potential for growth is there and it probably won't decline -- the balance sheet protects against that -- but which way it goes isn't clear quite yet.
The final call
I have to go with the buy position. Yes, the company's share price has spent quite awhile at the current level, but Activision has shown that it can survive, even prosper, during a recession. When consumer wallets loosen up a little, sales and earnings will grow. Plus, the company has enough creative talent, and can sign on more, to generate new, successful franchises over the next several years.
Finally, my risk analysis shows that the company itself exhibits only a moderately low risk level. It may take a couple of years as earnings and free cash flow grow before the market recognizes this, but an enterprise value-to-free cash multiple of 10.6 is too low for a company of this quality to keep for too long.