This article is part of our Rising Star Portfolios series.
I admit I'm not totally up to speed with today's video games. For me, it pretty much starts with Galaga and ends with Donkey Kong (and Ms. Pac-Man fits in there somewhere). Don't get me wrong, I enjoy playing video games. I even have a PlayStation 2 at home. Granted, I haven't put many miles on it since my stint in the coldest regions of Kazakhstan, but I still have it.
However, if you're a Fool, you know Activision Blizzard (Nasdaq: ATVI). If you're not a Fool, you still probably know Activision Blizzard. We're talking about one of the world's largest video game publishers. And you know what? I think it's just getting started.
The business
Formed by the merger of Activision and Vivendi in 2008, Activision Blizzard is a market leader in video game publishing, covering everything from Guitar Hero to the world's No. 1 subscription-based MMORPG (massively multi-player online role-playing game) World of Warcraft. Activision Blizzard produces games in-house as well as with third-party developers to reach multiple platforms while attracting the largest audience possible.
The business is easiest viewed as the two pieces that make up the whole. The Activision segment produces games primarily for consoles (think PlayStation and Xbox) and its two most popular games are Call of Duty and Guitar Hero. The Blizzard segment produces games geared toward the MMORPG audience. Its most popular game, World of Warcraft, is played around the world and has built up a current subscriber base of 11.5 million enthusiasts.
Why buy?
The merger in 2008 formed a global powerhouse. And I love companies that shape industries. The third-party developer model gives them flexibility in developing the core content that die-hard fans love and compelling fresh content for new audiences. Take, for example, the new 10-year agreement with Bungie. Known best for its popular Halo series, Bungie will now partner with Activision Blizzard to develop and publish the "next big action game universe." To me, this looks like the beginning of a beautiful friendship.
Like Blinky chasing after Pac-Man, the move to digital is unavoidable. To be sure, Activision Blizzard just saw its first quarter where sales from online channels were higher than retail sales. Activision recognized this trend early on, which is actually what prompted the merger with Vivendi. It saw the success of Vivendi's World of Warcraft subscription-based model and realized the costs and difficulty involved with building such a service. Thus the merger and the rest, as they say, is history. With a truly global reach and a management team ready to take on all comers, I see a lot of growth ahead for this superstar.
What's it worth?
It is tough to put a valuation on companies that make their hay from intellectual property. Games have a shelf life, so they need to keep putting out killer content. Digital distribution is going to be a key driver as there are about 5 billion people in the world still without Internet access. With margins trending upward over time due to lower distribution costs, I see shares being reasonably worth around $13 today. With close to $3 billion in cash and short-term investments and zero debt on the balance sheet, I'm excited to buy into this company at today's prices. I am plunking down $1,000 on this gamer with the confidence that it will be worth a lot more years from now.
Risks
A key risk with this company is the power of substitutes: There is a lot of competition out there these days for our entertainment dollars. Companies like Netflix (Nasdaq: NFLX) and Google (Nasdaq: GOOG) are looking for every possible way to distribute new content to gain audience share, and Activision is dependent on the success of a few key hit franchises. It will need to continue developing cutting-edge content to keep its audiences growing. This is also an extremely competitive industry, and lower development costs should open up the field to new players.
My Foolish bottom line
It took me a little while to come around, but enough digging has convinced me of gaming's staying power. And after looking at all the players, there's only one I want to put my money on. I am going to enjoy following this one, for sure. Now, if I can just figure out what I did with my copy of Donkey Kong.
This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. Click here to see all of our Rising Star analysts (and their portfolios).
