Video game maker Activision Blizzard (Nasdaq: ATVI) is one of the most popular stocks in all of Fooldom. A total of 6,900 CAPS players have entered Activision into their scorecard, and 98% of them believe the company will outperform the S&P 500. The headlines would lead you to believe this is a no-brainer; among Activision's recent successes:
- Modern Warfare 2 (2009) was the second-best-selling video game of all time.
- Black Ops (2010) topped $1 billion in sales in the first six weeks on the market.
- World of Warcraft: Cataclysm (2010) was the fastest selling game of all time, selling 3.3 million copies in its first month.
- Starcraft II: Wings of Liberty (2010) was close on Cataclysm's heels, selling 3 million copies in its first month.
And what do investors have to show for this? Shares have gone down 10% since Modern Warfare was released 15 months ago. This leads frustrated investors to ponder:
For the love of God, when will this stock start moving up?
There are four hypotheses as to why the stock has been held down and what it will take to get it going.
Hypothesis No. 1: The P/E is out of whack
Currently, the company's P/E sits at 39.6. Non-recurring charges have caused this key ratio to be a little crazy. This is primarily due to the 2008 merger between Activision (which makes console video games) and Blizzard (which focuses on online gaming). The forward P/E, which is free of such one-time charges, is at a much more reasonable 14.
Although it's tempting to place the blame on the skewed P/E, I find it hard to believe that institutional investors are unaware of these circumstances. Maybe when the P/E normalizes, it will help, but I don't think this is our culprit.
Hypothesis No. 2: Social gaming is taking over
When Facebook opened up its platform to apps, casual gamers came in droves. Farmville, the site's most popular app, has more than 53 million active members. Angry Birds, another popular app available on Facebook as well as smartphones, has been downloaded 50 million times.
While the price tag for such games is either minuscule or nonexistent, why would anyone pay up for Activision games that can run as much as $60? Could the ground be shifting under Activision's feet, as bearish analysts say?
Again, I don't think we have our culprit here. The sales numbers from the latest releases make it pretty clear that consumers are still willing to pay up for quality games.
Hypothesis No. 3: There's no guarantee of future blockbusters
The video game industry can be brutal. Instead of raw materials or brand power, video game companies live and die by the quality of the games they produce. Talent is the most valuable asset to these companies. Even if Activision has been on a tear lately, who's to say that it will continue?
Here I think investors have a valid concern. Electronic Arts (Nasdaq: ERTS) used to sit atop the gaming industry. But a lack of creative and engaging games has caused the company to remain relatively stagnant for years now.
I believe, however, that Activision has a pretty solid plan for approaching this problem. Instead of having just one studio develop its games, Activision has 16 different studios at its disposal. The sheer quantity of engineers working on the next big thing raises the probability that a quality end product will rise to the surface.
How can investors be convinced of such an outcome? In one word: consistency. Two years of blockbuster games is nice, but some may consider it dumb luck. Run that streak up to five years, and now we're looking at a trend.
Hypothesis No. 4: The gaming industry is in a cyclical depression
The past few years have not treated video game companies well at all. The just-ended 2010 saw video game sales show no growth. The year before, video game sales fell 8%.
Activision, Electronic Arts, and Grand-Theft Auto maker Take Two Interactive (Nasdaq: TTWO) have all been stuck in a two-year rut. In the 1990s and early 2000s, the gaming industry expanded its base of customers rapidly. Though this was good for profits at the time, it spelled trouble when the recession arrived in 2008. Instead of a base of hard-core gamers, these companies now had customers who had no problem walking away from the newest release.
Without a doubt, this has been the foremost drain on the industry, and the price of Activision's stock. There's only one thing that will truly improve this situation: time.
Eventually, unemployment will fall, consumer spending will rise, and more video games will be bought. When that time comes, investors will be looking for the cream of the crop to invest in. Expect to see Activision shares skyrocket when that day comes.
