Activision Blizzard's (NASDAQ: ATVI) shares are on a roll.
Year to date, the stock is up more than 30%, versus a gain of just 6% for the S&P 500. Most of that bounce came right after the game maker announced surprisingly strong earnings last month. But Activision has been trouncing analysts' estimates for some time, so that can't be the only reason that shares jumped.
Still, even after the recent pop I think the stock has room to run. Here are a few reasons that the rally may just be getting started.
Console gamers have every reason to be impatient. They've had to wait for eight years between console upgrades. Over that time they've seen their smartphones get smarter and more powerful, and they've seen tablets rise from nothing to become a huge force in computing and gaming. All the while, gamers have been stuck with consoles that were first designed back when MySpace dominated the Internet.
That's finally changing. Nintendo (OTC:NTDOY) released its next-gen console this past holiday. Microsoft's (NASDAQ:MSFT) new Xbox is rumored to be coming out this year. And Sony (NYSE:SNE) has already unveiled its next-gen system -- sort of.
The console upgrade cycle brings risks to Activision's business, as transition years can be bumpy. But it also offers huge opportunities. The installed base of console gamers in the U.S. and Europe alone is 183 million. If the hardware makers can convince a good portion of that base to upgrade, demand for Activision's software titles should get a real shot in the arm.
But the company has received no boost from next-gen hardware yet. Nintendo's Wii U was actually a disappointment out of the gate.
Weak sales of the family-friendly console could slow the growth of Activision's latest hit franchise. It struck gold in the Skylanders combination of console gaming with a physical toy component, and the title has quickly leapt to over $1 billion in total sales. Activision is now looking to extend the franchise and defend it against Disney's (NYSE:DIS) new challenge to the category, Infinity, set to come out in the summer. This is how an Activision executive explained their latest innovation, Skylanders SWAP Force:
While others are just entering the category that we created, we're moving that category forward by introducing yet another innovative new play pattern, dynamic swapability. SWAP Force expands upon the success of the franchise as a signature gameplay by letting kids not only bring their toys to life, but to swap parts and create their own unique characters in the physical world, which are then recognized in the digital world.
SWAP Force has the potential to do well, but Activision also boasts other promising titles in its pipeline. The company will soon be bringing Diablo III -- last year's best-selling PC game -- to Sony's console. And it is busy working on a Call of Duty expansion into China, along with a major new multiplayer universe, Destiny. No sales from those last two titles are included in the company's 2013 outlook, which calls for $4.1 billion in sales this year, as compared to $4.9 billion in 2012. Still, Activision's close relationship with Sony suggests that Destiny might be ready in time for PS4's launch, powering additional sales gains for the company.
Bigger shareholder returns
Finally, Activision may be planning to deliver more cash directly to shareholders. The company generated $1.3 billion in cash from operations last year, but still dialed back its share repurchasing. After spending $700 million buying back stock in 2011, it forked out just $300 million last year.
That trend could reverse this year. In its earnings announcement last month, the company said it was considering "substantial stock repurchases" and dividends as part of a group of what it called "non-ordinary" transactions that could impact this year's results.
"Non-ordinary" is actually a great term to describe the type of year that Activision is facing. From a major console refresh to a big slate of new titles, its business is definitely in transition.
Still, Activision has a strong base of games to keep the revenue flowing, and it has a decent chance at succeeding with the new content in development. It's true that the company just tore through the $15 billion market cap threshold. But at three times trailing sales, it is well within the range that shares have traded at over the past few years. There's no reason that Activision can't continue to grow from here.