Activision Blizzard’s (NASDAQ:ATVI) stock has gained 35% since the turn of the year. But the video game publisher’s rally faced a bump on the road last week as Venture Beat reported that the company’s massively multiplayer online role playing game (MMORPG) project code named Titan might be going through a restructuring process.  The game is expected be the successor to Blizzard’s revolutionary World of Warcraft franchise, which accounts for $1 billion of the company’s $4.8 billion revenues, but has been losing subscribers to free-to-play counterparts. Free-to-play online MMORPGs like Aion: Ascension, Vindictus and Allods Online have cut the WoW subscriber base from nearly 12 million in 2010 to a mere 8.3 million at the end of the first quarter of 2012.
While investors might be worried about the fate of the online subscription stream, we believe the company’s business model is strong enough to absorb the impact of a further decline in subscriptions. After accounting for a decline in subscribers to 5 million by the end of the decade, our $16 price estimate for Activision Blizzard implies a 10% premium to the current market price.
World of Warcraft was once a big cash cow for Activision with online subscription fees accounting for 40% of the company’s revenues and 60% of the gross profit in 2008. There were around 10.5 million WoW subscribers at that time, with the company earning close to $110 per subscriber. The game remained popular for the next two years with the number of subscribers increasing to 12 million in 2010. However, the company started losing its customers in 2011, ending the year with 11 million subscribers. Despite this, Activision reported a 7% year-on-year increase in revenues and a 19% increase in gross profits. Other games like Call of Duty took over the mantle from World of Warcraft, whose revenue contribution dipped to 30% in 2011 and further to just 20% in 2012.
Although the Mists of Pandaria expansion pack released last year temporarily boosted the subscriber base to above 10 million, the number of subscribers at the end of 2012 was just 9.6 million. The company lost 1.3 million subscribers in the first quarter of 2013 alone and expects a further drop in the figure through the year. We expect Activision to maintain at least 5 million subscribers through expansion packs like Mists of Pandaria, which sold 2.7 million copies on the first day of its release last year as well as renewed interest through the WoW based free-to-play online card based game, Hearthstone: Heroes of Warcraft.
We also expect a substantial drop in the average revenues per subscriber as the company adjusts its fee structure to compete with free-to-play MMORPGs. The revenue contribution from this stream is expected to go down to 12% by the end of the decade.
CoD Answers The Call Of Duty
The Call of Duty franchise is the new cash cow for Activision. Annual editions of the franchise have made the top ten best selling games across the globe for the last five years.  Call of Duty: Black Ops II was the highest selling game worldwide last year. According to our analysis, Activision had 17% of the global video game market share in terms of units sold with 11% from Call of Duty, which sold more than 20 million copies. Black Ops II also accounted for 16% of the Xbox 360 and PS3 games sold worldwide last year, helping Activision beat the industry wide decline in sales caused by console fatigue.
In the U.S., Black Ops II accounted for 14% of the Xbox games sold and 18% of the Playstation 3 games. As a result, Activision reported a 25% year-on-year increase in revenues for the all important holiday period. In contrast, video game sales for the entire industry plunged 22% during the last three months of 2012. 
We expect further editions of Call of Duty to be released in the coming years allowing a smooth transition to the next generation of consoles. Both Sony’s Playstation 4 and Microsoft’s (NASDAQ:MSFT) Xbox One are expected to be launched later this year and will help revive video game sales. 
Like all good things, it is imperative that Call of Duty’s run at the top will eventually come to an end. However, given Activision’s penchant for periodically developing hit franchises like World of Warcraft, Call of Duty, Diablo and Skylanders, we expect the company to capitalize on the industry revival brought on by the eighth generation gaming consoles.Notes: