Activision Price Estimate Revised to $22 On Digital Revenues, Margin Improvement

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ATVI: Activision Blizzard logo
ATVI
Activision Blizzard

Activision Blizzard’s (NASDAQ:ATVI) Call Of Duty: Ghosts was once again the best selling game in February, reaffirming the Call of Duty franchise’s dominance in the first person shooter (FPS) genre. [1] Annual editions of the franchise have made the top ten best selling games across the globe for the last six years, warding off competition from games such as Electronic Arts’ (NASDAQ:EA) Battlefield and Microsoft Studios‘ (NASDAQ:MSFT) Halo. [2] In the U.S, titles under the franchise have consistently made it to the top of research group NPD’s monthly list of top selling games. FPS games account for about 20% of global game sales, with Call of Duty accounting for nearly half the genre’s sales. Dominance in the FPS genre will be crucial for Activision, as the market enters a console transition period.

Another trend driving Activision’s earnings is the margin expansion it has been able to achieve; the company’s EBITDA margins have expanded from 17% in 2008 to nearly 40%. Gross margins for the publishing business (which accounts for more than 70% of the revenues) have increased from 42% in 2008 to 75%, driven by high-margin digital streams. Keeping these trends in mind, we have increased our price estimate for Activision Blizzard’s stock to $22.

See our complete analysis of Activision’s stock here

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Video game publishers are no longer just reliant on physical sales of video games, but are also earning from digital support streams such as extra downloadable content (DLC), full game downloads, in-game advertising and subscriptions. Digital sales accounted for 25% of Activision’s revenues through the fourth quarter of 2013 and 34% for the full year. These streams have lower costs; the cost of revenue for physical products sold is about 50% of the net revenue while the cost of revenue for online and digital services is just 30%. However, digital streams are dependent on the popularity of Activision’s products, and the company will have to keep a prudent mix of both physical and digital revenues to maximize earnings. As a result, we expect gross margins to remain around 75% through the decade.

What Does Activision Have To Do To Maintain Growth?

Like Activision, Electronic Arts has also been able to accommodate digital streams and maintain growth while increasing efficiency. Digital revenues accounted for a third of EA’s revenues during the December quarter. The similar nature of the companies’ operations necessitates a comparison between the two. Activision’s strength is in the FPS domain while EA’s strength is in the sports domain. Soccer-based game FIFA accounted for 7% of global game sales on the Xbox platform last year, Madden NFL accounted for 3%. EA has exclusive licensing agreements with both governing bodies, the NFL and FIFA, which allow it to maintain a near-monopoly in sports games. However, Activision does not enjoy such exclusivity and will face competition from other titles.

Marketing and product development will be important for the company to maintain its position in the FPS market, as consumers shift to the next generation consoles. Product development costs have gone down from 33% of the gross profit in 2008 to 17% in 2013, as the company has cut back on the number of titles released. However, we expect increased expenditures in this stream as the company develops games for new consoles, taking into account the advanced technical specifications required. We expect R&D expenditures to increase to over 20% of the gross profit in the coming years before coming down slightly in the long term. SG&A expenses should follow a similar trend.

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Notes:
  1. February NPD: PS4 sells more, Xbox One leads in dollar amount []
  2. VGChartz []