Activision’s Earnings Preview: Digital Expansion To Drive Revenues

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ATVI: Activision Blizzard logo
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Activision Blizzard

The American gaming giant, Activision Blizzard (NASDAQ: ATVI) is scheduled to announce its second quarter report for the 2014 fiscal year on August 5. [1] The company announced better-than-expected results in its first quarter report, with strong performances from core franchises and expansion in the digital domain. However, the company witnessed a 4% decline in non-GAAP revenues to $772, but earned 68% of its revenues from digital channels, allowing it to report a record high operating margin of 31%. ((Activision Blizzard’s (ATVI) CEO Michael Morhaime on Q1 2014 Results – Earnings Call Transcript))

Activision’s innovative toys-to-life franchise Skylanders continues to perform well along with Call of Duty: Ghost, which continues to stay among the top 10 selling games after 7 months of its release. [2] The company accounted for nearly 13.4% of global video game software sales last year. [3] According to the research group NPD, new video game software sales were lagging behind the hardware sales till April, but it gained momentum in May. Gamers spent $274 on new video games at retail in May, up 57% over the same period last year. [4]

Our $22 price estimate for Activision Blizzard’s stock is in line with the current market price.

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See our complete analysis of Activision’s stock here

The second quarter was an important period for the gaming industry this year, as it witnessed the 2014 Electronic Entertainment Expo (E3), which provided a huge platform to all major game developers to showcase their upcoming title releases. During the event, Activision unveiled its highly anticipated trio of titles: new Call of Duty (COD) franchise- Call Of Duty: Advanced Warfare, new innovative title from Skylanders brand- Skylanders Trap Team and the most awaited game of the year –Destiny. ((Activision relies on its 3 top titles to drive revenues))

Digital Domain To Play A Key Role

The gaming landscape has changed over the last few years with the advent of smartphones and tablets, providing easy access to games and eventually leading to the rise of casual gaming. Video game developers such as Electronic Arts, Nintendo and Activision Blizzard (NASDAQ:ATVI) have been forced to change their business model to adapt to the digital revolution. Digital expansion is a priority for both Electronic Arts and Activision as they head into the new era of gaming. Already a dominant force in FPS genre, Activision aims at strengthening its hold over the segment as its competitor Electronic Arts (NASDAQ:EA) is rapidly climbing up the ladders in this segment with its Titanfall & Battlefield franchises stealing market share from Activision’s Call of Duty.

  • Call Of Duty Franchise: Bigger And Better

In the first quarter, Activision’s digital income was driven by Call of Duty: Ghosts and Skylanders SWAP Force, which were the 2 top games in North America and Europe. Call of Duty is one of the best Western interactive franchises since its launch in 2003, with over $9 billion of life-to date revenues. In 2013, the company launched Call of Duty: Ghost, which became the #1 best selling game on next generation consoles- Microsoft (NASDAQ:MSFT) Xbox One and Sony PlayStation 4. Activision’s Call Of Duty franchise is the leader in the FPS genre with nearly 50% of the total shooter game sales worldwide. We expect the franchise to maintain that share in the FPS genre.

Moreover, the company announced the release of the next edition of Call of Duty franchise- Call of Duty: Advanced Warfare during the latest E3 event. The title is to be released in November 2014 on all major platforms. The gamers can pre-order their Call of Duty: Advanced Warfare to get their personalization pack. Looking at the success of the franchise and the pre-release demand in the market for its new edition, the company expects more gamers to go for the Downloadable Content (DLC), thus generating strong revenues from the digital content of this franchise.

  • World Of Warcraft- Expansion Packs To Keep The Franchise Alive But Not For Long

Activision continues to lose subscribers for its massively multiplayer online role-playing game (MMORPG) World of Warcraft. The franchise was once a cash cow for Activision, accounting for nearly $1 billion in annual revenues, reaching a peak of 12 million subscribers in 2010. However, competition from free-to-play titles led to a decline in the subscriber base which fell to 7.6 million subscribers at the end of the March quarter. Activision is trying to revive interest in the franchise through another expansion pack- Warlords of Draenor. This fifth expansion pack is to be released in December this year with Standard Edition being priced at $49.99 and Digital Deluxe Edition being priced at $69.99. [5] Despite Activision’s best efforts, we expect a continuous decline in World of Warcraft subscribers through the decade, as core gamers are shifting their interests to other genres.

Strong Consoles Sales To Boost Title Sales

In its latest June report, NPD reported that gamers spent $736.4 million on new physical video game products at U.S. video game retail shops, up 24% from $593.5 million in June 2013. [6] In June, new hardware sales rose 106% year-over-year, primarily due to console hardware sales. Considering that consumers spent $ 292.7 million on new hardware alone, the gaming industry believes that the twin consoles still have a lot of demand among the core gamers. The popularity of the new consoles suggests that a sales revival is likely around the corner, and both EA and Activision have strong lineups to capitalize. With most of the games released on only the new platforms, gamers were forced to buy the next generation consoles. Activision might be eagerly looking forward to the release of titles such as Call of Duty: Advanced Warfare, Skylanders Trap Team and Destiny.

Activision will launch its much-anticipated title Destiny in September 2014. The company has suggested a budget of $500 million for developing and promoting the game and expects to develop it into a $1 billion franchise. The company expects the initial sales of these titles to rise, considering hardware sales would translate to better software sales. As these titles are the core profitable franchises, a boost to their sales would drive the overall revenues of the companies.

The company’s Skylanders franchise can have a significant impact on its revenue growth as well. (See: Activision confident with Skylanders franchise despite tough competition)

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Notes:
  1. Activision Blizzard Q2 2014 Earnings call transcript []
  2. June NPD report []
  3. VGChartz, 2013 Global Yearly Chart []
  4. May 2014 NPD: Watchdogs & Mario Kart 8 fuel industry wide surge []
  5. Warlords of Draenor: expansion pack []
  6. June 2014 NPD []