Activision Blizzard $20 Fair Value: New Games, Industry Trends Support Growth

ATVI: Activision Blizzard logo
Activision Blizzard

Video gaming giant Activision Blizzard (NASDAQ:ATVI) has finished a record year, posting the highest revenues and profits in its history for a calendar year. It completed 2011 with $4.75 billion in revenues and $3.4 billion in profits, an increase of 7% and 18%, respectively, from the prior year. If this was not enough, the company’s gross margins grew by a massive 7 percentage points to reach 71% in 2011, as compared to 64% in 2010.

With the additions of highly promising revenue streams  in 2011 such as Call of Duty: Elite and Skylander Spyro’s Adventure, and a solid pipeline of games for 2012-13, Activision looks all set to topple further records going ahead. Activision Blizzard competes with other game developers like Electronic Arts (NASDAQ:EA), Take-Two Interactive Software (NASDAQ:TTWO) and casual gaming mainstays such as Zynga (NASDAQ:ZNGA). Below we look at the factors that supports our $19.92 price estimate for Activision Blizzard, which is at a premium of 55% to its current market price.

See our full analysis for Activision Blizzard here

Changing video-gaming landscape is playing in favor of Activision

Video-gaming landscape is swiftly changing from retail to digital. Digital gaming is the most important focus area for gaming publishers including Activision Blizzard. While the company’s MMO gaming division is already purely digital, Activision Blizzard is taking impressive strides in other areas too. Digitally downloadable content (DLC) in the form of map packs and full digital PC games downloads are contributing handsomely to the company’s revenue growth. The progress of Activision in digital business can be gauged by the fact that its digital revenues increased by an impressive 14% in 2011, which is almost double the growth rate of its net revenues in 2011.

However, the more significant impact of changing gaming landscape has been on the company’s margins. Fueled by a changing product mix having fewer hardware peripherals, Activision’s gross margins climbed by a staggering 7 percentage points to reach 71% in 2011. With digital business continuing to enjoy the focus of video-gaming industry, we expect the trend to carry forward.

Additionally, changing dynamics of the gaming industry has provided Activision Blizzard a shot in the digital distribution too. Digital distribution is a highly lucrative market for publishers such as Activision, because apart from reaching its customers directly, the company is also shunting midway retailers such as GameStop (NYSE:GME) thus improving its margins further.

Strength of Call of Duty franchise on XBox 360 and Sony PS3

Call of Duty is widely regarded as the all time highest selling third-party gaming franchise in dollar terms. The franchise enjoys an unmatched popularity on both XBox 360 and PS2 with all of its recent three versions, Call of Duty: Modern Warfare 2 (MW2), Call of Duty: Black Ops and Call of Duty: Modern Warfare 3 (MW3) surpassing the sales records set by their predecessor games. While there were threats from rival EA’s Battlefield 3 until the launch of MW3 in November 2011, the game literally blasted any threats whatsoever, amassing $1 billion in sales in just 16 days after its release.

Call of Duty 9, the next game of the franchise due to launch in 2012, has already started featuring in the discussions on leading gaming forums. Considering the heightened anticipation levels and the reputation of Call of Duty games in first person shooting genre, we expect COD 9 to be a major contributor for Activision in 2012.

Huge prospects in Call of Duty: Elite and Skylander Spyro’s Adventure

In addition to the successful Call of Duty MW3 in 2011, Activision launched its multiplayer gaming service Call of Duty: Elite and  Skylander Spyro’s Adventure, a new intellectual property that combines the use of toys with video games.

The initial reception of Call of Duty: Elite has been terrific with nearly 1.5 million gamers subscribing for the $50/year service as of January 31st 2012. And with an array of services such as prioritized monthly downloadable content, daily competitions with virtual and real life prizes, pro analysis and strategies, Elite TV etc the trend is expected to continue further.

Skylander Spyro’s Adventure has also received a thumbs up from both gamers and critics. By combining games with toys, Activision is trying to explore its options in the toy industry as well. Though undermined  by the massive success of MW3 in 2011, Skylander Spyro’s Adventure did contribute its bit in Activision’s console revenues. Additionally, we also believe that this casual gaming franchise holds the potential of reviving Activision’s prospects in handheld division. Nonetheless, Activision has high hopes from the franchise and is planning a sequel for the game in fall 2012.

Solid pipeline for 2012-2013

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An impressive pipelines of  games for 2012 and 2013 is one of the primary reasons behind our bullish view on Activision Blizzard. The company plans to launch its highly anticipated PC game Diablo III on May 15th, the pre-orders of which have already topped U.S. gaming charts. Additionally, Blizzard has also tactfully linked World of  Warcraft (WoW) with Diablo III, by providing free Diablo III copies to WoW’s annual pass users in order to address declining WoW subs.

Going by the high anticipation of Diablo III and the expected launch of StarCraft II: Heart of Swarm and World of Warcraft: Mists of Pandaria in 2012, we believe 2012 can be a huge year for Blizzard Entertainment.

Understand How a Company’s Products Impact its Stock Price at Trefis

Note: For the gross profit and margins calculation, Trefis considers only product costs and online subscription costs as the company’s direct expenses.