Macro Tsimmis

intelligently hedged investment

Activision Blizzard (ATVI) update #21—Why do we love Activision Blizzard?

Posted by intelledgement on Sun, 02 Jan 11

Well…actually, we don’t. Or at least we try not to. Our relationship with the stocks in our Intelledgement Speculative Opportunity Portfolio (ISOP) is based mostly on enlightened mutual financial self interest.

The company originally sold shares to the public in order to raise capital; they could only be successful in this if the buyers thought the stock price was likely to go up. So the company have an interest in seeing the share value appreciate because it makes it easier for them to raise more capital in the future, if necessary, and makes the treasury stock they still own more valuable for purposes of acquisitions.

We buy (or occasionally sell short) shares of a company’s stock because we believe the value of the stock as determined by the market is—or soon will be—out of whack with the true value of the company.

Should either party decide it is not in their best interest to continue the relationship, it ends. Either we unload the position or the company “goes private,” buying back all the stock in the hands of outside shareholders (rare, but it does happen). No regrets. No emotional entanglements.

Now admittedly, we do prefer companies that are involved in interesting stuff to write about, because that is either entertaining or educational—or, preferably, both. And we do tend to root for the companies whose stock we own. But we would never buy or sell short a stock just because it was interesting, unload a position because the company was too boring, or hold on to a stock when fortune turns against it because we are “in love” with it.

Why are we talking about this now? Well a couple of months back, there was an article published about our game publishing company, Activision Blizzard (ATVI) by an ATVI skeptic, one Anders Bylund, entitled, “Why Do You Love Activision Blizzard?” The thesis of the article is that ATVI stock is unlikely to perform well going forward because the company’s growth has stalled, primarily because they have a dearth of genuinely new product and their existing franchises are—or will be—in decline.

It’s always a good idea to be familiar with the things that can go wrong for any company you invest in, so whenever someone volunteers a cogent opinion as to why some stock you own is a bad investment, it’s worth paying attention just in case he or she has some fresh insight to contribute. According to Bylund, “On a trailing-12-month basis to smooth out seasonal effects, Activision’s sales are on a 4.9% growth trajectory and earnings are rising by just 18%. That’s a serious slowdown from recent years….” And the reason for the slowdown, Bylund says, is the company’s overreliance on their franchise—that is, publishing sequels and add-ons—and a lack of fresh, innovative product: “Where’s the innovation? How is Activision changing to keep up with the times? …Check back in five years, and the new giants of the gaming industry may very well be Zynga and Rovio, with the former market leaders reduced to dinosaur status and fighting over table scraps.”

So is this criticism valid? Well starting with the bottom line, since we purchased ATVI stock for $9.12 a share exactly two years ago today, the price has appreciated to $12.44 as of the close on Friday. Figuring in the 15-cent dividend, we are up 38% or about 17% on an annualized basis. Sounds good…except that our benchmark for this portfolio is the NASDAQ index, and in the same time frame, it has appreciated from 1632.21 to 2652.87, which is an ROI of 63%…a compounded annual growth rate (CAGR) of 28%. So, so far, ATVI is not keeping up with the Joneses.

What about the sales growth falloff? When we purchased ATVI, their trailing twelve-month (TTM) sales were $3.4 billion (that is through the 30 Sep 08 quarter because results for the CY08 fourth quarter were not yet available in early January 2009). Their TTM sales now (again not counting 4Q10 because we do not have those data yet) stand at $4.6 billion. That is a two-year CAGR of 15%, which, while not spectacular, is reasonably healthy. While as Bylund pointed out, the 2010 growth was only +5%, in 2009 it was +26%.

So the key question is, how valid is Bylund’s contention that the anemic 5% sales growth in the last twelve months is likely to be the norm for ATVI going forward because they are failing to innovate and are likely to be knocked off by the likes of Farmville and Mafia Wars? And the answer is: not so much.

First of all, while the supercharged growth of Facebook has created a market for social network gaming, anyone who has played Mafia Wars knows that comparing it to World of Warcraft (WoW) is roughly akin to comparing tic-tac-toe to chess. Yes, they are both games, but someone who is looking to fill in a casual five minutes waiting for the movie to start is going to prefer the former and someone looking for an immersive gaming experience requiring more powerful hardware than a smartphone and prepared to spend an hour or more is going to prefer the latter. In other words, they appeal to different audiences with different needs and Farmville is no more likely to supplant WoW than vice versa.

As for the decline of their franchise properties, while it is true that sales of the Guitar Hero follow-ons have been very poor, there is no sign of any slackening of enthusiasm for Call of Duty or WoW. Call of Duty: Black Ops was released 9 November and generated $650 million in sales in the first five days. It bagged $1 billion in sales in the first seven weeks. Cataclysm, the latest WoW expansion module sold 3.3 million copies within the first 24 hours of its release on 7 December, a new record for a PC game. WoW now has over 12 million subscriber/players worldwide. And last July, the company revived the hoary old Starcraft real-time strategy game franchise—last previously updated in 1998—and their Starcraft II: Wings of Liberty game sold three million copies in the first two months of release.

The observation that Activision Blizzard is short on innovation is fair in the narrow sense that most of their best properties have been acquired rather than designed inhouse. But they have been innovative in their marketing. Turning a decent real time strategy (Warcraft) game into the most successful MMORPG (WoW) ever counts as innovative. Perfecting the subscription model counts. Cracking the Asian market (Starcraft in Korea and WoW in China) counts. It’s too soon to tell with Major League Gaming as to whether that will succeed or not, but Blizzard’s support of that effort counts as innovative. And how about adding zombies to Call of Duty? Do you see Zynga thinking of putting zombies in Farmville?  🙂

Let’s see how 4Q10 turns out with the release of Call of Duty: Black Ops and Cataclysm…plus a full quarter of subscription income from China, where WoW was shut down for several months in 2010 through 31 August. The decline in the growth of sales in 2010 is a legitimate matter for concern, but it is too early to hit the panic button.

Previous ATVI-related posts:

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