Activision Blizzard, Inc., (ATVI) CEO Hosts Activision Blizzard Transaction Conference (Transcript)

Jul.26.13 | About: Activision Blizzard, (ATVI)

Activision Blizzard, Inc. (NASDAQ:ATVI)

Activision Blizzard Transaction Conference

July 26, 2013 8:30 am ET

Executives

Kristin Mulvihill Southey - Former Vice President of Investor Relations

Robert A. Kotick - Chief Executive Officer, President and Director

Dennis Durkin - Chief Financial Officer

Analysts

Brian J. Pitz - Jefferies LLC, Research Division

Colin A. Sebastian - Robert W. Baird & Co. Incorporated, Research Division

Edward S. Williams - BMO Capital Markets U.S.

Douglas Creutz - Cowen and Company, LLC, Research Division

Eric O. Handler - MKM Partners LLC, Research Division

A. Justin Post - BofA Merrill Lynch, Research Division

Arvind Bhatia - Sterne Agee & Leach Inc., Research Division

Operator

Good morning, and welcome to the Activision Blizzard Announcement Conference Call. I'd now like to turn the call over to Kristin Southey, SVP and IR and Treasury. Please go ahead.

Kristin Mulvihill Southey

Good morning, and thank you, everyone, for joining us today for the Activision Blizzard Transaction Conference Call. With me today are Bobby Kotick, CEO of Activision Blizzard; Thomas Tippl, COO of Activision Blizzard; Dennis Durkin, CFO of Activision Blizzard; and Chris Walther, Chief Legal Officer of Activision Blizzard.

I would like to remind everyone that during this call, we will be making statements that are not historical facts. These are forward-looking statements that are based on current expectations and assumptions that are subject to risks and uncertainties. As indicated on the slide that is showing, a number of important factors could cause the company's actual future results and other future circumstances to differ materially from those expressed in any forward-looking statements.

Such factors include, without limitations, sales levels; current macroeconomic conditions; increasing concentration of titles; consumer spending trends; our ability to predict consumer preferences, including interest and specific genres and preferences among competing hardware platforms; maintenance of key relationships, including the ability to attract, retain and develop key personnel in developing high-quality titles; the seasonal and cyclical nature of our industry; changing business models, including digital delivery of content competition; the possible declines in prices; product returns; price protection; product delays; adoption rate and availability of new hardware, particularly during the expected console transition; rapid changes in technology and industry standards; the current regulatory environment; litigation and associated costs; protection of proprietary rights; counterparty risks; economic, financial and political conditions and policies; foreign exchange and tax rates; capital market risk; potential changes associated with geographic expansion; the possibility that expected benefits related to the transactions to be discussed may not materialize as expected, and those transactions not being timely completed, if completed at all.

These important factors and other factors that potentially could affect the company's financial results are described in the company's most recent Annual Report on Form 10-K as amended, and in the company's other SEC filings. The company may change its intentions, beliefs or expectations made at any time and without notice, based upon any changes in such factors in the company's assumptions or otherwise.

The forward-looking statements in this presentation are based on information available to the company as of the date of this presentation and while we believe them to be true, may ultimately be prove to be incorrect. The company undertakes no obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after today, July 26, 2013, or to reflect the occurrence of anticipated events. You can find additional information about the transactions to be discussed in the company's Form 8-K filed earlier today, with the SEC.

And now, I would like to introduce our CEO, Bobby Kotick.

Robert A. Kotick

Thank you, Kristin, and thank you, all, for joining us today.

As you saw in last night's press release, Activision Blizzard is announcing a very exciting transaction that represents a tremendous opportunity for the company and its shareholders.

Activision Blizzard will acquire approximately 429 million shares and certain tax attributes from Vivendi in exchange for $5.8 billion in cash, approximately $13.60 a share before taking into account the benefit to the company of these tax attributes.

Separately, in a simultaneous transaction, an investor group led by Brian Kelly and me will acquire approximately 172 million shares from Vivendi for $2.3 billion in cash or approximately $13.60 per share. Brian and I are personally investing a combined $100 million to purchase company's shares from Vivendi through our investor group.

Activision Blizzard share repurchase from Vivendi will reduce the outstanding share count to approximately 690 million shares. This will be meaningfully accretive to Activision Blizzard's shareholders. Following completion of the transaction, Vivendi's stake in the company will be reduced to approximately 12%. And the investor group will hold approximately 24.9% of the company's outstanding shares, which leaves the majority of shares with public shareholders. We expect to emerge from this transaction even stronger than we are today, an independent company with a best-in-class franchise portfolio, and the focus and flexibility to drive long-term shareholder value and expand our leadership position as one of the world's most important entertainment companies.

We expect significant EPS accretion, as much as 29% on a GAAP basis and 33% on a non-GAAP basis in 2013.

In addition with our new capital structure, we expect to have a lower weighted average cost to capital, and we believe we can nearly double our return on equity to more than 20% for our shareholders. It also leaves the company with a significant cash on hand to preserve our financial stability.

5 years ago, we made one of the best decisions in our company's history when we joined forces with Blizzard Entertainment. By bringing Activision and Blizzard together, we united in one company, some of the best creative and business talent in the industry and some of the most important entertainment franchises in the world, including Call of Duty and World of Warcraft. Since that time, we've continued to reach new levels of success by delivering new games like Sky Landers and Diablo III. We also look forward to launching Destiny.

Also, over that time, we generated over $5.4 billion in operating cash flow and returned more than $4 billion of net cash to shareholders through buybacks and dividends. We're very grateful for Vivendi's partnership through this period, and we look forward to their continued support.

The personal investments of over $100 million combined that Brian and I are announcing today are a reflection of our lasting commitment and confidence in the future of Activision Blizzard and our industry. In addition to Brian Kelly and me, the investor group includes Davis Advisors, Leonard Green & Partners, Tencent, and one of the largest global institutional investors. We couldn't be more excited about this transaction, which provides significant benefits to shareholders and positions us well to lead the next era of entertainment.

Now I'll turn the call over to our CFO, Dennis Durkin, who will review the financial details, and then take you through our preliminary Q2 results and updated financial outlook. Dennis?

Dennis Durkin

Thanks, Bobby, and good morning, everyone.

I will start by providing perspective on the transaction, give you an update on our Q2 operating performance and calendar year outlook, and then open the line for your questions.

Today's transaction, which has been unanimously approved by the special committee of the Board of Directors for Activision Blizzard, as well as the company's overall board, is expected to close by the end of September 2013, subject to certain customary closing conditions.

Under the terms of the transaction, Activision Blizzard will repurchase from Vivendi 429 million company shares or approximately 38% of our current shares outstanding for $5.8 billion. The $13.60 per share purchase price represents a 10% discount to the closing price of our stock yesterday, before taking into account the future benefits from certain tax attributes acquired as part of the transaction.

Simultaneously and separately, an investor group led by Bobby and Brian will acquire 172 million shares of Activision Blizzard directly from Vivendi for $2.3 billion in cash. The investor group will own approximately 24.9% of the company's outstanding shares. Vivendi will retain 83 million shares or approximately 12% of outstanding Activision Blizzard shares post transaction.

Following the transaction, Activision Blizzard will have approximately 690 million shares outstanding, 63% of which will be owned by public shareholders.

Activision Blizzard will fund the acquisition, including estimated transaction fees and upfront interest, with approximately $1.2 billion of cash and $4.75 billion of newly issued debt. In addition, we also expect to establish a $250 million revolving credit facility. We have already received committed financing for the transaction from Bank of America Merrill Lynch and JPMorgan.

Following the transaction, Activision Blizzard will have a new capital structure, which reduces our weighted average cost of capital and nearly doubles our return on equity.

From a balance sheet perspective, as of June 30, we had $4.55 billion in cash and investments, and no debt. We expect to receive approximately $4.6 billion in net cash from our financing after estimated transaction fees and upfront costs. On closing, we expect to pay Vivendi approximately $5.83 billion for their shares, which would leave us with more than $3 billion in cash on hand, most of which is foreign, and all of which helps secure our future financial stability.

Going forward, we are confident that our free cash flow generation will support the debt we are taking on, while also allowing us the flexibility to continue to invest in our business and drive value for our shareholders over time.

Now let's take a quick look at our preliminary Q2 operating results. Note that as is customary, we will be hosting our regularly scheduled second quarter earnings call next Thursday, August 1, after the market closes.

For the second quarter ending June 30, we expect GAAP net revenue of approximately $1.05 billion and non-GAAP net revenue of $608 million, with GAAP earnings per diluted share of approximately $0.28 and non-GAAP earnings per share of $0.08, all of which were above our prior outlook.

For the quarter, Activision Blizzard was the #1 independent publisher in North America and Europe combined, including accessory packs and figures. We also had the #1 and #2 best-selling titles year-to-date, Skylanders Giants and Call of Duty: Black Ops II. Additionally, Blizzard Entertainment's World of Warcraft remained the world's #1 subscription-based MMORPG ending the quarter with approximately 7.7 million subscribers.

Now let's turn to our outlook. For GAAP, in light of our Q2 performance, we are increasing our full year 2013 GAAP outlook. For the calendar year, we now expect GAAP net revenues of approximately $4.31 billion as compared to our previous outlook of $4.22 billion, and GAAP earnings per diluted share of $0.77 as compared with our previous outlook of $0.73 per diluted share.

For non-GAAP, we are also reaffirming our calendar year outlook of $4.25 billion in net revenues and EPS of $0.82 per diluted share. These calendar year EPS numbers do not yet take into account the substantial future accretion that will take place after the closing of the transaction.

On a pro forma GAAP basis for the full year 2013, EPS accretion would be 18% to 29%, increasing our $0.77 EPS to a range of $0.91 to $0.99. On a non-GAAP pro forma basis, EPS accretion would be 23% to 33%, with EPS increasing from $0.82 to a range of $1.01 to $1.09. For both GAAP and non-GAAP, the EPS is based on a fully diluted share count of about 725 million shares for the year.

The significant accretion reflects the 38% reduction in shares outstanding at closing, partially offset by approximately $150 million to $225 million in incremental after-tax interest expense associated with a debt we will take on. Note that these numbers are only pro forma and meant to give you some visibility into the impact have you been operating under our capital structure for all of 2013.

Keep in mind that our actual reported full year numbers will reflect lower accretion given that there will be only 1 quarter of lower share count in interest costs.

In closing, as a result of this important transaction, Activision Blizzard will emerge a stronger independent company. This transaction will provide significant EPS accretion for shareholders, a lower weighted average cost of capital and a near doubling of return on equity.

Following the transaction, Activision Blizzard will have a cash on hand of over $3 billion, plus we expect to continue to generate cash flows that can support our debt, while continuing to invest in our growth. All of this positions us well to continue delivering great games and superior shareholder returns over the long term.

Kristin, I'll pass it back to you.

Kristin Mulvihill Southey

Great. Thanks, Dennis. As a reminder, we have only published our preliminary results and we'll be holding an Earnings Conference Call on August 1, so our time is limited. So let's focus your questions on the transaction we just announced. With that, we'll open it up for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Brian Pitz from Jefferies.

Brian J. Pitz - Jefferies LLC, Research Division

I'd love to see the accretion. Maybe just some thoughts. You said you've mentioned about $3 billion in cash left over. Thoughts on that? Should we look for investment opportunities overseas? How should we think about your use of that cash going forward? And then just quickly on the outlook. The past quarter, previously, it seemed like you'd be getting incrementally more negative on the end of the year. Can you just talk about, from previous quarter to now, has your view stabilized into the console transition at the end of the year?

Robert A. Kotick

Sure. Thanks at lot, Brian. I'll maybe talk to the second question first and then come back your cash question. Relative to outlook, I think we talked about starting last November about how console transition years are often very unpredictable years. And this year is proving that out in terms of a lot of new information coming out about the new console and work. As excited as ever about the new consoles that are coming out, but the reality is they're not in market yet. And timing and quantity of those is still somewhat uncertain. And the back half of the year, as you've seen, is very, very competitive. So I think the combination of that were $0.25 into our year of $0.82. And it just makes sense for us to be very prudent as it relates to the back half. And so I think as it relates -- it's bullish as we've ever been about the opportunity long-term, but also very transparent about the short-term risks and choppiness that we see in the day-to-day market. Relative to our cash position and international cash, we're obviously very focused on preserving our cash flow and driving cash flow over the long term. As Bobby mentioned in his remarks, we've generated over $5.4 billion of cash over the last 5 years, over $1 billion on average per year. And we're going to continue focusing on doing that now inside of our new capital structure. We've had in the past about 35% to 45% of our cash flow has been domestic, and that will be used to service the domestic debt that we'll be raising. So thanks, Brian.

Operator

The next question we have comes from the line of Colin Sebastian who's from Robert Baird & Company.

Colin A. Sebastian - Robert W. Baird & Co. Incorporated, Research Division

Great. I guess first off, Bobby, with the new-found independence of Activision, are there any specific corporate or product strategic initiatives that you're now free to pursue that perhaps were not viable options before this deal consummates? And then secondly, can you talk a little bit about Tencent's role in the deal, if they gain a board's seat or have any other influence beyond just be the passive shareholder or perhaps even in any relationship related to development distribution of further titles?

Robert A. Kotick

So I would say, for starters, Tom, remember, of the 22 years I've been doing this, 17 of them were as an independent public company. But I think the importance of this transaction is that, it gives us the opportunity to really reward our public shareholders. And you'll see that in the accretion, you'll see that in the financial flexibility. And that obviously will mean because we don't have somebody that is focused on returning a minority control stake that we have more flexibility for future acquisition opportunities to accept, if there were any. As far as Tencent, I think their investment just confirms the enthusiasm that we have in our partnership for Call of Duty in China. And they do not have a board seat. They're a passive investor and I think it was largely as a result of the enthusiasm for what we're doing together.

Operator

The next question we have comes from the line of Edward Williams who's from BMO Capital Markets.

Edward S. Williams - BMO Capital Markets U.S.

Just a couple of quick questions. Can you give us a sense as to what your ideal debt level is? If you're comfortable with this level or if you're looking to pay down debt? Or as you start to generate more cash, how that cash may end up being deployed? And then also, can you give us a sense as to how you determined the price?

Dennis Durkin

Sure. Thanks Colin -- or sorry, thanks, Ed. Relative to debt levels you have to be very comfortable with the debt levels in this transaction relative to kind of our EBITDA and our cash flow generation, and then our domestic cash flow generation, most importantly. Over time, like all capital allocation and capital structure decisions, our board will evaluate the right mix of that relative to our future operating plans and future operating needs. And then...

Robert A. Kotick

One thing I would add about that, Ed, is we still have very significant cash balances even after going out and raising the debt capital that we're raising.

Dennis Durkin

That's right. And there's a question on price, Bobby.

Robert A. Kotick

So what was the question?

Unknown Executive

How did you arrive at the price?

Robert A. Kotick

Well, we had an independent special committee that negotiated the price directly with Vivendi.

Operator

The next question we have comes from the line of Doug Creutz.

Douglas Creutz - Cowen and Company, LLC, Research Division

I wonder if you could just discuss how the composition of the board my change? And what, if any, role ASAC might have in the new Board of Directors?

Robert A. Kotick

The director process will be exactly as it was prior to the merger though. There's a nominating governance committee that will nominate independent directors. ASAC doesn't have any rights to nominate board members. Brian and I are representing the ASAC investments on the board. And so it'll be consistent with what we've done historically with independent, strong-minded board members who have a lot to contribute.

Operator

The next question we have comes from the line of Eric Handler, and he's from MKM Partners.

Eric O. Handler - MKM Partners LLC, Research Division

Two for you. First, are there any rights of first or second refusal held by Activision in the event that one of the members of ASAC decides to sell their shares? And then secondly, do you foresee that there'll be any restricted covenants and debt agreement that would prevent you guys from repurchasing shares in the open market or paying a dividend going forward?

Unknown Executive

With regard to the question about whether there are any rights of the company to negotiate or to have a right of first refusal for ASAC shares, the answer to that question is no, there are no such rights.

Dennis Durkin

And with regard to your second question on restricted covenants in the package, in our financing package, we're going to be working to optimize that package with our banking partners to develop the right marketing story relative to marketing that debt, and at this point, we don't have any sort of guidance or details to share relative to that.

Operator

The next question comes from the line of Justin Post and he's from Merrill Lynch.

A. Justin Post - BofA Merrill Lynch, Research Division

Just one follow-up. The $150 million to $225 million after-tax interest expense, could you just give us the tax rate you used in that calculation? And roughly what interest rate range does that contemplate on the debt?

Dennis Durkin

Yes, thanks, Justin. Yes. On the $150 million to $225 million, it's roughly 36% rate here in the U.S. It's what our expectation is. And on the cost of capital for that, it's probably in the 5% to 7% range, and we'll see where we are relative to the market terms. Ideally, we'd like to end up on the lower end of that range but market conditions will determine where we finally price that.

Operator

And the next question we have comes from the line of Arvind Bhatia from Sterne Agee.

Arvind Bhatia - Sterne Agee & Leach Inc., Research Division

My question is, Dennis and Bobby, you mentioned the tax attributes in your prepared remarks. Can you go into that a little bit more how that might be incrementally accretive?

Dennis Durkin

Sure. Thanks, Arvind. So yes, just to clarify, we bought essentially Vivendi's U.S. holding company, which inside of that holding company owned about 429 million of our shares, as well as net operating losses from previous activities inside that entity, including Vivendi Games. And so the tax attributes inside that are primarily net operating loss carryforwards. And they're also accompanied by a few hundred million -- $200 million-related indemnity for those -- from Vivendi. So over the next 4 to 5 years, we expect to realize the cash benefit of this. And you know, the way to think about it is it's roughly $200 million of net after-tax opportunity from the transaction from these tax benefits or approximately $0.43 for each of the 429 million shares we're buying back. And we'll be giving more guidance in the future about how that might flow through our P&L. But at this time, our tax rate guidance remains unchanged at 27% for 2013. So thanks, Arvind.

Operator

Thank you. That was the last question. I would like to turn the call over back to Kristin Southey for closing remarks. Thank you.

Kristin Mulvihill Southey

Well, thank you, everyone. On behalf of everyone in Activision Blizzard, we want to thank you for your time and consideration, and we look forward to speaking to you next Thursday on our traditional earnings call. Have a great day.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect, and enjoy the rest of your day.

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