Another Blowout Quarter For Activision Blizzard

Apr.29.14 | About: Activision Blizzard, (ATVI)


Hearthstone revenue could already be 1/3 of World of Warcraft's.

Destiny is likely to be this holiday's game of the year.

Exciting new games in the pipeline beyond 2014.

ATVI will report Q1 earnings after the bell on May 6th. The last time I wrote about Activision Blizzard was in November of 2012. World of Warcraft was the biggest subscription-based MMO in the world, with over 9 million subscribers, and the Call of Duty series was consistently the best-selling game year after year on all consoles. After being range-bound between $10 and $12 since the financial crisis, Activision finally broke out of its shell and has gone on to nearly double since then. With the perpetual concern over World of Warcraft's declining subscribers and the proliferation of the Free-to-Play model, how much longer can Activision Blizzard continue to be the top dog in the video game industry?

Blizzard has certainly been busy this year, putting out two major titles in the first quarter alone. Diablo III: Reaper of Souls, the game's first expansion pack, was released on March 25th and sold 2.7 million copies in its first week. Speaking as someone who has put over 20 hours into the expansion, it really is a great improvement over the original. Blizzard truly listened to player criticism and addressed most, if not all, the gripes players had with the current meta game. It took them long enough, but the end-game finally feels rewarding. I spent over 100 hours playing the original Diablo III and only got 1 legendary item in that entire time. With the new Loot 2.0 system introduced in this expansion, I've gotten over 10 in about 2 weeks of play. For non-gamers, this means players now get a greater sense of accomplishment from every session of play, compared to the tireless grind of the old system.

Alright, so Diablo sold well, but they removed the real-money auction house, meaning there's no longer any reoccurring revenue from the game. What is Activision Blizzard going to do from now until they launch Destiny and the newest Call of Duty in the fall? What's going to be their money maker in this upcoming report and also for Q3? The answer has become very clear over the past 3 months. It's going to be their Free-To-Play surprise smash hit, Hearthstone.

Hearthstone is a fast-paced strategy card game that's easy to learn and massively fun to play. It had been in beta for many months before officially launching on PC and Mac on March 11th. The game launched on iPad April 16th, and went on to be the top free game on its first day. First, let me give a little disclaimer. I've been a Blizzard fan for many years, and I've been playing this game every day since I picked it up. At this point, hundreds of hours have spent playing. I've actually stopped playing Diablo and now currently play Hearthstone as my only game.

Blizzard announced before the iPad launch that the game already had over 10 million accounts. This is a massive number that cannot be overlooked. World of Warcraft currently has about 8 million subscribers paying $15/month. I've spent a surprising amount on microtransactions in Hearthstone this quarter, especially the first few weeks I got into the beta. It's possible to play completely for free, using in-game Gold to buy new packs of cards and also to enter a tournament style of play Blizzard has dubbed "Arena". Some of my friends strictly do all their Arena runs and pack buying with Gold they've earned from quests, but many quickly end up dishing out the $1.99/per run to play a second, third, and sometimes fourth Arena run of the night. The deals on buying packs wholesale are a bit pricey, but not out of the question. I expect Blizzard to have pulled in an average of $3-4/month per player in Q1.

Based on my own play, this is actually a conservative estimate. With the immediate success on iPad and launch on smartphones due out in the fall, Hearthstone is likely to be the key focus of a blowout May 6th report. Q2 guidance will likely be raised due to unexpected demand from Hearthstone. Q3 will be relatively quiet, unless Blizzard decides to release the latest World of Warcraft expansion, Warlords of Draenor, earlier than most expect.

The World of Warcraft naysayers have been predicting the death of the game since shortly after it came out in 2004. It's still the biggest paid MMO nearly 10 years after its launch, and new content is added every other year. Similarly, Call of Duty has been the best-selling console game for 5 years in a row, despite the continuous claims that each new version offers nothing new.

Activision recently announced a new three-year development cycle for upcoming Call of Duty games, starting with this year's release. Each of the three studios now making the Call of Duty games will take three years to develop their installment (there were 2 studios before this), giving designers more time to innovate for each title. It will also give the content creators for each team more time to focus on DLC and micro-DLC, which have been large and high-margin opportunities and significant engagement drivers. This year's installment will be the first since the new consoles have launched, so I expect demand to still be high.

Between MSFT Xbox One and SNE PS4, over 12 million new consoles have been sold since November, silencing all the analysts who predicted last year that the video game industry was dying. It's very possible that this year's Call of Duty won't break the record (for the 3rd time in a row) for fastest-selling entertainment property like Black Ops II did in 2013 ($1 billion in sales in 3 days). I don't attribute this slowdown to less demand, but rather to competition. This competition won't be coming from EA's new Battlefield game or any other company's game, but rather from Destiny, Activision's first new IP in many years.

Destiny is a next-generation first-person shooter created by the makers of the esteemed Halo series, Bungie. After their contract ended with Microsoft in 2010, Bungie signed a 10-year contract to make games for Activision. Destiny has a huge open world similar to World of Warcraft, but is a first-person shooter like Call of Duty. After being a smash hit at last year's E3, you can bet to see a lot more in-depth game-play at this year's E3 in June. Running home to play Halo was one of my fondest memories as a middle schooler, and I don't expect anything less than amazing from Bungie's first release in 4 years. Activision CEO, Bobby Kotick expects it to be the biggest new IP launch of all time.

The company has finally bought themselves out of their Vivendi ownership, and Xbox One and PS4 are off to a fantastic start. Looking beyond 2014, there is still a lot to be excited about. Heroes of the Storm, which will also likely be shown off in more detail at E3, is Blizzard first attempt in the MOBA category. Initial reviews have been mixed, but with no launch date yet, Blizzard has a lot of time to refine the game if it hopes to compete with the likes of League of Legends in that space. Probably Activision's biggest trump card of all, Titan, has still yet to be officially announced. There have been rumors swirling around in the gaming community for years about exactly what Titan is and when it will be announced. While I don't expect any official information anytime soon, this IP has clearly been a huge ongoing project for Activision, and has had major R&D spent on it over the years. Don't price in to your 2015 expectations, but definitely keep your eye out at next year's BlizzCon for some concrete info on the development process and where it stands.

Activision Blizzard has an exciting and jam-packed rest of 2014 ahead of it. The company has successfully broken into the Free-to-Play category with Hearthstone, and will do it a second time within the next year with Heroes of the Storm. World of Warcraft subscribers could be down this quarter with Hearthstone out, and because we are a few months away from a new expansion. Historically, subscribers decline a few months before a new expansion and then get a significant boost when it's released. Call of Duty will do great again this holiday, but maybe not record-breaking. The slack will be more than compensated by Destiny. I expect this Q4 to eclipse Q4 of 2013 and for 2014 to be a record-breaking year for Activision Blizzard.

Disclosure: The author is long ATVI. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long ATVI January 2016 Calls