The Activision-Blizzard (ATVI) bears continually talk down the company’s strengths. This time last year the discussion focused on how it would be impossible for the company to top their industry leading, megahit, "Call of Duty: Black Ops." These bears said the "Call of Duty" franchise was getting stale. However, this year’s installment, "Call of Duty: Modern Warfare 3," easily accomplished the apparently impossible. The success highlights Activision’s somewhat simple, unsexy strategy of creating new, quality content for existing flagship titles.
The New Attack
Because of Modern Warfare 3’s success, this year the negative talk was forced to shift and began focusing on a decline in Activision’s other best seller, World of Warcraft. Early last year, following the launch of World of Warcraft’s latest expansion pack, active game users reached a peak at12 million. During the last three quarters usage declined to just north of 10 million. This is not the sharp, early decline one often sees from Activision’s competitor Zynga’s (ZNGA) games, but it is still troubling. Over the past couple of months the bears have emphasized the decline and linked Activision’s fortunes with the coming end of World of Warcraft’s dominance. Interestingly, this theory has driven Activision’s stock down 15% during the time Modern Warfare 3 sat atop all sales charts.
Adding fuel to the bears’ fire, Activision’s chief competitor Electronic Arts (EA) is trying to break into World of Warcraft’s territory with the recent launch of Star Wars: The Old Republic. We have seen EA have success in launching games in genres where Activision dominates. However, their success does not seem to dampen the sales at Activision. The best example of the phenomenon is EA’s Battlefield franchise. While Battlefield is strikingly similar to Call of Duty, both franchises have seen strong growth. The competition between EA and Activision is obviously not a zero sum game. We may see a similar dynamic develop between World of Warcraft and Star Wars: The Old Republic.
Just as the detractors wrongly attacked Activision last year, this year’s attack is misguided as well. To understand the mistake, it is necessary to understand the ongoing success of World of Warcraft and have more nuanced knowledge of its structure and life cycle. The game is the most successfully monetized title in the history of its genre. For an unprecedented seven years, through three expansion packs, it dominated the online, role-playing segment. Even its detractors don’t believe it will be overtaken anytime soon. The game continues to have the largest paying player base in the industry. As with Call of Duty above, the company has set an impossibly high standard and it seems the Activision stock is a victim of its own company’s past successes.
Content Drives Usage
World of Warcraft has a more complicated structure and life cycle than the average game. High profit Western users pay for the game and its expansions upfront and through a continued subscription. Low margin Eastern users purchase time cards and pay thorough micro-transactions. As new content is released it is consumed by users, a portion of which then lapse in their usage or subscription. New content is released primarily with expansion packs but also throughout the year following the expansion with a small number of major patches that extend the storyline of the most recent pack. Adding to this complexity is the fact that all geographies do not get expansions and their subsequent patches at the same time. It is unfair to ask Activision to maintain ongoing usage or subscription for every user in this dynamic atmosphere in an aging title. Users spike following these content releases as content is consumed by lapsed players. In fact, this is the purpose of the new content.
During its last conference call Activision gave the latest, lower user number stating the majority of decline had come from the East. A few weeks later, their Chinese distribution partner NetEase (NTES) reported high revenue for the quarter from World of Warcraft. Reconciling this discrepancy is a key to understanding what is at play with the user numbers. One theory relates to the timing of content. The latest expansion pack was not released in China until early July. A number of users consumed the new expansion in July and August (creating profits for NetEase) but lapsed by quarter end in September.
Will we see 12 million users again following the release of the fourth expansion set? One does not have to wait until that time to test the “content drives usage” theory. Both the Western and Eastern audiences saw a major patch release in December. Additionally, there was geographic expansion to Brazil bringing content to a larger base. These content expansions coupled with a strengthened marketing and promotional plan should abate user loss in the recent quarter. Of particular importance to the marketing plan is the inclusion of the Diablo III game to those who commit to a year long World of Warcraft subscription. Once more, Activision increases content to create and maintain usage.
On the February conference call we will justifiably hear a lot about the success of Modern Warfare 3 along with other successes and future projects. However, the bears are planning to shift the focus onto the user number for World of Warcraft. These bears are looking for another three quarter million loss in users. However, a small loss or rising number would be a big surprise to the analyst and commentator community and allow the success of the latest Call of Duty along with the strong pipeline to be fully appreciated in the stock price.
Shareholders can not expect World of Warcraft’s dominance to last forever. However, the situation is not as bad as the bears purport. Because of the strength of its content, the franchise will continue to provide hundreds of millions of dollars in bottom line profits each year. Shareholders rest comfortably knowing the same teams that created the content for World of Warcraft are at work on other existing and new intellectual properties.