The Street continues to be bullish on game-makers Activision Blizzard (ATVI) and Electronics Art (EA) - with the former even receiving a "strong buy" rating. Based on my review of the fundamentals, multiples analysis, and DCF model, I find the strongest upside at Activision.
From a multiples perspective, Activision is the cheaper of the two. It trades at a respective 19.3x and 13x past and forward earnings with a dividend yield of 1.3% and fare cash flow yield of 7.3%. EA, on the other hand, trades at 15.2x forward earnings with a free cash flow yield of just 1.6%.
At the recent fourth quarter earnings call, Activision's Billionaire CEO, Bobby Kotick, noted several highlights:
2011 was another record year for Activision Blizzard. In 2011, we generated nearly $1 billion in operating cash flow. And over the last 3 years, we've generated over $3.5 billion in operating cash flow, and we've returned more than $3 billion in value to our shareholders through dividends and stock repurchases.
In the U.S. and Europe, we remain the largest and most profitable third-party interactive entertainment company and the largest and most profitable third-party interactive entertainment digital publisher. We again delivered better-than-expected financial results and achieved multiple financial and operational records, as we have for the last few years. We achieved record operating margins and record EPS, which grew more than 17% over the prior year, and as I mentioned, we generated nearly $1 billion in operating cash flow, which allows us to continue to invest thoughtfully in our future growth and return capital to our shareholders.
New franchises, such as Skylanders, may come with considerable uncertainty, but they have been by and large a success. Skylanders Giants will keep this momentum going while building off of the success of the company's legacy franchises. "Call of Duty: Modern Warfare 4" was the best-selling game ever in a single year, beating the previous record set by predecessor "Call of Duty: Black Ops." This marked the eight consecutive year that franchise grew revenue. Going forward, investors will benefit from greater clarity over the release of Starcraft and Warcraft expansion pacts, as well as "Diablo 3." Any signs of stability in subscribers over "World of Warcraft" will be a major catalyst for value creation.
Consensus estimates for Activision's EPS forecast that it will grow by 3.2% to $0.96 in 2012 and then by 14.6% and 9.1% in the following two years. Modeling a CAGR of 8.9% for EPS over the next three years and then discounting backward by a WACC of 9% yields a fair value figure of $15.32, implying 24.2% upside.
Electronic Arts had a strong second quarter with a beat in both the top and bottom line. I am particularly attracted to the company's diversification in the social video game market. "The Sims Social" has been a major success on Facebook and I expect further launches to keep the momentum going.
Consensus estimates for EA's EPS forecast that it will grow by 21.4% to $0.85 in 2012 and then by 36.5% and 31% in the following two years. Assuming a multiple of 16x and a conservative 2013 EPS of $1.13, the rough intrinsic value of the stock is $18.08, implying 3.8% upside.