Activision Earnings Preview

| About: Activision Blizzard, (ATVI)

Summary

ATVI's quarter was driven by COD Black Ops III and Hearthstone expansion packs as well as a successful Overwatch launch.

Estimates are aggressive, but look beatable given Overwatch's huge early success.

We remain cautious on the stock's valuation and near all-time high share price.

We are cautiously optimistic on the prospects of an earnings trade with ATVI.

Activision (NASDAQ:ATVI) reports Q2 earnings Thursday, 8/3, after the close. We are tethered by the valuation and the idea of buying into a stock near all-time highs, but we also feel the stock will report a good quarter that will top Street estimates. Additionally, the stock has a strong history of popping on good earnings. We are cautiously optimistic that shares will head a few percentage points higher in trading Friday, 8/5, and believe there is a favorable risk-reward profile for a trade heading into the ER.

The quarter was primarily driven by three things:

  • Call of Duty
  • Hearthstone
  • Overwatch

Call of Duty had lots of positive momentum in Q1 and likely carried that over to Q2 with the release of a second map pack for Black Ops III. Exiting Q1, management announced that more people were playing Black Ops III than any other game in the company's history. Roughly 85% of PS4 buyers in North America during Q1 opted for the Black Ops III bundle, and this contributed to the game setting records for follow-on digital content sales and Season Pass attach rates. The second Black Ops III expansion pack was first launched for PS4, and then later launched for Xbox One and PC. The expansion pack itself goes for $15, but can be bundled with a Season Pass for $50. This certainly added a boost to revenue for the quarter.

Hearthstone also had a lot of positive momentum in Q1. Blizzard's 23% MAU growth in the quarter was largely driven by Hearthstone, which itself saw 20% revenue growth. The game grew its user base to 50 million registered players last quarter. That growth likely continued in Q2 thanks to a third expansion pack released at the end of April, which has already seen a tremendous amount of success. Following the launch, the game set DAU and hours played records.

The biggest catalyst in the quarter was Overwatch. Management expected the game to have the biggest launch since Diablo in 2012, yet the game has hit 10 million players even more quickly than Diablo III did. In one of the biggest launches ever, Overwatch netted 7 million players in the first week. That climbed to 10 million over the first 3 weeks, or roughly 500,000 new players per day. By comparison, Diablo 3 sold 6.3 million units in its first week, and it took 1-2 months for Diablo 3 to get to 10 million players. Overwatch is growing with much quicker pace, and this points to upside to management's guide.

In Q2 of 2012 when Diablo III launched, the company topped Street expectations and grew revenue an astounding 50% YoY. The $1.05 billion the company reported in non-GAAP revenues was significantly higher than the $805 million the company guided for (31% better) and so was the $0.20 in Non-GAAP EPS (100% better). This quarter, the company is guiding for $1.38 billion in revenues while the consensus estimate stands at $1.46 billion (only 6% higher). On the EPS side, management is guiding for $0.38 while the Street stands at $0.42 (only 11% higher). From this perspective, given the magnitude of Overwatch's success coupled with COD and Hearthstone expansion packs, the estimate looks rather beatable. This is especially true considering guidance was built-in with the expectation that the Overwatch launch would be as big as the Diablo III launch, not bigger. In reality, Overwatch has grown to 10 million players much more quickly than Diablo III did.

It is also interesting to note that Electronic Arts (NASDAQ:EA) reported a solid quarter on 8/2 and the stock rallied just about 2% in response. As would be expected, ATVI and EA earnings are highly correlated. This gives us faith ATVI will report rather good numbers after the bell on 8/2. Also of note that ATVI has a rather strong history of topping earnings and the stock popping in response.

We aren't terribly attracted by the valuation of ATVI here at 19x forward earnings on 14% projected growth, but analysts do see a 5-year forward earnings CAGR of 23% and this gives us slightly more confidence in the 19x multiple. The stock is also trading near all-time highs, and this too gives us pause. Because of these reservations, we are not loading the truck with shares of ATVI, but are cautiously optimistic that the stock could provide for a profitable earnings trade.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ATVI over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.