Activision: Growth Already Built into Stock

Activision, Inc. (ATVI) reported record revenues of $1.48 million in the third quarter of fiscal 2008, up 80% year-over-year. The year-over-year growth was fueled by the success of Guitar Hero III: Legends of Rock and Call of Duty 4.

Q3 is a seasonally strong quarter for the company. Gross margin improved to 48.5% from 41.4% in Q3 2007 and 35.5% in Q2 2008. GAAP EPS was $0.86. Excluding stock-based compensation expense, EPS was $0.90 beating our and consensus estimates of $0.80. Given a year-over-year decline in total revenue in FY2009, we expect to see the company's product mix shift, with owned intellectual property and lower cost licensed property comprising a greater portion of publishing revenues.

We also expect the merger with Vivendi Games to be completed during Activision's first fiscal quarter. Going forward, management upgraded its outlook for 2008. For full year 2008, revenues are now expected around $2.65 billion, up from the earlier estimate of $2.45 billion. Excluding the impact of equity-based compensation expense, EPS is estimated to be $1.07.

For Q4, revenues are expected to come around $350 million while EPS, excluding equity-based compensation expense, is expected to be $0.04. While Activision's recent results have been impressive, we believe that favorable operating momentum exists in the coming quarters. The company's portfolio of proven franchises, success of newly-launched properties, impressive product pipeline and excellent financial condition pave the way for further growth.

However, we think the prospects are largely built into the stock at the current time, leading us to our Hold rating. The shares are trading at roughly 25.5x our revised fiscal 2008 EPS estimate of $1.07, which excludes stock option expense, and 27.8x our 2008 EPS estimate that includes stock option expense (GAAP).

Additionally, the shares are trading at about 24.8x our FY2009 earnings estimate of $1.10, which excludes stock compensation expense. Our current target price of $30 implies a P/E multiple of 28x our FY2008 EPS estimate, which is higher than the industry median but towards the lower end of ATVI's historical range. Multiples on forward operating earnings are a bit lower when the company's cash balance of nearly $1.2 billion ($3.76 per diluted share) is backed out.

Comments

[CardboardZombie]

Okay, I'm going to have to disagree with you there.
ATVI cannot be valued the same way after the merger with Blizzard.
Half the model will be a highly profitable subscription based model. Margins will actually increase as Blizzard will get a more profitable distribution deal for WOW (NCTY has it now). In addition, Starcraft II is on the horizon and it will have an even bigger following than World of Warcraft (10 million members paying $10 per month and counting)! So ATVI is merging with a company that is about to double it's huge profit margin sub base in the next two or three years. So you cannot value them the way you have been in the past. New video game giant with higher margins and higher growth. Can't use the same valuation.
Please go back and fix your EPS and valuation method.
Come back when you have a $37.50 price target.
Thank you.

[PenName Dave]

World of Warcraft... nuff said

[wengem]

Cardboard Zombie, you are way off base on the Starcraft 2/WoW comparison. Starcraft is just a multiplayer real-time strategy game and will use the existing (free) Battle.net to connect players. It is not the next WoW and you can't start charging a subscription fee for this type of game... especially when you've been giving it away for years. Compare to sales of Warcraft 3 or Command & Conquer 3 for a more accurate picture. 5-10 million copies sold and no revenue from subscriptions is more like it.