Company Name: Activision Blizzard
Ticker: ATVI
Price: $19.4
52-week range: $13.27 - $21.50
Market cap: $13.8B
Recommendation: Buy
Activision
Activision develops (through studios it owns) and publishes console games. Current portfolio includes Call of Duty, Skylanders, Amazing Spiderman etc.
I expect Activision to slightly lose its market share in a growing market.
Ø We're at the beginning of the largest ever console cycle. A rising tide lifts all boats.
o Given the pattern of previous two cycles, console software sales are estimated to grow ~10% in 2014, ~40% in 2015, and ~20% in 2016.
Ø Very limited challenge from small independent competitors
o Small studios cannot afford developing high-quality titles. One AAA title can easily cost $10+m with the cost of a top title going up to $200+m.
o People tend to buy well-known franchises or titles published by well-known companies, as price of "trial and error" is high. Freemium model doesn't work in console market, as console (with global annual sales of ~26m units) has much smaller reach than smartphone (~900m units) and PC (~300m units).
Ø Launch of Destiny this fall can potentially offset increasing competition from other big names
o EA's new game Titanfall and Disney's to-be-released Infinity 2.0 will compete head-to-head with Activision's Call of Duty and Skylanders, respectively.
o Activision's to-be-released Destiny is expected to be a billion-dollar franchise.
Overall, I expect Activision to grow its topline and earnings by 5% in 2014, 35% in 2015, and 15% in 2016.
Blizzard
Blizzard develops PC and mobile games. Current portfolio includes World of Warcraft, Hearthstone, Diablo, Starcraft etc.
World of Warcraft (WoW)
Blizzard's cash cow. Originally launched in 2004 with 4 expansion packs released so far, this title is expected to be eventually replaced by a free-to-play MMO currently under development.
Ø Future pace of decline is expected to slow down
o The trend of declining subscriber numbers was reversed in Q4 2013. This was surprising, given that it was 3~4 quarters before the release of next expansion pack and historically seasonality hasn't affected subscriber numbers.
o Developing cycle for each future expansion pack is shortened from 7 quarters to 4~5 quarters.
World of Warcraft brought in ~$800m in 2013. I expect its revenue to fall by 10% every year. This estimate translates into ~$720m in 2014, ~$650m in 2015, and ~$590m in 2016.
Hearthstone
Launched in March 2014 and the profitability of which is largely ignored by the market, Hearthstone is the first influential online adoption of collectible card game (CCG). It's free-to-play and much easier to learn than other CCGs, so it has a much larger potential audience (like League of Legends to other MOBA games). On the development side, it's easy to tweak balance and add more interesting mechanisms that traditional board games cannot achieve.
Ø DAU estimated to be 2~3m globally
o Have 10m registered accounts as of April 2014
o Forum activities ~0.1x of that of League of Legends, which has ~30m DAUs
o Currently ranked No.3 and No.10 in China and US iTunes Store Top Grossing sections respectively
Ø ARPDAU estimated to be $0.2; revenue benchmarks
o Mobile casual games like Wind Runner and Dragon Flight have ARPDAU around $0.15. Most mobile RPG card games have ARPDAU above $0.6. But given those games are pay-to-win where a single person can spend hundreds of thousands dollars, I expect Hearthstone to be in the low range.
o This is equivalent to each DAU buying 60 packs of cards (300 cards) per year, which is expected to give 3 legendary cards (the rarest cards in this game)
o On average, Yu-Gi-Oh! sold ~2b cards annually from 2006 to 2011. If we assume everyone bought the cheapest card set ($2.5 per 10 cards), then annual sales would be ~$500m.
Ø High operating margin, ~50%
o The dev team is small (~20 people, compared to ~120 behind WoW).
o No product cost, as the game is online distributed.
o Firm level operating margin is 30%. Cost of sales and product development each accounts for 20% and 13% respectively.
I expect the game to generate revenue of ~$150m in 2014, ~$300m in 2015, and ~$500m in 2016. This translates into operating income of $75m, $150m, and $250m.
Heroes of the Storm
Blizzard's take on League of Legends (MOBA). This game is currently in Alpha test and expected to be released in Q4 2014. It's hard to see the potential yet, so this doesn't factor into my valuation. If this game can be as successful as League of Legends, it can achieve $500m of annual revenue in 4 years.
Other PC games
With one expansion pack for Diablo released in Q2 and one for Starcraft to be released in Q3, revenue this year is estimated to be $700m. It's hard to predict beyond that, as no games are announced to line up for years in the future. There was no major release in 2011, but other PC games still generated $300m revenue. So for simplicity, I assume that revenue generated by other PC games stays at $400m beyond 2014.
Valuation
CY2013 financial results (amount in millions)
Revenue | Operating Income | |
Activision | 2895 | 971 |
Blizzard | 1124 | 376 |
Distribution | 323 | 8 |
Total | 4342 | 1355 |
Revenue forecast
2014 | 2015 | 2016 | |
Activision | 3040 | 4104 | 4719 |
Blizzard | 1540 | 1310 | 1450 |
Distribution | 320 | 320 | 320 |
Total | 4900 | 5734 | 6489 |
Operating income forecast
2014 | 2015 | 2016 | |
Activision | 1020 | 1376 | 1583 |
Blizzard | 529 | 500 | 581 |
Distribution | 10 | 10 | 10 |
Total | 1559 | 1886 | 2174 |
Net income/EPS forecast (with interest expense of $220m, effective tax rate of 23%, and shares outstanding of 712m)
2014 | 2015 | 2016 | |
Net Income | 1024 | 1283 | 1500 |
EPS | 1.44 | 1.80 | 2.11 |
If ATVI trades at 17.5x P/E, on par with its peer companies, then
2014 | 2015 | 2016 | |
Share Price | 25.2 | 31.5 | 36.9 |
Further Research
Ø More on Activision
Ø NetEase revenue breakdown and exposure to Blizzard
Disclosure: I am long ATVI.