Activision Blizzard: Bad PR, Good Long-Term Fundamentals

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About: Activision Blizzard, Inc. (ATVI)
by: Value Kicker
Summary

Basic corporate reorganization at Blizzard is being blown out of proportions. Activision Blizzard realizes that it needs to speed up its game development and IP creation while cutting unnecessary costs.

Upcoming pivot to mobile could unlock more revenue opportunities from existing IP.

Due to the large share price decline, the company is trading at a discount relative to its peers.

Intro

Activision Blizzard (ATVI) is one of the world's largest videogame companies. Its IP is among the most well-known and successful videogames ever created and include such hits as Call of Duty, Skylanders, World of Warcraft, Hearthstone, StarCraft, and Candy Crush Saga. Despite achieving record revenues in 2018, the company's stock has lost nearly half its value from its highs. What exactly is going on? My belief is that much of the decline has to do with the continuous bad press the company has been receiving in the gaming community and perceived management issues. In particular, the perceived "strained" relationship between Activision and Blizzard.

The Blizzard Issue - A brief history

A little bit of history is needed here to understand the context. The company primarily operates as three segments, each focused on a specific gaming niche. These segments are Activision (focusing on the mainstream market with its annual release schedule), Blizzard (more geared toward "hardcore gamers"), and King Digital (focused on mobile). Blizzard and King Digital were acquired by Activision in 2006 and 2018 respectively.

Blizzard is one of the gaming industry's pioneers having ushered classic IPs such as Warcraft, StarCraft, and Diablo in 1990s which would go on to revolutionize the gaming industry. Basically, during its time, Blizzard was the Apple (NASDAQ:AAPL) (or at least Apple during the time of Jobs) of the gaming industry in the sense that the games it produced had exceptional polish.

Blizzard has cultivated its sterling reputation over the years by putting its games ahead of its deadlines. As the founders have been quick to point out, the company is run by and comprised of gamers who have dedicated themselves first and foremost to putting out great products before they worry about sales figures and deadlines. It's an enviable mantra, and not one that many developers have the luxury of following.

Source: The History of Blizzard - IGN

Blizzard has for years operated as if it were a separate company to Activision, despite the 2007 merger between the Bobby Kotick-run company and Vivendi's video game business. Blizzard, which is famous for its development mantra, "It'll be ready when it's ready," has a reputation for releasing superb, highly-polished video games that aren't beholden to an annualized release schedule. Activision, on the other hand, releases a new Call of Duty each year.

Source: New report reveals concern within Blizzard about Activision relationship

Hardcore gamers have fond memories of the old Blizzard and still cling to the hope that the "old Blizzard" is still somewhere down there despite Activision Blizzard being a merged company for more than a decade. Given the historical backdrop, it's easy to spin or overblow any news as some sort of "corporate overlord" vs. "the artistic true gamers". But the fact of the matter is Activision Blizzard is a business first and foremost and cutting costs to refocus strategy is something that every corporation does.

Cost-cutting and pivoting: Good for the long term, Bad PR in the short term

Despite its game releases being critical darlings and loved among the hardcore fan base, Blizzard has not released that many games lately and quite frankly has failed to fully maximize the value of its IP. Activision has fewer IP (the main one being the Call of Duty series) and yet is able to maximize its value for years on end. The inefficiencies in Blizzard in the past were being masked by the wildly successful World of Warcraft series but are no longer the case given stagnating monthly active users across its titles. Out of the three business segments (Activision, Blizzard, and King), Blizzard had the lowest operating margin at 30% for 2018 and this was taking into account the highly anticipated World of Warcraft expansion Battle for Azeroth.

Source: 2018 Investor Presentation (EVENTS & PRESENTATIONS | Activision Blizzard, Inc.)

Furthermore, the fabled "Blizzard Polish" is no longer able to cut in today's gaming environment. Unlike in the past, games that are released today are already in the cutting edge of graphics and the ability to download patches makes the pursuit of perfection no longer necessary. So given the need to shake things up at Blizzard, what would be the best way to go about it? How do you develop more games without spending more money? The answer is simple, redirect headcount from non-game-development departments in particular areas like publishing, esports, QA, and IT.

Source: May 2019 Investor Presentation (EVENTS & PRESENTATIONS | Activision Blizzard, Inc.)

Activision Blizzard's secret weapon in the mobile space

After its acquisition of King Digital in 2016, I thought I would be seeing a lot of Blizzard content on mobile. However, the success of Candy Crush at the time probably led the higher-ups to let King create IP for mobile on its own for the time being. Given the lack of new blockbuster IP though (Candy Crush still remains King's highest revenue generating IP), there seems to be renewed interest in pushing other Activision Blizzard IP into the mobile space. The first of which is Call of Duty Mobile and although this game is being developed by Tencent (OTCPK:TCEHY), you can be sure Activision Blizzard will be using the same monetization techniques it has learned from its King assets namely effectively using microtransactions and advertising. I suspect more mobile games from other Activision Blizzard properties may be coming soon. Given the size of the mobile games market, this is a tremendous opportunity for Activision Blizzard. A lot of the gaming press seems to be focused on the Blizzard side of the business due to the bias I've mentioned previously; however, King actually made up for slightly less than a third of the company's total 2018 revenue ($2 billion in revenue vs. Blizzard's $2.2 billion and Activision's $2.4 billion) and shows no sign of slowing down in 2019. So, despite all the protests from the hardcore gamers, this is a smart move for the company. At this point, the company should probably rename itself to Activision Blizzard King.

Source: Blizzcon - Diablo Immortal Q&A - is a late April Fool's joke?

Valuation and Conclusion

Synergy can be defined as the whole being worth more than a sum of its parts. For the longest time, Activision Blizzard has operated as three distinct entities, therefore, failing to maximize the synergies in its business. This is starting to change as the Activision side of the business is starting to impose financial discipline on the Blizzard side of the business and leverage more its company-wide experience and expertise (as evidenced by the Activision leveraging Blizzard's existing Overwatch League to build a Call of Duty League and King developing a Call of Duty game for mobile).

The company is currently undergoing some internal reorganization in order to align its strategy for the future. An overly passionate fan base is blowing mundane corporate news out of proportion. The bad news that is affecting the company is nothing out of the ordinary for a large corporation. In terms of valuation, the company is trading at a P/E of 20.3 which is lower than its peers in the gaming industry. In my view, the company should be trading closer to 25 P/E. Using the 2019 EPS of 2.16, this would imply a value of 54 and an upside of 16% from current prices.

Source: P/E comparison with peers

A premium for Activision Blizzard is well-deserved as the company has a loyal and dedicated fan base for all three operating segments (in particular Call of duty, Blizzard, and Candy Crush) ensuring it will have a base level of recurring revenue for years to come. For long-term investors, the shift in strategic direction at the company to focus on mobile and the implementation of cost-cutting measures should be viewed as a positive. The bad press is just temporary.

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.

Additional disclosure: Caveat emptor! (Buyer beware.) Please do your own proper due diligence on any stock directly or indirectly mentioned in this article. You probably should seek advice from a broker or financial adviser before making any investment decisions. I don't know you or your specific circumstances, therefore, your tolerance and suitability to take risk may differ. This article should be considered general information, and not relied on as a formal investment recommendation.