Larry Busacca/Getty Images Entertainment
This article was co-produced with Wolf Report.
On November 20, I published “Activision Blizzard: Is It Time to Get Greedy When Others Are Fearful?”
Co-produced with Dividend Sensei, it featured his bullish analysis of the company and my more cautious interpretation. For my part, I wrote:
“… I just began to keep a checklist on top of all the analysis I’m used to doing. That’s thanks to Guy Spier [author of The Education of a Value Investor], who wrote:
“‘Before pulling the trigger on any investment, I pull out the checklist… to see what I may be missing.’
“One of the items on my own checklist is now, like Spier, to see if anyone in management has a ‘difficult personal experience that might radically affect’ his or her ‘ability to act’ in shareholders’ best interest.”
As many of you know, Activision Blizzard (NASDAQ:ATVI) CEO Robert Kotick is going through some “stuff.” Namely, pressure to step down amidst accusations of a sexual harassment-filled corporate culture.
As such, I just wasn’t “willing to invest capital until I” saw “how the discrimination allegations [will] impact its C-suite members’ decision-making processes.
But some of the 46 total comments disagreed, like Marcelito, who said, “It’s most definitely a buy opportunity. All the commotion will pass, but you will see Q4 sales will be stunning.”
And Trade in Mexico agreed with, “The drop in ATVI is a huge buy [opportunity].”
As such, while I remain “out” on Activision Blizzard, I’m letting Wolf Report add a third take. I hope you enjoy.
We May Be Looking at Overreaction Territory
Wolf Report’s take is in between Dividend Sensei’s and mine.
After writing “Activision Is Not Cheap” on November 16, he now says:
“I certainly did not expect that I would update my thesis and write a new article on [it] as quickly as this. However, the market dictates what I write about and what's investable – not so much my desires and wishes for what ‘should’ be appealing.”
Like me, he got a not-unexpected amount of commentary. And we both can point to short-term “proof” that our concerns are "validated" thanks to Activision’s continuing price decline since writing what we wrote.
(Source: Seeking Alpha, ATVI article)
But we both know a few weeks’ worth of market movement is irrelevant. In this case, we could easily blame the slide on the Omicron variant or recent Fed statements.
Regardless, Omicron isn't as long-term relevant for Activision’s health as other factors. So let's look at recent Seeking Alpha news stories published in the past half month or so, such as:
- Activision, board stick up for CEO; employees walking out in protest
- Activision Blizzard drops another 3% as analysts weigh CEO's fate
- Activision stock downgraded by JPMorgan on misconduct overhang
- Microsoft's Xbox chief 'evaluating' ties to Activision in swelling scandal
- Activision CEO would consider stepping down if issues are not fixed quickly
- Activision Blizzard dips 2% as more analysts absorb CEO controversy
- Nintendo exec weighs in on Activision Blizzard controversy
For his part, that makes Wolf Report somewhat skeptical:
“While none of the fundamentally overhanging risks and things I mentioned in my first article have changed – and I consider them to be absolutely relevant here – it would be unfair in the extreme to not point out that we're starting to look at overreaction territory.”
So let’s look further into its current share-price condition.
Evaluating Activision Blizzard’s Valuation
Here’s more of Wolf Report’s opinion:
“While no one could have predicted Omicron or the utter barrage of negative news against ATVI here, what does withstand the test of these weeks and these arguments is my [original stance] where I said that ATVI is not cheap.”
He adds that, less than two weeks ago, it was trading at an 18x weighted price-to-earnings (P/E) ratio.
(Source: FAST Graphs, November 15)
However, he goes on to say, the situation has changed. At last check, “Activision has dropped below a 15.5x P/E and is now trading at a price of around $57 per share.”
He doesn’t like investing in gaming companies as a general rule. But he will be crystal-clear here and say that he believes this one looks like it’s trading at fair value. Maybe even an undervalued price point.
ATVI is set to grow earnings at around 9%-10% on average per year going forward, after all. And the company very rarely misses its forecasts.
As such, the single absolute deal-breaking uncertainty holding him back (i.e., its valuation) has now subsided.
“At 17x-19x P/E, we had to consider… the likelihood of volatility sending the company down below 15x, as it’s done before. Trading at 15x P/E or close to it though, that risk is now [lessened]…”
Like me, he knows the current scandal’s fallout could continue. “And it's clear that it could cost Activision business as well as result in some brand tarnishing.”
Yet the company's earnings ability remains impressive.
At current valuations, you're looking at conservative forward 15x P/E multiple returns of almost 8%. Going by the next few years, that could come to market-beating levels.
Admittedly, he’s “unwilling to consider premium-based returns because of the massive volatility this company has shown over time.” And he presents the following chart to prove his point:
(Source: FAST Graphs)
He also points out how Activision yields less than inflation. And its dividend growth rate is unlikely to be at a level where it could weigh up volatility here.
However, fair is fair. So he’s fine concluding that, from here, ATVI will likely produce market-beating returns even on a conservative forward basis.
Yet that doesn’t mean he’s buying into the stock today.
A Conversation With Wolf Report About Investing in Activision
The following two segments are all Wolf Report, starting right now…
Wolf Report: I want you to take a step back and consider the company – especially if you're bullish on, invested in or plan to invest in ATVI. In short, let's go back to the basics with a conversation of sorts [that may or may not be based on a real one he had via Seeking Alpha messenger].
Why do you want to invest in ATVI? This is a question, and it's a serious one.
Answer: I want to get market-beating returns from an investment and a nice yield that's well-covered.
Wolf Report: Great. So do I. But that doesn't necessitate an investment in ATVI, only a safe company with good fundamentals. And, not to put too fine a point on it, but there are safer and better investments out there in terms of conservative rates of return, credit, and safety.
Answer: I believe in and like the company's products, and I believe they'll do just fine going forward.
Wolf Report: Again, so do I. I love many Blizzard Activision games, even If I favor the older ones. But liking a company's products doesn't mean it’s a good financial investment. In fact, I’d go so far as to say that the two often have very little to do with one another.
Answer: I don't just believe the company will revert to fair value; I expect it to… give me over 30%-35% annually at a 25x forward P/E!
Wolf Report: That's fine. It could do that. But I could still show you at least four investments today – with better yields, similar or better credit ratings, and lower multiples – that would deliver similar returns without the company trading at 25x P/E.
If this is your reason, I truly believe you’re selling yourself short.
More Activision Analysis Straight From the Wolf Report’s Mouth
At the risk of being repetitive, the bottom line is this…
"Liking" a product is wildly different from buying into the company that makes it. Or at least it should be.
This is one of the things I often have to explain to the people I manage portfolios for.
Most of us have limited capital for investing. Which means there's a barrier on how much you're able to invest. Which means you need to maximize the returns on every cent you invest.
That's all I'm interested in making you see.
As a wholly unemotional investor, I don't care much about the companies I put my money in – not beyond their fundamentals and the circumstances that directly influence their ability to make money for me.
In order for them to convince me they’re worthwhile, they need to make more money than other alternatives. Moreover, I want them to generate that money more safely and preferably with higher income (yields) than my other choices out there.
Whether they make/offer beer, burgers, computer games, financial services, real estate, weapons, or electricity beyond proper asset allocation. I don't want to hold too high exposure to any one particular industrial segment, after all.
So when I say that I don't want to invest directly into ATVI, that doesn't mean:
- I don't believe in it.
- I don't like it or its products.
- I don't believe it could outperform the market.
It’s just that none of these factors are enough for me. I want more.
And I want more for you as well.
In Conclusion…
Following the latest decline, Wolf Report acknowledges that Activision Blizzard could be considered a buy with a nearly 8% per-year upside – conservatively speaking – going forward.
That’s an impressive amount for this company. And it wouldn't surprise him if it outperformed from there.
But Activision’s appeal, he says, disappears the second you start to consider alternate investments in other sectors that offer:
- Equal or greater safety
- Higher yields
- Equal or better credit ratings
- Better upside at more conservative forward earnings, revenue, or fundamental multiples
- No management risk
This makes for a very problematic bullish ATVI stance in his book. If you're really interested though, he’d suggest looking at options possibilities.
The recent volatility has vastly increased ATVI put options’ value. He says you can get some great returns from the February 2022 puts especially if you're willing to bid.
(Source: Yahoo Finance/IBKR, Google Sheets)
Keep in mind that these numbers may change as we move forward. But Wolf Report would consider targeting a $47-$50 strike price for a 10%+ annualized rate of return at lower risk, bidding to buy ATVI at a conservative rate of return above 12%-13% from a capital exposure of less than $5,000.
That’s how he would play it if he was going to play it. Dividend Sensei is playing it straight through shares. And I’m not playing it at all.
How about you?
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