Activision Blizzard's Controversy: Punished Too Hard

Summary

• Despite being bombarded by negative catalysts, Activision Blizzard continues to have a positive outlook from analysts.
• Its efforts to increase revenue from its mobile platform position the company well to capitalize on the growing mobile game market.
• It benefits from its strong balance sheet and growing projected free cash flow, which can be reasons for shareholder value improvement.
• ATVI enjoys positive insider trading and is trading cheaply at 19.74x earnings.

Kevork Djansezian/Getty Images News

Activision Blizzard (NASDAQ:NASDAQ:ATVI) is one of the world's largest video game publishers operating in America, EMEA, and Asia Pacific. It has been in the industry for over 40 years and has a portfolio of popular franchises such as Call of Duty, Diablo, World of Warcraft, Hearthstone and Candy Crush. Following a devastating lawsuit filed against ATVI in July 2020 and the subsequent involvement of its CEO in such controversies, the company stumbled and lost some of its staff and key employees, delaying the release of Overwatch 2 and Diablo IV. The company also lost significant sponsorships, all of which contributed to the spike in downward revisions to its top line and earnings per share. All of these factors contributed to the loss of confidence in its current CEO's leadership, instilling noise and fear in the market, resulting in a sharp decline wiping out 45 percent from its last year's highs. Considering ATVI's current risk/reward ratio, the recent drop in its price unlocks a good opportunity for a potential pullback opportunity.

Staff Revolting and Leaving, Lost Sponsorships and a Mountain of Lawsuits

There are many more known facts to mention why ATVI dropped massively for the over the last few months. To name a few, the problem about its workforce and missed sponsorships with big companies like Coca-Cola (NYSE:KO) and T-Mobile (NASDAQ:TMUS), which affected mostly it's Blizzard Entertainment segment. In addition to the loss of its Overwatch League sponsorship, two of ATVI's key employees responsible for Diablo 4 and one World of Warcraft designer have confirmed their departure from the company. To summarize, the majority of the negative news against ATVI has a significant impact on its Blizzard Entertainment segment, which generates the least revenue at 26.2 percent.

In my opinion, the market punished ATVI too harshly. As one of the well established companies in its market, it is too pessimistic to think that ATVI cannot handle the reshuffling of its current workforce. However, despite the mountains of lawsuits and negative sentiments, most analysts have a bright forecast for ATVI's top line, as can be seen in the image below:

Source 1: TradingView

It remains above last year's figure of $8,086 million when compared to its current 2021 consensus, despite the spike in its downward revision due to the aforementioned controversies. There are still a few positive catalysts about its Blizzard Entertainment segment like a huge update for their Hearthstone game, which may become a hit in 2022 for its bigger E-sport prize pool of $3 million.

Improving Revenue From Mobile Games

Unlike consoles, which restrict the gamer's ability to use it wherever they please, mobile games benefit from the potential ease of being used anywhere as the economy continues to attempt a successful reopening, transitioning work from home to the traditional workplace settings. Revenue from mobile games is expected to reach $116.4 billion in 2024, growing at an 11.2 percent compound annual growth rate from 2019.

Source 2: Statista

One value-adding catalyst of ATVI is its growth in mobile games revenue as shown in the image below.

Source 3: Company Filings, Prepared by the Author, Amounts in millions

The management pointed out the following improvements and what investors should expect with their mobile game:

On mobile, Call of Duty net bookings grew over 40% year-over-year in the third quarter, driven by double-digit growth in the west, and it continued contribution from the game in China.

The team continues to refine the player experience, building on learnings from the title's first 2 years to optimize content, events, and features for our communities around the world. And at the same time, we continue to ramp our teams working on new mobile title within the Call of Duty universe.

ATVI also acquired Digital Legends, a mobile game developer, and hired developers to further improve its COD Mobile. According to the management, they are also in the progress of releasing Diablo Immortal, a mobile version of Diablo, to the public in H1 2022.

More Fear, More Upside Potential

Source 4: Prepared by the Author

Following a precipitous decline in its price, ATVI improved its short interest relative to October 2021 and improved potential upside based on today's price. ATVI's investors have a 35 percent upside potential, as indicated by the average of DCF and simple relative valuation models in the chart above.

Source: Prepared by the Author

I completed the five-year DCF model with the assistance of analyst estimates; the total revenue of $8,750 million is slightly higher than what management anticipates. In my opinion, it remains achievable as the company has already surpassed it with its TTM revenue of $9,052 million, which is an all-time record.

I also expect that its operating income will continue to grow to 37.6 percent by the end of the model as the company continues to restructure its workforce, converting contractual workers into full-time employees.

Source 5: Seeking Alpha and Yahoo Finance, Prepared by the Author

Above are my assumptions and WACC calculations and as well as its selected 5 year historical data which helped me to complete my DCF model.

Clearer Sign of Potential Bottom, Pullback

Source 6: TradingView

ATVI currently pivoted at $57 level, providing early signs of bullish price action and preparing to attempt breaking its monthly trend line resistance as demonstrated in the chart above. There is a huge gap clearly visible in its daily timeframe that may drag the price down lower that may draw a potential double bottom in the coming weeks. Strong catalysts like an update about the release of its Diablo IV and Overwatch 2 can help the stock eliminate today's bearish price action. Currently, its MACD indicator crossed already, suggesting a bullish price action in the coming trading weeks. Consolidation above its current 52 week low will provide investors a better pullback opportunity set-up.

Conclusive Thoughts

ATVI also benefits from positive insider buying from its Director, as illustrated in the chart below, which has an average cost of $87 per share starting from its May acquisitions.

Source 7: Finviz

On top of the positive insider trading, the management is paying only $18 million as part of its agreement with the Equal Opportunity Commission to compensate the aggravated parties due to the controversies, which is not that material compared to what the company earns. Investigating ATVI's balance sheet brings more positive outlook for the company. Its current ratio generated an all-time record of 5.56x without deteriorating its debt/equity ratio of 0.21x, better than its 5 year average of 0.33x. With no significant long-term debt maturing before 2026 and growing projected free cash flow, it is likely that investors will see an increase in share repurchases or dividend payments in the coming quarter, making this a stock worth monitoring.

Thank you for reading!

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives 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.

Comments

[Persaltish]

I used to play World of Warcraft. It was fun. Therefore this is a great stock...

Well, maybe...

But this is a business that has faltered a lot lately. They are late with important new releases and they have a very angry portion of their workforce demanding the CEO's head on a platter. I suspect they are having a hard time hiring top talent right now and we know they are losing talent in the meantime.

There is a really simple fix to the talent problem: Fire Kotick. BUT, he's actually been a great CEO in some ways so his departure would create another new crisis. But, they have to do something fast or watch their once great enterprise bleed out. If they dump Kotick and bring in a young genius they might have a chance. Or they might die fast. But if they do nothing, I think they will die slowly. That would be a shame. All the more because I own some stock.

[Mozman]

@Persaltish

I dont think so. They should hold the line and ignore the wok folk. They might still fail but if wok folk win nobody will want to play their games.

[The Beautyful One]

@Persaltish If blood is in the water, do you also expect the sharks to leave if you throw in a bloody steak?

[brzaha]

@Mozman They are pretty good at alienating consumers on their own. Their strategy only works because of the brand strength of COD, Overwatch, Wow and Diablo etc. If they lose their best people because no one wants to work in a toxic environment, they are going to lose more gamers as those games suck more and more over time.

EA, and Activision are really bad long term buys in my opinion because they lack new promising IP, and many of their blockbusters fall on their face. This was all prior to the lawsuits. If you think of their workers as a cost line on a balance sheet you're going to wake up with stale investments in a couple years.

[fshoutofwtr]

Pet peeve: You should back out the net current assets when calculating P/Es. It's lazy to take the market cap and divide by earnings without backing out net current assets. On 9/30 ATVI had $8B in net current assets -- mostly cash -- far more than the working capital needed to run the business. Imagine how high ATVI's P/E would be if they had $100B on the balance sheet if you calculated P/E this way. Anyhow, the P/E is probably ~17x right now, which is very cheap for a business like this, whereas ~20x seems cheap, but not as cheap. Just my two cents.

[jerseyvalueinvestor]

@fshoutofwtr why do people need to remove net current assets from PE. Please elaborate, you can apply this concept to most tech companies to get a p/e well over 100. so with your method most tech compnies have insane valuation right?

[Stevaaayyy]

Go woke, go broke. Long ATVI

[Mozman]

@Stevaaayyy

Nerve bet against the orcs!

[uhoh]

Sell. AAA P2E crypto games are coming hard

[John Poorer]

@uhoh Jesus and Mary Jane my friend. Your one-liner cannot be taken as an advice.

There are many stocks that should be sold today. ATVI is not one of them.

[jerseyvalueinvestor]

@uhoh disagree, im long splinterlands a p2e game, i dont see these small players unseating AAA game developers, more likely AAA game devs come into p2e and blow away any game relying on graphics to be popular, thats why i like Splinterlands, a strategy card game, not reliant on fancy graphics.

Now those space based p2e games, those are all going to ZERO when AAA game studios enter the space

[uhoh]

@jerseyvalueinvestor don't know what u r talking about. Splinterlands is trash

[EBIX EBUCKS]

This company was doing mass layoffs even before the recent scandals. It seems ill. The punishment of the stock price seems justified. If the firm turns around quickly, the stock could be a good buy at these prices. I remain skeptical.

[Calm_Investor_999]

Long $ATVI

[Hanno]

Well, valuation is cheap vor atvi. One should know what's the problem here! Maybe aTVI is part of the tech sell off?

[The Beautyful One]

The problem with ATVI is not a PR problem, though it may seem that way. The chaos in the company creates an execution problem. The talented people mostly have left or are in the process of leaving. The company is burdened with a bunch of activists that it can't get rid of due to said PR problem. Look at the pipeline of products and how they have been delivered/are in the process of being delivered. If ATVI manages to fail basic execution on their CoD blockbuster (such as basic collision detection etc.), it means that the 5 % of people that are relevant to a companies success are vanishing rapidly. This is also in line with what you hear through insider rumors. At the moment Bobby does not care and will do anything to survive, even if it means throwing his company under the bus short-term (in his mind). The problem is, this cultural change and the people that remain will do lasting damage. The talent is moving to smaller companies, what remains is loudmouth activists and mediocracy. It does not bode well for a company that depends on technical excellence and creativity.

[ocbearclaw]

@The Beautyful One Wow this is a very good comment. I was talking to my wife about buying some ATVI and this comment really resonated with our decision making process. Thank you

[The Beautyful One]

@ocbearclaw Well, considering how ATVI is apparently hammered today, luckily you did not buy yet :-)

[Mozman]

@The Beautyful One

I hope your wrong because if the orcs go and only the faeries remain, this company is a goner.

[webchow]

"Key people have confirmed leaving"

While on the surface, that's a bad thing. However, another way to look at it is this, younger, hungry employees will now be able to move up and gain control of more creativity. This could be a massively positive outcome for a company that may have been relying too heavily on rehashing old games.

[Mick Research]

"ATVI enjoys positive insider trading.."

Didn't that happen before the recent scandal? I haven't seen any insider buying in the last few months.

[Bruce Bohannon]

Thanks for the work. Observation - My first glance at a very reliable site does not suggest material insider buying! Yes Peter buys 3,950 Shares in Aug 21 - But Robert K (Bobby) Sells a few hundred thousand $$ in shares in the same month. It's not my money so I don't feel a need to study that aspect much closer... Appreciate the article and comments.

[low frequency]

It's becoming value amongst growth

[garvy]

I bought atvi 60 bucks
Too cheap to ignore and strong balance sheet. All the noise can be fixed overtime . Their titles and franchise has lots of followers and fans