|Shares Out. (in M):||773||P/E||22.5||20.6|
|Market Cap (in $M):||37,100||P/FCF||20.3||19.1|
|Net Debt (in $M):||-1,550||EBIT||1,961||2,099|
|Borrow Cost:||Available 0-15% cost|
Activision Blizzard (ATVI) Background: One of the world’s largest publishers of video game software. Its three business segments include: Activision (Call of Duty), Blizzard (World of Warcraft, Overwatch, Hearthstone), and King (Candy Crush).
Thesis: The SHORT investment thesis is based on seven key factors:
“Dusty” Franchises. Core franchises are old, declining, and poorly positioned with nothing meaningful in the pipeline.
Competitive and Dynamic Marketplace. Not just Fortnite anymore. EA’s free-to-play Apex Legends launched on February 4, 2019 and within one week had 25 million registered players. Apex Legends now has 50m+ registered players.
Not Suited to Mobile. Growth in the industry is coming from mobile adoption. The majority of Activision Blizzard’s franchises are not well-suited to mobile devices.
eSports Over-Hyped. Activision Blizzard’s CEO, Bobby Kotick, has compared the Overwatch League opportunity to the NFL. A better comparison would be competitive bird calling. The league has failed to drive Overwatch revenues and is failing.
Significant Employee Turnover. High-level turnover suggests serious issues beneath the surface.
Stagnating Operating Earnings. The Activision and Blizzard segments have been anemic for nearly a decade even while the stock price has been up 2-4x over the same period. EPS over the same period has increased solely due to financial engineering. Expect flat or declining operating earnings going forward.
Valuation. Expensive. ~20x next year’s earnings which I expect to deteriorate over time.
“Dusty” Franchises: A key measure of the health of a game is the number of monthly average users (MAUs). While Activision Blizzard does not disclose this figure per each title, they do disclose the figure on a segment basis. In recent years, especially post the acquisition of King (in 2016), management has taken to highlighting the fact that on a combined basis, total MAUs across all three segments have averaged in the 350m+ range. More important, however, is the fact that in each segment, MAUs have been stagnating and, in most cases, declining for the last few years.
Activision Blizzard has not released a meaningful new title since 2016 (Overwatch) – and it stated on its 4Q18 conference call (held on February 12th, 2019) that it did not expect to release a major title in 2019. The cornerstone of the Company’s existing revenue and earning’s base are the Call of Duty and World of Warcraft franchises both of which are over a decade old and both are seeing player-base erosion to newer, “fresher” titles such as Fortnite and Apex Legends.
Competitive and Dynamic Marketplace: The video game publishing industry is more competitive than ever. The conversion from analog to digital was hailed by the major publishing CEOs as an opportunity to transition their companies’ business models from a “hit-driven” model to a Video Games as-a-Service (VGAAS), recurring revenue model. However, what they failed to see was that this transition would also open the market to new, disruptive competitors. In the last two years, Activision’s business has been meaningfully impacted by the entrance of the Battle Royale game mode epitomized first by PUBG, then by Fortnite and even more recently Apex Legends. While Activision has done its best to respond, it is clearly on the defensive and no longer dominates the “shooter” segment like it once did. Pressure on the Activision segment will only get worse.
Not Suited to Mobile: Industry executives, and Activision Blizzard management in particular, frequently express their enthusiasm regarding their outlook for industry growth. What they fail to mention is that most of the growth in the industry is coming from the mobile gaming category. Based on my calls with former Activision Blizzard employees, a common thread was that the majority of Activision Blizzard’s IP is not well-suited to being published in the mobile format. For example, Call of Duty is a fast-twitch, first-person experience and I was frequently told that it would be very difficult to translate this experience to mobile in a satisfying way. On the other hand, World of Warcraft involves an incredible amount of keyboard and mouse text-based communicating with many other players – this type of interaction would translate very poorly as well.
eSports Over-Hyped: “We believe our eSports initiatives could rival traditional sports for audience interest, advertiser interest, sponsors, ticket sales and merchandise sales, both virtual and physical” – Activision Blizzard CEO, Bobby Kotick on the May 3, 2018 Earnings Conference Call. While ot just Activision Blizzard, they are the worst offender in hyping up the potential of eSports – likening it on many occasions to the NFL. Many equity research desks have also been reinforcing this position:
These types of tables are common and attempt to show eSports as a nascent but huge opportunity. A key point they miss is that “eSports” is not a monolithic category – it consists of dozens of individual titles each of whose popularity is waxing and waning. Additionally, a huge flaw in the analysis, at least as it pertains to the Overwatch League (Activision Blizzard’s big bet on eSports) is that the viewing experience is HORRIBLE. I personally attended the Overwatch League Grand Finals at the Barclays Center in July 2018 and it was virtually impossible to tell what was going on. There is no way that Activision Blizzard’s eSports will take-off in its current form. Finally, I attended the major industry trade show, E3, in June 2018 and there were clear signs of a bubble. Everywhere you went, people who had no business being there were attending the show because they wanted to “get in on the eSports wave.” Picture YouTube star wannabes everywhere.
Significant Employee Turnover: In the last twelve months the Company has seen significant turnover in the executive ranks. The President of the Activision segment left in 1Q18 followed by the departure of the President of the Blizzard segment in 4Q18. In early January 2019, CFO Spencer Neumann left for the CFO job at Netflix. Shortly after, the CFO of the Blizzard segment departed to take the CFO job at Square, Inc. High turnover is not damning in and of itself, but suggests more trouble beneath the surface.
Stagnating operating earnings: Consistent with Company guidance for 2019, I expect 2019 EBIT to be down ~17% (management said “high-teens” on their February 12th, 2019 conference call). Backing out the EBIT from the King segment, this would put them ~16% below the level they earned back in 2011. As noted in the previous sections, I believe their competitive position, and prospects are more challenged than ever and, as a result, would not be making optimistic projections. As noted in section (4), I would not count on eSports to save them.
Valuation: Currently trading at ~20x next year’s earnings which I expect to stagnate or decline over time. The market is expecting growth from this company and all evidence is to the contrary. From a long-term perspective I would not be surprised to see this trade < $30 as the earning power crumbles and the multiple collapses however tactically there will be significant volatility and I would be more inclined to put the trade on after more near-term enthusiasm.
Risks to Thesis: ATVI gets acquired by Google, Apple, Amazon, or Microsoft. ATVI does another King-like deal. Fundamentally I believe Activision Blizzard is severely challenged – however the risk to the thesis comes from a potential acquirer taking a strategic interest in them. Google, Amazon, Apple, and Microsoft are all working on streaming services -- acquiring Activision (or any other triple-A publisher) would theoretically provide them with differentiated, exclusive content.
1Q19 Earnings Call - the market will be expecting guidance / outlook for 2020 as 2019 is effectively a wash. Management will presumably give optimistic outlook for 2020 but nothing tangible to report which will likely move the stock higher. The next "catalyst" will be E3 over the summer during which Activision will "hype" their upcoming fall Call of Duty. The next true "catalyst" will be when they report 4Q19 earnings and we know how this year's Call of Duty did.
Any interim catalyst will be meaty news on COD mobile or updates on a new Franchise/IP, Overwatch DLC/updates, or related.