Description

Finally a value stock being posted on Value Investors Club that can be bought in volume. Activision is well know and there is a lot of research out there so I will keep this short. ATVI is the number 2 video game maker for the game console market. They make games for PlayStation 2, Xbox, and GameCube and the PC.

A word of two about the game industry: If a company comes out with a hit, the stock gets a higher multiple than the rest of the group because investor think the growth is a great trend that will last forever (eg, one hit after the next.) But realistically, it’s a back and forth thing.

If you look at the 12 trailing months EPS, you see they earned $1.27/share with a $12.50 stock price. Sounds great at a 10 PE, but there is more to the story. Yesterday ATVI put out a press release stating they will miss the analysts consensus eps of ~$1.30, and will only earn $0.88/share for FY03 which ends March 31 03. ATVI’s products are not selling well this Christmas. Analysts were expecting .84/share for the Dec quarter and ATVI just put out a warning saying they will only do .60/share and for next quarter (march quarter) they expect a loss of .15/share as opposed to analyst predictions of .01 profit. A bad year has spawn a huge number of downgrades, but that’s just focusing on the near term. Over the long term Atvi has a great business in a growing market, a great brand, and a ton of cash to grow the business going forward. Right now at $12.50/share, ATVI is a great deal because you have a company with $9/share of cash earning at least $.80/share year.


They also stated that due to game release delays they will only earn $.80 in FY04. You can read about this in the latest PR. I have to admit $.80 seems a little conservative seeing as during a good Christmas selling season last year (last 12 months included it) they did $1.27. With the strong console growth out there, i feel ATVI's normal eps is probably more like $1/share that should grow 10%/year for the next 5 years.

In any case 12.50/$0.80 is a PE of 15, which is not spectacular, but it does not tell the whole story.

Firstly, ATVI has no debt, even better at the end the calendar year she will have $9/share of cash, or about $580mil cash. Looking at the B/S i'd say that their WC is overfunded by about $400M, meaning they could grow the business modestly if they gave back $400mil to the shareholders.

So if we back that out, thats $5.80 of too much cash, and now: ($12.50-$5.80)/$.80= a pe of more like 8. And thats depressed eps.

The EV/EBITDA story is even more convincing that she is cheap. Looking at the last 12 months EBITDA of 200M, A marketcap of 850mil. Thats 850+0-580= 270 EV

270/200= EV/EBITDA of 1.35 using the ttm ebitda
a more realistic ebitda going forward is about $150 mil assuming .80/share, so:
270/150= 1.8x ev/ebitda. That’s VERY cheap!!!

Lets check the industry comps (for the comps I’ll use the last 12 months ebitda, which should be pretty conservative seeing how great last Christmas was compared to this year for the game makers.)

ERTS
(8.3bb-927mm)/350mm=21 ev/EBITDA
(8.3bb-927mm)/237mm=31 ev/NI (there is no debt)
PE02: 34.3
PE03: 24

THQI:
(543-206)/150 = 2.25 EV/EBITDA
(543-206)/40 = 8.8 EV/NI (there is no debt)
PE02:12.5
PE03:11
(cheap too, but only $5.21 cash, beta is 1.2, for $13.60 stock)

TTWO:
890-75/100 =8.15 ev/ebitda
890-75/70 =11.5 ev/ni (there is no debt)
PE02: 12.46
PE03: 12.74

I think that EV/Ni is a better multiple to look at than ev/ebitda. ATVI pays quite a bit of money for the licensing rights to launch products like Spiderman, Star Trek, Minority Report, Tony Hawk Skater, ect… ERTS has more home grown games so they don’t pay those licensing fees and that’s why the EV/EBITDA looks crazy. The licensing costs are capitalized, but it looks like they are ammortorized pretty quickly (~1year). You can find the amortization in the CFO line as opposed to the investing cash flow line. So FCFE is usually pretty close NI over the long run. Cap-ex and Depreciation are pretty closely in line too. So if we look at EV/NI for atvi:
270/54=4 EV/NI, that’s a 25% earnings yield on the enterprise.

About the capitalization of the licenses: First thing that comes to mind is, are they over capitalizing? Well look at the B/S and take a look at the size of PPE + the intangibles and the earnings. If anything, intangibles and the like are understated. Moreover: looking at the last few years, FCFE exceeded NI by a small amount in all years over the last 3 FYs: the FCFE I calculated pulls out the positive cash flows from ‘tax benefits of stock options and warrants exercised’, and the ‘expense related to common stock warrants’ (I don’t know why that’s in the CFO section):

FY Year (ends march): 02 01 02

NI: 53.2mil 20.5 -34
FCFE: 53.5mil 59.73 -30.9

Amazing how they’ve achieved the eps growth with a fcf greater than NI. That could have to do with how aggressively they’ve been expensing things. All R&D is expensed, the and the rights are capitalized, but they get written off in about a year, and the games usually stay on the market longer.

If we use a DCF valuations (using NI as the FCFE, seems logical), assuming $.80 in fy 04, it normalizing to $1 in FY05, then growing 10% for the next 3 years, an 11% discount rate for this high growth phase (beta is really only 0.6 so 11% is sort of high in light of capm). Then assume perpetual growth at 3%. And a discount of 10% for the stable growth phase, plus about $5 for the ‘overfundedness’ of the WC gives us a Price of:$20. That’s not bad!

Rumor is that Sony will cut the price of the PS 2 from $199 to $149. MSFT should follow. Consoles are selling well, and the growth opportunities in Europe and Asian are great especially with the weak dollar.

With $9/share the margin of safety is there, but the only worry is that atvi will make a stupid acquisition. But realistically, that extra 400mm is only earning 1 or 2% after-tax. So a ROIC above that from an acquisition that isn’t too risky can really grow eps. There is also 150mil stock buyback authorized buy as of October unused.

Catalysts:
Cheap, a takeover target.
Acquisition that is accretive to eps.
A hit title that pushes the stock back to a euphoric level.
150mmil stock buyback authorized, none used as of the last 10-q filed in October.

Catalyst

Cheap, a takeover target.
Acquisition that is accretive to eps.
A hit title that pushes the stock back to a euphoric level.
150mmil stock buyback authorized, none used as of the last 10-q filed in October.