Activate Your Activison



Highlights:

  • Strong Demand for New Releases: Since March, 2014 Activision Blizzard has released 3 new franchises and will launch Overwatch in 2016. ATVI released Hearthstone in June 2014 and since then the game has gained above 30 million players. Destiny was released in September 2014 and reached 20 million players by August 2015. Heroes of the Storm was released in June 2015 and have approximately 20 million players.
  • Demand for Current Franchises: Activision Blizzard has many franchises which continue to see strong demand. Although Call of Duty advanced warfare saw a decline in sales compared to previous releases, it was the bestselling game in 2014. Call of duty Black Ops 3 the next expansion which will be released in November 2015 is expected to see an increase of 15% in sales compared to previous expansion. World of Warcraft continues to be the largest MMORPG in the world.
  • Overwatch Release: Activision Blizzard will release Overwatch in 2016. The First player- shooter game will be the first entirely new franchise launched by Blizzard in 17 years. The game has seen a large interest by gamers worldwide. The beta will be released in Q4 2015. Overwatch is expected to be Activision Blizzard’s next huge franchise. Overwatch will enter a market that has been dominated by Team Fortress 2 for the past 8 years however, critics believe that Overwatch can completely eliminate their competitor.
  • Strong Forecasted Industry Growth: The video game industry is expected to grow 9.4 % this year, from $83.6 billion to $91.5 billion, partially due to the increase of the average age of gamers. As Activision Blizzard is the largest player in the interactive gaming industry, the growth of the industry is important in order increase their market cap.. Mobile game industry is expected to grow from 25 billion to 45 billion in 2018.The E-sport business is worth 278 million today and is forecasted to reach 765 million by 2018.
  • E-Sport Division: Activision Blizzard announced in October 22nd that the company will launch a new division focused on E-sports. Steve Bornstein, The former CEO of ESPN will serve as a chairman. The CO-Founder and CEO of Major League Gaming will be joining the unit as Vice- President. Activision Blizzard has shown interest in the growing E-sport market, with the releases of Heroes of the Storm, Hearthstone and Overwatch the company is focusing on competitiveness.



Business Description
Company: Activision Blizzard (NYSE: ATVI) is the world’s largest interactive gaming company. They develop and distribute video games through the PC, consoles and hand-held mobile devices. Activision (Blizzard) has a long standing reputation of making the “best games” in town. The company consists of three operating units: Activision, Blizzard, and Distribution. Activision has produced famous names like, “Call of Duty,” “Destiny,” and “Skylanders”. Blizzard is most known for “World of Warcraft,” “Diablo,” and “StarCraft”. Currently Activision Blizzard has 27% of the video game market.

Segments: Through its segments, the company currently offers products on the following platforms (% of all revenue):

  • Consoles (36.4%): Games on consoles such as Xbox, PlayStation and Wii
  • PC (24.4%): Games on Personal computers such as Heroes of the Storm and StarCraft
  • Handheld (10.5%): Includes such as Hearthstone and Skylanders on smartphones and tablets.
  • Distribution (8.0 %): Warehousing and sales distribution to third party entertainment publishers.
  • Online (20.7%): Subscriptions from World of Warcraft.

Historically, Activision Blizzard’s revenue breakdown for their product lines has been volatile (Exhibit 2), where Blizzard, manufacturer of most PC, Hand-Held and Multiplayer online games has the highest operating margin of 43.95% (Exhibit 4). On the other hand, Activision, the main manufacturer of console and handheld games has a 28.37% gross margin while Distribution has the lowest gross margin of 8%.

Investment Rationale:

  • Strong Track Record amd Long Lived Franchises: Activision has a strong track record, creating the best-selling game of the world 5 times in the last decade. Furthermore, Activision has continued to make expansions in order to keep their popular games competitive for more than a decade. . Games such as World of Warcraft, StarCraft and Diablo continue to be the top leader in their genre. Activision Blizzard believes that they currently have the strongest portfolio in the history. The three largest games with the largest growth potential are Hearthstone, Destiny, Heroes of the Storm and Skylanders. All of these games have above 20 million players and are continuing to grow. Knowing that Franchises have a long life, these games will continue to generate revenues for at least 5-10 years.
  • Anticipated Upcoming Releases: The four largest upcoming releases are Overwatch, Black Ops 3, StarCraft 2 Legacy of the Void and World of Warcraft Legion. Overwatch is the first entirely new franchise from Blizzard in 17 years and is a first player shooting game. Critics believe that the game has the ability to eliminate their only direct competitor Team Fortress 2. The Call of Duty franchise was named the world’s largest gaming franchise in the world and in September 2015 they will launch Call of Duty Black Ops 3. It is the world’s most anticipated game for the holiday season. Furthermore, StarCraft 2 Legacy of the void will launch in November 2015 and is the last expansion of StarCraft 2. It is the world’s most anticipated PC game for the holiday season. World of Warcraft which is the world’s largest Massive multiplayer online Role-playing game is expected to launch an expansion at the same time as they are releasing their Warcraft movie in June 2016.
  • Demographic Changes and Increase of E-Sport Popularity: The average age of people playing video games has increased from 30 in 2012 to 35 in 2015 (Exhibit 5). Older generations growing up playing video games continue to play as they grow up, increasing the overall amount of people playing video games. Additionally, the older generations higher discretionary income. As a result the video game industry is expected to grow 9.4 percent this year, from $83.6 billion to $91.5 billion. The PC game industry is forecasted to grow from $26 billion in 2014 to $35 billion in 2018. As Smartphones continues to take over the world, the access to mobile games is increasing. According to Newzoo the mobile gaming industry is expected to grow from 25 billion to 45 billion in 2018. More than 100 million people are watching video games online each month and that number is expected to increase to 145 million viewers per month in 2017. The amount of E-sport tournaments grew from 320 in 2009 to approximately 1900 in 2014. Price money in E-sport tournaments grew from half a million dollar in 2000 to 35 million in 2014. According to Newzoo, E-sport is a 278 million business today and is forecasted to reach 765 million by 2018.

Strong Portfolio of Franchises: Activision Blizzard has some of the world’s most recognized franchises. Call of Duty is the number one video game franchise in the world. World of Warcraft is the largest Massive multiplayer online role-play game in the world. Hearthstone was named the best handheld game in the world in 2014. StarCraft was the bestselling PC strategy game in the world at its release and its latest release StarCraft 2 Hearts of Swarm was named Expansion of the year in 2013.
Destiny was the largest new franchise in the world at its release and named game of the year in 2014 by BAFTA.

Largest Interactive Gaming Company in the World: Activision blizzard is the largest interactive gaming company in the world with a 27% market share. With the largest market share, the company has a strong position in negative economic conditions. Additionally the mobile game industry’s expected growth in the next four years (Exhibit 8), thus smaller video game companies may encounter difficulties in keeping up with the industry trends and keep their market share. Successful video games have in most cases been costly to develop in the past, making it more difficult for smaller companies to enter the market.

Consistent Successful Releases: Activision Blizzard has a record of creating new successful franchises from scratch. The company has generated games such as World of Warcraft, Hearthstone, Skylanders, Call of Duty and Guitar Hero. They are continuously beating competitors in market they are located in or creating new areas of the gaming industry previously unknown in the gaming industry. Activision Blizzard has a track record of 6 “Number 1 Selling-Game” in the world for the past decade and multiple “Game of the Year Awards”.
Loyal Customer Base: People playing video and computer games are loyal to their company and their preferred games. After playing countless hours of a game, players will continue to buy the upcoming releases. Each expansion steals players from the previous release making it important for each individual to get the latest expansion in order to find competitors or enable new materials. Games like Call of Duty, World of Warcraft, and StarCraft are games that have been in the lead for several years. Loyal customers continue to buy the next expansions or new releases because they trust the company to make a successful and enjoyable game. Furthermore, Activision Blizzard is not very cyclical as customers will continue to play games in poor economic conditions. Video games have an addictive nature, making it difficult for gamers to stop, and make it more likely that they will spend money inside the games.

Diversified Game Portfolio: ATVI has games on all gaming platforms, genres, and products attracting people of all ages and genders. Activision Blizzard is striving to have the best games in all genres. The company offers first-person shooter games, Massive multiplayer online role-playing games, Multiplayer online battle arena games, Multiplayer online battle arena first person shooting games, shared world first person shooter games, Music games, skating games and online card games. Activision Blizzard has been an innovator of adding new popular genres to the gaming world. Additionally, as one segment of the entertainment software sees high popularity Activision Blizzard seizes the opportunity to jump in on what they believe will be long lasting trends.

Strong Brand Recognition: Maintaining a community of players who view the brand positively is essential in the gaming industry. Activision Blizzard is one of the most famous video game companies in the world. Almost every gamer in the world independent on preferred platform has played a game from either Activision or Blizzard. Activision Blizzard is famous for delivering top quality content. When making a purchase, customers know that games from Activision Blizzard will keep a high standard and rarely disappoint. Activision Blizzard is known to have the best games in the areas they are doing business within.




Financial Analysis:

Revenue Breakdown: Activision Blizzard is operating through three segments: Activision, Blizzard and Distribution. Since quarter 1, 2012 Activision has generated approximately 52% of the company’s revenues, Blizzard generated approximately 40% and distribution generated approximately 8%. They are selling games through 5 segments, consoles, PC, handheld, online and distribution. In quarter 2, 2015, Consoles generated 36.4%, Distribution generated 7%, Online multiplayer generated 20%, PC generated 18.1%, Handheld generated 10.5% and Distribution generated 8%. Consoles are the largest segment which includes games on platforms such as Wii, PlayStation and Xbox. Online multiplayer revenues consist of subscriptions from World of Warcraft. PC consists of games played on personal computers and handheld are games that are played on smartphones or tablets. Looking at Exhibit 12, it’s important to recognize the seasonality of the two segments. During the holiday season Activision outperforms Blizzard significantly due

o the higher demand of video games.

Brand Loyalty Effect on Revenues: Brand loyalty and recognition drive both repeated and new game purchases for customers at Activision Blizzard. One way to see the impact of brand value is the continuous repurchases of expansions. Call of Duty, World of Warcraft, StarCraft, Diablo and Guitar Hero, Tony Hawk pro skater are games that have been on the market for several years but still see a continued demand.
Activision Blizzard has seen a YOY average quarterly revenue growth of 3.04% since quarter 1 2010 while Electronic Arts has seen a quarterly revenue growth of 1.83% for the same period. Brand loyalty has favorable impact on the operating margin. Less research and development costs for expansions lead to a decrease in cost of goods sold, allowing them to achieve a higher profit margin.

Increase in Digital Sales: The increase in digital sales is favorable for Activision Blizzard as the costs are lower when selling games directly to the customer. Since Q1 2012 the average growth of retail sales were – 5.7% per quarter, while digital average growth was 10.9% per quarter for the same period. Digital sales decrease the costs of goods sold, as the games are sold online instead of through a retailer. Since Q1 2012 the operating margin increased by an average of 6.05% per quarter, not including quarter 4, 2014, which had an increase of 1428%. The increase in the operating margin is highly affected by the increase in digital sales.


Valuations

In this section, we estimate the fair values of Activision Blizzard. It should be noted that all input data were derived from historical company data and pro forma estimates.

Franchise Value Model: The Franchise value model incorporates the company’s ability to repeat its business model at a lower cost. As return on equity for the company is estimated to decrease over the next year, the franchise value model is a good fit. I estimate that the market has not incorporated the franchise ability of the company into the current price. Using the Franchise value model I estimate a fair value of $40 and an undervaluation of 14%.

Growth Duration Model: Using the growth duration model we can find the fair price to earnings ratio. The growth duration model gives us an insight on what the forward P/E should be using the earnings per share growth of the company. I derived the earnings per share growth of 57% from my pro forma. For this model I compared Activision Blizzard to Electronic Arts and estimated a fair price to earnings of 22. Using this model I estimated a fair value of $42 and an undervaluation of 19%.

Average Fair Value: Using the franchise value model and the normalized P/E model I estimated a fair value of $41 and an undervaluation of 17%.

 

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