ATVI - Activision Blizzard

[mikazo]

Hey guys,

 

I've been mulling some thoughts around about Activision Blizzard lately, and can't decide how I feel about it. I thought I'd post what I've found so far and then see what other people think. ATVI had a bit of a rough time back in 2008, but apparently their current CEO Bobby Kotick was named CEO July 2008 when Activision merged with Blizzard, and you can see noticeable improvement since then.

 

Revenue and gross profit over the past 4 years showed major growth in 2009, followed by modest growth in 2010 and 2011. Gross profit margin was 39%, 46%, 52%, and 63% in 2008, 2009, 2010 and 2011 respectively; a clear upward trend can be seen. Similarly, R&D costs were 50%, 32%, 27% and 22% of gross profit in 2008, 2009, 2010 and 2011 respectively; a clear downward trend. Similarly again, SG&A expenses were 62%, 48%, 38% and 33% of gross profit in 2008, 2009, 2010 and 2011 respectively; another clear downward trend.

 

Net income has seen significant growth each year; it was negative $100m in 2008 and was over $1b in 2011. Cash & equivalents has stayed stable over the past 4 years, never falling below $3b on an annual basis. The company has no long-term debt and more than enough cash & accounts receivable to cover their current liabilities. Return on assets and return on equity have been meager in the past, but were 8% and 10% respectively for 2011. Lastly, ATVI initiated a dividend policy in 2010, so there's room for dividend growth.

 

I like to use WEB's "owner earnings" (net income plus deprec./amort. minus capex) because it's simple and quick. So looking at owner earnings for ATVI, they were $232m, $391m, $519m and $1,161m for 2008 to 2011, respectively. These are significant spurts of growth each year. Using these numbers, I came up with a valuation for ATVI of just over $20/share. ATVI closed at $11.53 today, so if my valuation is more or less accurate, that's quite a margin of safety.

 

So now that the numbers are out of the way, I can talk about the business itself. Everyone's biggest worry is that the number of World of Warcraft subscribers are falling. This isn't surprising, given that the game was originally released in 2004. The fact that it has been the king of MMORPGs for that long is impressive. Every time another MMO comes out, someone calls it "the WoW killer". Most recently, Guild Wars 2 holds this claim, according to many. While I don't expect WoW to stick around forever, it looks like it has at least another 2-3 years left in it. According to ATVI's most recent quarterly conference call, it's normal to see a small drop in subscribers before an expansion pack release, which they have planned for this fall. When asked if the company would consider using leverage, they said it wasn't on the table at this time.

 

In addition to WoW, ATVI is also releasing Call of Duty Black Ops 2. What's impressive is that the sales of each new CoD release outperforms its predecessor, and they're essentially all the same game! You shoot people with guns. Not to mention Starcraft 2's popularity; it's actually a spectator sport. It also has an expansion in the works. In addition, the long-awaited Diablo 3 was released recently, for which there will no doubt also be expansions. I have a lot of faith in ATVI's impressive lineup of game titles.

 

Of major concern to me were two issues. The first is that ATVI is known for pushing back release dates and taking a very long time to release games that they've announced. From what it looks like though, they take their time to get things right, and it pays off in the long run. They've supposedly been working on a new MMO for a while now, but it hasn't been announced yet. If anyone has a chance at the next biggest MMO, it would be Blizzard. They've clearly already learned a ton about what to do and what not to do when making an MMO.

 

Secondly, the employment agreement they have in place with Bobby Kotick scares me a little. I don't know if this is normal as employment agreements with CEOs go, but here are the excerpts from the 2011 proxy statement:

 

Robert A. Kotick is party to an employment agreement with us, dated as of March 15, 2012 (the “Kotick Employment Agreement”), pursuant to which he serves as our President and Chief Executive Officer. Mr. Kotick’s term of employment under the Kotick Employment Agreement began on March 15, 2012 and will end on June 30, 2016.

Pursuant to the Kotick Employment Agreement, Mr. Kotick’s annual base salary was increased to $2,000,000, retroactive to July 1, 2011.

...

In addition, Mr. Kotick received a one-time cash sign-on bonus payment of $2,500,000 in connection with his entering into the Kotick Employment Agreement, which was paid at the time the Salary Adjustment Payments were paid to Mr. Kotick. In addition, the Compensation Committee, at its sole discretion, may award Mr. Kotick a performance bonus at any time in an amount and form determined by the Compensation Committee. Mr. Kotick is also entitled to participate in all benefit plans generally available to our senior executive officers and we are required to maintain a supplemental term life insurance policy in the amount of $18 million for the benefit of his estate until March 14, 2022.

...

As an inducement to enter into the Kotick Employment Agreement, Mr. Kotick received a grant of 2,061,006 restricted share units, the number of which was based on a fair market value on the date of grant equal to $25,000,000. If, and only if, the Company’s non-GAAP gross profits for 2012 (as determined in accordance with the Kotick Employment Agreement) are greater than or equal to $500,000,000, on March 15, 2013 the restricted share units will immediately vest with respect to 20-sixtieths of the award (representing the twenty month-long vesting tranches between August 1, 2011 and March 1, 2013) and thereafter one-sixtieth of the award will vest on the first day of each month, with the exception of the final tranche, which will vest on the expiration date of the Kotick Employment Agreement.

...

As further inducement to enter into the Kotick Employment Agreement, Mr. Kotick received a grant of 4,122,012 performance shares

...

Pursuant to the Kotick Employment Agreement, if there is a change in control (as defined in the Kotick Employment Agreement) during the term of his employment under the Kotick Employment Agreement after December 31, 2012 or Mr. Kotick is terminated without cause (as defined in the Kotick Employment Agreement) during the six months prior to a change in control, Mr. Kotick will be entitled to a cash bonus payable upon such change in control in an amount of at least $30,000,000, which may be increased to up to $45,000,000 at the good faith discretion of the Compensation Committee.

 

Retroactive pay increase? Cash signing bonus? Crazy benefits for the next decade? Performance share grant? Restricted share grant? $30m change of control clause? Holy crap, that's a lot of inducement just to stay at the same company for 4 years! Either it's a terrible company to work for or he's just really really greedy...

[hyten1]

mikazo,

 

i haven't done much research, nor am i am expert in this industry. but just reading what you wrote.

 

valuing atvi at 20bil is a little high (just at a first glance). I always think what else can I buy with 20bil? there are quite a lot of other stuff (companies that I can buy)

 

 

these are all companies less than 20bil (just a quick list)

 

DFS, YHOO, WDC, GPS, NFLX

 

i am just thinking out loud here, not saying ATVI is a bad investment (considering I don't know much) but at first glance an valuation of 20bil is pretty high, considering what else you can buy with that money. also considering the nature of the gaming biz.

 

hy

[MahOyster]

A short thesis on ATVI.

 

http://stableboyselections.com/2012/08/03/activision-atvi-short/

[mikazo]

Thanks for the thoughts. That's the other concern that I forgot to mention, Vivendi is looking to sell their 60% stake in Activision, which is about 666.5 million shares. At today's closing price of $11.53, that's worth about $7.7b. I assume market price because I doubt Vivendi will be able to sell for a premium to the market price, given the lack of interest in buyers so far. Vivendi's reason for selling is that they're looking to raise cash to lower their debt ratio. This has nothing to do with ATVI's performance; Vivendi just needs the cash.

 

The fact that there are no interested buyers is the concerning part. But if you think about it, who would buy ATVI? EA has nowhere near $7.7b in cash. Time Warner was approached, who also doesn't have enough cash. Microsoft was approached, but is probably saving cash to push forward with Windows 8. If anyone was going to buy most of or all of ATVI, it would probably be MSFT so that they could have games like Call of Duty exclusive to their Xbox platform and games that Blizzard makes exclusive to Windows. This probably wouldn't be a good thing for ATVI.

[Green King]

are u sayings it worth current 32 times earnings ? While coke is only 20. what am i missing ? hidden asses ? or is the earnings understated by alot ?

[mikazo]

I was basing my valuation on future owner earnings over the next ten years, assuming a particular growth rate and discount rate. This is sort of why I don't like posting my own valuations because everyone comes up with something different according to what they feel is the best way to value a company.

 

Regardless of valuation, I'm more concerned about the issues I mentioned above and what others think about those issues. For example, the next WoW-killer, the CEO employment agreement, the attempted sale by Vivendi.

 

I forgot to mention in regard to the stableboyselections short thesis, they mention that the traditional video game industry is in decline. I would disagree and say that video games are thriving; it just happens to be near the end of a console hardware release cycle. The Xbox 360, PS3 and Wii are all showing their age, and Nintendo already has Wii U plans in the works. So the video game environment as a whole doesn't worry me in the least. Kids will still bug their parents to buy them video games no matter what the situation is in the eurozone crisis or no matter what the US debt ceiling is.

[king888]

The traditional video game hardware is in declining. No doubt about that .But I would say it will not directly affect ATVI

because ATVI is the content owner which can shift to new platform easily.

 

The future of game industry relies on "Cloud" or steaming game . The hardware will be just the interface.

Sony's $380 Million Gaikai Acquisition

 

Kabam and Kixeye also have a great content for hardcore gamers in browser/social platform. But the game franchise of

these new startup is nowhere near ATVI

[mikazo]

An interesting, if somewhat biased, history of Activision Blizzard: http://www.teamliquid.net/forum/viewmessage.php?topic_id=128252

[Liberty]

Here's a pretty good series of videos on the early days of Blizzard (originally Chaos Studio, iirc):

 

https://www.youtube.com/watch?v=XWU25ov1XSY

[racemize]

as a pretty avid diablo 3 player, user base is dropping quickly.  The upcoming 1.04 patch and/or PVP may renew interest, but they are having issues after the smashing release.

 

That being said, it is pretty par for the course for blizzard to release a game and then fix it up over time.

[Green King]

There is no question Blizzard is the best there is in terms of games and business strategy. Most of my childhood was spend on playing their games. But is it a good investment ? At this price i don't know. Also what are their returns like per game ? since it take years for them to come up with game. Do you know their return look like for a new game ? D3 WoW SC2 ?

[eclecticvalue]

At this price I don't think ATVI is a great investment. IMO ATVI is priced in. Because you have a timetable of these releases so the market can incorporate it into the stock price. When Diablo 3 was released, the market did not swing wildly to the upside.  Also gamers are getting into the stock market so they have sense whether these new releases will do well.Therefore, there is no edge. The case from the bulls is that ATVI can keep on growing and the earnings power increases. I don't think the earnings power will be consistent since the best games such as the forthcoming Starcraft expansion packs take a long time to create. Since Blizzard takes a long time in developing games you are bound to see delays. Therefore, no consistency in the earnings. The Activision studios have not created new franchises in a while so future earnings potential is diminished for the time being. It seems like ATVI's strategy is to create a franchise which has traction among gamers and milk it by creating sequels. Kind of like what Hollywood is doing. Gamers may become tired of it. There is dissatisfaction in the community.

 

  One thing that has not been mentioned is goodwill makes up majority of the assets and stockholders equity. I don't think there is margin of safety in the balance sheet. I would check the accounting policies on goodwill to see if they have changed it, ATVI may have to realize goodwill write downs in the future.

[mikazo]

Green King and ecclecticvalue both make good points. I never thought of trying to figure out return on invested capital on a per-game basis. I suspect that even inflation might come into the picture due to such long time horizons for franchises as a whole. It is also a good point that goodwill makes up a significant portion of the total assets and has been slowly declining for quite some time. Blizzard states that they're working on a brand new MMO, but will it turn into a profitable franchise? Very difficult to tell.

 

I used to play video games quite a bit when I was younger, but part of the reason that I stopped playing them is that all games seemed to be a different spin on one of a few standard genres or styles, and nothing was new or innovative. The other reason I stopped playing is that I grew up and now have a lot more responsibilities. :)

 

I've been letting my thoughts on ATVI mull around for about a week now and I've decided that there are too many questions and uncertainties in my mind to commit to a purchase. From what I've read from interviews with Bobby Kotick, he doesn't strike me as the type to put shareholders very high up on the priority list. That, plus his employment agreement and the concerns stated by others in the posts in this thread led to my decision to pass on ATVI.

[T-bone1]

I think part of the reason for the high valuation is that assumption that vivendi will sell ATVI in the near term.

[mikazo]

I think part of the reason for the high valuation is that assumption that vivendi will sell ATVI in the near term.

 

Activision Becomes Independent With Buyout of Vivendi

 

http://www.bloomberg.com/news/2013-07-26/activision-management-to-buy-vivendi-stake-for-8-17-billion.html

[NomadicRiley]

One of the interesting things about the ATVI / Vivendi transaction is it has the net effect of retiring ~1/3 of the previous outstanding ATVI shares.  ATVI purchased the shares at $13.60 each using a combination of cash, issued debt and bank loans.  The CEO and Chairman also formed a group w/ institutional investors and bank loans to buy ~25% of the company also at $13.60.

 

Net result should be that for the same financial results, all the per share numbers should increase by ~25% when taking into account the reduction in shares + incurred interest on the debt.

[eclecticvalue]

One thing I forgot to realize was the Vivendi stake in atvi suppressed the stock price. Correct me if I am wrong.

[mikazo]

Activision Blizzard offers $5.9B for Candy Crush maker King Digital

 

http://www.ctvnews.ca/business/activision-blizzard-offers-5-9b-for-candy-crush-maker-king-digital-1.2640089

[blainehodder]

Very cool anecdote on Hacker News this morning:

I met Bobby Kotick (Activision CEO) as an Intern at Activision in 2008 and I asked him specifically if they were considering getting into "casual games" which were just starting to come into their own.

I'll never forget his answer: "No one has figured out how to really make money with casual games yet, but once someone does, we'll just buy them."

[saltybit]

http://www.barrons.com/articles/why-one-analyst-thinks-activision-is-the-next-disney-1501881943

[Patmo]

One gripe with that article, I dont think Overwatch will make a huge dent as an esport. Its just way too awkward to watch. Plus blizzard has been known to be pretty terrible in the esports space. Good news is there is lots of room for improvement there, and they have top notch talent to make it happen eventually. But I dont see any of their current games making it as a premier esport nor blizzard doing a good job in this space within the next couple years. Given some time, they will make it happen for sure. The esports wave is just starting anyway.

[ccplz]

Why is Overwatch awkward to watch?

[Jurgis]

Why is Overwatch awkward to watch?

 

It's been over watched...

 

 

 

Sorry, could not resist.  8)

[racemize]

Why is Overwatch awkward to watch?

 

I imagine because it is a first person shooter, and watching team-based first person shooter is liable to make your brain fry.  Imagine watching football, but you only have cameras from individual points of view.  Seems like they could fix this by adding some overhead cameras, but depends on map-size and whatnot.

 

In any event, Heroes of the Storm is actually doing ok. 

[Patmo]

It's all over the place, you can't follow the action well and neither can the commentators. Spectating one random dude in first person is fine, but competitive matches is another story. Maybe Blizzard can come up with a solution in time for their league start, but the game is not designed to make it easy. The aggregate number of overwatch viewers on twitch are routinely lower than a single individual LoL or pubg streamer.

 

That said, I am not advocating against going long this company, Blizzard is a really, really solid developer and I seriously doubt that they would miss the esports boat. Im just skeptical about this particular game being the title that will kill it.