Activision Blizzard: Playing Diablo’s Advocate

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January 25, 2010 | SIN Picks | | Author Asif

There are two sides to every story and when it comes to investing in individual stocks, for every logical argument that one could provide for buying a stock, there may be an equally strong reason for avoiding it. My last article about gaming company Activision titled Ten Reasons I am Buying Activision Blizzard (ATVI), generated a healthy discussion on Seeking Alpha with 33 comments following the article and also resulted in a TV interview with a Canadian station called Business News Network.

While I briefly touched upon some of the risks of investing in Activision in my previous article, I did not get a chance to elaborate further and have for some time now wanted to write this post, playing devil’s advocate to my long case for Activision.

The Industry:

The original thesis for investing in Activision Blizzard was not just the potential of Blizzard’s pipeline of games and Activision’s strong franchises but also the notion that the video game industry is traditionally resilient in recessions by providing one of the cheapest forms of entertainment ($0.60/hour when compared to $2/hour for DVD rentals). However the Great Recession we just experienced was not kind to the video game industry. The industry saw sales decline by 8% in 2009 to $19.66 billion from $21.4 billion in 2008, which was incidentally a record year. Software sales fared even worse with an 11% year-over-year decline to $10.5 billion.

The troubled video game giant Electronic Arts (ERTS) not only lowered its forecast for the quarter ended December 31, 2009 but lowered its non-GAAP earnings forecast for its full fiscal year, which ends in March, down to $0.40 to $0.55 from an earlier forecast of $0.70 to $1.00. EA executives expect industry sales to be flat to down 5% in 2010. The interesting thing about this forecast is that Electronic Arts has some highly anticipated games coming out in the current quarter including Mass Effect 2, which is the top selling game for XBOX 360 on Amazon even before its release date of January 26, 2010. It is nice to see Activision’s Call of Duty: Modern Warfare 2 in second place on the best seller list after spending 268 days in the top 100.

Despite EA’s gloomy outlook and the slump in the industry, we may still be on the money with Activision as the company reaffirmed its 2009 outlook when it reported results for the third quarter. This was before Call of Duty: Modern Warfare went on to register $1 billion in worldwide sales.

Current Games and Pipeline:

The worldwide success of Call of Duty: Modern Warfare 2 foreshadowed some of the recent misses in the Activision lineup. The critically acclaimed DJ Hero did not live up to its expectations when it was released last quarter and neither did Tony Hawk Ride, which was panned by both critics and gamers alike. The $120 price tag for the game (now $99.99) probably did not help much either. Guitar Hero Van Halen, which was released right before Christmas hardly struck a cord with customers. Unless Activision signs up bands like U2, the Guitar Hero series appears to be running out of steam. The only title from Activision that looks interesting for 2010 is time travel sci-fi game called Singularity that reminds me of a few episodes from Lost: Season 5.

The good news is that the Blizzard division might pick up the slack in 2010 thanks to the highly anticipated release of Starcraft II and an expansion pack for World of Warcraft called Cataclysm. Starcraft II will be split into three parts (one game for each of the three races Terran, Zerg and Protoss) and hopefully at least the first part will ship in the first half of 2010. There is also the possibility of Diablo III in 2011 (or beyond), expansion packs for each of the three Starcraft II games and another Massively Multiplayer Online Role-Playing Game (MMORPG) along the lines of World of Warcraft. Call of Duty or Diablo may translate well into a MMORPG.

Fourth Quarter Earnings:

Activision Blizzard is scheduled to report fourth quarter and full year 2009 on February 10th. Expectations for non-GAAP earnings in the fourth quarter are running very high with analysts expecting the company to report earnings of 41 cents per share on revenue of $2.23 billion. In contrast the company generated non-GAAP revenue of $2.34 billion in Q4 2008 but that was as a result of three big hits, Guitar Hero: World Tour, Call of Duty: World at War and World of Warcraft: Wrath of the Lich King, in a single quarter.

The recent success of Call of Duty: Modern Warfare 2 may not be sufficient to help Activision meet or beat the street consensus for earnings this quarter. However the reason Activision Blizzard is the largest position in both the SINLetter Model Portfolio and my personal portfolio has little to do with the company making its numbers this quarter and more to do with buying an industry leader with a strong pipeline at an attractive valuation.




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Comments

  1. sumayya
    January 27th, 2010

    Hi,

    Well all I can say is that I love Diablo and Hellfire :) Lets hope it does well.

  2. ming
    February 9th, 2010

    I ask myself, would I buy Diablo 3? Would I buy Starcraft 2? HELL YEAH. I think that these games are not only popular in the western world, but they have cult status in Asia and are perceived as value for money as they have a non recurring one time payment as far as online play is concerned. I’m long this stock. I don’t think that the performance of a video game company can be estimated by its competitors figures, but rather the track record of games and the following it has, as well as a sound continuity plan (balanced internet play). If you want to buy this stock, think like a gamer.

  3. Asif
    February 9th, 2010

    Ming, when I first wrote about Activision Blizzard back in September 2008, I started out by mentioning how big Starcraft was in South Korea and how a man there died playing it. I totally get what you are saying and Activision Blizzard is the biggest position in my personal portfolio. However there are two sides to every trade and I was using this blog post to explore the risks the company and stock face.

    You can find the original write-up about Activision from September 2008 here,

    http://www.sinletter.com/archives/SINLetterSeptember2008.aspx#ATVI

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