Activision Blizzard, Inc. (NASDAQ:ATVI) Is Discarding Tradition To Model A Successful Future

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The industry of video games is heating up as existing players up their game and newcomers cause disruptions. As an incumbent, Activision Blizzard, Inc. (NASDAQ:ATVI) can leverage its huge fan base and reputation to stay competitive, but being an incumbent also makes the company a target.

In a competitive environment, like the video games industry, being innovative rewards and Activision has been trying to do just that. The company is breaking away from some traditions that may have held it back in one way or the other.

Expanding franchise portfolio

Initially, Activision seemed comfortable relying on only a small number of game franchises, which it tried to squeeze the most money out of as long as it could. That strategy is changing for the better as the company is now focused on introducing more games frequently and expanding its franchise portfolio.

The management of Activision is working to expand the company’s franchises to 10 from 5.

Digital sales

For a very long time, Activision seemed to put more emphasis on developing games for traditional platforms like personal computers and consoles. However, in recent times, the company is moving to digital games rendering and mobile platforms, which are expanding its revenue potential.

Through digital sales, Activision is able to enjoy higher profit margins because of the low overhead costs associated with game distribution. As such, the digital strategy is attractive for long-term growth and profitability.

Expanding geographical focus

It is no longer sensible for any serious games publisher to narrow its geographical focus. Fortunately, Activision has been paying attention to the changing trends, and the company is making efforts to expand into markets outside the U.S., with Asia-Pacific turning out to be a particularly interesting region. Activision has expanded into China and the progress is inspiring, despite the existence of some teething problems here and there as you would expect in any new market.

With digital distribution, Activision can easily reach a wider audience around the world with modest investment in additional distribution infrastructure, improving sales and margins in the process.

Adding more channels

Activision is also expanding into new media channels like television, thus unlocking new revenue opportunities.

Hope for a better future

Given the strong demand for Call of Duty and the relaunch of titles like Guitar Hero, Activision Blizzard, Inc. (NASDAQ:ATVI) is entering the second half of 2015 with a lot of optimism.

Expansion of StarCraft II, the launch of Overwatch and contributions from Heroes of the Storm and Hearthstoneare are some other potential growth levers in the second half going forward. These titles should especially contribute to stronger growth on the digital front.

To put itself on the path to a more successful future, Activision is not only trying to come up with brand new titles, but is also reinvigorating existing titles to continue squeezing more revenue from them.

So far so good:

Activision continues to sign up more Hearthstone players with the number hitting 30 million. Heroes of the Storm is in a massive breakout, giving League of Legends from Riot Games a run for its money and boasting more than 70 million active users and counting.

Next-gen consoles narrative

Consoles still make a significant portion of Activision’s overall game distribution. It is estimated that there will be 49 million next-gen consoles in use by the end of the year, which means significant upside potential for Activision on the digital front.

Uptake of Xbox One and PlayStation 4 is being fueled by price cuts, and widespread adoption of these consoles indicates widening revenue opportunities for Activision. Microsoft Corporation (NASDAQ:MSFT) and Sony Corp (ADR) (NYSE:SNE) are trying to outdo each other in the console space, thus the attractive pricing of the devices. Additionally, Xbox One and PS4 are also being enriched with virtual reality capabilities, which should expand Activision’s customer engagement opportunities.

Big beat conservative outlook

Second quarter 2015 highlight:

Activision generated revenue of $759 million in the second quarter of 2015, up 13% excluding the impact of foreign exchange. Consensus estimates called for revenue of $666 million for the quarter. Call of Duty continued to offer much needed support, leading to a more than 35% increase in active user base.

Non-GAAP EPS for the second quarter was $0.13, coming above the consensus estimate of $0.08. EPS drew support from disciplined expense management and increases in digital revenue.

Current quarter and full-year guidance:

The management of Activision made a more cautious guidance for the current quarter and full-year, increasing previous projections by smaller margins compared to the margins by which it beat estimates in the second quarter of 2015.

Activision modeled the current quarter’s revenue to come in at $930 million at a time when the consensus estimate calls for $866 million.EPS for the third quarter is forecast to be $0.14, in line with the consensus estimate.

For the full-year 2015, revenue and EPS are predicted to come in at $4.6 billion and $0.30, respectively. Previously, the company guided for revenue and EPS of $4.4 billion and $1.20, respectively.

Given the growing excitement around Call of Duty, titles in the pipeline and the push into new geographical markets, Activision’s estimates for the current quarter and full-year look light at best.

Capital allocation

Activision Blizzard, Inc. (NASDAQ:ATVI) may continue to return more funds to shareholders through dividends and buybacks. The company in May paid out dividends of $0.23 a share but withheld stock repurchases, despite the $750 million buyback authorization. Activision’s balance sheet shows that the company can afford to return more cash to shareholders. The company finished the second quarter with more than $4.5 billion in cash and short term investments.

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Area of concern for Activision

Performance volatility: It is always difficult to predict how the market will receive a new product, a problem that is more compounded in the video game industry, thus posing serious revenue and profitability volatility. Activision could suffer adverse material impact on its financial performance if, after a heavy investment in a new game, things fail to turn out as expected.

Business seasonality: The video game business is largely dependent on consumer discretionary spending, which means that demand for video games tends to be high around holiday seasons and low in most parts of the year. Therefore, soft consumer discretionary spending around the holiday season can adversely impact revenue and profitability of video game companies and Activision is not immune to the challenges.

Revenue concentration: There is a lack of revenue diversification at Activision. The company relies on Call of Duty and World of Warcraft for most of its revenue. That means that the rise of a new competitive force, or trouble in one of the key franchises, could lead to adverse material impact to the company’s revenue and profitability.

Bottom line

By breaking away from some traditions, Activision Blizzard, Inc. (NASDAQ:ATVI) is setting itself up for success. However, the company needs to accelerate its reform efforts, especially revenue diversification, to eliminate existing growth and profitability challenges.

Disclaimer: The opinions and data expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisory capacity, nor is this an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the company or companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.

Neha Gupta

Neha Gupta has been in the financial space for over six years now. Gupta earned her MBA degree from Symbiosis Centre of Distance Learning in 2009 and her passion for finance led her to pursue Chartered Financial Analyst (CFA) course. She has successfully completed Level II of her CFA. She is a veteran in article writing, which is depicted in her numerous pieces published on SeekingAlpha, Nextiphonenews, InsiderMonkey, MarketWatch, and Techinsider. Her crisp and eloquent writing finds its best place in Researchcows, where emphasis is given on developing rich content for various websites, products, business plans, trainings, and book writing.

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