Is There Cause For Alarm In Activision Blizzard, Inc. (NASDAQ:ATVI)?


Activision Blizzard, Inc. (NASDAQ:ATVI) reported a disappointing 4Q2015 in which both revenue and EPS missed consensus estimates. Weaker sales of casual games were blamed for the poor quarter. Going ahead, the management provided what appears to be a conservative outlook for 1Q2016. Activision continues to invest in expanding its portfolio of games and the completion of the acquisition of King Digital Entertainment PLC (NYSE:KING) should add to long-term bright spots in the company.

4Q earnings highlight

Adjusted revenue of $2.1 billion ($1.35 billion on reported basis) compared with the consensus estimate of $2.2 billion. EPS of $0.83 compared with the consensus target of $0.86. It is worth pointing out that 4Q2015 marked the first quarter since 2011 when Activision missed EPS target. Soft sales of causal games and adverse forex fluctuations negatively affected Activision’s 4Q results, officials said.

The chart below captures Activision’s revenue for the last five quarters:

Despite the weakness in causal games category, Activision’s core franchise of World of Warcraft and Call of Duty impressed with results that exceeded expectations.

2016 outlook

Activision Blizzard, Inc. (NASDAQ:ATVI) is looking for 1Q2016 revenue and EPS of $800 million and $0.11, respectively. Wall Street is projecting revenue of $756 million and EPS of $0.19 for the quarter. For full-year 2016, the company is looking for revenue of $6.25 billion and EPS of $1.75. Analysts on the average are looking for 2016 revenue and EPS of $5.05 billion and $1.73, respectively. The 2016 performance projections include estimated contributions from King Digital.

What are the bright spots in Activision?

Strengthening digital category

In 4Q2015, digital segment played a major role in supporting the topline amid weaker casual game sales. Revenue in Activision Blizzard, Inc. (NASDAQ:ATVI)’s digital category rose 29% YoY to $2.6 billion in 2015. The action was supported by solid jump in in-game purchases, whose combined revenue rose 57% YoY. Full game download revenue was up 65% in the year discounting forex related impacts. It is worth noting that the 57% growth in in-game purchases shows Activision’s success in player monetization.

Activision could witness further spike in digital revenue following the acquisition of King Digital. The acquisition should boost Activision’s scale and scope in digital and mobile game segments.

Promising longer-term prospects

Activision Blizzard, Inc. (NASDAQ:ATVI)’s longer-term outlook is a bit bright despite the short-term frustrations caused by underperformance in the casual game segment. The release of Destiny 2 and the closing of King Digital acquisition should strengthen revenue growth, especially by expanding the company’s scale and scope in digital and mobile platforms, which are lucrative sources of revenue.

The company also stands to benefit from favorable industry trends in the video game industry.

Cost synergies in combination with King Digital

King Digital’s spending on general and administrative expenses amount to $150 million annually. After the merger, there is an opportunity for Activision Blizzard, Inc. (NASDAQ:ATVI) to trim some of that cost by eliminating duplicated expenses.There is room to remove about $100 million in general and administrative costs following the combination of the companies.

King Digital also funnels about $500 million in research, sales and marketing activities every year. There is an ample opportunity for Activision to lower these expenses, allowing for financial savings that can be felt on the bottom-line.

Advertising opportunity

Acquisition of King Digital will boost Activision’s active user count to 500 million and allow the company to grow across geographies, audiences and platforms.

There is a huge advertising revenue opportunity for Activision once it completes the acquisition of King Digital. To put things in perspective, Zynga Inc (NASDAQ:ZNGA) generates nearly $56 million in ad revenue from its base of just 68 million monthly active users (MAUs). In comparison, King Digital has close to 450 million MAUs but still doesn’t generate any advertising revenue. As such, the huge user base is an untapped opportunity that Activision can leverage to boost topline growth. Looking at what Zynga is able to squeeze out of its small user base, you get the impression that there is a nearly $200 million revenue opportunity at the minimum in the monetization of King Digital’s user base through advertising.

Because monetizing user base comes at a small cost, the related revenues are usually accompanied by high margins. That means that monetizing the nearly 500 million MAUs of the combined company could bring about significant boost to the bottom-line as well.

King Digital generated revenue of $461 million in 4Q and reported adjusted EPS of $0.38.

What’s disturbing about Activision?

Coping with emerging platforms

Activision Blizzard, Inc. (NASDAQ:ATVI)’s business is currently predominately console and PC based. While there is opportunity in emerging gaming platforms such as tablets and smartphones, they are initially coming as a challenge to Activision’s core business. You find that tablets and smartphones compete for the entertainment time and budget against legacy consoles and that complicates the picture for Activision.

The company has to work hard to defend its core console-based business as it tries to translate the challenge presented by emerging platforms into opportunity.

Battle for the emerging game platforms

The contest for the control of emerging game platforms such as Android, iOS and IPTV is likely to be tough and costly. Activision Blizzard, Inc. (NASDAQ:ATVI) could see its marketing related expenses go up is it battles for the control of the new game platforms to broaden revenue growth and offset pressure in console sales. The popularity of the emerging game platforms also threatens to limit the console sales faster than traditional video publisher can catch up in the emerging platforms.

Volatile performance

The Video game business relies so much on hit releases and that causes limited visibility into the performance of a newly released game. Sometimes a title can receive lukewarm reception and end up generating revenue that is not commensurate with the investment that went into developing it. That also explain why video game business is sometimes characterized by huge profitability swings. Activision Blizzard, Inc. (NASDAQ:ATVI) is not immune to those risks.

Dangerous revenue concentration

Activision draws the majority of its revenue from Call of Duty and World of Warcraft franchise. Because of that revenue concentrate, the company could face serious disruption if its franchises fall out of favor with players or a competitor eats into the market share of its core franchises.

Conclusion

Activision Blizzard, Inc. (NASDAQ:ATVI)’s longer-term outlook is bright despite the near-term 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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