Activision Blizzard: Can Starcraft 2: Wings of Liberty Lift the Stock? (ATVI)

Activision Blizzard, Inc. (ATVI)
Shares of video game publisher Activision Blizzard (ATVI: Charts, News, Offers) have been stuck in a rut for the first half of 2010, following a 15% two-month decline in video game sales in America. With a controversial reputation as one of the most hated, yet most profitable publishers in the world, Activision Blizzard is a divisive company to gamers and investors alike. It’s much-hyped 2008 acquisition of Vivendi’s video game division, Blizzard Games, has yet to revive the stock price. Now, with the release of the eagerly anticipated Starcraft 2: Wings of Liberty, will investors return to lift ATVI off the ground?

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Stock Analysis

Shares of Activision have bounced between a narrow 52-week range between 9.93 – 13.00. Current trailing P/E is at 50.08 while the forward P/E is an impressive 13.6, signifying high expectations for growth. The current 5 year PEG ratio, key for a growth stock like ATVI, is at 1.1, signifying a safe current valuation. ATVI pays a 0.15 annual dividend. The stock split 2 for 1 near all-time highs in September 2008 (18.62 post-split) and has been in decline ever since. Activision ended FY2009 reporting total revenues of $4.3 billion, an increase of 41.4% over FY2008. It also reported net income of $113 million, as opposed to a loss of $107 million the previous year. The net profit margin so far for 2010 has been an impressive 29.13%, a huge increase over the meager 2.64% of 2009. Video game sales hinge greatly on the overall retail picture, and U.S. retail sales have declined now for two consecutive months.

Activision Blizzard’s income is split mainly between two groups – Activision Publishing, which accounts for 66% of total revenue, and Blizzard Entertainment, which accounts for 25%. It’s biggest direct competitor is Electronic Arts (ERTS: Charts, News, Offers)

Activision Publishing, composed of a stable of independent developers, is responsible for the company’s well known console flagship titles – Call of Duty (which also includes the Modern Warfare series) and the popular party games Guitar Hero and DJ Hero. The Call of Duty first-person shooter series, which started on the PC in 2003, is the company’s best seller, selling 55 copies worldwide earning $3 billion in sales. The Guitar Hero series has to date brought in $2 billion. Activision’s core titles are now being challenged by several publishers – on the music/party front by Japanese publisher Konami’s (KNM: Charts, News, Offers) Rock Band series, and on the first person shooter front by multiple contenders – most prolific of them Microsoft’s (MSFT: Charts, News, Offers) Halo series. Also noteworthy is that former Halo developer Bungie Studios joined Activision in April 2010, bringing in another developer for the popular first-person shooter genre. It also has several licensing deals with Dreamworks and Marvel (now owned by Disney) for movie and comic book games.

Activision Publishing is also facing criticism from gamers and critics that it milks franchises dry with endless sequels and pricey expansion packs. Many investors fear that the law of diminishing returns will eventually catch up to Activision, although that has not been the case yet. Activision confirmed that worldwide sales of Modern Warfare 2 had topped 20 million copies, making it the 3rd best selling video game of all time in the United States. Activision has also claimed that Guitar Hero III: Legends of Rock has been the first video game of all time to exceed $1 billion in worldwide sales.

Blizzard Entertainment has created three of the most well-known franchises in PC gaming – the subscription-based massive multiplayer online (MMO) game, World of Warcraft, the real-time strategy game Starcraft, and the multiplayer role-playing game, Diablo. While Blizzard’s releases are few and far between, its games have tremendous staying power in an otherwise disposable market – Starcraft has been continuously played for 12 years, culminating in massive televised tournaments in South Korea, and World of Warcraft has been played from 2001 to the present day, commanding 62% of the lucrative subscription-based MMO market. In the world of video games, Blizzard’s replay value combined with steady income equals the dream product that many publishers seek to attain.

Software piracy has been a huge concern to Activision. 4.1 million copies of Modern Warfare 2 (PC) and 1 million copies of the XBOX 360 version were downloaded off the Internet through easily accessible P2P (peer-to-peer, i.e. “torrent”) networks, and earned the unscrupulous title of “The Most Pirated Game of 2009″, incurring a loss of $300 million in potential sales for Activision. Piracy has also prevented Activision from making significant investments to gain headway in China, which has a massive black market for pirated games. As Internet bandwidth improves, with hackers at every corner ready to crack the newest copy protection technologies (such as Securom and Starforce), widely distributed pirated disc images are now chipping away significantly at both PC and console game sales. To make matters worse, the newest home consoles (XBOX 360 and PS3) can be easily modified to play burned discs; both also contain high capacity hard drives that can also be used to store copied, extracted games. This has led to a less innovative, more profit-driven business model based on reliable franchises at Activision.

CEO Bobby Kotick has been the polarizing face of Activision since 1991. He has stated that he will only publish games that have the potential to develop “into $100 million franchises”. He has stated that he doesn’t currently play games, but makes business decisions based on market trends. A shrewd strategy like his should make him a hero to stockholders, but it hasn’t. Kotick heavily sold shares worth a total of $41.81 million in 2009, $22.15 million of that sold immediately after the release of Modern Warfare 2, which hasn’t helped his reputation. He has also had an acrimonious relationship with several prolific developers in his stable – the most publicized of these Infinity Ward, the creators of the hit Modern Warfare series. Kotick fired Jason West and Vince Zampella, the heads of the studio, over “creative differences”, causing 35 employees to quit in March 2010. The two later took several prominent members of their team to form Respawn Entertainment, and partnered, to Kotick’s chagrin, with Activision’s arch rival Electronic Arts. A month later, Activision was sued for $125 million by former and current Infinity Ward employees over unpaid royalties. Shareholders and gamers were livid. A Facebook page named “Gamers against Bobby Kotick & Activision” appeared and gained attention in the media. Petitions for a boycott and piracy of Activision products began to appear, damaging the company’s reputation further. Activision issued a press release claiming it treated developers “very well” in order to contain the damage.

Another developing front which may affect Activision’s future is the rise of social “cloud” gaming. Both Electronic Arts and Google have bought into the Facebook growth story with the former purchasing Playfish and the latter investing heavily in Zynga, both significant publishers of Facebook games. While Activision hasn’t directly invested in any social game maker, it has launched applications to directly connect to its Battle.net service to Facebook, in hopes that the integration will help bridge the gap between social networking sites and its upcoming heavyweight PC games which rely on the Battle.net service – Starcraft 2 and Diablo 3. Microsoft and Sony also tried similar approaches by launching XBOX Live and Playstation Network integration into Facebook applications, with minimal impact.

Anticipation now grows for Activision Blizzard’s Starcraft 2, to be released on July 27th. The real-time PC strategy game is anticipated to be one of the bestselling video game titles of all time. It is also significant for the entire video game industry, which has not had any best-selling, market-moving titles for two months. This game may finally be the catalyst to bring the bulls back to Activision and video game stocks. Activision currently trades at $11.67, and has an average analyst target price of $14.72. Activision will report earnings on Aug 5, 2010.

Other News About ATVI

• StarCraft II: Wings of Liberty Midnight Launch Event
• Activision: Call of Duty “is the closest thing this generation has to a ‘Star Wars’
• New Guitar Hero to feature Rush’s 2112

Other Stocks in the News

• Electronic Arts (ERTS: Charts, News, Offers): S&P Even More Bearish; Cites Weak Consumer
• Baidu (BIDU: Charts, News, Offers) Profit, Sales Beat Expectations; Market Share Rises
• Nokia (NOK: Charts, News, Offers) Earnings: It Keeps a Smartphone Lead — but Apple and Google Will Pass It Soon

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