We live in an increasingly digital world. Just ask game producers. Video games, once console-dominated, are increasingly digital and internet-based. Options abound for multi-player game-play, online interaction, and interfaces. Many games are simply designed for cellular devices, as consumers increasingly move mobile.
Video and computer games represent a constantly evolving industry, but one major player has continued to see success over the last decade of transformation: the creator of the World of Warcraft computer game, CandyCrush mobile game and Call of Duty franchise of video games.
Activision Blizzard (ATVI, Financial) has had an impressive string of successes across platforms. Yet the company faced shrinking income in 2017 and less-than-stellar earnings results in first quarter 2018. That said, we see some interesting growth potential for this business as it continues to lead the industry forward.
Mixed financial performance
A financial evaluation of Activision Blizzard’s performance reveals a mixed, but mostly positive, record.
Revenue growth has been a mixed bag over the last several years. Revenue jumped significantly from 2015 to 2016, $4.7 billion to $6.6 billion. This 42% jump sent the stock upwards. It would be promising if this kind of trend continued, but unfortunately revenue growth lagged in 2017, increasing by only 6% to $7.0 billion. Such a significant drop in growth to 6% from 42%Â cannot be overlooked, and gives us pause for Activision Blizzard’s future.
The declining revenue for Activision Blizzard’s resulted in depressed earnings for 2017 as well. While costs remained relatively flat for cost of revenue, SG&A and R&D, an unusually high income tax expense of almost $900 million dropped overall earnings on the year. Earnings dropped to $273 million from $966 million.
While we do not believe these revenue and earnings numbers spell disaster for Activision Blizzard’s future, we also caution that revenue growth must get beyond 6% per year. A healthier number of 15-20% is desirable if the spectacular above-40% number from 2016 cannot be repeated. Interestingly, but not terribly surprisingly, Activision Blizzard’s stock did not suffer nearly as much as one might expect from a significant decline in growth. The stock is up over 33% year-over-year from this time last year.
Earnings surprise likewise presents a mixed bag, although most significantly earnings per share hit 34 cents for the first quarter of 2018, a 13% increase over 2017. That gives some hope that earnings could rebound from their disappointing performance last year.
Earnings per share have outpaced expectations half the time over the last year and missed expectations as many times. Earnings per share for the second quarter of 2017 were 51 cents, 43 cents for the third quarter of 2017, 88 cents for the fourth quarter of 2017 (as is to be expected with holiday traffic), and 34 cents for the first quarter of 2018, representing +104%, -4%, -3% and +17% surprises, respectively. Earnings look to rebound from 2017 and reach a more respectable growth number for 2018. This will be telling.
The key to the future
A major key for Activision Blizzard’s future hinges on whether it can develop another hit game. Its revenue continues to move increasingly toward the digital space, reaching almost 80% of its total in 2017. The next hit game, therefore, will likely come in the digital space.
Activision Blizzard is responsible for a variety of hit popular games including CandyCrush, World of Warcraft, Call of Duty, StarCraft, Tony Hawk and Guitar Hero. Its suite of games continues to perform at the top of its industry in revenue and user traffic.
The company has a market cap of over $50 billion and a team of almost 10,000 of the world’s brightest designers, creators, data analysts and management. Given its track record, if it cannot make a few great hits in the next several years, no one can.
It is a bit of a risk to say revenue will continue to grow based on future games, but Activision Blizzard’s track record speaks for itself.
Verdict
A success story wins. While very likely not a four- or five-fold gainer (again, look at our younger tech stocks for that kind of return), the game-maker is a relatively safe play with the potential for considerable growth.
Disclosure: I/We own no stocks discussed in this article.
(This article was co-authored by Clyde Wm. Engle Jr., an investment analyst with Almington Capital - Merchant Bankers.)
