Rare Delays Prompt Lower Sales Outlook; Buy for Reiterated EPS
Activision Blizzard, Inc.
Rating: Outperform
Price: $11.55
Activision posts Q2 EPS upside from higher margins, lower tax rate. Activision reported Q2 revenue and EPS of $801.0 million and $0.08 versus our estimates of $800.0 million and $0.07. It was able to offset a higher share count with higher margins and a lower tax rate. It delayed StarCraft II and Singularity into 2010, which, while not a big issue, forced its sales forecast 6% lower. It reiterated EPS.
Delays make 2010 more attractive. Activision’s 2010 slate was fine, but not really exciting for investors, especially after a strong 2009. After the delays of StarCraft and Singularity, 2010 looks better and may keep investors on board after the holidays. Investors worry about Activision always issuing conservative out-year guidance, so strong titles are crucial to maintaining optimism into a new year.
Recent worries are in guidance; now eyes turn to the holiday. ATVI has underperformed the market over the past month due to fears about product delays and WoW in China. These issues are now factored into Activision’s guidance.
Activision remains our top pick in videogames. Activision is our top pick in videogames, due in part to its year-end slate. With the likely top game of the holiday in Modern Warfare 2, two new peripheral games in DJ Hero and Tony Hawk Ride, and three titles to revive Guitar Hero, there is little doubt in our minds that it should gain share. Our $15 price target is 19x our 2010 EPS estimate of $0.80.
Detailed Discussion
EPS Beat from Gross Margin, Lower Opex and Tax Rate
Activision reported Q2 revenue and EPS of $801.0 million and $0.08 versus our estimates of $800.0 million and $0.07. It was able to offset a higher share count with higher margins and a lower tax rate. Activision also officially delayed Blizzard’s StarCraft II into the first half of 2010 and new IP Singularity into 1Q10. Both delays were somewhat expected by the Street, and Activision’s reiteration of EPS guidance of $0.63 had the stock trading up in the after-hours market.
Game Delays Affect Fiscal-Year Guidance
Activision had previously announced the delay of Singularity, but had not yet factored it into formal guidance, so the Street was expecting it. The StarCraft II delay was widely rumored, factored into estimates by some analysts, but was still a surprise to the Street at large. We had $70 million of revenue from Singularity in our model and $185 million for StarCraft II. Activision took down its sales forecast by $300 million on top of its $26 million Q2 beat, so it clearly had higher expectations than we did if nothing else changed.
Battle.net Gets Some Air Time, Takes Fall for StarCraft Delay
The delay of StarCraft II was essentially blamed on Battle.net, Blizzard’s online matchmaking service. The updated Battle.net has been promised as something well beyond what we have come to expect, although details have been sparse. On the call, Blizzard disclosed that the service is being looked at as the “premier online gaming destination,” and “the foundation for all future online games at Blizzard.” It will feature tournaments, rankings, multiplayer matchmaking, social networking, cross-game communication and a unified login for Blizzard games, which previously was not the case. Specifics beyond this will likely come closer to the release of the game, but it is clear that Blizzard is aiming high. The primary questions remain (1) whether it will be able to monetize these services, and (2) whether this investment and latest delay in StarCaft II will be justified financially.
Delay of ‘World of Warcraft’ in China Is Still Minimal
Activision discussed its progress in China with the World of Warcraft transition in a bit more detail. It is still awaiting government approval to open the game for new users, but its existing-account beta test seems to have gone well last week. It reported that over 4.2 million accounts were activated. While it did not mention any concurrent user statistics, which would give us a better idea of its true progress, we view this level of account activity positively. The final roadblock now seems to be government approval, which Activision does not have a good read on, and even mentioned as something that is out of its control.
We have removed $15 million in revenue from Q3 due to the delay of World of Warcraft in China. This is based on a run rate of $250 million in game revenue per year, a 32% royalty to Blizzard, and the game being offline two months in the quarter. If it came online more quickly, it would not have a material effect on our estimates.
Activision Lowers Industry Forecast, Unsurprisingly
Following other publishers’ reduction to their industry forecasts, Activision made a similar move and lowered its industry forecast to flat to slightly down from low to middle single-digit growth previously. This should not surprise investors given the number of sources that have provided similar commentary. What may surprise investors is that Activision was the first to open the door to the potential for industry sales to be down this year. We continue to believe that small fluctuations in the end market will not dictate a publisher’s success. Instead, market-share gains should be the primary focus, for which we believe Activision is particularly well positioned.
‘Mattress’ Cash Is Better Suited for Share Repurchases
Activision announced an increase of $250 million to its already announced $1 billion share-repurchase program. To date, it has repurchased $668 million at an average price of $10.41, or 64 million shares, which leaves it with $582 million authorized outstanding. Since Activision reported Q2 interest income of $0 on nearly $3 billion in cash, it clearly would be better to use some of its excess cash to buy back shares.
Delays Make 2010 More Attractive
Activision’s 2010 slate was fine, but not really exciting for investors, especially after a strong 2009. After the delays of StarCraft and Singularity, 2010 looks better and may keep investors onboard after the holidays. Investors worry about Activision always issuing conservative out-year guidance, so strong titles are crucial to maintaining optimism into a new year
Activision Is Best Positioned for Holiday Share Gains
ATVI has underperformed the market over the past month due to fears about product delays and WoW in China. These issues are now priced into Activision’s guidance. It is our top pick in videogames due in part to its year-end slate. This is the case despite its delay of Singularity and StarCraft II into next year. With the likely top game of the holiday in Modern Warfare 2, the two newest peripheral games in DJ Hero and Tony Hawk Ride, its foray into the racing genre with Blur, and three Guitar Hero titles with Band Hero, Guitar Hero V and Van Halen, there is little doubt in our minds that it should gain share. The main variable will be consumer acceptance of its high-ASP (average selling price) peripheral titles, which has been a risk for the past few years with Guitar Hero. However, the novelty of new peripherals for DJ Hero and Tony Hawk will likely keep the titles in high demand, so we see less risk than we would in the same year if this were each game’s second or third iteration.
Category: ATVI, Games | Tags: ATVI, earnings -