Is now the time to buy Activision Blizzard?
Opdateret: 3. maj 2022
The stock price of Activision Blizzard has dropped lately and is almost as the same level as the march 2020 crash. I have previously written a post where I compare the numbers of three large American videogame companies, and Activision Blizzard did come in second due to the numbers. The stock price has dropped since the news broke about a harassment scandal that affected female employees. In this analysis I will investigate if I would buy Activision Blizzard.
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should mention that I have never owned shares in Activision Blizzard. Nor have I ever owned shares in any of their direct competitors. I do have exposure to the gaming industry though, as I own shares in Microsoft, Sony, Tencent and Turtle Beach. If you would like to know what else I own, or if you would like to copy my portfolio, you can do so here. As always, I will try to keep this analysis objective.
Activision Blizzard is an American video game company. The company operates in three segments, Activision, Blizzard and King. While Activision and Blizzard are similar, as they generate revenue from full-game and in-game sales, King is a little different. King also generate revenue from in-game sales but unlike the other segments, it also generates revenue from in-game advertising. They are most known for the following franchises, Call of Duty, Warcraft, and Candy Crush, which are all franchises that generates over a billion dollars in annual net bookings. They also own other very popular franchises such as Diablo and Overwatch, which could be the next two dollar billion franchises to emerge from Activision Blizzard, as Activision Blizzard expects to have at least two more billion dollar franchises in the portfolio within the next few years. While Activision Blizzard has more games in the portfolio and in the pipeline, they are using a lot of resources into these franchises, as they have found that gamers are getting more deeply invested in their favorite franchise and play fewer games for longer. These franchises are well known all over the world, meaning it is very easy to determine that Activision Blizzard has a brand moat.
Their CEO is Robert A. Kotick. He became the CEO in 1991, following his purchase of a significant interest in the company, which was then on the verge of insolvency. He used to study history at the University of Michigan, while he also started a technology company called Arktronics that developed software for Apple. As Arktronics developed software for Apple, Robert A. Kotick met Steve Jobs who advised him to drop out of college, which is what Robert A. Kotick ended up doing. Before purchasing a stake in what is now called Activision Blizzard, Robert A. Kotick tried to purchase Commodore International but was unsuccessful. Besides being the CEO of Activision Blizzard, he, among other things, also serves at the board of directors at Coca-Cola. Looking at the results of Activision Blizzard, there are no question that Robert A. Kotick has done a remarkable job as a CEO. Since he become the CEO in 1991, the company's book value per share has grown at a compound annual growth rate of 30 %. It means that if you had invested $1.000 in Activision Blizzard 20 years ago, and reinvested dividends, those $1.000 would be worth $82.190 in the end of 2020. If you had invested $1.000 in the S&P 500 at the same time period, it would be worth $4.223. If I had written this analysis 6 months ago, I would most definitely have had great faith in the management but unfortunately, we have had some bad news this year. The news broke about several sexual misconduct incidents in the company, and according to a report, Robert A. Kotick should have known about the incidents and have failed to disclose them to the board. Robert A. Kotick should have told colleagues that he would consider leaving the company if he cannot quickly fix the issues, the question is if it is too late. Employees has staged walkouts demanding the CEO to resign and it has certainly damaged Activision Blizzard in their quest of attracting new employees.
I believe that Activision Blizzard has a brand moat. Unfortunately, we have a lot of uncertainties regarding the management. Nevertheless, let us investigate the big five numbers to see if Activision Blizzard lives up to our requirements for a strong moat. In case you want an explanation about what the big five numbers are, you can have a look at "MY STRATEGY" on the website.
The first and most important number we will look into is the return on investment capital, also known as ROIC. We want to see 10 years of history and we want the numbers to be above 10 % in all the benchmarks. The older benchmarks are a bit underwhelming but in no way alarming. The new benchmarks look promising and if Activision Blizzard continues to have a ROIC above 10 % moving forward, it would be a lot more interesting.
The next numbers we will investigate are the Sales Growth Rates. Ideally the numbers should be above 10% in each benchmark and increasing. It is a bit of a mixed bag, as we see some very compelling numbers bit also some that leave something to desire. I'm not alarmed by numbers like these, and it wouldn't keep me from investing in the company, but I'm not impressed neither.
The next numbers are the EPS Growth Rates. As with all other growth rates we want the numbers to be above 10 % in all benchmarks. All numbers are well above the requirement, which is very positive. We do see some numbers that are very high, and these numbers won't be consistent, but it doesn't matter. Activision Blizzard delivers on the EPS growth rate in all benchmarks.
The Equity Growth Rate in all benchmarks looks great. According to Phil Town this is the most important of the growth rates. It is encouraging to see that Activision Blizzard delivers numbers well above 10 % in all benchmarks except for the oldest one. What is even more encouraging is that the equity growth rate is growing from benchmark to benchmark, which is something you would like to see.
Finally, we investigate the Cash Growth Rates. Once again, the numbers are very mixed. We have benchmarks that tops the requirement, we have some that are underwhelming and one bad year. While I would like to see better numbers all over, I will not stay away from an investment based on numbers like these, as you need to look at the overall picture.
To shortly summarize the five numbers from Activision Blizzard. The most important number will always be the ROIC, which slightly underperformed in the oldest benchmark but deliver in the newer benchmarks. Hopefully the trend will continue, and Activision Blizzard will continue to deliver a ROIC of more than 10 % moving forward. The EPS growth rate delivers fantastic numbers in all benchmarks, and the equity growth rate as well, despite in the oldest benchmark. It is very encouraging for me to see numbers like these. The sales growth rate and the cash growth rate leave something to the desire in some of the benchmarks but nothing I would be worried about if I wanted to invest in Activision Blizzard. All in all, I would feel comfortable investing in Activision Blizzard, if you solely looked at the historical numbers.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. We do so by dividing the total long-term debt by current cash flow. Having done the calculations on Activision Blizzard, they show that Activision Blizzard can pay off their debt in 1,64 years. It is below the requirement of 3 years, which means that debt in my opinion isn't an issue, if I should choose to invest in the company.
Like with all other companies, there are some risks if you choose to invest in Activision Blizzard. The largest one right now is the uncertainty of the management. Will they be able to recover the trust of their employees, customers, and investors, or will they need to resign. And if they resign, who will run the business moving forward. I haven't seen a natural heir to Robert A. Kotick, and there is no way to know if a new management can deliver the same results. Another risk is one that Activision Blizzard mentions in the annual report and is that companies such as Activision Blizzard need to attract and retain skilled personal to effectively conduct their business. How much will these sexual misconduct incidents, and how the management didn't react on them affect Activision Blizzard ability to retain their skilled personal. And no matter how much the current or a possible new management does to prevent it to happen again, you would guess that it could hurt their ability to attract new skilled personal, at least short-term. Finally, we have the risk that a relatively small number of their franchises are responsible for the revenues. 76 % of the revenues in 2020 were from Call of Duty, World of Warcraft, and Candy Crush. If one of these franchises would fall out of favor, it would significantly hurt Activision Blizzard's business.
It isn't all doom and gloom though. Activision Blizzard still has a lot of possibilities to grow their business. Right now, Activision Blizzard engage approximately 400 million players around the world monthly, and they believe they will be able to more than double the number of monthly players, as they unlock the full potential of their franchises. They have already introduced a mobile version Call of Duty in 2019, and the effect of the launch has been stunning, as it means that in 2020 three times the numbers played Call of Duty in 2020 compared to two years earlier. These free-to play experiences, not only on the phone, but also on console and PC, is expected to lead to strong in-game monetization and additional sales of premium content, which grew by 40 % year over year in 2020. It means that Call of Duty has established a clear and replicable blueprint for how their franchises can reach more players on more platforms. This blueprint will be replicated for their Warcraft franchise, and management has high expectations that it will make the franchise grow as well. Management will also continue to grow Candy Crush, and what I like the most is that they will continue to build the advertising business of Candy Crush, and advertising usually has very high margins. In 2020, they grew the revenue of in-game advertising on Candy Crush with approximately 50 % year over year. Finally, they will also launch Diablo 4 and Overwatch 2 in the coming year, as they have been delayed.
All right, we have gone through the numbers, risks, and potential regarding Activision Blizzard and now it is time for us to calculate a price. To calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use an EPS as it was in 2020 at 2,82. I chose an Estimated future EPS growth rate of 10 (which I believe is possible), Estimated future PE 20 (which the double of the growth rate, as the historically PE for Activision Blizzard has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY", we come up with the sticker price (some call it fair value or intrinsic value) of $36,16, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Activision Blizzard at price of $18,08 (or lower obviously), if we use the Margin of Safety price.
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The operating Cash Flow last year was 2.252. The Capital Expenditures was 78. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 54,6 in our further calculations. The Tax Provision was 419. We have 778,89 outstanding shares. Hence, the calculation will be like this: (2.252 - 54,6 + 419) / 778,89 x 10 = $33,59 in TEN CAP price.
The last calculation is the PAYBACK TIME. It is also described in "MY STRATEGY". With the Free Cash Flow Per Share at 3,62 and a growth rate of 10 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $45,54.
I believe that Activision Blizzard is an interesting company with some great franchises. I personally believe that they will continue to grow their franchises, and maybe they will be able to make Diablo and Overwatch into billion dollar franchises as well. I'm even more intrigued by Candy Crush and if they can continue to grow in-game advertisement, as it could improve their already solid margins. However, I'm very concerned about what is going on with the management, and how this will affect Activision Blizzard moving forward. You might not give too much importance to management, but management is what will drive the company forward. I'm still undecided when it comes to Activision Blizzard, and I guess I will need to play the waiting game for some time. Nevertheless, if you are more optimistic regarding the issues with management will be resolved one way or another, I would argue that buying Activision Blizzard at the PAYBACK TIME price at $45,54 would be a great price, if it falls that low.
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