First Stab At A Valuation: Activision Blizzard, Inc. (ATVI)

First Stab At A Valuation: Activision Blizzard, Inc. (ATVI) – Comments And Criticism Welcomed! by indigoreality

Investment Thesis

I am recommending a Buy position for Activision Blizzard Inc. Based on multiple valuation methods, the average fair market value of ATVI is $41.33. Activision is the largest video game firm in the world. It currently controls the entire video game realm with famous franchises including Call of Duty, Warcraft, Starcraft, Diablo, and the recently acquired Candy Crush. ATVI also owns Major League Gaming, a professional esports organization that hosts major video game tournaments worldwide. I believe they are positioned for a large growth as they enter a new genre of gaming with their Overwatch, first person shooter game. They are also expected to release a movie in 2016 made after the hit franchise Warcraft. And as Virtual Reality systems such as Oculus develop, so too will ATVI build games for that arena.

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Activision Blizzard, Inc. (ATVI) – EIC Analysis

Economy

The markets have been very volatile at the beginning of 2016 giving ATVI a YTD return of nearly -18% while the S&P 500 only suffered -5%. The economy for video games is still very strong and worldwide. Four out of five households owned a video game console in 2014 and the U.S Computer and Video game sales have been increasing, even through the financial crisis.[1] Over the last five years, ATVI has had a total return of 200%, outperforming the S&P 500 by near 4x.

Industry

The video game industry is in a mature state characterized by cyclical growth and strong competition. The industry relies on constant new releases of popular video games to attract consumer sentiment and fuel demand. Over the last decade we’ve seen a large shift over to “social games” being played on devices that connect to the internet. Sales are largely generated through new channels that incorporate downloadable content, in-game purchases, advertisement revenue, and subscription fees. Esports has also risen to play a major role in gaming industry. MLG hosts professional competitions in CounterStrike: GO, Call of Duty, DOTA 2, Starcraft, and Halo. The amount of live viewers for esports events overall have been increasing over the year as we see more and more international competitive play amongst new games. Last year, the largest esports event reached 36 million in 2015.[2]

Company

Activision Blizzard is primarily driven by the sale of its video games. They have large market shares in all types of gaming systems including mobile, console, and PC. They recently acquired King Digital, producer of Candy Crush, the top downloaded game in the iOS store in 2015[3] and ranked #6 in the highest grossing app.[4] They are also known for World of Warcraft, the largest Massively Multiplayer Online Role-Playing Game in the world which hit a subscriber base of 12.5 million players in 2012[5], and are currently reaping a base subscription fee of $15 per player per month. Last year, ATVI generated around $4.6B in revenue while King generated around $2B. Together in 2016, they are expected to generate around $6.5B.

DCF/NPV Valuation

A DCF model was created to estimate ATVI’s net present value . The following assumptions were made: a 6% projected growth for 2016 from the completion of the King Digital acquisition, revenues from mobile would grow from last year as the smart phone industry grew, and a conservative yet consistent year-on-year growth between 1-2% for the next 10 years with a terminal growth rate of 2%.

Activision Blizzard, Inc. (ATVI)

Activision Blizzard, Inc. (ATVI)

ATVI historically has no debt. They recently took on debt for the purchase of King Digital and has been paying it down annually. I project this debt will be completely paid off in the future and accounted for that in our assumptions. Their NPV and Share price is highly affected by the discount rate and growth rate. As they move away from debt and towards full equity, their value increases.

Activision Blizzard, Inc. (ATVI)

Activision Blizzard, Inc. (ATVI)

APV Valuation

An APV model was also created to account for their change in capital structure. ATVI went from historically no debt, to taking on close to $5B in debt on their balance sheet after acquiring King Digital. Their long-term debt has decreased this year. I’m inferring that ATVI does not tend to take on debt and will pay this off. Therefore, an APV valuation would reflect a closer accurate towards the company’s intrinsic value. The APV value for the firm came out to $33.10 per share. The below picture shows the APV projected cash flow and tax shields. This is under the assumption that ATVI does not take on anymore debt or acquisitions and continues to gradually pay off their current debt.

Activision Blizzard, Inc. (ATVI)

Activision Blizzard, Inc. (ATVI)

PE EPS Multiple Valuation

The last method of valuating ATVI was to project the EPS growth over the next 10 years and multiple the terminal EPS by the forward P/E ratio. Their Price-to-Earnings ratio is currently 25.63. Their expected EPS in year 2025E is 1.65. This is using a conservative approach assuming their outstanding shares remain constant. Using the projected DCF model as a base, the estimated fair value based on the PE EPS multiple was $42.27.

Activision Blizzard, Inc. (ATVI)

Technical Analysis

Based on technical analysis, the stock has dropped almost 20% from its 52-week highs. On the monthly chart, we can see a very strong convicting bounce off the 20-day moving average. The moving averages are ordered in a bullish manner and the most recent red candlestick shows very strong buy volume from its long tail.

Activision Blizzard, Inc. (ATVI)

Conclusion

Activision Blizzard is expected to have a huge boost in earnings this year due to the King Acquisition. I expect growth to subside the following year but remain stable as mobile games grow slowly with console and PC. Outside of mobile, I project 7% growth in PC revenues and 9% growth in console games over the year. Operating margins have increased slowly since 2014 and will expect to grow on average 1% a year. The recommend fair value price is based off three different valuations that all result in a higher expected share price. I expect ATVI’s share price to increase by 20% over the next 10 years in a neutral to bullish economy.

References:

[1] http://www.theesa.com/wp-content/uploads/2015/04/ESA-Essential-Facts-2015.pdf

[2] http://www.theverge.com/2013/11/19/5123724/league-of-legends-world-championship-32-million-viewers

[3] http://recode.net/2015/09/02/candy-crush-saga-clash-of-clans-top-apple-app-store-downloads-sales/

[4] https://thinkgaming.com/app-sales-data/2/candy-crush-saga/

[5] http://www.statista.com/statistics/276601/number-of-world-of-warcraft-subscribers-by-quarter/