Why Activision may come roaring back (online.barrons.com)

7 August 2012 10 h 36 min Comments Off

The company’s stock, in a slump for a few years, should soon benefit from a new game and a partnership in the booming China market. The upside could be as much as 50%.

Bring on the pandas. In late September, Activision Blizzard plans to release the latest extension of its wildly popular World of Warcraft, a multiplayer online game set in a fantasy universe. Mists of Pandaria will include a new race of people, with a new language and unusual traits, as well as a new adventurer class outfitted with special weapons and armor and skills and powers.

Investors are hoping the Asian-themed game will breathe new life into one of the videogame maker’s top franchises, and give Activision Blizzard’s shares a much-needed lift. The stock (ticker: ATVI) has been in the doldrums for much of the past few years, the result of a down cycle for packaged videogames for consoles ike Playstation3 and Xbox and intense pressure from cheaper games played on smartphones and tablets such as the iPad.

Mists of Pandaria, the company’s latest game, is set to launch in September.

The launch of Mists of Pandaria is one of a few events in the coming year that should benefit Activision Blizzard’s stock price. A number of its new releases are topping the charts in the U.S. and European markets, and it recently formed a promising partnership with Tencent Holdings (TCEHY), China’s largest Internet provider, to grab a bigger piece of that country’s booming games market by making its popular Call of Duty available online.

All of this could help Activision shares, which have fallen about 10% this year, versus a gain of nearly 11% for the broad market. At a recent $11.25, the stock was trading at just 11 times next year’s estimated earnings per share, or eight times, excluding cash on the balance sheet. Success with the new initiatives and some resulting margin expansion could lift those multiples smartly; the shares could rise as much as 50%.
Complicating the Activision Blizzard story somewhat is the news that its controlling shareholder, the French telecommunications and media conglomerate Vivendi (VIV.France), is interested in selling the 61.5% stake it obtained through the $19 billion merger of Activision with Blizzard Entertainment in 2008. But it’s not clear when or if a deal will go through, or what it might look like. Under at least one scenario, Activision’s shareholders could come out ahead.

THERE’S NO QUESTION that teaming Activision with Tencent could pay off nicely. Call of Duty will be free to play but will include an in-game store, at which players can buy gear and accessories. Terms weren’t disclosed, but Wall Street expects the deal, which could launch in mid-2013, to add meaningfully to Activision Blizzard’s annual earnings per share, with one analyst putting the eventual potential as high as 17 cents a year. The consensus estimate for total earnings in 2013 is $1.08, up from 98 cents this year.

The Chinese online gaming market, estimated at nearly $7 billion in 2011 with 160 million online gamers, is expected to increase by 20% this year and reach more than $9 billion by 2014.

Tencent, which offers China’s No. 1 game, CrossFire, a free-to-play multiplayer game comparable to Call of Duty, is the top game operator in China with $2.5 billion in revenue in 2011. NetEase (NTES), with which Activision has partnered to offer World of Warcraft in China, is No. 2, with $1 billion in revenue.

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Despite the slide of Activision’s stock, it has held up far better than its gaming counterparts, Electronic Arts (EA), down 42% year to date; T ake-Two Interactive Software (TTWO), off 40%; and Nintendo (NTDOY), down 21%. That’s a testament to the company’s lineup of top titles and its pipeline of new games, as well as the savvy cost management of Chief Executive Bobby Kotick and Chief Operating Officer Thomas Tippl.

Activision is debt-free and has taken advantage of its depressed share price by repurchasing shares. It bought back 26.4 million in the first half of this year for about $315 million.

Last week, the game maker reported better-than-expected second-quarter earnings of 20 cents a share, compared with the consensus estimate of 12 cents. The company raised its outlook for the full year to 99 cents a share, on an adjusted basis, on $4.63 billion in revenue, from a prior 95 cents and $4.53 billion. Still, the shares lost some ground because investors were surprised by a bigger-than-expected losses of subscribers to its blockbuster World of Warcraft. Part of the problem was that the launch of Diablo III siphoned off subscribers.

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IT’S HARD TO SAY how the Vivendi developments will play out. After four years of a successful and mutually supportive relationship, new management at Vivendi is refocusing on its core French telecommunications and cable businesses and shedding assets considered to be nonstrategic, such as the Activision Blizzard stake.

But it won’t be easy to find a buyer for Vivendi’s shares that would also be the right partner for Activision. For one thing, there’s a limited pool of buyers that would be interested in ponying up $7 billion to $8 billion, the possible range based on Activision’s current share price. Mentioned as the most likely candidates to have both strategic interest and wherewithal are Microsoft, Tencent, and even Time Warner Cable (TWC).

Vivendi is said to be seeking a premium, but many suggest it will be forced to accept a discount if it wants cash and a speedy sale. And Activision will most likely be seeking the same hands-off arrangement with any new buyer that it has had with Vivendi., which could limit buyer interest. The best outcome for Activision would be for the company to buy back shares from Vivendi, offer some to the public and bring in a strategic buyer as a minority shareholder. This would also provide broader support for the company’s stock. Activision currently doesn’t qualify for inclusion in the S&P 500 because another company holds a controlling stake.

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So far, Activision’s stock has responded in muted fashion to the various reports about Vivendi. More important for investors are the developments under way at Activision itself, and they look promising. Game on !

Source: online.barrons.com (04/08/2012)

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