Activision Blizzard, Inc. Stock Charges a High Price for Low Growth

ATVI stock has a major problem

It’s easy to forget now, but Activision Blizzard, Inc. (NASDAQ:ATVI) was pretty much a dead stock for the first few years of this decade. The ATVI stock price flat-lined around $11 from mid-2009 to the beginning of 2013.

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ATVI stock traded for a low double-digit EPS multiple, as investors fretted about the coming decline of the key World of Warcraft franchise and its impact on sales and earnings growth.

Fast-forward a few years, and the story appears very different. ATVI has risen 470% in five years. The stock trades at almost 29x 2017 EPS estimates.

The video game sector is one of the hottest in the market and ATVI actually has been the weakest of the big three developers.  Electronic Arts Inc. (NASDAQ:EA) is up 694% in five years and Take-Two Interactive Software Inc (NASDAQ:TTWO) has gained a whopping 854%.

But if you look closely, I’m not sure the story is quite as different as valuation would suggest. Activision’s purchase of King Digital has been a smashing success, admittedly. The company paid less than 9x EPS for the business backing out King’s cash on the books.

But for the rest of Activision Blizzard, earnings growth remains a serious problem. WoW still is declining. Call of Duty may be showing its age.

The optimism toward eSports is real, and so is the opportunity there. But this is a company now worth almost $50 billion. And eSports alone isn’t going to support that type of valuation.

Growth Concerns for ATVI Stock

Tracking Activision’s non-GAAP net income over the years shows that the company simply isn’t growing earnings the way one might expect.

Even adding back the impact of revenue deferrals (which changed how ATVI presented its adjusted figures in the middle of last year), growth has been relatively minimal, with two notable spikes:

  • 2010: $991 million
  • 2011: $1,087 million
  • 2012: $1,350 million
  • 2013: $999 million
  • 2014: $1,057 million
  • 2015: $975 million
  • 2016: $1,659 million
  • 2017: $1,656 million

2012 simply was a blowout year, buoyed by the launch of Diablo III. But between 2010 and 2015, Activision Blizzard’s net income actually declined.

EPS skyrocketed, but that was due to a huge share repurchase, as ATVI took out the stake formerly owned by Vivendi SA (ADR) (OTCMKTS:VIVHY).

In 2016, earnings spiked due to the addition of King, formally acquired on Feb. 23. Activision Blizzard’s legacy business did grow.

But the company also said on the Q4 conference call that King’s addition to earnings had been more than the 30% the company originally forecast, which in turns suggest that the legacy business grew in the range of 20% year-over-year.

That may even be aggressive, given that King on its own generated $617 million in adjusted net income in 2015. And some of the old concerns persist in 2017.

Earnings are guided flat. Again, for a stock trading at almost 29x P/E. Revenue for the Blizzard segment is down 13% YTD, with both WoW and Hearthstone seeing lower revenue year-over-year in Q3, according to the post-earnings conference call.

Operating income ex-King is down 11% through the first nine months of the year.

ATVI still is reliant on franchises that may be in decline. According to the 10-K, 69% of 2016 revenue came from CoD, Candy Crush, WoW, and OverwatchCandy Crush has rebounded after declining before the acquisition, and the social media space looks stronger than many thought.

Zynga Inc (NASDAQ:ZNGA) is at its highest level in three and a half years.) But long-term, Candy Crush growth still seems modest, at best. Call of Duty reviews have weakened. Warcraft is in outright decline.

That puts a lot of pressure on Overwatch and its role in eSports.

What Drives The ATVI Stock Price Higher?

The eSports opportunity undoubtedly is huge. Luke Lango detailed the numbers on this site last month, arguing that ATVI could turn out be the next Walt Disney Co (NYSE:DIS) with a potential marriage of content and sports.

But Lango also argued last week that near-term expectations look too high – and I can’t help but agree with him. Again, the ATVI stock price suggests a $49 billion market cap. Even assuming eSports becomes a major part, and I believe it will, it only supports a fraction of that valuation.

Much of the rest still is based on the legacy franchises, most of which have varying degrees of concerns. Digital downloads and in-game content will drive revenue. And it may be that I’m underestimating the potential generational shift driving optimism toward ATVI stock.

But some degree of that shift is priced in, and at some point Activision Blizzard is going to have to drive the growth that supports the current price. King aside, it’s not doing so so far this year. It needs to do a lot better – and soon.

As of this writing, Vince Martin has no positions in any securities mentioned.

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