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Higher Rates May Put a Cap on Activision Blizzard, Inc. Stock

ATVI stock - Higher Rates May Put a Cap on Activision Blizzard, Inc. Stock

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Video game publisher Activision Blizzard, Inc. (NASDAQ:ATVI) just reported fourth quarter and full-year numbers, and they were about as good as everyone expected them to be. The guide was also pretty good. The call went well, and everything is in place for big growth in the future through various eSports initiatives. But ATVI stock is struggling for gains after those strong numbers.

The stock can’t really seem to find its footing amid a broad market sell-off sparked by higher rates. Indeed, in February alone, Activision stock has dropped 10%.

The numbers for the fourth quarter  and a strong 2018 guide were supposed to save this stock. They were supposed to underscore just how strong the growth narrative is, making investors forget that the valuation is starting to get squeezed by a climbing 10-Year Treasury Yield.

That didn’t happen. Why? ATVI stock is richly valued. Yes, it always has been richly valued and that has worked well in a low-rate environment. But in an environment where rates are trending higher and valuations become that much more important, a big valuation might not work as well for ATVI.

What’s the move? If you’re in it for the long haul, I can’t blame you. This stock will likely head markedly higher in a 5-10 year window thanks to a booming eSports business. But in the near to medium term, I think ATVI stock struggles thanks to a valuation under pressure from higher rates.

Record Year, More to Come, but Valuation Is Rich

Activision broke a ton of records in the quarter and in the year, led by strength in the company’s rapidly growing digital business. The company reported record quarterly and full-year revenue, as well as record digital revenue. ATVI also reported record high margins and record cash flow for the full year.

The big records are mostly because of a big thing in the video game world called micro-transactions. Essentially, not only are these big video game publishers selling you games, but they are also selling you a whole a bunch of exclusive add-on content in the game.

ATVI is no stranger to this trend. The company delivered record in-game net bookings in the quarter (over $1 billion) and for the year (over $4 billion).

Better yet, the best part of this growth narrative is still to come. ATVI is the undisputed leader in the big growth eSports market. The company is in the early days of its massive Overwatch League (or OWL), the eSports community’s first attempt to legitimize eSports as a league on par with the NBA, NHL, MLB, and NFL.

OWL has been a massive hit in the early going, with 10 million unique viewers in week one and 280,000 average viewers per minute. The league is set to expand globally later this year.

ATVI is also behind Call of Duty World League, another huge eSports initiative with big growth potential. This one is less new (it began in 2016), but as eSports goes mainstream, popularity for CoD World League is only growing.

CoD World League has already sold out each of its World League Global Open events, and the season’s launch event had more than double viewership hours over the prior year.

With all these positives both currently happening and on the horizon, it is tough to see why Activision stock might not be a good investment here. But all you need to do is look at the numbers.

Earnings this year are expected to be $2.45 per share (growth of roughly 11%). ATVI stock trades at $66.50. That means Activision stock is trading at 27-times forward earnings for earnings growth of 11%.

I do expect that earnings growth rate to trend up over the next several years as OWL gains mainstream traction. But even at 15%, that is still a price-to-earnings/growth (PEG) ratio of 1.8. The S&P 500 is much less expensive, with a PEG ratio of just 1.3.

Bottom Line on ATVI Stock

Bulls will point out, as I have in the past, that ATVI stock has had a bigger PEG ratio than the market for the past five years and that it hasn’t mattered. ATVI stock has still been a big-time out-performer.

That’s true. But that was when rates were at all-time lows. Now, those rates are starting to creep up, meaning valuation is becoming more important than it has over the past 5 years. In this higher rate environment, it is tough to see how Activision stock is an out-performer. It has a PEG ratio nearly 40% larger than the market’s PEG ratio.

Consequently, I think there are tough times ahead for ATVI stock. That’s a near to medium term outlook. Longer term, this stock will head a lot higher thanks to eSports.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.  

Article printed from InvestorPlace Media, https://investorplace.com/2018/02/atvi-stock-higher-rates/.

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