Video game publisher Activision Blizzard (NASDAQ:ATVI) announced record fourth-quarter 2018 earnings Feb. 12. However, it was the 8% cut in headcount that sent Activision stock higher.
Should investors be confused? Yes and no. Here’s why.
Business Is Slow
It’s never easy to announce job cuts. It’s especially tough when your CEO says the following about your business:
“While our financial results for 2018 were the best in our history, we didn’t realize our full potential,” CEO Bobby Kotick stated in its Q4 2018 press release. “To help us reach our full potential, we have made a number of important leadership changes. These changes should enable us to achieve the many opportunities our industry affords us.”
Activision Blizzard’s revenues and adjusted earnings in 2018 were $7.5 billion and $2.1 billion, respectively — both are records. It made $2.72 a share in 2018, also a record. In terms of growth, revenues increased 6.9% year over year, while EPS rose 23.1% over fiscal 2017.
All good, right? Not so much.
Analysts were expecting Q4 2018 revenue of $3.04 billion and $1.28 in earnings per share. Activision delivered $2.84 billion in net bookings (excludes deferrals) and $0.90 a share.
And fiscal 2019 is shaping up to be slow.
Analysts were expecting Activision to deliver $7.3 billion in revenue on the top line and $2.58 a share on the bottom. The company’s guidance: $6.0 billion in net revenue, $6.3 billion in net bookings, and $2.10 a share.
More than 12 analysts cut Activision’s price target as a result of this guidance miss. A big reason for the cut has to do with free-to-play games. Fortnite and Apex Legends are putting a crimp in sales of its top titles such as Overwatch, Hearthstone and World of Warcraft.
“It becomes increasingly difficult to convince gamers to pay $60 when high-quality competitive offerings are free,” Jeffries analyst Timothy O’Shea said in a report to clients. “We believe it is inevitable more free games will arrive, and our No. 1 prediction for 2019 is that Activision will announce a free-to-play game.”
The analyst believes Overwatch is one possibility to go free-to-play. Call of Duty: Blackout is another.
However, to get to that point, it has to up spending on game development. Hence the layoffs.
Make Hay While the Sun Shines
Approximately 750 employees are expected to lose their jobs. For them, no explanation will suffice. However, it makes sense from a business perspective to do this kind of restructuring while business is at record levels, for two reasons.
First, Kotick recognizes that Activision faces a severe threat to future revenue generation from free-to-play games and the only way out is to develop games that people want to play: free or otherwise. That’s why it’s increasing the resources it provides to its core and incubation development teams by 20% in 2019.
That money has to come from somewhere.
The second reason to do a restructuring now is that it can afford to do so. In 2018, it generated $1.7 billion in free cash flow, which means the affected employees will receive a comprehensive severance package including health benefits, career coaching, and job placement assistance.
However, free cash flow in 2018, was 24% lower than in 2017, despite lower capital expenditures. It’s clear Activision’s cash machine is slowing making these cuts even more import to rightsizing the business.
It might sound like something an MBA would say, but when a company grows as is the case with Activision, it’s more than plausible that its cost structure’s gotten out of whack given the current business climate.
Activision’s actions are those of a responsible employer. To not could mean more jobs are lost in 2-3 years as competitors eat its lunch.
Bottom Line on Activision Stock
The average analyst target price is currently $54.70. That’s an upside of 22% over the next 12 months.
Given the proactive steps, Activision is taking to deliver for shareholders; I like ATVI stock at current prices. It’s rare that job cuts make sense. These do.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.