Before Activision (NASDAQ:ATVI) reported its fourth-quarter earnings, Activision stock fell from about $85 in Oct. 2018 to as low as $40.
Electronic Arts Inc. (NASDAQ:EA) and Take-Two Interactive Software, Inc. (NASDAQ:TTWO) are not faring that much better, either, losing around one-third of their value from their 52-week highs. Why are gaming stocks out of favor and should value investors even consider Activision, especially when the company is forecasting weaker results going forward?
Activision generated record net revenue of $7.5 billion for the year. In Q4, the company’s revenue was $2.38 billion, also setting a record.
EA’s 2018 EPS of $2.72 was also the highest ever and came in well above its 2017 EPS of $2.21 levels. But EA’s 2018 operating cash flow was $1.79 billion, below last year’s $2.21 billion.
Markets glossed over the strong figures and focused instead on its weak booking numbers. Even though its bookings of $7.26 billion reached records levels, they were only slightly ahead of last year’s $7.16 billion. With bookings growth clearly slowing, investors are unwilling to pay a premium for Activision stock.
After Activision stock dropped 48% from its yearly highs, the shares trade at a more reasonable price-earnings ratio of 19.
The Risk to Activision Stock Posed by Freemium Games Is Overstated
Fortnite, which Epic Games published, is the hottest cross-platform game on the market. It is popular not only on mobile devices but on consoles and PCs, too. That has worried the owners of Activision stock and ATVI itself. If consumers can install and play Fortnite and similar games for free, how will Activision justify charging high prices for its blockbuster franchise, Call of Duty?
ATVI is well-positioned in mobile devices through its ownership of King Digital, the maker of the popular, free mobile game, Candy Crush. In Q4, King’s revenue grew 5% YoY to $543 million, and its operating income jumped 28% to $207 million. And for the first time since ATVI acquired King, its monthly active users reached 268 million, thanks to the launch of Candy Crush Friends in October 2018.
For now, Activision is strategically well-positioned to grow its market share in the free-to-play games market. Using effective marketing techniques, ATVI could increase its MAU and revenue in this space.
Exploiting Its Core Strengths
Activision may double down on its efforts in esports and Call of Duty, and invest more in its Battle.net in 2019. It has to. It cannot afford to think only of the revenue and profits from its core titles. Instead, it needs to add tools that gamers will use and appreciate, thereby improving its monthly user metrics.
Management did not go into much detail on how it would reinvigorate demand for its Call of Duty franchise. In the second half of last year, demand for the latest game in the series slowed even though ATVI lowered the prices it charged for the game. ATVI’s World of Warcraft game did not perform any better even after new features were added to it.
As expected, Activision said on its Q4 conference call that it would cut its operating costs and lay off some of its employees, while putting more resources into its digital network.
Potential Catalysts for Activision Stock
Blizzard’s strong Q4 results may continue in 2019. Its success in China will continue thanks to the benefit of its extended deal with NetEase (NASDAQ:NTES). The two firms began their collaboration in 2008, a move that brought Starcraft II and the Battle.net platform to China. The extension will bring Diablo, World of Warcraft, Hearthstone, Heroes of the Storm and Overwatch to the region.
Despite laying off 1,500 of its employees, Activision is hiring talented game developers to bolster Overwatch, the Call of Duty franchise, and the Candy Crush games. If these developers improve the games on which they’re working, gamers will come back and maybe open their wallets to buy in-game products and additional console games in 2019.
The Bottom Line on Activision Stock
2019 is a transition year for Activision, so expect ATVI stock to trade in a range instead of bouncing higher. 26 analysts cover Activision stock, and 17 of them rate the stock a ‘buy.’ Per Tipranks, analysts’ average price target on Activision stock is $55 per share. If investors use a five-year DCF Revenue Exit model that assumes just 5% revenue growth over the next year, Activision stock may still drop another 10%.
But Activision stock is close to becoming a value name. Assuming customers return in 2020 after the company boosts its spending this year, ATVI stock could be a good investment for those who like to buy and hold stocks.
As of this writing, the author did not hold a position in any of the aforementioned securities.