Why the Recent Weakness of Activision Stock Is Temporary

The headwinds which have hit ATVI stock over the past few quarters won't stick around forever

At one point in time, Activision (NASDAQ:ATVI) was one of Wall Street’s favorite stocks. The video game publisher was reporting record quarter after record quarter, as the tailwinds of organized video-game competitions were converging with a strong content lineup and strong engagement to produce numbers that investors got really excited about. From early 2016 to late 2018, ATVI stock went from under $30 to over $80.

3 Takeaways for Activision Stock Following Q4 Earnings
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But the strong rally of Activision stock was short-circuited in late 2018 by a few things. First, the stock market sold off, thanks to rising rates and escalating trade tensions. Second, Activision found itself on the wrong side of a shift in the video-game market from pay-to-play to free-to-play. Third, the organized- competition tailwind started to slow, and investors began to fear that it wasn’t going to become as powerful as previously thought.

Activision’s numbers dropped, investors’ sentiment towards ATVI stock eroded, and ATVI stock fell off a cliff. From late 2018 to today, ATVI stock has tumbled from over $80 to barely above $40.

This recent weakness in Activision stock is temporary. That’s because the things which killed ATVI stock won’t stick around forever, while the non-cyclical drivers of long-term value will have staying power. As as result, I actually think Activision stock is a good buy at this point. Today’s headwinds will become old news, and will even turn into tailwinds by late 2019. As they do, Activision stock will soar higher.

Within the next few years, ATVI stock could and should return to $80.

Headwinds Are Temporary

As I previously noted, three headwinds have weighed on ATVI stock:  deteriorating macroeconomic sentiment, a non-cyclical shift from pay-to-play to free-to-play, and a slowdown in organized video-game competitions, or  eSports. All three of these headwinds are temporary, so the recent weakness of ATVI stock is temporary, too.

On the macro front, rising interest rates and the trade wars have been headwinds. But the Fed has already moved to the sideline, so the rising-rates headwind is gone for now. Meanwhile, trade tensions are rising. But it just seems like a bunch of talk right now, and considering many recent tariff hikes won’t be implemented for a long time, both sides are clearly expecting talks to progress and anticipate that a deal will get done soon. Consequently, the rising trade tensions should disappear, too.

The rise of free-to-play, “Battle Royale” games like Fortnite have hurt Activision’s slate of pay-to-play games. But Activision’s video-game content has non-cyclical appeal. The company is just struggling with distribution right now. Consequently, much like Disney (NYSE:DIS) pivoted to streaming in the face of a non-cyclical consumption shift, Activision will pivot increasingly to free-to-play games in the face of the ongoing shift towards such games. This will turn the company’s free-to-play headwind into a tailwind, and Activision’s numbers and investor sentiment should consequently improve.

Lastly, the eSports world may be slowing down, but this slowdown won’t last.  eSports leagues like OWL will one day generate large amounts of revenue for Activision, much like the NBA, NFL, and NHL, mostly because there are just as many video-game players in the world as basketball, football, and hockey players. Sure, this industry will have hiccups, but its long-term trajectory remains favorable.

All in all, then, the headwinds weighing on ATVI stock today won’t stick around forever.

Its Tailwinds Are Non-Cyclical

Once Activision’s current headwinds pass, they will be replaced by tailwinds, and Activision stock will run higher.

Over the next several months and quarters, Activision will increasingly pivot into the free-to-play arena. The company will likely launch free-to-play but abridged versions of its Call of Duty games. By taking that course of action,  the company will align itself with the free-to-play trend, while sustaining its pay-to-play business. The result will be renewed top-line momentum and gains by ATVI stock.

In addition, Activision will continue to dive deeper into the mobile arena, which is a big growth area for the video-game market. It will also continue to build out its eSports leagues. Most importantly, it will continue to work on cloud gaming, and pivot increasingly towards a subscription-style gaming model.

All of those initiatives will help sustain healthy, long-term revenue growth for Activision.

The  revenues of the whole video-game market is expected to increase at a 10% annual clip over the next several years. Activision should able to grow slightly above that average, given the company’s huge eSports push and 2019’s depressed base. Margins may take a hit from the free-to-play and/or subscription shifts. Thus, the company’s profit growth will likely run around 10% per year.

Assuming current Street estimates for roughly $2.50 in EPS in 2020 are right, then 10% annualized profit growth would result in  $4 of EPS by 2025. Based on ATVI’s  average forward multiple of 20, that equates to a 2024 price target for ATVI stock of $80.

The Bottom Line on ATVI

Activision stock has been hit hard over the past few quarters. But the negative catalysts won’t stick around forever. As the headwinds move into the rear-view mirror, Activision will get back to its normal self, and its revenues and profits will increase at a healthy rate. Once the company gets back to its normal self, Activision stock will rally towards $80.

That will all happen over the next few years, making today’s $40 prices seem like a steal.

As of this writing, Luke Lango was long ATVI and DIS.

 

 


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