Activision Blizzard (NASDAQ:ATVI) reports third-quarter earnings on Thursday afternoon and it looks like a key report. Activision Blizzard stock rallied nicely starting in late August. But with resistance clearly holding in recent weeks and fundamental questions still surrounding ATVI stock, there’s the potential for a big move in trading on Friday.
To be honest, I’m not sure that move will be higher. I’ve long been a skeptic toward Activision Blizzard stock for one key reason: its growth has been surprisingly subpar. Excluding the benefits of tax reform and the acquisition of social developer King Digital Entertainment, net income in 2019 actually will be below levels seen in 2010.
The reason for that weakness is simple: Activision really hasn’t developed a new hit this decade. Overwatch is probably the closest it’s had, yet per Activision’s 2018 10-K its revenues have declined in each of the last two years.
Given that problem, I’m far from convinced that ATVI stock can hold the current 21-times forward price-to-earnings multiple (even excluding the company’s current net cash on the balance sheet). And given that Activision Blizzard isn’t going to unveil anything new along with Thursday’s third-quarter report, technically and fundamentally, I see a path to downside for Activision Blizzard stock.
One piece of good news for Activision Blizzard stock ahead of earnings is that expectations are low. The company’s guidance for Q3, given with Q2 report, projects a 27% decline in revenue year-over-year.
Activision Blizzard historically has guided quite conservatively, so investors shouldn’t expect such a steep decline. Still, the average Street analyst projects a 20% drop in sales. Adjusted earnings per share will fall sharply as well: the company guided for non-GAAP EPS of 20 cents, while the Street projects 23 cents against 2018’s 42 cents.
That said, declining earnings don’t necessarily mean a declining ATVI stock price. The company’s launch schedule is impacting the YOY comparisons. And I’d expect two aspects of the release will be more important than the headline results for Q3.
First, Activision Blizzard needs to raise its full-year guidance. Again, this is a company that historically has guided very conservatively, often to the point of so-called “sandbagging.” Wall Street has adapted: the average non-GAAP EPS estimate this year is $2.20 against the company’s $2.02 guidance.
So have investors. If Activision Blizzard doesn’t raise its guidance, that suggests lowered expectations for the full year. Particularly with the 20%-plus rally from August lows, lowered expectations are not priced in.
Second, management needs to provide bullish commentary on World of Warcraft Classic. Fears of declining subscribers to and revenue from World of Warcraft have driven skepticism toward ATVI stock for years. But the launch of Classic appears to have catalyzed the August rally. Positive commentary about user and revenue trends would suggest that World of Warcraft remains a cash cow and drive post-earnings optimism toward Activision Blizzard stock.
The Case Against Activision Blizzard Stock
That said, I’m not sure even raised guidance and WoW strength is enough. Again, both the Street and investors almost certainly expect the guidance hike. And while a stable WoW helps the bull case, it’s not driving the growth priced in at over 20 times earnings.
Meanwhile, the technical picture looks potentially worrisome ahead of the report. Resistance has held firmly and repeatedly at $56, creating a so-called “multiple top” that usually is bearish (to be fair, technicals also suggest that post-earnings gains through that resistance would set up a nice breakout).
Fundamentally, Activision Blizzard still needs to prove that it can drive growth. The rise of Epic Games‘ Fortnite has pressured ATVI, along with rival Electronic Arts (NASDAQ:EA). Take-Two Interactive (NASDAQ:TTWO) clearly has outperformed in this new environment. TTWO also reports on Thursday afternoon, making it a hugely important afternoon for the entire video game industry.
I’m skeptical there’s a real catalyst coming with the report. That’s not to say there are no catalysts. The company’s plans for 2020 released at BlizzCon included well-received details on Diablo IV and Overwatch 2. New consoles coming from Microsoft (NASDAQ:MSFT) and Sony (NYSE:SNE) should drive higher sales in next year’s fourth quarter.
But those catalysts are known, and after the recent rally look priced in. I’m skeptical there’s anything in Q3 that really changes the story.
And I continue to believe that story isn’t good enough. It’s simple to argue that video game usage is only going to grow, and that between that and esports, Activision Blizzard should benefit. But those trends already exist, and the company is headed for a decade of close to zero organic profit growth.
Activision Blizzard needs to deliver something more than that. It may do so down the line, but I wouldn’t expect any game-changing news on Thursday afternoon.
As of this writing, Vince Martin has no positions in any securities mentioned.