After some challenging quarters, Activision Blizzard (NASDAQ:ATVI) seems to be back on track. This turnaround is also reflected in the ATVI stock price. After trading in a narrow range between $45 and $50 for nearly eight months, the stock has finally moved higher. Further, there are reasons to believe that ATVI stock will continue to move higher in 2020.
Before discussing the “bull” story, I want to point out some challenges that ATVI faces in 2020 and beyond. Fierce industry competition remains a key concern. The point to note is that competition is not just from players like Electronic Arts (NASDAQ:EA) or Take-Two Interactive (NASDAQ:TTWO).
Free-to-play games are likely to have a negative impact. As an example, Fortnite, which was launched by Epic Games, has been a runaway success. There is little doubt that the success of Fortnite has impacted the active users for ATVI, among others.
It is also expected that for the period 2019-2023, the free-to-play model will boost growth for the gaming industry. Therefore, ATVI will face this headwind in the coming years. On the positive side, ATVI is also planning to introduce free-to-play games, and this will boost the company’s audience size and engagement.
Upside Triggers
Purely from a valuation perspective, ATVI stock currently trades at a forward price-to-earnings ratio of 23.4. When we compare peers, Electronic Arts is trading at a forward P/E of 21.8. In addition, Take-Two Interactive is trading at a forward P/E of 24.7.
Therefore, at best, ATVI stock is fairly valued when compared to peers. If the stock has to trend higher in 2020, the markets need positive triggers in the form of stronger earnings growth. I believe that’s likely, and I expect the following factors to support the upside.
- The first look at Diablo 4 was revealed in November. If the powerful franchise launches in 2020, it can boost revenue and earnings growth. When Diablo 3 was launched, 20 million copies were sold between 2012 and 2014.
- World of Warcraft’s coming expansion, Shadowlands, will launch in 2020. Overwatch 2 is also in the pipeline and should come in the next 12-18 months. Therefore, with a healthy pipeline of releases, Activision Blizzard is well positioned for growth.
ATVI stock might be fairly valued at this point. However, earnings should bump up visibility in 2020 and 2021. That can take the stock higher.
Healthy Financials Support Bullish View
Even amidst challenging industry conditions, Activision Blizzard has healthy financial metrics. As of September 2018, the company reported cash and equivalents of $3.4 billion. This has increased to almost $5 billion as of September 2019. During this period, the company’s debt has remained stable at $2.7 billion.
Further, for the third quarter, ATVI reported free cash flow of $275 million. This implies an annualized free cash flow of $1.1 billion. In other words, the company’s net debt will continue to decline even if FCF remains at current levels. I do expect FCF to accelerate with new launches.
Therefore, I don’t see any balance sheet concerns for ATVI. In addition, the company has ample financial muscles to lower debt and aggressively invest in new gaming content.
My Final Thoughts on Activision Blizzard Stock
Call of Duty: Mobile is likely to help Activision Blizzard maintain positive momentum in the fourth quarter of 2019. In addition, it is important to mention that esports holds immense potential in the long term.
Considering these factors, ATVI stock is certainly interesting for 2020 and beyond. With a strong pipeline of releases, top-line growth can possibly accelerate along with healthier earnings growth.
From a risk perspective, competition in the industry is fierce. Weak monthly active user numbers is indicative of the competition. However, the company can use its financial muscles to attract users through paid and free-to-play models. This will more than offset the risk related to competition.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
