For a long time, I’ve been bearish on Activision Blizzard (NASDAQ:ATVI) for one key reason: the company’s profit simply hasn’t grown meaningfully for many years. And yet ATVI stock keeps rising, recently touching a 15-month high after its well-received fourth-quarter earnings report.
I’m simply not sure for how long that contradiction can hold, although it’s persisted for quite awhile. Even though the shares are still below their 2018 highs, Activision Blizzard stock has gained 55% over the past three years and 180% over the last five years. And it has potential growth catalysts ahead.
New consoles from Sony (NYSE:SNE) and Microsoft (NASDAQ:MSFT) should drive increased demand for Activision Blizzard’s games in Q4. ATVI stock bulls long have pointed to potential revenue and profits from eSports. Worldwide demand for video games continues to rise.
Still, Activision Blizzard needs to turn those potential catalysts into consistent growth. If it doesn’t, presumably investors will run out of patience with ATVI stock at some point.
The Earnings of Activision Blizzard’s Main Businesses Have Stayed Stagnant
Activision Blizzard’s earnings per share have grown over the past decade. In 2010, its EPS was 79 cents, excluding some items. In 2020, ATVI expects EPS, excluding the same items, of $2.22. But that growth has all come from three specific catalysts.
The company’s 2013 share repurchase agreement with former majority owner Vivendi Entertainment (OTCMKTS:VIVHY) turned out to be a steal: Activision itself and its executives paid less than $14 per share. And the deal dramatically cut Activision Blizzard’s share count, sharply boosting its EPS.
The 2016 acquisition of Candy Crush developer King Digital Entertainment was another brilliant move. King was cheap, since Candy Crush appeared headed for a long-term decline. U.S. corporate tax reform provided the final boost.
But it appears that the earnings of Activision Blizzard’s video-game business will be only modestly higher in 2020 than in 2010. A decade ago, the company generated $1.371 billion of adjusted operating income.
In 2019, the Activision and Blizzard segments combined delivered operating profit of $1.314 billion. Its EPS guidance for the consolidated business indicates that its profit will increase modestly in 2020.
The two business’ combined 2020 profits may reach $1.4 billion in a bullish scenario. If that scenario materializes, Activision Blizzard’s earnings, excluding King’s contribution, will have grown roughly 2% over ten years.
Reasons to Be Upbeat on ATVI stock
It’s possible that ATVI’s earnings growth will accelerate. It has some positive catalysts ahead. New consoles will drive demand for its key Call of Duty games. A new streaming deal with Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL) unit YouTube should increase ATVI’s profits in 2020 and beyond.
And the company has a stable base of previously released games. Most notably, ATVI bears have been waiting for World of Warcraft’s profits to decline for years now. In fact, the company’s reliance on that game was a key reason ATVI stock was so cheap in the first half of the last decade. That’s why the company and its management got such a good deal from Vivendi. But last year’s launch of World of Warcraft Classic enabled ATVI’s subscriber base to double in the second half of the year, Activision Blizzard stated.
The combination of eSports, new consoles, and a revived WoW franchise should be enough to drive some growth — or at least that’s what the bulls would argue. But it’s worth noting that over the last ten years, Activision Blizzard has also had catalysts.
Is This Time Different?
After all, new video-game consoles were released during that period. A shift to digital downloads should have boosted the margins of ATVI and its competitors Electronic Arts (NASDAQ:EA) and Take-Two Interactive (NASDAQ:TTWO). eSports and the strong economy already have helped ATVI’s results.
Activision Blizzard’s earnings will get a boost from new consoles. But what then? Will its earnings fade in 2022 and/or 2024, as they did in 2019 and are expected to do in 2020?
They could. Its core franchises of CoD, WoW, Candy Crush and Overwatch accounted for two-thirds of its revenue in 2017, according to an SEC filing by the company. They generated 58% of its 2018 sales.
So well over half of its revenue is coming from four key aging franchises. The sales of the two core Activision Blizzard platforms — WoW and CoD — did not increase over the last decade. Overwatch’s revenue declined in 2018 before rebounding in 2019. It seems to be asking a lot for those franchises to suddenly accelerate so many years after their initial releases.
ATVI Stock Is Priced for Growth
The issue is that Activision Blizzard is now priced for reasonably solid and consistent growth. Even excluding its net cash of around $4 per share, ATVI stock still trades at about 20 times analysts’ average 2021 EPS estimate.
That price-earnings multiple historically indicates that growth is on the way. And analysts’ average estimates (but not the company’s conservative guidance) suggest growth is coming. But in 2021, many new video-game consoles are expected to boost ATVI’s growth
I’m not convinced that will happen. At the very least, Activision Blizzard hasn’t proven it can actually grow. Until it does, I’ll personally have a difficult time turning bullish on Activision Blizzard stock.
As of this writing, Vince Martin has no positions in any securities mentioned.