Activision Blizzard (NASDAQ:ATVI) is 2-for-2 in quarterly earnings so far in 2011. The video game publisher opened big, reporting a 32% jump in net income in its first-quarter earnings in May. Now it has even more to celebrate. The company turned in net profits totaling $335 million in its second-quarter earnings report Thursday, a 53% increase over the same period in 2010.
Most promising of all for the company is digital sales — downloadable games purchased off of the Internet to PCs and game consoles like Microsoft‘s (NASDAQ:MSFT) Xbox 360 as well as secondary downloadable content for those games — rose 27% year-on-year. Net revenue from digital products totaled more than $1.1 billion, up from the nearly $970 million last year.
Activision is proving to investors that it’s ready for the all-digital future. Despite a strong release schedule going into the back of 2011, though, ATVI faces stern challenges that may curb what’s been an impressive earning year.
First is the lack of a guaranteed major title release from ATVI’s Blizzard studio. A sequel to the company’s fan-favorite series, Diablo III, might come out before the year is out, but it’s far from guaranteed. The absence of a major new Blizzard product isn’t the biggest worry in regards to the studio, though.
After seven years, the company’s massively multiplayer online role-playing game World of Warcraft is beginning to lose subscribers en masse. The publisher revealed during its earnings call that Warcraft‘s subscriber base had declined to just more than 11 million players, each of whom pay a $14 monthly subscription fee. Before the December 2010 release of the Warcraft expansion Cataclysm, a product that sold more than 7 million copies in its first 24 hours on shelves, the game commanded a subscribership of more than 12 million.
A loss of 1 million players in less than a year, especially after the release of new additional game content, is cause for concern. Activision Blizzard even made a limited version of Warcraft free to play at the end of June, a promotional move that typically signals an online game is entering the end of its maximum profitability. The signs suggest the company’s decade-old cash cow is finally running dry at a time when its revenue is needed most.
Activision also needs to worry about over-saturating the market with its most successful franchises. Call of Duty: Modern Warfare 3, the latest entry in the company’s most successful running franchise, is due out in November. While last year’s entry, Call of Duty: Black Ops, went on to become the fastest-selling game in U.S. history by selling nearly 14 million copies in just four months, ATVI and its shareholders would do well to remember how fickle its audience is.
Modern Warfare 3 will be the eighth consecutive Call of Duty game released in as many years. It’s precisely that sort of over-exposure that forced the publisher to shut down its Guitar Hero franchise. In 2009, Guitar Hero 3 became the first game to make $1 billion single-handedly. By February of 2011, ATVI struggled to sell even 90,000 copies of Guitar Hero: Warriors of Rock.
Call of Duty is the company’s greatest source of revenue aside from World of Warcraft, and if it isn’t careful, it won’t have either filling its coffers by 2013. Investors looking at ATVI’s consecutive quarters of strong earnings would be wise to view the stock with caution. The company will be standing on thin ice by the holidays.
As of this writing, Anthony John Agnello did not own a position in any of the stocks named here. Follow him on Twitter at @ajohnagnello and become a fan of InvestorPlace on Facebook.
