Activision Blizzard – CoD shoots the lights out, cash sluggish

Activision reported third quarter revenues of $2.0bn, up 52.4% year-on-year and ahead of guidance of $1.8bn. That reflects a very strong performance from new Call of Duty (CoD) releases, as well as growth in the King mobile gaming business.

Underlying earnings per share more than doubled to $0.88, however free cash flow shrank year-on-year.

The group expects revenues to remain broadly flat next quarter, with earnings per share of $0.63.

Activision shares fell 2.3% in pre-market trading.

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Our View

With a large portion of the world’s population confined to the couch for much of the first half of the year it’s not surprising gaming activity has surged. As the home of some of the world’s most successful computer game franchises, Activision Blizzard is a natural beneficiary of that trend.

Call of Duty is the world’s top selling console franchise, and has been for 10 of the last 11 years. World of Warcraft continues to top lists of the best games in its genre 16 years after it was released and Candy Crush remains among the most lucrative mobile games in the US.

We particularly like the mix of console, PC and mobile gaming. In a rapidly changing industry the group has fingers in every pie and recent innovations have seen the group make the most of its varied portfolio. Profit growth has averaged 7.5% a year since 2008, but that’s being ploughed back into the business for now – with a modest prospective dividend yield of 0.3%.

Unlike some rivals, Activision Blizzard owns its most powerful brands outright, so it doesn’t have to share success with licence holders.

The benefits of that set-up are most noticeable when it comes to Call of Duty. A mobile version of the game has more than tripled the number of Activision players and, while these are likely to be lower revenue players, if Activision can hold onto them they could be lucrative. Meanwhile Activision’s answer to Fortnite’s Battle Royale format, Call of Duty: Warzone, has racked up tens of millions of players in a matter of months. A recently launched Call of Duty League means the company’s also looking to capitalise on the growing popularity of esports.

esports see professional gamers compete live, with fans watching on TV, online or in stadiums. Audiences have been growing and are now over 400 million globally. Activision’s got experience in the space with the Overwatch League in its third season with 2019’s grand finals attracting 1.1 million viewers. In the past 70% of viewers have fallen in the 18-34 year old age bracket.

Millennials are a difficult group for marketing teams to reach, since they consume less traditional media than older generations. That makes esports attractive to advertisers, and advertising revenue can be high margin. We think Call of Duty has the potential to dwarf Overwatch in advertising terms, but it’s still early days. Meanwhile news that the King mobile gaming business has managed to grow advertising revenues even as other digital advertisers struggle is encouraging.

However, for all Activision’s past successes it can’t afford to rest on its laurels. Gaming is going through significant change, with consoles giving way to cloud based gaming and the market place getting increasingly crowded. It’s possible that the next generation of games consoles will be the last, and change is always more difficult for incumbents. Activision clearly recognises the threat and is increasing investment in its major franchises.

On balance we think the quality of Activision’s intellectual property gives it an edge. However, a premium catalogue of games comes with a premium price tag. The shares currently trade on a PE ratio of 23.2 times earnings, above the long run average and that’s based on profits that are likely to be higher than “normal” thanks to the Covid related boost.

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Third Quarter Results

Monthly Active Users (MAUs) in the Activision division reached 111m in the quarter, compared to just 36m a year ago. That reflects very strong results from Call of Duty Modern Warfare and Warzone, with hours played up seven-fold year-on-year. Call of Duty Mobile maintained “impressive levels of reach” and is about to launch in China.

Blizzard reported 30m MAUs in the third quarter, that’s down from 33m a year ago although World of Warcraft users were steady year-over-year. There are currently 10m monthly Overwatch players.

The King mobile games divisions reported 249m MAUs in the third quarter, with Candy Crush growing players year-on-year and remaining the top grossing franchise in the US app store. Advertising net bookings were up double-digits year-on-year.

Free cash flow in the quarter came in at $172m, down from $275m a year ago. Although is up 8% for the last 12 months as a whole.

The group finished the year with net cash of $3.8bn compared to $3.1bn at the start of the year.

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