I am bullish on Activision Blizzard (ATVI) and believe it has a lot of room for growth. Although there is noise surrounding company culture and corporate governance, it is still one of the most popular video game developers.
Investment Thesis
Activision Blizzard is one of the largest video game developers in the world for consoles, mainly the Sony PlayStation and Microsoft Xbox. It also has a massive presence in the mobile gaming and PC space.
The company is fundamentally strong, with a conservatively managed balanced sheet and excellent cash flows. Activation has kept its expenses low while consistently increasing revenue. Excess pent-up demand due to an increased customer base provides an additional opportunity for the company to gain market share.
With new consoles hitting the market, video games need rebuilding to take advantage of their superior processing power. Following the 2020 lock-downs, Activision Blizzard saw an increase in its customer base due to existing users and new customers adopting the hobby, fueled by stimulus money and additional time spent at home.
The video game industry expects to see an 11% compounded annual growth rate through 2026, and Activision Blizzard is improving its company governance to attract new talent. The company is a compelling long-term growth play despite concerns surrounding its corporate governance.
Future Outlook
Prior to 2016, Activision’s revenues remained relatively flat. In 2016, after acquiring King Digital, the company increased its presence on mobile gaming platforms. This acquisition was critical to the company’s success in recent years. In 2020, smartphone games accounted for almost 50 percent of video gaming revenue worldwide and helped Activision hold its position in the video game market.
The company addressed its plan to decrease unnecessary costs in its recent 10Q filing, but then also stated that it does not expect to realize significant savings, as “cost reductions in our selling, general and administrative activities are expected to be offset by increased investment in product development.”
Despite Activision’s increased investment in product development, it managed to increase its cash position by $1.1 billion in the year following September 2020.
Company Financials
Activision Blizzard’s balance sheet is extremely healthy with very little debt, $10 billion of cash and short-term assets, and total assets of $23.977 billion. Its total liabilities are only $7.027 billion with only $3.6 billion of debt.
Over the past five years, the company’s operating expenses have remained relatively flat. What this means for investors is that the company is increasing its revenues year after year while keeping its operating expenses consistent. The company’s financials, paired with the increasing market demand, shows excellent upside potential.
(See Activision Blizzard stock analysis on TipRanks)
Valuation
When valuing Activision’s intrinsic value, investors must consider multiple factors. The first is its current free cash flows and future prospective cash flows. The company also has a strong balance sheet with plenty of cash and long-term assets with relatively little debt. Calculating its weighted average cost of capital, investors will find it to be approximately 6.4%. To account for variances, the calculation below will include a discount rate of 7.1% as a margin of safety.
Activision’s current free cash flow is $2.812 billion with an expected growth of 13.4%, taking into account the expected industry growth and Activision’s additional market share. Using a discount rate of 7.1% annually, its present value of future cash flows is $39.029 billion. After accounting for its current net assets, Activision’s intrinsic value is approximately $55.979 billion, giving the stock a price target of $93.63.
Risks
Activision stock has several risks. For one, the video game market is growing relatively slowly compared to other tech industries such as the social media market. With an expected growth rate of 11% annually, the video game industry falls short of other industries. Although the industry as a whole is growing slower, this is not an accurate measure of success and will not hinder the company’s ability to deliver results.
Additionally, due to the bad press surrounding sexual misconduct and toxic culture claims, the company may experience difficulty employing quality talent in the near term. These issues are likely short-term in nature and are a problem that every company faces as society shifts to a more inclusive work environment.
Moreover, the video game industry saw a surge of interest during the lockdowns of 2020. The risk here is the possibility that those additional revenues were short-term in nature and will not continue. On the other hand, the growth is not likely a short-term trend as video games are know to be addictive. Those who purchased video game consoles will likely continue using them due to their fun and addictive nature.
Analyst Consensus
Turning to Wall Street, Activision has a Moderate Buy consensus rating, based on 13 Buys, 5 Holds and 1 Sell assigned in the last three months. At $90.44, the average Activision Blizzard price target implies 59.25% upside potential.
Final Thoughts
There is some noise surrounding Activision, but investors need to remember it is a fundamentally sound company with excellent financial management. With the mobile and console gaming market growing, Activision will continue dominating with its superior titles. Activision Blizzard’s strong financial position, coupled with additional consumer demand, provides a bright future outlook, moving into 2022.
Disclosure: At the time of publication, Aaron Stine did have a position in any of the securities mentioned in this article.
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