Activision Blizzard (ATVI) is a company that develops and publishes interactive entertainment content and services worldwide.
Popular titles include Call of Duty and Diablo. We are neutral on the company.
Competitive Advantage
There are a couple of ways to quantify a company’s competitive advantage using only its income statement. The first method involves calculating the earnings power value (EPV).
Earnings power value is measured as adjusted EBIT after tax, divided by the weighted average cost of capital, and reproduction value can be measured using total asset value. If earnings power value is higher than reproduction value, then a company is considered to have a competitive advantage.
The calculation is as follows:
EPV = EPV adjusted earnings / WACC
$36.9 billion = $2.581 billion / 0.075
Since Activision Blizzard has a total asset value of $24 billion, we can say that it does have a competitive advantage. In other words, assuming no growth for Activision Blizzard, it would require $24 billion of assets to generate $36.9 billion in value over time.
The second method is by looking at a company’s gross margins because it represents the premium that consumers are willing to pay over the cost of a product or service. An expanding gross margin indicates that a sustainable competitive advantage is present.
If an existing company has no edge, then new entrants would gradually take away market share, leading to decreasing gross margins as pricing wars ensue to remain competitive.
Taking a look at Activision Blizzard, we can see that gross margins have expanded in the past several years. As a result, its gross margins indicate that a competitive advantage is present in this regard as well.
Risks
To measure Activision Blizzard’s risk, we will first check to see if financial leverage is an issue. We do this by comparing its total debt-to-free cash flow. This number currently stands at 1.28, which has been trending down since 2013, when it was 3.94.
Overall, we don’t believe that debt is currently a material risk for the company because its interest coverage ratio is 30 (calculated as EBIT divided by interest expenses).
However, a big risk that is plaguing the company in the medium term is its toxic workplace culture. There has been a lot of negative news surrounding the CEO, who apparently knew that sexual harassment was happening at work and chose to do nothing about it.
This has caused investors to call into question the credibility of Activision’s leadership team, which has resulted in a steep sell-off since July.
In addition, since Activision’s success hinges on its ability to create high-quality content, there is the risk that future releases may not be received well by consumers. Therefore, it is important that the company takes its time to release well-thought-out games that keep players engaged.
Furthermore, there are other risks associated with Activision Blizzard. According to Tipranks’ Risk Analysis, the company disclosed 34 risks in its most recent earnings report. The highest amount of risk came from the Tech & Innovation category.
The total number of risks has decreased over time, as shown in the picture below.
Wall Street’s Take
Turning to Wall Street, Activision Blizzard has a Moderate Buy consensus rating, based on 14 Buys, five Holds, and one Sell assigned in the past three months.
The average Activision Blizzard price target of $88.13 implies 34.8% upside potential.
Final Thoughts
Activision Blizzard is a leader in the video game industry with a quantifiable competitive advantage. In addition, the recent negativity surrounding its workplace culture has greatly reduced the price to an attractive level.
Nonetheless, we remain neutral because the stock is currently in a downtrend and prefer to see a clear trend reversal before entering a position.
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