Why Investors Should Pay Attention To Activision Blizzard

By Motley Fool StaffMarketsFool.com

The gaming industry is crushing it this year, and Activision Blizzard(NASDAQ: ATVI), the company behind huge franchises like OverWatch, World of Warcraft, and Candy Crush, is one of the biggest and best-performing players in the space.

In this clip from Industry Focus: Tech, Motley Fool analysts Dylan Lewis and David Kretzmann walk listeners through the fundamentals of the company, how the stock has performed over the last few years, where the majority of revenue is coming from and why that's such a good sign for future growth potential, the most important question marks going forward, and more.

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A full transcript follows the video.

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This video was recorded on May 26, 2017.

Dylan Lewis: Why don't we start out with the big fish in the space, Activision. I think a lot of Foolsare probably familiar with this company. It's beena recommendation for quite some time, as you mentioned,going back to 2014. But,I think it's been involved in the premium services for over a decade.

David Kretzmann:Yeah.

Lewis:And gamers mightknow this company for itsOverwatchandWarcraftfranchises,among some others. Recent quarter, thecompany hit new records for revenue, EPS, and cash flow.David, what's been fueling all that growth for them?

Kretzmann:You teed that up nicely. The company, essentially, hasthree different segments. You have Activision, which isprobably best known forCall of DutyandDestiny, those shooter action games. Then,you have Blizzard,which is best known for the online multiplayer games likeWorld of WarcraftandOverwatch. Then,a couple years ago, they acquiredKing Digital, which is mobile gaming,most famouslyCandy Crush.

Lewis:I feel like you can see someone playingCandy Crushon any metro commute, it's always there.

Kretzmann:It has someincredible staying power, we can talk about that. The mainhighlight for me this quarter, that Blizzardsegment is really doing well thanks toOverwatch,which is now the eighthbillion-dollar franchise in the company'soverall portfolio of game franchises. That'spretty incredible for just a year. And it's Blizzard'sfastest-growing new franchise ever. It's reachedover 30 million players globally in less than a year after launch, itlaunched in spring of last year. That Blizzardsegment, thanks toOverwatch, isdoing really well. You're seeing theirmonthly active user count continue to tick up steadily thanks toOverwatch.

Lewis:This is, in some ways,kind of like the social media platforms we talk about,where there is that MAU numberyou can look at an addition tosome of the more financial metrics, andget a sense of how these platforms and games are doing.

Kretzmann:Yeah,absolutely. One of the things tokeep in mind with these video game companies is their quarter-to-quarter results and year-to-year results will be lumpydepending on the timing of a game release.Call of Duty, I'm not sure what sequel they're on,probably seven or eight at this point, but that'sobviously huge. Pretty much anything that hasCall of Dutyon [it] will sell well,even if the reviews aren't all that great. So, that issomething to keep in mind. Depending onwhen you have these new gamesdeveloped and launched, you willsee those numbers ebb and flow. Butall in all, you do want to see that user count andoverall user engagementcontinue to tick up over time,because that usually leads topretty good financial results.

Lewis:Insome ways, it's kind of like the movie studio business. You findsomething that resonates with your audience, and you milk,you keep putting out titles in that franchise,because you know it's a story, or the characters,or a storytelling approach, orsomething like that, that people just love, andthey can't get enough of. So, you see that yearly releases orevery other year releases for a lot of these titles.

Kretzmann:Yeah. That's been anoverarching theme and revolution of the video game space. If yougo back five or 10 years, primarily,you would go into the store andbuy the physical disc of the game. In that case,the shelf life of the game wasn't necessarily that long. You needed to get that physical discin front of customers,whether it was atWal-MartorGameStopor wherever. Andif you didn't do well at that initial launch,then the shelf life of that gameprobably wouldn't be too long. But, theshift toward digital, wherepeople are downloading the games, they'reable to do microtransactions within the games, they'reable to download extra maps or levels of the games over time,then all of the sudden you can buy a game in 2014 andstill be playing it today, still be paying money as a player and a user of that game. That'spart of the reason why you're seeing theprofitability of all of these companies we'retalking about today continue to tick up over time, because thatdigital revenue is high margin. Onceyou get those users andyou're able to continue to engage with them over time, itdoesn't cost a lot to sell another map to themdigitally, where people can just downloadover the internet.

Lewis:Andyou can push updates to those users, too, right?

Kretzmann:Yeah,you're seeing a lot of live events and live updates and things like that. These games arevery much a living entity. It's not like you're just buy onephysical disc and then that's the only edition you havegoing forward. It will continue to evolve over time.

Lewis:Andyou see that in the company financials, too. Looking at the most recent quarterfor Activision,online sales were up 50% year over year, andthey now make up 80% of revenue,which is crazy. And some of that is the transition to digitalaway from physical with those games.I think some of that is also the acquisition of theKing Digital property, andeverything they have under their umbrella. Oneof the things that is interesting with Activision is,particularly relative to these othervideo game publishers, theyactually have a surprising amount of goodwill on their balance sheet. About half their assets are in goodwill. Forpeople who might not remember, goodwill is anintangible assetoften tied to the difference betweenwhat you can actually tie value to andwhat you pay for something in an acquisition. Other times it'sbrought in with brand value and things like that. They boughtKing Digital for $6 billion a couple years ago, andthat is part of that huge goodwill number. AndI think a lot of people are wondering how thatacquisition looks and what the property is doing for them.

Kretzmann:Yeah, to me that's the biggest question mark still with the company. WhenActivision acquired Kingback in late 2015, andthatacquisitionwas announced, King had about 475 millionmonthly active users,almost half a billion, which ismore thanTwitterand a lot of these other social networks, sothat's an incredible number. But that slow and steadily tickeddownward each quarter up until now, where now it's at about350 millionmonthly active users. Butthere are some bright spots there. Theratio of daily active users to monthly active users, so,essentially, the hyper-engaged users,is at a record high. And thepeople who are paying for the games are paying more each quarter. So,it's kind of like you have this small but growing base of really engagedpeople who are just playingCandy Crushlike crazy, andthey're paying a lot to upgrade through the game, anddifferent things like that. Those people are paying more. That's howmanagement will spin it. ButI think overall, the question there is,how easy is it for them toreplicate that success withCandy Crush, or is that all it's about. One thing that wasinteresting in the conference call this quarter was, they mentioned thatActivision and King will be partnering up, and they'll look to build aCall of Dutymobile game.I think that could justify the acquisition to meeven more than just bringingCandy Crushunder your umbrella. Butif they're able to use King's expertise indeveloping mobile games, andtransitionCall of Dutyinto the mobile space,that could be really interesting, andI could see that justifying thepremium that they paid. Hopefully that would help them avoidhaving to write down that goodwill andadmit that they paid too much for King. So,some things to like there, but for me, that's probably the biggest question mark withActivision, still to be determined.

David Kretzmann owns shares of Activision Blizzard and Twitter. Dylan Lewis has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Activision Blizzard and Twitter. The Motley Fool owns shares of GameStop and has the following options: short July 2017 $24 calls on GameStop. The Motley Fool has a disclosure policy.