Activision Blizzard Earnings Outlook: Digital Should Drive Revenue Growth and Margin Expansion

Activision (NASDAQ:ATVI) will report its fiscal Q4:11 (ending December) results after market close on Thursday, February 9, and hold a call at 1:30pm PT (888-481-2845, passcode 8472934, or at http://investor.activision.com/events.cfm).

We expect Q4 results slightly above our estimates for revenue of $2.17 billion and EPS of $0.55, compared to consensus for revenue of $2.20 billion and EPS of $0.56, and guidance for revenue of $2.17 billion and EPS of $0.55.  We expect Q4 upside from Call of Duty: Modern Warfare 3 sales and digital strength.

MW3 has surpassed company and industry records.  On December 12, the company announced that MW3 sales had surpassed $1 billion in sixteen days. Due in part to the timing of the announcement (nine days earlier than last year), we expect y-o-y sell-in growth of two million units. In addition, Activision announced Call of Duty Elite premium subs of over one million. We believe this figure has grown substantially since then due to the late-January introduction of the first map packs for MW3 for premium Elite subs only. Due to network effect, gamers will feel compelled to join Elite instead of waiting months for non-Elite content collections.

Digital should drive revenue growth and margin expansion. We do not expect domestic World of Warcraft subs to decline meaningfully in Q4 despite the release of EA’s Star Wars: The Old Republic MMO, released on December 20, as that game had a free 30-day trial, delaying any subscription spending decision until the March quarter. In addition to  Elite, 2012 catalysts will include  CoD content collections,  WoW growth overseas,  Diablo III’s Auction House, and Blizzard releases (multiple expansion packs). At an operating margin of over 50%, digital, which was over 60% of Q3 revenue, will be key to long-term profitability growth.

Activision shares continue to trade at an extremely low multiple due to high revenue concentration among Call of Duty packaged goods sales and World of Warcraft. In our view, Elite and Skylanders this year, as well as multiple Blizzard releases and a Bungie game next year should allay some of those concerns.

Maintaining our OUTPERFORM rating and $19 price target, which reflects a forward multiple of 17x our 2012 EPS estimate of $0.95 plus an estimated $3/share in cash. This is at the low end of its historical multiple range, reflecting continuing industry malaise and risk from dependence on a few franchises.

Michael Pachter is an analyst at Wedbush Morgan.

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