DEEP ANALYSIS: Activision Blizzard Earnings Insights

The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.                 

Activision (NASDAQ:ATVI) Q2 beat driven by Diablo III and high-margin digital growth.  Revenue was $1,054 million, compared with our estimate of $825 million, consensus of $832 million, and guidance of $805 million. EPS was $0.20, compared with our estimate of $0.12, consensus of $0.12, and guidance of $0.10. Publishing revenue was $373 million (we estimated $273 million) and Blizzard revenue was $634 million (we estimated $497 million). Management disclosed sales of over 10 million units of Diablo III, a staggering number for a PC game. Due in part to Diablo III, digital revenues continued to be strong, up to $497 million in Q2 from $298 million in Q1.

Unexpected WoW subs decline will likely weigh on the stock in the near-term. WoW subscribers dropped to 9.1 million at the end of Q2, down from 10.2 million in Q1, and 11.1 million a year ago. Management attributed the drop to the end of an expansion cycle (prior to the release of Mists of Pandaria), cannibalization (at least temporarily) by Diablo III, and declines in Asia, where ARPU is significantly lower. We estimate a $0.01 – 0.02 impact to EPS for the year if subscribers stabilize.

Full-year guidance was again raised by an amount less than the quarterly beat. Despite delivering non-GAAP EPS of $0.20, ten cents above guidance of $0.10, full-year EPS guidance was raised by only four cents to $0.99 from $0.95. Management chose to remain cautious due to macro uncertainty, risks to consumer spending, and the back-end loaded nature of 2012 results.

Strong release slate for 2012 and beyond to drive positive revenue growth. With two Blizzard games and highly-anticipated sequels for Call of Duty and

Skylanders expected in 2012, and two more Blizzard releases and a Bungie game in 2013, Activision (NASDAQ:ATVI) is in a position to deliver dramatic revenue growth this year and next, and given the leverage from these high margin titles, it is likely that earnings will once again grow more rapidly than revenues in both years.

Notwithstanding its solid performance, investors remain cool on Activision and the sector.  Until investors become comfortable that video games are not a “fad”, we expect multiples to remain at historically low levels.

Maintaining our OUTPERFORM rating and $19 price target, which reflects a forward multiple of ≈ 13x our 2013 EPS estimate of  $1.20 plus $3/share in cash. This is a discount to the market multiple due to weak investor sentiment towards the video game industry, which is suffering from packaged goods declines.

Michael Pachter is an analyst at Wedbush Securities.