DEEP ANALYSIS: Activision Blizzard’s Long Term FATE
The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.
Over the past few weeks, there have been numerous reports of a potential sale of Activision Blizzard (NASDAQ:ATVI) by its parent company, Vivendi. These reports became more credible at the end of last week after the departure of Vivendi’s chief executive. Jean-Bernard Lévy left the company reportedly over strategic differences with the board of directors. Mr. Levy reportedly sought to maintain the current composition of the French conglomerate, while the board preferred more drastic action after recent share price and business struggles, increasing debt, and a costly damages decision, among other factors.
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As a result of its recent struggles, Vivendi is reportedly considering monetizing its investments in certain non-core assets, including Activision Blizzard. We believe the company could maximize liquidity by selling Activision Blizzard, if it can find a buyer at the right price.
While a sale of Activision Blizzard is likely the preferred route for Vivendi, we assign a low probability to this outcome, as, in our view, there are not any readily apparent buyers. Activision Blizzard dwarfs the other domestic publishers in terms of market capitalization (at ≈ $13.5 billion) and enterprise value (at ≈ $10 billion); international game publishers have made smaller acquisitions in the past, and have focused on developers rather publishers. For example, in the last two years, Tencent Holdings of China invested a reported $400 million to purchase Riot Games and $600 million for a minority interest in Epic Games, far below Activision Blizzard’s current valuation. In addition, we don’t think that U.S. media companies are interested in large gaming acquisitions due to a spotty track record in gaming for many. The core video game industry is seen (incorrectly, in our view) as being in a state of perpetual decline, and we think this is an impediment to a prospective purchase by many media companies. Over the past several years, Disney (NYSE:DIS) has committed resources to the purchase of Playdom ($764 million for social gaming), Time Warner (NYSE:TWX) has made several small acquisitions (TT Games for $150 million, Rocksteady for $150 million and Netherrealm and other assets for approximately $100 million), and Viacom has purchased and written off Harmonix (more than $500 million). We do not believe News Corp. (NASDAQ:NWS) has any interest in the sector, following the departure of its former executive, Peter Chernin, and do not believe that Comcast is considering expanding its video game presence. Finally, we do not view the video game hardware manufacturers as potential buyers due to the cannibalization of sales for top Activision Blizzard franchises caused by game releases on fewer hardware devices — Call of Duty on Sony’s PS3, and not Microsoft’s Xbox 360, for example.
We believe a spin-off of Activision Blizzard is a far more likely outcome, preceded by levering up the balance sheet and dividending out the cash. In this scenario, Vivendi would cause Activision to borrow a lot of money, likely $5 billion or so, given its relatively stable $1.2 billion annual free cash flow. That would leave Activision with $8.5 billion of cash and shortterm investments on its balance sheet, which Vivendi would then cause to be dividended to all shareholders. We believe that Activision requires around $500 million in cash for working capital, so a borrowing of $5 billion would permit a dividend of $8 billion. As the holder of 61% of Activision’s common stock at March 31, 2012, we estimate Vivendi would receive approximately $5 billion in cash, easing its mounting debt concerns. Activision Blizzard’s enterprise value is currently around $10 billion, and its enterprise value would presumably not change with such a balance sheet restructuring; however, debt would hypothetically be $5 billion of the enterprise value, leaving $5 billion for the stock.
We expect some volatility for Activision Blizzard shares in the near-term as investor concern increases around the long-term fate of the company. In our view, Activision shares could move up on expectations that the company will be purchased at a premium and run independently, and could move down should Vivendi instead decide to borrow, pay a dividend, and spin off the shares (in which case, we believe Vivendi shareholders would likely flood the market with Activision stock). Post spin-off, Activision’s share price would presumably rise by the amount of cash generated each year going forward, as it would likely use the cash to pay down debt, causing a shift in the allocation of its enterprise value as the debt balance declines and the equity picks up the slack.
Michael Pachter is an analyst at Wedbush Securities.
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