Here’s Why Activision Blizzard Is an Outperform

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

Activision Blizzard (NASDAQ:ATVI) Q1 results significantly exceeded expectations. Revenue was $804 million vs. our estimate of $737 million, consensus of $704 million and guidance of $690 million. Key drivers of revenue included digital (53 percent of total), Skylanders Giants, Call of Duty: Black Ops II, StarCraft II: Heart of the Swarm, and World of Warcraft. Q1 subs for World of Warcraft were 8.3 million, down 1.3 million sequentially, driven primarily by losses in the East. EPS was $0.17 vs. our estimate of $0.12, consensus of $0.11, and guidance of $0.10. The EPS beat was driven by betterthan-expected top-line growth (including for higher-margin digital) and cost control.

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FY:13 guidance still remains somewhat conservative. The company increased FY:13 guidance for revenue to $4.250 billion from $4.175 billion and for EPS to $0.82 from $0.80. Despite beating Q1 EPS guidance by $0.07, full year guidance was raised by only $0.02 due to several factors expected to impact 2H, particularly in Q4, including an evolving release slate from competitors, Wii U weakness thus far, the console transition, and World of Warcraft subscriber declines.

Lowering our FY:13 estimates due to the announcement Destiny as a 2014 title. Decreasing our 2013 estimates for revenue to $4.36 billion from $4.74 billion, and for EPS to $0.90 from $1.05 to reflect Q1 upside, revised guidance, and the 2H challenges listed by management. Decreasing our 2014 estimates for revenue to $4.66 billion from $4.74 billion, and for EPS to $1.00 from $1.05.

Digital expansion continues to drive revenue growth and margin expansion. Digital revenues continued to benefit margins, with Call of Duty DLC purchases (ala-carte and through the Season Pass) offsetting declines in WoW subs. In addition, turning Elite into a free service appears to have stabilized and lengthened the tail of Call of Duty: Black Ops II sales.

We expect WoW subs to stabilize when a second MMO is launched, expected sometime in 2014. The MMO and Destiny should provide growth next year.

Maintaining our OUTPERFORM rating, but raising our 12-month price target to $22 from $21. We value Activision shares at a market multiple of 18x our 2014 $1.00/share EPS estimate, plus approximately $4 per share in cash. The company communicates clearly, executes well, and its management appears to truly understand how to make money. We recommend that investors accumulate shares of Activision Blizzard while they remain below our 12-month price target.

Michael Pachter is an analyst at Wedbush Securities.

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