- Activision Blizzard seems better positioned to report an earnings/sales beat in Q1'16.
- Given the acquisition of King and the impact it will have on the company, I'm fairly certain the stock isn't fully valued.
- As such, I have raised my revenue estimate going into the quarter and maintain my full-year $1.90 non-GAAP EPS estimate.
Activision Blizzard (NSDQ:ATVI) will report results on May 5th 2016. The stock seems somewhat undervalued going into the earnings report, as many on the sell side have revised estimates slightly lower in response to third-party channel checks. However, I remain incrementally positive on the company given the depressed valuation, meaningful acceleration of full game digital downloads (margin accretive), and game line-up going into the second half of 2016. However, notwithstanding the difficulties in sustaining revenue growth and integration of King Digital Entertainment, I believe Activision Blizzard is better positioned to deliver a sales/earnings beat going into Q1’16 given the lack of visibility on digital downloads and continued uptake in console hardware over the past couple of months.
The company provided non-GAAP outlook of $800 million in revenue and $0.11 in diluted EPS, which compares to consensus estimates of $811.92 million and $0.12 diluted EPS. The company included in its guidance the revenue/earnings accretion from King Digital Entertainment. Furthermore, the company closed the transaction on February 23rd 2016, according to its recent press release. Analysts are anticipating the company to report 15.5% y/y sales growth, which is mostly driven by the acquisition rather than the strength of ATVI’s holiday line-up, despite promising sales figures of Black Ops 3.
Source: Wedbush Securities
Going into the month of March video game software grew by 8% for the entire industry. Of course, the big winner was Ubisoft following the launch of The Division and Far Cry Primal, which distorted the physical sales for the entire universe of major publishers. Furthermore, it was reported that ATVI experienced a 20% y/y decline in the month of March, but this is only inclusive of physical game sales. Given ATVI’s results are heavily dependent on World of Warcraft (PC title) and Call of Duty Black Ops 3, it’s hard to make an accurate judgment call on what this exactly entails for ATVI’s upcoming earnings call.
After all, Black Ops 3 is sold via console bundles, and with the PS4 and Xbox One experiencing 25% and 52% shipment growth respectively, it’s likely that Black Ops 3 gets mixed into the hardware growth figures. Furthermore, Activision Blizzard continued to shift sales to digital, which isn’t captured by NPD’s estimates. I also confirmed that these figures aren’t inclusive of game downloads via a brief conversation with Michael Pachter over at Wedbush Securities. There’s no third-party that’s tracking the revenue from game downloads.
As it currently stands, Activision Blizzard generated 57% of its non-GAAP revenue from digital, so the drop-off in the prior year is partially attributable to revenue mix shifting even further to digital titles. Therefore, it’s highly possible that ATVI will meet its own guidance when taking into consideration the strong sales of Black Ops 3, which was estimated to sell 655,000 units (Wedbush) quarter to date. Furthermore, on the PC front, ATVI released Star Craft 2 Legacy of the Void, which sold 1 million copies on the first day of launch in Q4’15 and I anticipate some of that momentum to carry through into Q1’16. Hence, ATVI’s results aren’t as game console dependent given platform diversification in mobile and PC.
Michael Pachter from Wedbush Securities mentioned,
The NPD results were in line with our expectations, and reflect continued health of the games industry, especially in light of the fact that NPD data is limited to physical sales, while overall publisher sales include full game downloads (FGD). While we do not believe that FGD accounts for more than 20 – 25% of overall software sales, we think that FGD is gaining share, and thus we believe that overall NPD sales data understate likely industry growth by 300 – 500 bps. It is easy to conclude that the industry remains healthy.
In Q4’15 the company reported a 45% decline in physical retail channel revenue, so the 20% decline in Q1’16 can be interpreted somewhat positively. The digital mix was 76% in Q1’15, and is likely to move up to 78% of total sales. I’m anticipating retail distribution revenue to decline by appx. 12% from $165 million to $145.2 million. I’m anticipating digital sales to grow 5 percentage points translating into $564.9 million. This totals to $710.1 million for core ATVI, and I’m forecasting King’s revenue to decline by 33.6% y/y, which translates to $401 million in incremental revenue. Therefore, I’m anticipating the non-GAAP revenue to come in at around $1.1 billion, which is well beyond the guidance provided for the quarter. Even if King’s revenue were to decline by 50% from prior-year, ATVI would report revenue of $1.012 billion on a non-GAAP basis. So, I feel somewhat confident that the company will beat on both earnings and sales going into the quarter.
Therefore, I still reiterate my deep value thesis on Activision Blizzard and I’m raising my price target from $35.65 to $39.75. I find it highly improbable that ATVI misses on either revenue or earnings going into the quarter. Even with accounting changes and deferred revenue baked into the equation, I’m not really convinced that the revenue recognition of King differs materially from ATVI. Furthermore, if top line exceeds the consensus materially, the stock will likely move considerably higher.
You can also see Amigobulls' Activision Blizzard, Inc stock analysis video for a quick look at the company's key financials.