Activision stock is now trading at about $10.75, about 15 percent down from its peak earlier this year. The stock dropped after Activision's earnings report, where the company beat estimates and raised its forecast for the year to a record level, but warned that 2013 results would not be as good. Logically, better earnings should mean the stock price would rise, but investors seem to be bearish on Activision's long-term prospects.
Investors seem to have taken CEO Bobby Kotick's warning about 2013 to heart. They may be focusing on what Activision didn't say: Whether World of Warcraft subscriptions would hold their level well into next year, or whether new IP from Bungie would have an impact on 2013 results. It may also be a reflection of general uncertainty about the as-yet unannounced next-gen consoles from Sony and Microsoft, when they might arrive and how well they might be received. What does this all say about Activision's potential for 2014 and beyond?
"Activision still provides a level of visibility that is unmatched by competitors, and the stock should trade at a premium valuation"
Colin Sebastian, RW Baird
I believe that many investors look at the video game sector through a fairly narrow lens, said Colin Sebastian, analyst with RW Baird. Since it's a hit driven business, the question more often than not is what's coming next, rather than how is business performing today. In Activision's case, they raised guidance upward, assuming that Call of Duty and Skylanders would sell at least reasonably well.
Sebastian feels the important issue is what Activision has in the pipeline for next year. Management was somewhat cautious given the strong performance of Diablo III this year and risks from the console transition, Sebastian notes. In this market, investors are unlikely to take anything for granted, and the next-gen consoles are still a year away. In our view, Activision still provides a level of visibility that is unmatched by competitors, and the stock should trade at a premium valuation.
John Taylor of Arcadia Investment Corp. sees Activison being properly careful about predictions for next year. While optimistic, the company is prudently cautious in predicting growth for its largest blockbuster properties, which are already best of breed and dominant market share leaders. Indeed, even though presales for Call of Duty: Black Ops II exceed the level of Call of Duty: Modern Warfare 3 last year, the current financial plan assumes a modest decline in revenue for the brand this year. Meanwhile, Skylanders is running well ahead of last year, and will likely be a big hit this holiday. Sustaining the volume from these mega brands during the platform transition next year will be a key challenge for management.
Billy Pidgeon, senior market analyst at Inside Network, thinks that the issue for investors isn't Activision's results per se. I think it's the sector revenue that's in question for the most part. In the short term, industry sales appear to be contracting. However, revenue growth is not completely transparent, and I believe there will be strong revenue growth in the industry overall beyond the next two years.
"Activision Blizzard's primary liability could be World of Warcraft, which appears to be past its peak and could see declining subscriptions"
Billy Pidgeon, Inside Social Network
Pidgeon believes big changes in the game industry are keeping investors cautious. There are major disruptions that are affecting the sector overall, including an under-reported shift from packaged software to paid digital downloads in the hardcore games category and changes in consumption where gamers are developing more specialized tastes, buying fewer new packaged games and playing those games for longer periods of time, mostly in multiplayer sessions. The casual and free-to-play games category has also seen high volatility, although much of the perceived under-performance in that category is likely due to unrealistically high short term expectations.
There's a good reason to be positive about Activision's outlook, according to Pidgeon. Activision Blizzard has been a consistent over-achiever in the traditional console market, and has historically been less susceptible to console cycles, Pidgeon noted. Activision Blizzard has long been consistent in deftly managing sales expectations and the publisher's franchises and overall sales revenues, more often than not, out-perform those expectations on a quarterly and annual basis. Activision Blizzard's release pipeline tends to be well rounded but lean, with a high hits to misses ratio.
Pidgeon sees some problem areas for Activision, though. Activision Blizzard's primary liability could be World of Warcraft, which appears to be past its peak and could see declining subscriptions. However, it's hard to fault Activision Blizzard for WoW's eventual decline, as the game has had an unprecedented eight-year run dominating the subscription-based massively multiplayer online games category, where most competing publishers have consistently failed to enter, let alone survive.
"Investors are exceedingly pessimistic about the next generation; most believe costs are going up and revenues won't go up as much, so they are staying away from all of the 'quality' names (EA, Ubisoft, TTWO)"
Michael Pachter, Wedbush Securities
Pidgeon is optimistic for the game industry's outlook. With the industry in transition, big publishers like Activision Blizzard, Electronic Arts and Ubisoft might appear to have more at risk, but they also have more diverse libraries and broader platform coverage, while smaller publishers will be seeking and creating highly specialized niches.
Michael Pachter of Wedbush Securities points the finger at Activision's warning about 2013 as the driver behind the stock drop. Stocks are valued based upon the sum of their expected future earnings, discounted back to the present, Pacheter explained. The past only matters to suggest what future earnings can be, and Activision suggested that its future earnings would be lower. They didn't really explain much about why, other than that Blizzard will be down, but the implication may have been that WoW is getting long in the tooth and CoD is approaching a peak. In any case, their gloomy forecast is what sent the stock lower.
I think people are unsure about WoW, Pacheter continued. The subscription revenue figure wasn't very robust, suggesting that western subs have continued to decline and are being replaced by lower revenue Asian subs. People want to see a sign that revenues from WoW are growing, and it isn't clear that they will grow again.
Will next-generation consoles and the prospect of a new Bungie hit help the stock price? Pachter doesn't think so. Investors are exceedingly pessimistic about the next generation; most believe costs are going up and revenues won't go up as much, so they are staying away from all of the 'quality' names (EA, Ubisoft, TTWO). All of these companies are trading at record low multiples.
The future beyond 2013 is murky. I don't think anyone really knows about the potential for 2014 and beyond. Activision has proven resourceful, building CoD into a massive franchise, seeing the potential of Guitar Hero, shrugging off the music fad and coming up with Skylanders, and giving Blizzard free rein to come up with whatever they like. I think they're going to be fine, but investors need to see evidence of management confidence, and management sent a pessimistic signal on the earnings call.
GamesIndustry International reached out to Activision for comment, but as yet there has been no response.