Activision Blizzard’s Rally Is Far From Over

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Activision Blizzard’s (NASDAQ: ATVI) rapid rally had seemed to be ending, following the post-earnings plunge. The company had rallied to a new 52-week high of $15.40 on May 8, but fell to $15.18 at the time of this writing. The driving force of the fall following the first-quarterearnings release was due to the cautious outlook issued by management.

The company performed overwhelmingly well during the previous quarter, topping analyst earnings estimates of 11 cents by 6 cents, or by more than 50%. Management highlighted various areas as a reason for the cautious commentary, including a shift in release dates for competing products and next-generation transition-related uncertainty among others. However, Activision Blizzard is now recovering from the slight decline and looks to be headed for a new 52-week high in the next few days.

 

 

ATVI data by YCharts

Bumps on the road, but the journey continues

Activision Blizzard’s rally was triggered by the impressive results reported during the December quarter. But the more recent earnings report delivered a blow to what had seemed a sustainable rise. Analysts are still very optimistic on the stock with at least 17 of them rating it as buy.

The stretch achieved between January and May seems to suggest a sprint rally, but following the recent halt, the scenery has since changed to suggest otherwise. Following the cautious guidance issued by management with regard to outlook, there is little to suggest that the stock is going to continue with the rally witnessed over the first quarter in 2013. However, I would like to think of it as some sort of deceleration, with the price now settling for a gradual rise.

Some would find it easy to conclude that the sucker rally is finally coming to an end, considering that the earnings yield, which recently capped a new four-year high, has also taken a tumble. However, the company’s fundamentals remain strong and it is placed at the top of its competitors. All numbers are counting in favor of Activision Blizzard in a field that includes aspiring market leaders and industry giants.

Activision sits at the top of competition

The company’s operating margin stands at 30%, one of the best in the gaming industry, while the profit margins are just slightly lower at 24%. Its gross margin stands at an amazing 66%, which is the same as that of Sony (NYSE: SNE). However, the industry average is at a whopping 70%, which tops the two giants.

Contrary to Activision, Sony operates in a variety of industries, including the film industry and electronics. The other rivals to Activision Blizzard are Take-Two Interactive Software(NASDAQ: TTWO) and Electronic Arts (NASDAQ: EA). The last two are quite smaller than Activision in terms of market capitalization while Sony is slightly bigger by about $4 billion.

Take-Two is the only unprofitable company among the trio of competitors. The company’s loss per share stands at $0.35 for the trailing 12 months. The industry EPS is at $0.40, well below Activision Blizzard’s, which stands at $1.08, the highest among the four companies. The Japanese electronics giant, Sony, has an EPS of $0.51, while Electronics Arts’ earnings per share stand at $0.31.

Sony seems to be the likely alternative for investors when choosing among these four stocks, but considering the current board events – Third Point hedge fund manager, Daniel Loeb has already indicated that he intends to have Sony’s entertainment unit spun-off from the rest of the business – the uncertainty is bound to push some investors away.

Just like Activision, Electronics Arts beat analyst estimates, ending a bearish run, with what seems to be a sustainable rally. Contrary to Activision, the Redwood City, CA-based company issued strong guidance, which media pundits believe could help sustain the stock’s current rally.

Activision’s China Opportunity With Tencent

Santa Monica, Cailf.-based Activision released a next-generation video game, an advancement to the Call of Duty series. The new Call of Duty Ghosts is well placed for use in the next-gen consoles, with renewals highly expected for Nintendo and Sony’s PlayStation.

Activision has taken huge steps also by signing a deal with China-based Tencent to take the game Call of Duty online to the world’s most populous country. The appetite for video games in China is experiencing high rates of growth, and Activision is wise to make friends with the Chinese company. China is known to be very strict in allowing foreign Internet content, a good example being the restrictions placed on Facebook and Google.

Activision chose to use the online platform in delivering the Call of Duty game to China due to the high piracy rates on disc-based media. Tencent Holdings is a top Internet services provider, and is also often called the Facebook of China. This is an excellent partnership, which will see the world’s largest video-game maker sell to the world’s most populous country via a more secure platform, free of piracy.

The announcement of the new Call of Duty Ghosts has been a highlight in the media, receiving positive reviews, and even overshadowing the announcement made by Microsoft about XBox One. The transition to a new-age console was always going to be a challenge, but the signs thus far remain positive for Activision Blizzard. Now we can wait for Call of Duty Ghosts to sell online in China. Having already managed $1 billion in sales within the first 15 days from the Call of Duty, it will be interesting to see how the Ghosts version fares, given the addressable market in China.

The Bottom Line

Activision is currently trading at about 15x in P/E. The company’s forward PE for next year is projected at about 14.90, which indicates  that the stock’s price is expected to grow at nearly the same rate as EPS. The company’s PEG ratio is estimated at 2.33 for the next five years, compared to the industry average of 1.67.

The analysts expect the company to report $0.85 in earnings for 2013, which would be an increase of $0.13 per share from 2012, or about 18% upside. This produces a projected stock price of about $17.91 per share. Therefore, Activision is not yet done with its current rally. Given the company’s recent history of outperforming analyst estimates, the earnings could be higher than expected, which means more upside. Additionally, having widened the window of opportunity by tying a deal with Tencent, the company should realize incremental revenues and earnings going forward.

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