UNIVERSITY OF OREGON Date of Presentation
11/07/08
INVESTMENT GROUP
Sector: Technology
ACTIVISION BLIZZARD INC.
RECOMMENDATION: BUY
Stock Data
Price (52 weeks) $10.26 – $18.18
Symbol/Exchange ATVI/NASDAQ
Beta 1.31
Shares Outstanding 659,219,243
Average daily volume 11,194,600
(3 month average)
Current market cap 6.5 Billion
Current Price $10.00
Dividend N/A
Dividend Yield N/A
Valuation (per share)
DCF Analysis $22.42
Comparables Analysis $6.26
Current Price $12.00
Target Price $19.18
(20% Comp , 80% DCF)
Summary Financials
2008 (In thousands)
Revenue $2,898,136
(92% Growth)
Net Income $344,883
(302% Growth)
BUSINESS OVERVIEW
Activision Blizzard is a fast growing company within the software publishing and distributing industry. Headquartered in Santa
Monica, CA they are primarily involved in the international publishing and licensing of interactive software and computer
products. These include: video games, pc games, and other secondary peripherals (for ex: the guitars that come with Guitar
Hero). During 2008 Activision made a significant merger with European online gaming giant: Vivendi. Since this drastically
changes their operations I will go over in more detail the significance of this merger further down in the report. Some of
Activision’s popular titles consist of: Guitar Hero, Call of Duty, Spiderman, Tony Hawk, and under the Blizzard segment:
World of Warcraft, Diablo, and Starcraft. Their products are usable across a multitude of platforms that include: Microsoft’s
Xbox, Sony’s Playstation, Nintendo Wii, handheld devices, and pc computers. These titles are the premier games within the
industry that has led to a revenue growth of 92% from 2007 to 2008. Activision also holds an array of licensing agreements
with companies such as: DreamWorks, Harrah’s Entertainment, Hasbro, MGM, and Marvel. These licenses give Activision
Covering Analyst: Russell Sneddon
Email: rsneddon@uoregon.edu
The University of Oregon Investment Group (UOIG) is a student run organization whose purpose is strictly educational. Member
students are not certified or licensed to give investment advice or analyze securities, nor do they purport to be. Members of UOIG
may have clerked, interned or held various employment positions with firms held in UOIG’s portfolio. In addition, members of UOIG
may attempt to obtain employment positions with firms held in UOIG’s portfolio.
Activision Blizzard university of oregon investment group
http://uoig.uoregon.edu
exclusive rights to publish games based on these company’s products. Traded in the NASDAQ under ticker symbol ATVI,
Activision Blizzard derives their revenues in two business segments internationally: Publishing and Distribution.
Publishing – Their Publishing division is their main revenue driver accounting for nearly 87% of net revenues in 2008. This
segment focuses on the development, marketing, and sales of their software products directly by license in North America.
Their customers include: mass retail outlets, consumer electronic stores, game specialty stores, and discount warehouses.
Internationally their publishing department primarily sells through third party distribution and wholly owned European
subsidiaries. They develop games both internally and externally, using third parties that have proven to have a successful track
record in the past.
Distribution- Activision’s Distribution segment focuses internationally on providing logistical and sales services to 3rd party
publishers. It is also where they manufacture their hardware that goes hand in hand with the games that they publish.
As you can see, Activision’s business is primarily its Publishing segment which also produces it highest margins. This has in
turn helped them to increase revenues while keeping costs low, ultimately making them more profitable. Another reason why I
chose this company is their continued emphasis on growth.
The “New” Activision Blizzard
As mentioned above, recently Activision merged with Vivendi owned Blizzard; the most popular online
multi-player publishing company in the world. The transaction took place in 2008 in which Vivendi took a
52% stake in which they paid $27.50 a share. This merger has combined both the #1 software publisher in
the US (ATVI), and the #1 online pc gaming company in the world (Blizzard). Blizzard’s products include
the most widely played online game in the market: World of Warcraft, as well as other titles that are
scheduled for release in the coming years. This transaction has now established Activision Blizzard as one
of the most dominant companies within the industry. By integrating Blizzard into their operations Activision will now add a
new line of revenue streams coming from online subscriptions. This is important in an industry were revenue growth is
extremely volatile because it depends on the number of new hit releases developed. By adding this new segment they now
have a more reliable constant revenue stream that will be in the billions of dollars. This is also important because it allows
more revenue allocation throughout the company. In recent years a large portion of Activision’s revenues came from a small
number of popular franchises. With this acquisition they are able to have more diverse income generators. Not only has this
made Activision the strongest company within the industry it has also given the company a significant strategic advantage
moving forward as more companies begin to focus on the online segment within the industry. Blizzard has continued to be
the industry’s leader in developing the most popular massive online role playing games. Recent statistics have customer base at
over 11 million people and growing. According to Activision’s CEO the new merged company has already expected to realize
a 100-150 million dollar gain in synergies; quoting “our merger is the most successful in the history of the video game
industry.” Together, Activision and Blizzard will continue to expand their customer base globally by targeting emerging
markets.
Revenue & Growth Strategy
In recent years Activision’s revenue growth has been unmatched by any in the industry. Last year it saw its revenues grow by
92% from year to year. Not only was its revenue growth substantial but it also has become more efficient in lowing cost and
increasing margins, leading to a growth in Net Income of 302% for the fiscal year ended in 2008. Activision is able to do this
by focusing their company on growth. They have made two key acquisitions in the past few years that have substantially
increased their position within the industry. These include the purchasing of RedOctane (maker of Guitar Hero), and the
acquiring of Bizzare Creations (long time successful European racing game publisher). Just recently they announced the
acquisition of U.K.-based Freestyle Games that specializes in music-based games. This is a strategic move in which it will allow
Activision to not only develop more music based games, but also to work on downloadable content for its Guitar Hero
franchise. With these new additions, Activision focuses their growth strategy on what they call their “big three” franchises:
RedOctane, Call of Duty, and Bizzare Creations. It is these franchises that have lead to such a significant increase in
profitability and in the future they will look to expand on these growing franchises. Because of their newly formed merger with
Blizzard, they now add a new segment to revenue growth: the online massive-multiplayer online role-playing games. This is
expected to be a large growth segment in the coming years with more than 13 million people currently playing online. This is
important because it now provides more revenue diversification, allocating revenues over more business segments. Although a
2
Activision Blizzard university of oregon investment group
http://uoig.uoregon.edu
large part of their revenue streams comes from North America, Activision has experienced significant growth internationally
growing revenues by 44% and 143% in Europe and other countries respectively. They have increased their international
market share by an estimated 100% year over year. Recently Activision has strengthened its international online presence by
forging a partnership with NetEase, the Chinese online gaming firm. Under this partnership NetEase will provide the
launching of popular online games like StarCraft II and Warcraft III in the China. This is an area where management feels they
can still achieve significant growth and improve their international market share. In appendix 4 you can see their revenue
breakdown by territory and business segment, which will provide some insight to their main revenue drivers. In the next few
years, I predict that Activision Blizzard will experience significant growth due to the release of some major blockbuster games
in both the video game consoles and online pc games segments. One in particular is the new expansion pack for World of
Warcraft, scheduled for release during this month. 2.4 million copies of the 2007 expansion pack for this game were sold in 24
hours, and a spokesperson for Wal-Mart stated, “the Wrath of the Lich King (new expansion title) has already achieved the
highest number of preorders ever sold at Wal-Mart.” I predict this is going to have a significant impact on Activision
Blizzard’s revenue streams for the year and provide solid growth in a struggling economy. Other hit releases include: Call of
Duty: World at War, Guitar Hero World Tour, James Bond: Quantum of Solace, and many more scheduled for release this
holiday season. As you can see Activision Blizzard is well prepared for this coming holiday season with more hit titles
scheduled for release than any other company in the industry. In the coming years I do not expect this slate of blockbuster
titles to decrease, in fact it is only going to get stronger with two of the most anticipated online pc games ever made: Starcraft
II and Diablo III, scheduled to hit the shelves in the next few years as well as many new console releases.
RECENT NEWS
• November 5, 2008 -Activision posts better-than-expected earnings. Activision again stunned Wall Street by beating
earnings expectations. They have maintained their revenue outlook for the rest of the year at 4.2 billion dollars.
• November 5, 2008 –Activision Blizzard announces 1 billion dollar share buyback
• November 3, 2008 -Wedbush Morgan maintains a 'Strong Buy' rating on Activision (Nasdaq: ATVI), but lowers price
target from $22.50 to $18. They expect Q2 profits to be slightly better than their estimates and continue to optimistic
about Activision’s future
• October 31, 2008- Activision Publishing's Dancing With The Star(TM): We Dance! Out Now for Wii(TM) and
Nintendo DS(TM).
• October 28, 2008 - World of Warcraft(R) Surpasses 11 Million Subscribers Worldwide. With a customer base of 11
million each paying monthly premiums, Activision is sure to have strong revenue growth
• September 15, 2008 -Take Two declines after Electronic Arts ends Talks. This ended a possible acquisition of Take
Two by Electronic Arts. This had a significant impact on the industry as Activision remains the world’s largest video
game maker
INDUSTRY
Activision Blizzard operates in the software publishing industry, specifically in the video game segment. The industry has
experienced tremendous growth since it first was established in the mid 1970’s. For older generations the advancement of the
gaming industry has been unmatched by almost any consumer product. One would only have to look at the graphics and game
play of the original Mario Brothers and compare that to a modern game to see the advancement of technology. Many experts
believe the industry to be in a growth stage of its lifecycle and expect this to continue for years into the future; predicting the
next few years to have industry growth rates of 20% and higher. The video game industry has evolved into two dominant
platforms: consoles and computers, while just recently we have seen handheld devices and mobile technologies emerge. The
profitability of any software publishing companies relies heavily on the direction of these platforms, because it is the basis on
which they develop their products. It is because of this that I feel it is appropriate to separate the industry analysis into three
3
Activision Blizzard university of oregon investment group
http://uoig.uoregon.edu
separate sub-industries to gain a better understanding of the industry as a whole. These three are: Console, Computer, and
Publishing Industries.
Console Industry
The major consoles today include: Xbox, Playstation, and Nintendo Wii. Many of these companies also
publish their own titles making them direct competitors of companies like Activision (Ex:
Xbox’s creation of Halo). Video game publishers such as Activision will need to continue to
be able to produce compatible games as these platforms evolve. It is not uncommon for these
console companies to come out with a new system every four to five years, thus it is extremely
important for publishers to be constantly adapting their internal processes. As common with many products, newly released
consoles tend to sell at high prices and continue to lower the price the longer it has been on shelves; however these do provide
alternative options for the cheaper shopper who might be satisfied with last year’s system. I see two major trends in this sub-
industry that should drive future growth for publishing companies. Many of the most popular games these days are either
online or interactive; meaning it involves some other peripheral enable to play it. The largest sales growth in consoles has
come from Nintendo’s Wii because it allows consumers to be a part of the game by making them in charge of their actions
through the use of a wireless infra-red controller. This has also diversified the customer base bringing in more women and
children than ever before. This is innovative technology I believe will be the foundation of future growth within the sub-
industry. Even though Xbox and Playstation do not encompass this same technology they have also experienced significant
growth due to interactive games. The emergence of games such as Guitar Hero and Garage Band has captured new customers
around the world, and will continue to build on this growth. Many online action games such as: Call of Duty, Halo, and
Madden Online, have also led to strong growth. However, the online subscriptions for these games are received by the console
manufacturers and not the publishers. The future of the console industry looks bright with a more diverse customer base.
Industry research shows that an increasing number of women and people over the age of 25. The future success for these
manufacturers lies in their ability to build on their platforms and release the next big gaming device as well as their ability to
publish well liked titles.
Computer Gaming Industry
The online computer gaming industry is one of the largest interactive entertainment Subscriber numbers to Massive Multiplayer Online Games, US
segments in the world, with an estimated 13 million people logged on. Although online Year Subscribers Percent Growth
2000 1,000,000 N/C
gaming as been around for several years it has experienced significant growth in the past 2001 2,600,000 160.00%
few years and I believe it to be the future of the industry as a whole. The popularity of 2002 3,600,000 38.50%
2003 4,200,000 16.70%
online games has grown because it offers many different aspects to the customer that 2004 6,000,000 42.90%
cannot be produced on regular consoles. These include the availability of expansion 2005
2006
6,600,000
10,900,000
10.00%
65.20%
packs, and the ability to compete in a virtual universe so big it takes days to travel from 2007 13,400,000 22.90%
2008 16,000,000 19.40%
one place to another. Also, because computers are already internet accessible it does not
require a connection or a monthly premium as it does when playing online with consoles. The table to the right taken from
IBIS World shows the growth of online PC gamers in the US over the past few years (2008 is an estimate). Keep in mind this
is only US growth which gives some idea of how big this segment is. This has been largely attributed to the development of
Massive online role-playing games. The largest of the online games is Blizzard’s World of Warcraft with an estimated 11
million people worldwide. The reason that I love the online aspect is that it provides more profitability for publishers; forcing
customers to pay monthly premiums enable to log on. This is different than the console industry where customers make a
one-time purchase of the game. The future of the online gaming industry is going to lie in the development of Massive online
role playing, strategic, and action games. These are games that some people categorize as addictive, requiring constant
attention and capturing audiences for hours, sometimes days at a time. The future of these gaming experiences will be in
games such as World of Warcraft, Diablo III, War hammer, Starcraft II, and other premiere titles that have already captured a
large customer following based on previously released games. Because this is such a competitive environment brand strength is
extremely important. Customers will look to those companies and titles that they know and retail outlets will pay huge
premiums to keep well known titles on its shelves.
4
Activision Blizzard university of oregon investment group
http://uoig.uoregon.edu
Video Game Publishing Industry
The video game publishing industry in concerned with the development of interactive software that is used by many different
platforms. This can be either in-house where the publisher creates, develops, tests, and releases games in the market place or
through third party affiliates. The ability for publishing companies to be successful lies in their ability to develop the next hit
game, which has increased development costs in recent years. Although hit games are important, just as important is the
development of strong franchises. Some of the strongest in the industry consist of: Electronic Art’s Madden and sports
franchises, and Activision’s Guitar Hero franchises. Franchises are important because they allow publishers to develop new
titles based on the franchise name, which ideally cuts marketing costs. This is because the franchises are already well known
within the industry, and retain strong brand loyalty amongst customers. Publishing companies experience high royalties costs
for gaming licenses and software royalties. For each platform that a publisher develops a game on they must pay a per-unit
royalty as well as a standard fee to develop games for these devices. These costs do not apply to PC’s. It is also common for
publishing companies to hold varies licenses that give them exclusive rights to publish a certain game, (Ex: EA’s license with
NFL, and Activision’s licenses with Marvel). These are strategic advantages that come with a hefty price and can drastically
increase the cost of sales. I believe the future of the game publishing industry to be highly competitive forcing some of the
smaller firms to either be acquired, merged, or bankrupt. This is because more and more popular titles are attracting a large
part of the market. The future profitability of these firms lies in their ability to maintain a successful and diverse product
portfolio including several strong franchises across many different next generation platforms. Equally important is the ability
to constantly adapt and adjust business processes as the technological aspects of the industry change. The best companies will
be those who are able to see trends before they happen and produce quality products that increase their global presence. I feel
that Activision Blizzard is the best positioned company to capture this future growth.
The video game industry is massive in size and has had continued growth for the past decade. The emergence of new
technology allows for the advancement of platforms. We are now seeing more handheld devices such as the Playstation
portable and Nintendo DS. Although these prove to be profitable platforms I do not believe them to be what is going to drive
future growth within the industry. The future looks brighter than ever with new technologies and new customer bases that will
fuel growth. The development of interactive and online games have propelled the industry into another growth period as
stated by Activision C.E.O., “demand for innovative interactive entertainment will propel the industry into what could be the
greatest growth period in its history.” Historically the industry has appeared recession proof. This is because their primary
customers will allocate the necessary funds to buy their products no matter what. Looking forward I continue to be optimistic
about this industry’s future. So far Activision has not seen any slowdown in sales due to economic conditions. According to
management retailers continued to put high demand for their products. Retail outlets have increased space for video games by
40% over the past year. Because Activision has the strongest products in the industry, retails will continue to demand their
products at the expense of other competitors.
S.W.O.T. ANALYSIS
Strengths –
• Strong Franchises that will continue to grow
• Strategic licensing agreements to popular titles
• Key mergers and acquisitions that have made them the strongest company in the industry
• New revenue streams coming from online subscriptions
• Large amounts of cash and no debt
• 2 of the top five titles in the console publishing industry
• #1 game in the computer gaming industry
Weaknesses-
• A large part of their revenue comes from a small number of popular titles
• Higher development costs to constantly adapt to new technological platforms
• Increasing pressure on margins from downward pricing of platforms after their release
• High costs due to licensing and development fees
• High seasonal demand
5
Activision Blizzard university of oregon investment group
http://uoig.uoregon.edu
Opportunities-
• Activision has grown its international market share and can continue to seek out new international markets
• Expand on their online titles diversifying their revenue generation
• Development of new peripherals for new games i.e. new Guitar Hero will come with drum set, bass, guitar, and
microphone. Possibility of a new Tony Hawk game coming with electronic skateboard.
• Expand market share and capture more growth by adding Blizzard to its operations
• The emergence of in-game advertising
Threats-
• New popular titles developed by competing companies can drastically reduce growth.
• Possible mergers between other publishing companies (EX: EA and Take Two), which could significantly reduce
market share
• Possible economic affects and lower consumer spending
• Constant technological changes that will require Activision to constantly adapt its business procedures
CATALYSTS
Upside
The integration of Blizzard into Activision makes it the strongest company in the industry. If they can successfully complete
and launch the next generation online role playing games this is going to lead to strong revenue growth for the future. This
along with Activision’s console publishing division will propel the company into its greatest growth period yet, paying off for
investors.
Downside
If economic conditions continue to worsen consumer spending could cause holiday sales to not reach estimated amounts. This
could drastically affect Activision’s revenue growth for the year, because a large portion of their year’s revenues come from
this season. Also the inability to release hit titles on scheduled release dates. This has not been a problem for them yet,
however with more technologically advanced gaming platforms this could cause problems in meeting release dates in the
future.
COMPARABLES ANALYSIS
For my comparables analysis I decided to focus on companies that Activision directly competes within the software publishing
industry. In addition I looked for companies with similar financial structures, and who are exposed to the same systematic
risks as Activision. These risks include economic uncertainty, consumer dependence, seasonality of sales, meeting release
dates, ability to acquire strategic licenses, technological advancements, and many more. I decided on the other four major
players within the industry: Electronic Arts, Take Two, THQ, and Konami. Because the software publishing industry is so
competitive, these are the companies that best represent the environment that Activision competes in. I did not want to
include such companies as Sony and Microsoft who are also major players in the publishing industry because that is a relatively
small aspect of their business operations. Each of these four firms target the same customers and compete directly for market
share. I feel that these companies are the best representation of Activision Blizzard’s competition and the risk that they face
moving into the future. The major problems I had with this analysis is that due to Activision’s recent merger many of its
business aspects have changed. Because of the terms of the merger many shares were issued while the revenue from these two
businesses for the year has remained separate. For these and other reasons I do not feel the comparable analysis accurately
valued Activision compared to its competitors. It is for these reasons that I decided to weight my comparable analysis at 20%.
Electronic Arts (ERTS) 35%
“Electronic Arts, Inc. develops, markets, publishes, and distributes video game software and content in North America,
Europe, and Asia. The company’s software games and content are playable by consumers on video game consoles; personal
computers; handheld game players; and cellular handsets. It offers games in a range of categories, including action-adventure,
casual, sports, family, fantasy, racing, music, role-playing, simulation, extreme sports, and strategy under the EA brand. The
company also provides online game-related services, including matchmaking and subscription services for game platforms.
Electronic Arts also sells advertisements in its games and on its Web pages. In addition, it co-develops, co-publishes, and
6
Activision Blizzard university of oregon investment group
http://uoig.uoregon.edu
distributes video games that are developed and published by other companies. Further, Electronic Arts operates The Sims 2
Store at its Web site, Thesims2store.com, for online shoppers in the United States and Canada. This online shopping site
enables the players of The Sims 2 to choose from a range of items for their Sims, including fashions, furnishings, decor,
entertainment, and home office items. The Sims 2 Store includes items from various Expansion Packs, including The Sims 2
University; The Sims 2 Nightlife; The Sims 2 Open for Business; The Sims 2 Pets; The Sims 2 Seasons; and The Sims 2 Bon
Voyage. The store also offers Stuff Packs, including The Sims 2 Family Fun; The Sims 2 Glamour Life; The Sims 2
Celebration; and The Sims 2 Teen Style. The company was founded in 1982 and is headquartered in Redwood City,
California.” – Taken from Yahoo! Finance
Electronic Arts is one of if not the top competitor that Activision faces within the publishing industry. Their products and
packages have a direct affect on how Activision’s market-share, as well as their ability to grow revenues. Like Activision, EA
does not use leverage as a source of financing and have continued to produce blockbuster titles over the past decade. The risks
that EA sports faces are directly in line with those that Activision face as they continue to compete in a competitive
environment. It is because of all these factors that I decided to weigh EA at 35%. I believe they are the best representation of
competition that Activision faces in the industry.
Take Two Interactive (TTWO) 30%
“Take-Two Interactive Software, Inc. engages in the development, publication, and distribution of interactive software games
designed for personal computers, video game consoles, and handheld platforms worldwide. It operates in two segments,
Publishing and Distribution. The Publishing segment develops, markets, and publishes software titles for the gaming and
entertainment hardware platforms, such as Sony’s PlayStation2 and Playstation 3 computer entertainment systems; Sony’s PSP
system; Microsoft’s Xbox and Xbox 360 video game and entertainment systems; Nintendo’s Wii, GameCube, DS, and Game
Boy Advance; and for personal computers. Its products consist of Rockstar Games, 2K Games, 2K Sports, and Global Star
Software. The Distribution segment distributes its products, as well as third-party console, handheld, and PC products
consisting of newly released and popular software titles, budget and catalog software titles, and hardware. It serves mass
merchandisers; video, electronic, and toy stores; national and regional drug stores; supermarket and discount store chains; and
specialty retailers. The company sells its software titles to retail outlets through direct relationships, as well as through third-
party distributors in North America and Europe. Take-Two Interactive was founded in 1993 and is headquartered in New
York, New York.” – Taken from Yahoo! Finance.
I chose to weight Take Two at 30% because like EA, Take Two is the best representation of competition that Activision faces.
This is because they offer similar products, especially their Grand Thief Auto series and are similar in structure (many of their
revenues are derived from a small number of franchises). Take Two is a relatively new company that has experienced
significant growth in the past five years just as Activision has. This makes me believe that many of their business processes are
similar to that of Activision as they continue to compete for blockbuster titles. Take Two is also similar in market cap and is
also exposed to many of the same risks as Activision. It is because of these reasons that I chose to weigh Take Two at 30%.
THQ Inc. (THQI) 15%
“THQ, Inc., together with its subsidiaries, engages in developing, publishing, and distributing interactive entertainment
software for various game systems worldwide. It offers video games, and other interactive software and content for play on
home video game consoles, such as Microsoft Xbox 360, Microsoft Xbox, Nintendo Wii, Nintendo GameCube, Sony
PlayStation 3, and Sony PlayStation 2; handheld platforms, including Nintendo Dual Screen and Game Boy Advance, PSP
portable entertainment system, and wireless devices; personal computers; and online. The company also offers wireless games
and other content, such as wireless wallpapers and ring tones. Its titles span various categories comprising action, adventure,
fighting, racing, role-playing, simulation, sports, and strategy. THQ markets and distributes games to mass merchandisers,
consumer electronic stores, discount warehouses, and other national retail chain stores directly, and to grocery and drug stores
through regional retailers and distributors, as well as games and other content for wireless devices through wireless carriers and
Internet. The company was founded in 1989 and is based in Agoura Hills, California.” – Yahoo! Finance
Because THQ Inc. is a relatively small player compared to my other two comparables (with a market cap in the millions), I
decided to weigh them at 15%. A majority of THQ’s titles are sports related titles that directly compete with those offered by
EA. Since Activision does not primarily offer sports titles I felt a lower weight was justified. I decided to use THQ because like
all my comparables they are a video game publishing company that is exposed to many of the same risks, costs, and business
7
Activision Blizzard university of oregon investment group
http://uoig.uoregon.edu
decisions that Activision has. Their operations are drastically affected by their ability to release hit titles, maintain customer
bases, and compete on the next generation platforms. In weighting THQ 15% I think this has given me the best model for my
comparable analysis.
Konami Corp (KNM) 20%
“Konami Corporation engages in the development, publishing, marketing, and distribution of video game software products
for stationary and portable consoles, and for use on personal computers. The company operates in three segments: Digital
Entertainment, Health and Fitness, and Gaming and System. The Digital Entertainment segment produces, manufactures, and
sells video game software for home use; video games for amusement facilities; and content for token-operated games. It also
involves in planning, producing, manufacturing, and selling card games, electronic toys, figures and character goods, music and
video package products, books, and magazines; building computer systems related to online games; maintaining and operating
online servers; producing and distributing content for mobile phones; and producing online games. The Health and Fitness
segment operates health and fitness clubs, and health-related business enterprises. It designs, manufactures, and sells fitness
machines and fitness-related products. The Gaming and System segment develops content and hardware for gaming machines
for casinos. It develops, produces, and sells gaming machines, such as video and mechanical slot machines and management
systems to gaming operators in North America, Oceania, and other overseas markets. The company, formerly known as
Konami Co., Ltd., was founded in 1969 and is headquartered in Tokyo, Japan.” –Yahoo! Finance
Because Konami operates in a different fashion; selling health and fitness products, toys, arcade products, and video games, I
decided to also weigh Konami Corp lower than the first two comparables at 20%. Although Konami is heavily engaged in the
publishing of video game software and accessories, their business structure and product diversity is slightly different than
Activision. In addition their financial structure is slightly different because of the use of debt financing. They are also operated
in Japan and face many different domestic risks than Activision. Konami is still affected by many of the same risks as
Activision however I feel they are also exposed to several other factors that may not be so critical to Activision’s operations.
Even with the lower weighting I feel Konami is a good comparable firm as it still competes within the industry and targets the
same customers.
Metrics
The metrics I decided to use in my analysis were: EV/Revenue and EV/Gross Profit. Choosing appropriate metrics was
difficult because many of the comparable firms reported negative numbers from EBITDA on down. This unfortunately made
my comparable analysis heavily dictated by top line items. However, in this industry I feel it is a company’s ability to generate
strong revenues and increase margins that make them successful, which justifies my two metrics. I looked for other industry
specific metrics like EV/# of R&D Employees. Unfortunately there was not enough information for each company to make
this an accurate measure. Because my comparable analysis was heavily dictated by top line items I felt it was not representative
of the bottom line success that Activision achieved compared to its competitors. Ultimately I decided to use only two metrics
because it gave me the most accurate model to analyze my firm. I weighed each of my metrics at 50% arriving at an implied
price of $6.26. Since only two metrics were available for use and the previously described concerns, I decided to weigh my
comparable analysis at only 20%.
o
DISCOUNTED CASH FLOW ANALYSIS
Revenue Projections
For my discounted cash flow analysis I used the percentage of revenue method. In projecting my revenues, I relied on a
number of different sources. These included: market analysis, industry research, company guidance, and analysis expectations.
My primary source was Activision’s investor relations and their most recent conference call. This gave me an accurate idea on
what their growth opportunities and plans consisted of as well as industry outlooks. I decided to project my revenues based on
business segments and territory. Their publishing segment is their primary revenue driver and accounts for nearly 90% of total
revenues. I projected Distribution revenues to be negative for the next few years due to the termination of a significant
customer last year. This should only affect its distributing revenue growth for a minimal period. I expect a large part of their
growth to come from their dominant territory: North America. This is due to the extreme popularity of their products
domestically. By focusing on territorial regions I was able to see revenue growth in separate Countries and how they compared
to each other. Separating by territory you can see that I have projected international revenue to grow substantially for the next
ten years. This is in line with their company focus as they continue to focus their growth internationally. For the first few years
8
Activision Blizzard university of oregon investment group
http://uoig.uoregon.edu
I have projected revenue to grow at double digit rates because of a number of different factors. In 2009, I expect strong
revenue growth due to the fact that Activision is releasing a number of blockbuster titles including: World of Warcraft
expansion pack and Guitar Hero World Tour and many more blockbuster titles for this holiday season. My revenue projection
for the rest of 2009 is conservative compared to company expectations; as they have projected revenues to be $4.9 billion. In
spite of growing economic concerns I maintain the belief that these products are less affected by economic downturn than
most consumer products. In 2010 I expect another big year for Activision with the release of highly anticipated PC games and
a whole new slate of console releases. I also expect better economic conditions moving into the holiday season of next year. I
have projected 2010 to be another high double digit growth year and then revenue growth to begin decreasing down to a
terminal growth rate of 3%. For the past 2 years Activision has out grown the industry by large margins and I expect the same
for the next few years. Also, I have estimated a new console to come out in 2014 leading to higher costs for Activision as they
have to be able to adapt their development procedures to meet these new platforms. Due to the release of the new platform I
have revenue picking up the next year as Activision begins to publish compatible titles for this next generation system. This is
a good estimated considering a new console historically has appeared every 4-5 years.
Cost of Sales & Other Costs
Costs of sales and services include: product costs, royalty payments, and intellectual property licensing agreements. I decided
to focus on company guidance as well as industry trends to project these costs moving forward. Product costs as a percentage
of sales are expected to decrease as revenues grow; particularly because they are a result from their publishing segment that
carries higher margins. Royalty and intellectual licensing costs come from fees that platform manufactures such as Sony and
Microsoft charge. These include a per-unit fee as well as a standard fee for publishing companies to make their games
compatible with these systems. Another portion of these costs come from licensing agreements with outside parties, granting
Activision exclusive rights to uses names, trademarks, copyrights, music, and other intellectual property items. In Activision’s
10-K report they expect 2009 sales costs to stay relatively in line with 2008 costs of sales. As the industry expands I expect
these costs to increase due to higher amounts fees based on new technology and the acquiring of new strategic licensing
agreements in the future. I decided to project other costs by themselves because it includes product development; a major
indicator of how successful publishing companies are in releasing new titles. Company management believes these costs to be
in line with 2008 for the 2009 fiscal year. Activision has recently cut down on these costs by outsourcing art and creation as
well as quality assurance. Moving forward I expect these costs to rise slightly as Activision puts more time and money into
creating and maintaining solid franchises. Because of my assumption that a new console will be introduced in 2014, I have
development costs rising significantly because of the effort it involves to adapt to a new platform. Selling, general, and
administrative costs is expected to increase due to higher marketing efforts internationally, employee bonuses, and a greater
amount of employees. This is expected to increase slightly, although they have cut some of these costs by creating an internet-
based customer relations service, as well as a more direct marketing campaign. I have these costs steadily rising, reaching a
peak in 2014 due to the arrival of a new platform. I expect them to decrease due to more efficient marketing, and
administrative strategies.
Cash & Cash Equivalents
Because of the volatility of Activision’s cash I decided to take them out of current assets and keep them steady moving
forward. Activision usually has large amounts of cash and cash equivalents on its balance sheet enable to finance operating
activities as well as acquisitions, however the level as a percentage of revenue has jumped around substantially. Because of the
uncertainly in predicting these cash balances, I decided that by keeping them constant I would have a model that is less reliant
on speculative assumptions.
Change in Net Working Capital
I projected current assets and current liabilities using a 6 year historical average as a percent of revenue. I keep these constant
moving forward. I added the constant cash value each year to current assets.
Short Term Investments
Due to the large fluctuation in short term investments I decided to take a new approach. Because Activision actively invests,
these numbers are subject to many uncertainties, including: foreign exchange rates, yields, overall market performance, and
economic conditions. Rather than to speculate on what their speculations might be and the income generated from those, I
decided to treat short term investments as excess cash and add it to PV of free cash flow. This made my model less reliant on
speculative estimates and provided me with a better model to derive a implied price.
9
Activision Blizzard university of oregon investment group
http://uoig.uoregon.edu
Beta
Because of Activision’s recent merger with Blizzard I thought it would make most sense to use the Hamada formula to
calculate a beta for Activision. Because the actual publishing industry is only comprised of a small number of major players, I
decided to also include other software publishing companies as well as console manufacturers. Because these other companies
have similar products I felt it was reasonable to compare the two. I arrived at a beta of 1.31 for Activision, which I feel is a
reasonable measure of its risk relative to the market.
RECOMMENDATION
After my complete analysis of Activision Blizzard I arrived at an implied price of $17.44 per share. This was derived at a 20%,
80% weighting of my comparable analysis and DCF projections respectively. I feel the Activision is the best company within
its industry. The products they produce and continue to build on will lead to strong revenue growth in the future. In addition
they have been able to increase margins and strategically place themselves within the industry. By adding Blizzard’s operations,
Activision has in my opinion is in position to capture more and more market share from its competitors. This, together with
my analysis is why I recommend a BUY for all portfolios.
10
Activision Blizzard university of oregon investment group
http://uoig.uoregon.edu
APPENDIX 1 – COMPARABLES ANALYSIS
in thousands of US dollars Activision Electronic Arts Take Two Interactive Konami Corp THQ Mean
Blizzard 35% 30% 20% 15%
Current Price $ 10.00 $22.37 $12.12 $20.07 $6.55 $15.28
Shares Outstanding 659,219 319,000 77,603 143,500 66,740 151,711
Market Cap $6,592,190 $7,136,030 $940,544 $2,880,045 $437,145 $2,848,441
Long-Term Debt $0 $0 $0 $365,057 $0 $91,264.25
Gross Profit $1,286,829 $1,860,000 $225,000 $815,000 $286,000 $796,500
Revenue $2,898,136 $3,665,000 $981,791 $3,155,392 $1,030,470 $2,208,163
Enterprise Value $6,592,190 $7,136,030 $940,544 $3,245,102 $437,145 $2,939,705
Net Income $344,883 ($454,000) ($138,406) $194,474 ($35,337) ($108,317)
Beta 1.31 1.59 1.64 0.94 1.82 1.4975
Cost of Service and Sales $1,611,307 $1,805,000 $735,030 $2,083,867 $720,420 $1,336,079
Metrics Weighted Average Implied Value Weights
EV/Revenue 2.27 1.95 0.96 1.03 0.42 $1.24 $5.44 50.0%
EV/Gross Profit 5.12 3.84 4.18 3.98 1.53 $3.62 $7.07 50.0%
Earning Per Share 1.19 -1.67 1.35 1.30 -0.86 ($0.05) ($0.03) 0.0%
Implied Price 6.26
Current Price $12.45
Undervalued ($6.19)
% -49.74%
11
12
university of oregon investment group
http://uoig.uoregon.edu
Activision Blizzard
Discounted Cash Flow Statement
0.5 1.5 2.5 3.5 4.5 5.5 6.5 7.5 8.5 9.5 10.5
2006 2007 2008 2009 Q12 A 2009 Q34 E 2009 AE 2010E 2011 E 2012 E 2013 E 2014 E 2015 E 2016 E 2017 E 2018 E 2019 E
Operating Revenue 1,468,000 1,513,012 2,898,136 1,303,203 3,124,675 4,427,878 6,591,427 8,216,916 9,775,607 11,158,941 12,338,399 13,976,323 15,250,697 16,249,853 16,806,824 17,311,028
% of Growth 3.1% 91.5% 52.8% 48.9% 24.7% 19.0% 14.2% 10.6% 13.3% 9.1% 6.6% 3.4% 3.0%
Operating Expenses
cost of service and sales 925,728 947,910 1,611,307 781,129 1,432,810 2,213,939 3,295,713 4,272,796 5,278,828 6,249,007 7,403,039 7,966,504 8,387,884 8,937,419 8,739,548 8,655,514
% of Revenue 63.1% 62.7% 55.6% 59.9% 45.9% 50.0% 50.0% 52.0% 54.0% 56.0% 60.0% 57.0% 55.0% 55.0% 52.0% 50.0%
Gross Profit 542,272 565,102 1,286,829 522,074 1,691,865 2,213,939 3,295,713 3,944,120 4,496,779 4,909,934 4,935,360 6,009,819 6,862,814 7,312,434 8,067,275 8,655,514
Gross Margin 36.9% 37.3% 44.4% 40.1% 54.1% 50.0% 50.0% 48.0% 46.0% 44.0% 40.0% 43.0% 45.0% 45.0% 48.0% 50.0%
Minus Depreciation and amortization 14,634 30,155 34,128 7,045 37,234 44,279 65,914 123,254 146,634 223,179 246,768 419,290 457,521 406,246 420,171 432,776
% of Revenue 1.0% 2.0% 1.2% 1.0% 1.0% 1.5% 1.5% 2.0% 2.0% 3.0% 3.0% 2.5% 2.5% 2.5%
Other Costs* 512,412.00 461,800 773,087 535,894 703,912 1,239,806 2,076,299 2,711,582 3,225,950 4,240,398 4,195,056 4,542,305 4,803,970 5,118,704 5,042,047 4,847,088
% of Revenue 34.9% 30.5% 26.7% 41.1% 22.5% 28.0% 31.5% 33.0% 33.0% 38.0% 34.0% 32.5% 31.5% 31.5% 30.0% 28.0%
Total Operating Expense 1,452,774 1,439,865 2,418,522 1,324,068 2,136,722 3,453,745 5,372,013 6,984,379 8,504,778 10,489,404 11,598,095 12,508,809 13,191,853 14,056,123 13,781,595 13,502,602
% of Revenue 99.0% 95.2% 83.5% 101.6% 68.4% 78.0% 81.5% 85.0% 87.0% 94.0% 94.0% 89.5% 86.5% 86.5% 82.0% 78.0%
Operating Income 15,226 73,147 479,614 -20,865 987,953 974,133 1,219,414 1,232,537 1,270,829 669,536 740,304 1,467,514 2,058,844 2,193,730 3,025,228 3,808,426
% of Revenue 1.0% 4.8% 16.5% -1.6% 31.6% 22.0% 18.5% 15.0% 13.0% 6.0% 6.0% 10.5% 13.5% 13.5% 18.0% 22.0%
Investment Income 26,595 34,952 50,289 10,859 44,279 65,914 82,169 146,634 167,384 246,768 279,526 305,014 324,997 336,136 346,221
% of Revenue 1.8% 2.4% 3.4% 0.7% 1.0% 1.0% 1.0% 1.5% 1.5% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0%
Gain on Investment 4,297 1,823 1,103 105
% of Revenue 0.29% 0.12% 0.04% 0.01%
APPENDIX 2 – DISCOUNTED CASH FLOWS ANALYSIS
Income before Provision for Income Taxes,…. 45,856 109,825 530,868 -9,917 987,953 1,018,412 1,285,328 1,314,707 1,417,463 836,921 987,072 1,747,040 2,363,858 2,518,727 3,361,365 4,154,647
Minus Provision for Income Taxes 5,605 24,038 185,985 32068.00 324376.21 356444.21 449864.87 460147.31 496112.05 292922.20 345475.17 611464.13 827350.33 881554.54 1176477.65 1454126.38
Tax Rate* 12.2% 21.9% 35.0% -323.4% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0%
Net Income 40,251 85,787 344,883 -41,985 663,577 661,968 835,463 854,559 921,351 543,998 641,597 1,135,576 1,536,508 1,637,173 2,184,887 2,700,520
Add Depreciation & Amortization 14,634 30,155 34,128 7,045 37,234 44,279 65,914 123,254 146,634 223,179 246,768 419,290 457,521 406,246 420,171 432,776
Operating Cash Flows 55,147 116,039 379,149 -34,924 700,811 44,279 901,378 977,813 1,067,985 767,177 888,365 1,554,866 1,994,029 2,043,419 2,605,058 3,133,296
% of Revenue 3.8% 7.7% 13.1% -2.7% 22.4% 1.0% 13.7% 11.9% 10.9% 6.9% 7.2% 11.1% 13.1% 12.6% 15.5% 18.1%
Current Assets 525,426 830,793 1,926,433 2,082,433 2,090,739 2,090,739 2,410,191 2,711,598 3,003,889 3,264,290 3,480,159 3,794,283 4,037,654 4,227,491 4,328,027 4,422,097
% of Revenue 35.8% 54.9% 66.5% 47.2% 36.6% 33.0% 30.7% 29.3% 28.2% 27.1% 26.5% 26.0% 25.8% 25.5%
Current Liabilities 193,856 341,169 556,071 621,558 810,916 810,916 1,207,146 1,504,836 1,790,293 2,043,635 2,259,640 2,559,607 2,792,994 2,975,979 3,077,981 3,170,321
% of Revenue 13.2% 22.5% 19.2% 17.0% 19.3% 18.3% 18.3% 18.3% 18.3% 18.3% 18.3% 18.3% 18.3% 18.3%
NWC 489,624 1,370,362 1,279,823 1,279,823 1,203,045 1,206,762 1,213,596 1,220,655 1,220,519 1,234,676 1,244,660 1,251,513 1,250,045 1,251,776
Activision Blizzard
Minus ∆NWC 489,624 880,738 -1,370,362 -90,539 -90,539 -76,778 3,717 6,834 7,060 -136 14,157 9,984 6,853 -1,467 1,731
Minus Capital Expenditures 30,406 17,935 29,400 4,220 17,919 22,139 32,957 82,169 146,634 223,179 308,460 349,408 381,267 406,246 504,205 519,331
% of Revenue 2.1% 1.2% 1.0% 0.3% 0.6% 0.5% 0.5% 1.0% 1.5% 2.0% 2.5% 2.5% 2.5% 2.5% 3.0% 3.0%
Free Cash Flow 24,741 -391,520 -530,989 1,331,218 773,430 112,678 945,198 891,927 914,517 536,939 580,041 1,191,301 1,602,777 1,630,320 2,102,320 2,612,235
PV of cash flow 728,020 788,297 659,084 598,753 311,476 298,129 542,514 646,707 582,843 665,920 733,128
Sum of PV of FCF 6,648,872
Excess Cash (short term Investments) 94,000
Activision Blizzard university of oregon investment group
http://uoig.uoregon.edu
APPENDIX 3 – DISCOUNTED CASH FLOWS ANALYSIS ASSUMPTIONS, HAMADA BETA, & BETA SENSITIVITY
Assumptions
Current Price $ 10.00 Terminal Growth Rate 3%
10 year Treasury 3.69% Terminal Value $ 27,276,982.66
Beta 1.31 PV Terminal $ 8,132,834.75
Market Risk Premium 7% ∑PV Free Cash Flow $ 6,648,872.24
% Equity 100.00% Long Term Debt 0
% Debt 0.00% Equity $ 6,592,192.43
Return on Debt N/A Firm Value $ 14,781,706.99
Return on Equity 12.86% Shares Outstanding 659,219
WACC 12.86% Implied Price $ 22.42
Current Price $ 10.00
Beta Sensitivity Analysis Hamada Beta
Companies Symbols Beta D/E Weights
S= .2466 Video Game Publishers
Activision ATVI
Beta σ Implied Price Under/OverValued
Electronic Arts ERTS 1.59 0
1.80 2σ $ 15.42 -61.05% THQ THQI 1.82 0
1.68 1.5σ $ 16.75 -57.69% Konami KNM 0.94 0.35
1.56 1σ $ 18.28 -53.83% Take Two Interactive TTWO 1.64 0
1.43 0.5σ $ 20.25 -48.85% Median 1.615 0 60%
1.31 0 $ 22.42 -43.37% De-Levered Beta 1.615
Consols
1.19 -0.5σ $ 25.03 -36.78%
Microsoft MSFT 0.887 0.22
1.06 -1σ $ 28.52 -27.96% Sony SNE 1.38 0.68
0.94 -1.5σ $ 32.56 -17.76% Median 1.1335 0.45 20%
0.82 -2σ $ 37.72 -4.72% De-Levered Beta 0.88
Other Software Publishers
Blackboard BBBB 0.87 0.68
Renaissance Learning Inc. RLRN 1.16 0.15
SkillSoft SKIL 0.86 0.68
McAfee MFE 1.36 0.79
Adobe ADBE 1.62 0.23
Median 1.16 0.68 20%
De-Levered Beta 0.80
Un-Levered Beta 1.31
Activision's Beta 1.31
Standard Error 0.246673
Levered Beta= Unlevered Beta (((1+(1-Tax Rate)*D/E))
13
Activision Blizzard university of oregon investment group
http://uoig.uoregon.edu
APPENDIX 4 – REVENUE, COSTS PROJECTIONS
Revenue Projections By Territory
2006 2007 2008 2009 Q12 2009 Q34 E 2009 AE 2010 E 2011 E 2012 E 2013 E 2014 E 2015 E 2016 E 2017 E 2018 E 2019 E
Net Sales By Territory
Publishing Revenues
United States 710,040 753,376 1,761,753 687,916 2,307,064 2,994,980 4,791,968 5,989,960 7,187,952 8,266,145 9,092,760 10,456,674 11,502,341 12,307,505 12,676,730 13,057,032
% Growth 6.10% 133.85% 70% 60% 25% 20% 15% 10% 15% 10% 7% 3% 3%
Europe 404,157 324,999 644,287 577,381 324,621 902,002 1,172,602 1,465,753 1,685,616 1,854,177 2,132,304 2,345,534 2,509,722 2,635,208 2,766,968 2,849,977
% Growth -19.59% 98.24% 40% 30% 25% 15% 10% 15% 10% 7% 5% 5% 3%
Other 40,466 40,663 99,126 31,906 121,739 153,645 245,832 368,749 497,811 622,263 684,490 732,404 783,672 838,529 880,456 906,870
% Growth 0.49% 143.77% 55% 60% 50% 35% 25% 10% 7% 7% 7% 5% 3%
Total International Revenues 444,623 365,662 743,413 671,287 384,360 1,055,647 1,418,435 1,834,502 2,183,427 2,476,441 2,816,794 3,077,939 3,293,394 3,473,737 3,647,424 3,756,847
% Growth -17.76% 103.31% 42% 34% 29% 19% 13% 10% 9% 7% 5% 5% 3%
Distribution Revenues 313,337 393,974 392,970 6,000 -15,719 377,251 381,024 392,454 404,228 416,355 428,846 441,711 454,962 468,611 482,669 497,150
% Growth 25.73% -0.25% -4% 1% 3% 3% 3% 3% 3% 3% 3% 3% 3%
Total Revenues 1,468,000 1,513,012 2,898,136 1,303,203 3,124,675 4,427,878 6,591,427 8,216,916 9,775,607 11,158,941 12,338,399 13,976,323 15,250,697 16,249,853 16,806,824 17,311,028
% Growth 3.07% 91.55% 53% 49% 25% 19% 14% 11% 13% 9% 7% 3% 3%
Other Cost Projections
2006 2007 2008 2009 Q12 2009 Q34 E 2009 AE 2010 E 2011 E 2012 E 2013 E 2014 E 2015 E 2016 E 2017 E 2018 E 2019 E
Cost Projections
Product Development 132651 133073 269535 250040 309951.488 560271.2688 821691.627 1026439 1673841.13 1233839.9 1327750.69 1372562.76 1462486.795 1344545.9 1211772
% of Revenue 0.09036172 0.087952376 0.093002882 0.19186573 0.07 0.085 0.1 0.105 0.15 0.1 0.095 0.09 0.09 0.08 0.07
SG & A Expenses 379,761 328,727 503,552 285,854 929,854 1,516,028 1,889,891 2,199,512 2,566,556 2,961,216 3,214,554 3,431,407 3,656,217 3,697,501 3,635,316
% of Revenue 0.25869278 21.73% 17.38% 0.21934725 21% 23% 23% 23% 23% 24% 23% 23% 23% 22% 21%
Total Other Costs 512,412 461,800 773,087 535,894 1,239,806 2,076,299 2,711,582 3,225,950 4,240,398 4,195,056 4,542,305 4,803,970 5,118,704 5,042,047 4,847,088
% of Revenue 0.3490545 30.52% 26.68% 0.41121299 28% 32% 33% 33% 38% 34% 33% 32% 32% 30% 28%
14
Activision Blizzard university of oregon investment group
http://uoig.uoregon.edu
APPENDIX 5 - SOURCES
- S&P Net Advantage
-Bloomberg
-Factset
-Yahoo! Finance
-Google Finance
-Activision Investor Relations
-IBIS World
-Investopedia
-Forbes
-IGN
-Ford Equity Research
15