Is Activision Blizzard Stock a Buy?

Activision Blizzard (NASDAQ:ATVI) is emerging from a year in which a pandemic temporarily boosted interest in gaming. However, as gaming levels fall to near pre-pandemic levels, the spotlight falls back on management and the games themselves. The question for investors now hinges on whether this video game stock can maintain its long-term growth.

Activision’s growth

Activision Blizzard continues to prosper in the industry it helped to found in 1979. Its franchises such as World of Warcraft, Call of Duty, and Candy Crush maintain enduring popularity. At present, the company claims almost 400 million players. Grand View Research forecasts the video game market will grow at a compound annual growth rate (CAGR) of 13% through 2027, indicating that players’ interest will likely continue to grow.

Young woman wearing headphones while playing a video game at her desk.

Image source: Getty Images

Still, one can forgive investors for wondering whether Activision can capitalize on that growth. CEO Robert Kotick has come under criticism for his compensation, which now exceeds $30 million per year after bonuses. In 2019, Kotick announced an 8% headcount reduction to address a revenue shortfall after net bookings — the sales the company took in, minus the money it had set aside for future spending — fell short of forecasts in 2018. Despite a failure to meet that goal, Kotick’s total compensation increased by over $2 million in 2018, to just over $30.8 million.

Aside from questions about management accountability, investors may also worry about reduced interest in gaming as pandemic-related numbers fall. Indeed, COVID-19 forced people to seek indoor entertainment, and the company experienced a temporary bump in interest. The company’s King Digital division, which produces mobile games, experienced a 10% increase in monthly active users (MAUs) between the first and second quarters. However, MAUs fell slightly below pre-pandemic levels as more people returned to work in the third and fourth quarters.

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Like in past years, established franchises, and not pandemics, drive gamer interest long term. In this area, Activision Blizzard stands on stronger ground. The company released Call of Duty: Black Ops Cold War in November. This helped Activision’s overall MAUs rise by double digits over the previous 12 months to 128 million for the quarter. Also, Blizzard’s World of Warcraft grew its MAUs for six consecutive quarters, with net bookings rising 40% year over year.

Activision Blizzard has also helped boost this growth through subscription services. Instead of a one-time sale of the game as in the past, now it receives monthly fees in return for updates to the latest versions and additional content.

Effects on financials

Subscriptions drove most of the revenue surge for Activision Blizzard in 2020. Overall revenue increased 25%. However, the portion from subscriptions, which makes up 71% of its revenue, rose 27%. Net income soared 46% to about $2.2 billion as expenses rose only 10% despite the massive surge in revenue.

This appears to have left the company in solid shape financially. Activision Blizzard increased its 2020 cash flow by almost $2.2 billion, a 29% surge from the $1.7 billion generated in 2019.

The company also added just under $1 billion in long-term debt in 2020. Most of this went to beef up cash balances amid the pandemic. Between debt and free cash flow, the company’s cash balance grew by nearly $3 billion last year. Moreover, with only $87 million in interest charges during 2020, free cash flow can easily address both the interest and principal on that debt.

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Such financials and the temporary increase in gaming brought about by the pandemic helped the stock price rocket higher in 2020. Activision Blizzard increased by 56% over the last 12 months.

ATVI Chart

ATVI data by YCharts

Moreover, between the stock price increase and the surge in profits, the valuation did not change significantly. The P/E ratio stands at 32, up from 30 one year ago. This matches Electronic Arts, which also maintains a multiple of 32, but comes in lower than Take-Two Interactive which supports a P/E ratio of just under 40.

Unfortunately, management forecasts a revenue increase of less than 2% for 2021. This points to a likely pause amid the unusually large increases in 2020 and the end of the pandemic. Admittedly, without immediate growth drivers, the stock could stagnate in the near term.

Moreover, both Microsoft and Sony released next-generation consoles late last year. The low revenue growth seems curious given that new console releases tend to lead to higher game sales. Furthermore, on the Blizzard side of the business, the stock fell after BlizzCon, its gaming convention, did not bring news of release dates for Diablo 4 or Overwatch 2.

What now?

Despite its challenges, Activision Blizzard’s best-performing franchises and focus on engagement should help its stock move higher over time. Indeed, management’s interests still appear separated from that of workers and stockholders. Moreover, the slow growth predicted for 2021 may cause stock growth to pause in the near term as the company catches its breath.

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However, some analysts believe the best is yet to come for Activision Blizzard. The company plans to increase content spending this year by nearly 40% above 2019 levels. Moreover, free-to-play points across more platforms and geographies and heightened social functionality also hold tremendous potential to continue increasing engagement longer term. With more opportunities for gamers to interact with its software, Activision Blizzard should continue to capitalize on gaming’s rising popularity.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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