Category Archives: Video games

Activision’s 3Q10: plusses and minuses

November 8, 2010 By in Current Market Thoughts, earnings conference calls, Industry Analysis, Stock ideas, Technology, Uncategorized, Video games Tags: , , , , , , , , , Leave a comment

the results

After the New York close last Thursday, ATVI reported its September 2010 quarterly earnings results.  On an adjusted basis, earnings per share were $.12 vs. the analysts’ consensus estimate of $.09 and the company’s guidance of $.08.

At the same time, despite the CEO, Bobby Kotick, citing “the continued strength in our business and our confidence in our continued execution,” ATVI revised down its expectations for the December quarter by about 4%, saying it was equal parts unfavorable foreign exchange movements (presumably meaning costs denominated in non-dollar currencies) and increasing competition in its Activision console game business.  On this news, ATVI stock dropped about 3% in Friday trading.

the details

August was a busy month for Blizzard:

–It launched its long-awaited StarCraft II, which sold 1.5 million copies in its first two days and 3 million in its first thirty days.  The fact that ATVI provided no information for the full quarter suggests sales slowed dramatically after that, however.

–It finally got government permission to launch the second expansion of World of Warcraft, named Wrath of the Lich King,in mainland China.  This was enough to push global WoW subscriber numbers decisively above 11 million+, where it had been stuck for some time, to 12 million.

For the yearend holiday season:

–WoW:  Cataclysm, the third WoW expansion, will be released on December 7th.

–Call of Duty:  Black Ops launches on November 9th.  Pre-sales for Black Ops have apparently been stronger than for Modern Warfare 2, which was ATVI’s blockbuster success of 2009.

–ATVI will also have its usual assortment of new Tony Hawk, music (DJ Hero 2) and James Bond games.

ATVI now has close to $3 billion in cash on its balance sheet.  The company generated about $1.2 billion in cash over the past twelve months, half of which it has used since February to buy $600 million worth of stock (or 55 million shares, 4% of the amount outstanding) at an average cost of $10.90 or so.

stepping back

ATVI has been a disappointing stock this year and a severe laggard since the market bottom in March 2009.  What can we expect from now on?

Here are the company’s year-to-date revenues and earnings by operating segment:

Activision Publishing:   revenues $983 million, operating loss $88 million

Blizzard:  revenues $1086 million, operating income $559 million.

This compares with an operating loss from the Activision segment of $49 million in the first nine months of 2009 and an operating profit of $393 million from Blizzard over the same period.

You might (correctly) say that this is not an entirely fair snapshot of ATVI’s results.  The Activision segment is highly seasonally skewed toward the December quarter.  Activision games also have their biggest sales in the US and European markets, both of which have been hardest hit by the financial crisis.  However, the figures also points to two realities:  the sudden maturation/contraction of the traditional video game console market, and (I think) that the cost structures of the game software companies are still geared for expansion.  In other words, there is still considerable cost-cutting to do.

When Activision and Blizzard merged a few years ago, I imagined the resulting company as the marriage of two equals:  Vivendi, the former owner of Blizzard, got better management for its games unit + a share in a viable shrink-wrapped software business; pre-merger Activision got access to a very talented group of developers + a share of a growing online subscription business in Massively Multiplayer Online Role Playing Games.

Today, the picture looks much different.  Yes, Activision management doubtless helped Blizzard expand–and finally publish Star Craft II. But the key difference is due to the collapse of the traditional video game business.  That’s what the numbers above show.

where to from here?

It seems to me that ATVI is trying to reposition itself, both in reality and in the minds of investors, as an incubator/administrative hub for MMORPGs.  It already has the immensely successful World of Warcraft. It has just launched Star Craft II, which it hopes will be a second.  And it is positioning the Call of Duty, franchise, and Black Ops in particular, to be much more like a MMORPG than a traditional console game.

In addition, ATVI says Blizzard is cooking up an as yet unidentified new MMORPG.  And the company has hired the team that created Halo for MSFT to produce a fifth.

The growth investor “dream,” then, is that Star Craft emulates Warcraft in becoming a source of $300-$400 million in annual income over the next few years.  And that it is followed by at least one other success–time frame unknown.  It would also be helpful if some combination of reduced costs/higher revenue have the traditional Activision games turning a profit again.

On the other hand, eps will be around $.75 for 2010.  What about 2011?  The launch of Star Craft II looks like it generated operating income of about $160 million in the September quarter.  Let’s assume ATVI produces an expansion pack next year that, to pluck a figure out of the air, generates half of the operating profit the game itself did, or about $80 million.  Let’s also say that Blizzard overall, ex the Star Craft expansion pack, grows by $50 million next year.  And let’s assume that the shrink-wrapped software business chips in an extra $30 million in 2011.  Maybe cost-cutting helps, maybe a better economy–and ATVI has always had a knack for identifying new trends.  That all ads up to flat earnings.

In any event, matching 2010’s earnings in 2011 is possible, if a tad on the optimistic side.

On the one hand, I find it hard to be confident that eps will be any higher than that.  On the other, the company has no debt and is immensely cash generative.  The prospective multiple is 12x-13x, ex the cash, which I think is reasonable.  And ATVI is waiting in the wings to buy more stock just a few percent below today’s price.

My bottom line:  For now, I think the stock goes sideways.  I’m not in a hurry to sell and I’d be tempted to trade it if it spikes up.  I’d also use it as a source of cash if another, really good, idea comes along.

ATVI’s June 2010 results: online strong, shrink-wrapped software weak

August 8, 2010 By in Current Market Thoughts, earnings conference calls, Industry Analysis, Stock ideas, Technology, Video games Tags: , , , , , , , , 1 Comment

the report

ATVI reported June quarter earnings after the close of trading in New York last Thursday.  Earnings per share on a GAAP basis were $.17 vs. $.15 in the second quarter of 2009.  On a non-GAAP basis, they were $.06 vs. $.08 in the second quarter of 2009.

The company forecast third quarter results that were slightly below sell-side analysts’ estimates, and it reaffirmed–but did not raise–full-year guidance.

Wall Street didn’t like any of this.  The stock fell 6.5%, to $10.99, in Friday trading.

Why not?

GAAP vs. non-GAAP

ATVI reports revenues and earnings two ways.  One is the way that Generally Accepted Accounting Principles require.  The second is a non-GAAP method that the company feels gives pertinent information that GAAP doesn’t.  Lots of companies do this.  In ATVI’s case, the issue is how to report the purchase of game software that has online content.  GAAP requires the company to estimate how long the customer will use that software and to spread the revenue, and associated costs, over the estimated period of time.  ATVI’s non-GAAP reporting shows the revenue and costs recognized all at once.

2Q2010 earnings are much higher on a GAAP basis than non-GAAP because last year was a big one for online content.  The positive glow is still being reflected in GAAP results this year.  Non-GAAP shows only the cash coming in today.

The level of earnings isn’t really what the market reacted to on Friday, though.  The composition of earnings was the issue.

Blizzard is doing fine…

Worlds of Warcraft continues to plug along, with about 11.5 million subscribers who paid $299 million to ATVI to play the game during the second quarter.  That’s up 3% from the $290 million they kicked in during the comparable period of 2009.

More important, ATVI made operating income of $155 million from WoW this quarter, up 16% from the $134 million it earned in June of last year.

Starcraft II is finally out

Starcraft is the second of Blizzard’s signature titles.  The long- awaited sequel to the original Starcraft title (1998) came out late last month.  The only information ATVI has released so far on revenues is that the game has sold 1.5 million copies in its first two days.  This would be the biggest launch in pc game history.

Just as encouraging, Blizzard says that while Starcraft online play is steadily building gamers are playing Warcraft online just as heavily as they were before the Starcraft launch.

The hope is, of course, that Blizzard can turn Starcraft, which has fanatic followers all over the world, into something akin to another Warcraft, generating large amounts of recurring revenue.

…not so for Activision

The Activision side of ATVI generated revenues of $333 million during the quarter, down 26% year on year.  It made an operating loss of $53 million during the three months vs. operating income of $21 million in the June quarter of 2009.

Yes, the overall market for traditional video games is weaker and this is the offseason (Activision makes most of its money around the year-end holidays).  But the company also had a couple of clunkers among its second quarter launches.

To some degree, these negatives were offset by continuing strong performance from Call of Duty:  Modern Warfare 2. Online sales of add-on map packs are very strong.  And the game remains the number one of its type in many markets.

The next iteration of the franchise, Call of Duty:  Black Ops, is also outdoing MW2 in early pre-sales.  And the company has new versions of its staple Guitar Hero and Tony Hawk games, as well as DJ Hero ready to meet seasonal demand.

what to do with the stock?

ATVI shares have been severe market laggards from the lows of March 2009.  So the first observation one would make is that holding the stock so far, as I have done, has been a big error.

ATVI’s problems have been of three types:

–although Blizzard has performed extremely well, the overall video game market has been weak.

–the collapse of the music genre blindsided Activision, creating a large writedown last year

–worries about management stability have arisen, given the departure of key executives from the Call of Duty franchise and recent reports of CEO Bobby Kotick-related legal action.

On the other hand, the company owns Warcraft, Starcraft, Call of Duty, and has new potentially significant (but we don’t know what they are yet) products coming from both Blizzard and Bungie (the studio that made Halo).

The company is saying it will earn $.72 a share in 2010, meaning the stock is trading at under 15x times earnings.  And ATVI has bought 31 million shares of its stock through the end of June at an average of just under $11 each.  So–rightly or wrongly–it sees value at these levels.

So to me the stock still looks cheap.

Personally, I’m continuing to hold, but the leash is getting shorter.  The risk, of course, as it is in any case like this, is that I’m letting ego get in the way of common sense–holding on because I somehow need to be right, rather than to make money.


Activision’s March 2010 quarter–very strong

May 9, 2010 By in earnings conference calls, Industry Analysis, Stock ideas, Technology, Video games Tags: , , , , , , Leave a comment

the results

ATVI reported 1Q2010 financial results after the close last Thursday.  Revenues were $714 million vs. company guidance, given on February 2, 2010, of $525 million.  EPS was $.09 vs. guidance of $.02.  Of the $.07 per share difference, $.05 comes from stronger than expected results from Call of Duty: Modern Warfare 2 and Worlds of Warcraft. The remainder comes from deferral into the June quarter of expenses ATVI had thought it would incur during the first three months of the year.

The company bought back 8.5 million shares during the quarter at an average price of $10.84, under its new $1 billion buyback program authorized on Feb 10th.  This buying, by itself, won’t support the stock.  But it does give an indication of what management considers a cheap price to be.

new guidance

The company raised its full-year earnings guidance, which is usually conservative, by $.02/share to $.72.  This is effectively a reduction in eps guidance for the remaining nine months of 2010 by $.03, since 1Q already came in $.05 better than forecast.  The reason?  Recent industry experience is that licensed properties, like Spiderman, Legos or Shrek, which appeal to casual gamers and mainly to children and young adults, are selling more poorly than they traditionally have.

ATVI will doubtless make up the “lost” $.02 through strength in its core businesses, so the company could easily have left its guidance for the rest of the year unchanged.  Lowering it simultaneously emphasizes the extraordinary strength of ATVI’s main franchises and underlines the weakness in the overall retail environment.

the main points of the conference call

—Starcraft II: Wings of Liberty will launch on July 27th, in 11 languages on 5 continents.  Retail preorders are already very strong.  Even though the game is in closed beta testing (and therefore not widely available), it is the second-most played PC game, trailing only Warcraft III.  WOL is the first of three installments of SCII, each focused on one of the three races, Terrans, Protoss and Zerg, of SCI.  WOL is the Terran game.  ATVI expects sales of WOL to be enough to produce the first up year for sales of PC games in a decade.

Success of SCII and its eventual development of an equivalent to subscription-based Worlds of Warcraft is a major part of the positive case for ATVI.

–ATVI took great pains to point out that it has had three development studios working on the Call of Duty franchise, not just  Infinity Ward, whose heads have left the company and are now being sued by ATVI.   Sledgehammer, and Treyarch, developer of the next installment of COD, called Black Ops, which will be released late this year are the two others.  The majority of Infinity Ward professionals remain with ATVI, at least for now, and the company is already at work rebuilding staff.

The major competition for Black Ops will be the latest installment of Halo, called Reach, from MSFT.  ATVI expects Black Ops’ sales to outpace Reach’s, which seems a pretty safe bet, considering that Reach is only available for X-Box and Black Ops will have a version for PS3 as well.  By release time, there will probably be 40 million X-Box 360s in Europe and North America, the main markets for this kind of game, plus 32 million PS3s.  Even if we assume half the PS3 owners also have X-Box and all of them buy the X-Box version (decision:  better graphics on PS3 vs. better online with X-Box Live), that still leaves 40% more potential buyers for the ATVI game than MSFT’s.

–ATVI also gave a few details of its 10-year contract with Bungie, the creator of Halo–the main one being that it expects the association to be accretive to margins from the beginning.

The Halo game still belongs to MSFT.  But the studio, its 200 professionals and a new concept already under development, are now ATVI’s. Reason for the Bungie switch?–ATVI’s market power aside, it’s the chance to sell to–and earn royalties from–all those PS3 consoles.

bits and pieces

–Worlds of Warcraft has begun to see increases in its number of subscribers again.  ATVI expects further gains as it launches the Cataclysm expansion pack later this year, overhauls the older areas of the site and gains permission from Beijing to add the Lich King expansion pack in China.

—WM2 players have logged 2+ billion hours of use on X-Box Live so far.

—ATVI had 1+ million downloads (at $15 each) of its latest COD extra map pack in its first 24 hours of availability.  Another one is planned for the second half.

–The company still doesn’t see mobile as financially attractive enough to commit resources to, despite its fast growth.

my conclusion

The stock, trading at about 13% this year’s earnings and yielding 1.4%, seems cheap to me.  The loss of the Infinity Ward executives could easily turn out to be a tempest in a teapot.  But I think for the stock to advance significantly, WOL has to be a smash hit.  I’m a long-time Starcraft fan, so I think it will be.  But that’s the bet.


Activision antics

May 6, 2010 By in Entertainment, Industry Analysis, internet, Stock ideas, Technology, Video games Tags: , , , , , , , Leave a comment

ATVI and ERTS–the last men standing

ATVI and ERTS are the only two large third-party video game software companies left standing (sorry, Ubisoft).  Add Nintendo to the list and you can delete “third-party” from the statement.

Sega was acquired years ago by pachinko machine maker Sammy and lost the lion’s share of its game staff.  Sony’s traditional Japanese management practices managed to alienate most of its developers and drive them out of the company, mostly between the PSI and PSII generations.  (By the way, one of the reasons social networking and online casual games have been so successful is the surfeit of game developers looking for work.)  Microsoft never arrived.  And Vivendi’s games unit, which contained Blizzard, maker of the Warcraft and Starcraft franchises, recently merged with Activision.

rising risk in shrink-wrapped game software

As I’ve written elsewhere in this blog, the risk profile of video game software development has risen radically over the past decade.  The short version of why:  there are about 300,000 inveterate gamers in the US and, say, 600,000 worldwide.  These are people who will buy any reasonable game, pay full price, play it 20-30 hours a week until they beat it, and then go on to the next one. Since games that work in one part of the world usually don’t appeal to gamers in another (Blizzard games are the notable exception), a game software company can probably count on selling 400,000 units of a good game to this sure-fire audience.  If we say that the development company gets operating income of $30 (after marketing costs) on each unit sold, then we can pencil in a minimum of $12 million in cash coming in the door from a good piece of software.

A couple of console generations ago, when development costs were, say, $5 million per game, the existence of these hard-core customers assured a profit.  Now, with costs having risen above $20 million, the “sure thing” money from video game-crazy customers only covers about half the price of making the software.  So the video game company has to rely on the much less predictable group of casual gamers to end up in the black.

The king of the mega-hit in the era of high development costs has been ATVI.  It gave us, among others, Tony Hawk, Guitar Hero and Call of Duty.

musical chairs

Because of its apparent Midas touch in the now-risky business of shrink-wrapped software, recent turnover of talent at ATVI has become a source of concern for Wall Street.  Specifically:

–after racking up huge losses by expanding its music game division just as demand for the genre was waning, the head of this unit departed ATVI.

–the founders, and many professional employees working at, Infinity Ward, creator of Call of Duty, left ATVI.  They formed a new company, Respawn, funded by ERTS.  All sorts of lawsuits are in the works.  One might see this move as a return to the womb, since the principals of Infinity Ward made their reputation by working on the ERTS game, Medal of Honor. Conspiracy theorists have seen the ERTS support as payback for ATVI’s pirating key developers from ERTS last summer.

–Michael Griffith, president and CEO of Activision Publishing, stepped down from his job, although he remains with the company.

At the same time:

–Bungie, the developer of the wildly successful Halo franchise for MSFT, has signed a ten-year deal with ATVI.  Halo still belongs to MSFT; anything new is ATVI’s.

It’s hard to know whether in a net basis ATVI is better or worse off with its new cast of characters.  My guess is that the business is relatively unchanged.  It’s also important to note that the Warcraft side of ATVI, which accounts for the majority of its profits is unaffected.

ATVI’s stock

ATVI has been a severe market laggard during the past year.  The stock was fine until last fall, when news began to emerge that the 2009 holiday selling season was going to be a relatively poor one.  Modern Warfare 2, the latest installment in the Call of Duty franchise, ensured that ATVI was relatively insulated from industry woes–though it did have the music game writeoff mentioned above.  But MW2 did little for ATVI other than preventing it from falling.

The stock began to perk up earlier this year, as the market began to look for laggards and after ATVI revised up its March quarter earnings guidance.  But then the Infinity Ward stories began to break and ATVI shares started to slide.

What to do?  I’m keeping my shares for now.  I take comfort from the huge (but maturing) cash generation from Warcraft;  I hope Starcraft will eventually get released; and I think ATVI management is sound.  I also own a social networking game company (DeNA in Japan) so ATVI isn’t an all or nothing bet for me.

If I saw someone working for me doing what I describe in the paragraph above, I would be very skeptical and wonder if he needed to wake up and smell the coffee.  For anyone wanting to switch to a different consumer discretionary name, however, the current period of stock market weakness is a natural time to do so.  Stocks that have gone up a lot tend to be hit by the heaviest profit-taking.  Stocks like ATVI don’t go down as much because they never went up.

ATVI reports after the close tonight.  Maybe the company will shed more light on its situation then.

If so, I’ll write about ATVI again tomorrow.

MSFT’s March 2010 quarter

April 25, 2010 By in Current Market Thoughts, earnings conference calls, Industry Analysis, internet, Stock ideas, Technology, Video games, Wireless Tags: , , , , , , , Leave a comment

MSFT reported its fiscal third (ending 31 March) quarter earnings results on April 22.  This is what I thought was interesting from the numbers themselves and the related company conference call.

the results

Revenue, factoring back in sales that are deferred under GAAP, was up 8% year over year.   Operating earnings were up 17%.  The operating leverage is due partly to the fact that incremental copies of software cost virtually nothing to make, and are therefore almost pure profit.  It also comes from continuing strong cost control.

Operating income benefitted a bit from the absence of severance charges ($290 million in the year-ago quarter), but that was offset by higher legal expense and the costs from the search agreement recently concluded with Yahoo and okayed by government regulators in February.

Net income was up by a much larger percentage, around 36%.  Although MSFT didn’t highlight this on the call, the most important reason the number was in the thirties rather than the teens was a $589 million swing from loss a year ago to profit this March on selling investment securities.  A lower tax rate helped a bit as well.

the reasons

Windows 7 adoption has been the fastest of any Microsoft OS, with 10% of personal computers worldwide now running it. (As a frustrated former Vista user writing this on a Mac, I’m tempted to analyze this as more a comment on Vista than on Windows 7.  But I have to acknowledge that W7 seems to have stemmed customer defections.  So it must be good.)

Sales in emerging markets were up by 20%+ year on year, with sales in developed markets advancing around 5%.  MSFT has begun to notice small- and medium-sized businesses upgrading their software, with revenues in this segment up 15%+.

Piracy is down.  Part of this is MSFT’s litigation efforts to enforce its intellectual property rights abroad.  Part is the increasing market share of global branded computer manufacturers vs. independent no-name “white box” makers, where software piracy is more prone to occur.

Worldwide PC sales are up 25% year on year.  MSFT estimates that consumer purchases are up 30%- and business buys up 15$.  Netbooks, where unit revenues are lower but where MSFT currently has almost all the market, are about 10% of the total.  MSFT unit sales are outpacing market growth.

upcoming quarters

Office 2010, the new Office suite, and a number of server software upgrades launch in the June quarter.  They should provide a steady boost to revenues over the next year or two.

In MSFT’s mind (and who would know better?), large corporations worldwide are clearly preparing for a major refresh/upgrade of their computer systems.  Most have pilot or prelaunch Windows 7 efforts under way now.  They’re planning to deploy W7 as quickly as they can, on the server infrastructure they have today.

Why the holdup?  I presume it’s the usual– IT chiefs want to be sure all the major bugs have been worked out of software before risk the firm’s information backbone by using it.  That takes time.

MSFT also has a large “cloud computing” business, its Online Services Division, which looks like it will report full-year operating losses of more than $2 billion.  At some point–I have no guess as to when–those losses will likely begin to diminish and eventually turn to profit.

What does MSFT do for an encore?

This is the (perhaps cruel or ungrateful) question Wall Street will eventually ask about MSFT.  The company generates enormous cash flow, has negligible debt and is in the midst of an extra-profitable period of upgrades to its basic products—the PC operating system/user interface and the collection of Office-brand business applications.

But the consumer portion of this transition, which is bigger than the business side, is quickly closing on its peak.  And since the market lows in March 2009, MSFT’s stock has doubled.  It has outperformed the S&P 500 by about 20 percentage points over this span, which already discounts at least some of the current good news.

my thoughts

I see two striking features of MSFT:  its enormous cash flow, and how that cash flow is deployed.

On the conference call, MSFT displayed justifiable pride in the fact that March quarter cash flow was a stunning $7.4 billion.  The total for the first nine months of the fiscal year was $18.5 billion.

What is MSFT doing with this money?

stock repurchases          $7.4 billion

additions to cash          $5.5 billion

dividends to shareholders          $3.5 billion

capital spending           $1.2 billion.

If I’ve read the balance sheet numbers correctly, about half of the stock repurchases go to offset the issuance of new stock to employees who are exercising stock options.  But about $3.5 billion has been used to shrink the number of shares outstanding by about half a percent.

MSFT already has about $40 billion in cash and short-term investments on the balance sheet?  Does it need more?  I don’t think so.

Anyway, it seems to me that MSFT could easily double its current dividend (not necessarily all at once; a steady increase over a year or more would be ok), which would produce a yield of 3.5%.  To do this would require a courageous further recognition by the company’s management of the firm’s maturity–a judgment Wall Street has long since made.  My guess is that it would do wonders for the stock’s price, even from here.

My initial reaction is that chances aren’t good.  But we can watch for signs.

By the way, I tried using Firefox to access the conference call and download the 10-Q, because I knew that MSFT doesn’t like Safari.  But the 10-Q wouldn’t download, the conference call narrative broke down twice and the timeline bar to skip/rehear portions appeared only intermittently and didn’t work.  I’m sure Redmond residents find this mirthful, but the humor doesn’t travel.