Predictability Of Revenue And High Margins Make Activision Blizzard A Good Investment, According To Industry Expert
December 29, 2009 - The Wall Street Transcript has just published Luxury Goods, Entertainment, Toys & Games Report offering a timely review of the Consumer Durables sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
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COLIN A. SEBASTIAN is a Senior Vice President in equity research covering Internet and interactive entertainment companies at Lazard Capital Markets. Prior to joining Lazard in 2006 as a Senior Analyst, he covered e-commerce and interactive entertainment at Thomas Weisel Partners, and was part of the Internet team that ranked second in the annual Greenwich survey. He is widely quoted in industry and financial media publications, including The Wall Street Journal, Business Week, Investors Business Daily, Financial Times and The New York Times, and he has appeared frequently on CNBC, Bloomberg and CNN. Prior to Wall Street, Mr. Sebastian served as Founder/COO of a Web-based career services start-up and as a business analyst leading a software development team for a Fortune 500 company. He received a B.A. from Vanderbilt University and an MBA from The Anderson School at UCLA.
TWST: What impact will downloading technology versus purchasing from retailers have on the industry?
Mr. Sebastian: Online downloading of games is still a small market. There are some pretty significant hurdles that are preventing mass adoption of distribution in this way. First of all, the time it takes to download games is much longer than for a song, an album or even a movie. Secondly, since games are big and there is a finite amount of storage capacity in the consoles, there is a limit on the number of games you can own on a hard drive. So what I am saying is that driving to a store and buying a game on a disk is still the most efficient method to acquire and use many games. Now over the long haul, with faster broadband speeds and better compression technology, we could see the pace of downloads accelerate. Also for the time being, the most useful and user-friendly format for online games is add-on content that consumers can purchase over the Internet. Also playing the games online with your friends or fellow gamers over an online network such as Xbox Live is very popular now.
TWST: So what are your favorite names in this space and why?
Mr. Sebastian: Among the group of companies in the industry that we formally cover, we have buy ratings on Activision Blizzard (ATVI) and GameStop (GME). For Activision, it really boils down to the predictability of revenues and high margins compared to many other game publishers. "World of Warcraft" and "Call of Duty" are two of the largest entertainment franchises right now, and we don't see any signs of these games slowing down. In 2010 Activision will bring to market the sequel to one of the most popular PC games of all time, called "StarCraft II." They have an expansion pack as well for "World of Warcraft" in the second half of the year, and the next iteration of "Call of Duty." Keeping in mind that this year's version, called "Modern Warfare 2," is on track to become one of the largest entertainment franchise of all time, we expect a billion dollars in retail revenues for the game. So that's obviously not only big from a video game perspective, but big from an entertainment perspective.
They also have "James Bond," a new license for them, and some additional revenues from the "Guitar Hero" franchise. Although this is an area where there could be some risk, as music games are declining in popularity. Activision is also the highest-margin company in the group, and so we think it deserves a premium valuation. In terms of catalysts, at this point we believe, as the industry shows some stabilization of trends and perhaps even some improvement, that there will be a resulting expansion in the earnings multiples that investors are willing to pay for high-quality companies. We also like GameStop, with the stock under a lot of pressure from the industry slowdown baked in here, and a lot of upside potential as the industry displays any green shoots.
TWST: Who are the laggards?
Mr. Sebastian: Well, at this point we see Electronic Arts as having structural challenges in its own business, and there is a work in progress in terms of management turning things around. We see tremendous value in a number of EA's assets, and the company's move to embrace mobile and online games could pay off over the long haul. But the vast bulk of the money made in interactive entertainment is still with console and PC games, so we are looking for some more stability and visibility in this segment of EA's business. They're going through a business model transition, cutting back on the traditional distribution model with disks in plastic wrap and moving more aggressively online.
As that strategy takes shape and if we see some of the fruits of that effort, then Electronic Arts has the potential to become a comeback kid of sorts for the industry. The same is true for THQ to some extent. We think with a little more sustained traction at retail, investors could take another look at the story. But in general, we think it will be difficult for smaller, second-tier software publishers to succeed long term as the market for games becomes more complex and on more platforms. In addition, as I mentioned before, second-tier games aren't selling as well, which is a disadvantage to the smaller, less-diversified publishers.
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