Activision Blizzard (ATVI +0.00%) is expected to report record adjusted revenue and profits for 2021, but this leading video game producer is currently dealing with major internal issues, including a lawsuit over a discriminatory workplace culture and an investigation by the Securities and Exchange Commission.
Turnover within the executive ranks at the Blizzard studio has resulted in the company pushing back the highly anticipated releases of Diablo IV and Overwatch 2, two games investors were counting on to drive growth in 2022. The stock price declined 30% in the second half of 2021, as analysts lowered next year's earnings estimates to be flat with 2021, or $3.78.
There is a scenario where the stock could continue underperforming this year, but the near-term uncertainty could also present a good opportunity to buy shares of this leading game company at a relatively cheap valuation.
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Near-term challenges
Activision Blizzard is not a highly diversified game producer, but its concentrated portfolio of popular titles makes it one of the top gaming companies in the world, in addition to one of the most profitable. It has eight game franchises that have produced at least $1 billion in lifetime revenue, it expects to report a stellar 41% operating profit margin for 2021, and it had 390 million monthly active users through the third quarter. Activision's record of delivering entertaining experiences to its fans means a new release from one of its franchises is usually a major growth catalyst.
However, the Blizzard segment has been steadily losing players for several years and is in desperate need of a new release to stimulate growth. Monthly active users (MAUs) at Blizzard have slid from 42 million following the release of Overwatch in 2016 to 26 million in the most recent quarter.
| Segment MAUs | Q3 2021 | Q2 2021 | Q1 2021 | Q4 2020 |
|---|---|---|---|---|
| Activision | 119 million | 127 million | 150 million | 128 million |
| Blizzard | 26 million | 26 million | 27 million | 29 million |
| King | 245 million | 255 million | 258 million | 240 million |
| Total | 390 million | 408 million | 435 million | 397 million |
Data source: Activision Blizzard. Figures in millions.
A lack of near-term catalysts could continue to pressure the stock in 2022. Without Diablo IV or Overwatch 2 coming this year, investors will be closely watching the performance of Call of Duty, in addition to content updates for World of Warcraft and King's mobile titles, most notably Candy Crush.
The problem is that, while Call of Duty is sustaining more than double the number of active players since releasing new free-to-play experiences a few years ago, user growth has stalled over the last year. The Activision segment (Call of Duty) finished 2020 with 128 million MAUs but ended the third quarter at 119 million. It's not unusual to see fluctuations like this from quarter to quarter across different titles, and it's possible Activision could report another spike in MAUs following the November release of Call of Duty: Vanguard when it reports fourth-quarter results on Feb. 3.
Remember, roughly two-thirds of the company's revenue comes from in-game spending, such as virtual currency (Call of Duty points) and other downloadable content updates. If a competing first-person shooter -- such as Tencent's Valorant or Electronic Arts' Apex Legends -- releases new content that pulls away Call of Duty players in the near term, Activision could be vulnerable to a further decline in its monthly active users, and therefore revenue performance, and that could further pressure the stock price.
Uncertainty is a friend to value investors
The stock is unlikely to recover until the company proves it can still grow without new releases, or it announces official release dates for Diablo IV and Overwatch 2, providing more near-term visibility to earnings.
Another wild card for Activision is what happens to CEO Bobby Kotick. There are increasing calls for him to resign, which is understandable given that Kotick currently has a Glassdoor approval rating of only 37%. A potential change at the top would present more uncertainty hanging over the company's near-term direction.
But thinking through all these scenarios, I'm reminded of this piece of wisdom from Janet Lowe's Warren Buffett Speaks. In the book, there is this famous quote from the legendary investor: "You pay a very high price in the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values."
One way or another, Activision Blizzard will get through these legal issues and improve its workplace culture. In the end, its gaming brands and loyal fans will remain. The company generated $2.8 billion in free cash flow over the last year through Q3, and the pending releases from Diablo and Overwatch should boost cash flow higher. On that note, it's noteworthy that initial sales of Diablo 2: Resurrected in September were a record for a remastered title from Activision Blizzard. If this is any indication, Diablo IV could break sales records for the franchise.
It's difficult to say whether the stock will rebound to its previous high by next year, but investors looking for an undervalued entertainment stock to get exposure to the growing video game industry may have a great opportunity here. The shares currently trade at just 14 times 2023 earnings estimates. At this price level, investors have a good chance of earning an above-average return over the next 10 years if they have the patience to hold an underperforming stock in the near term.
