1. INTRODUCTION

Activision Blizzard is a video game holding company founded in 2008. It is known for intellectual properties such as Call of duty, World of Warcraft and Starcraft, just to name a few. Recently Activision Blizzard has been under scrutiny due to several controversies and has gained track since Microsoft announced in January [1] to buy Activision for $68.7 billion, or $95 per share. The Microsoft deal has been approved by both the board of directors of Microsoft and Activision Blizzard and is expected to close at the ending of Microsoft fiscal year in June 2023. We further note several key points:

  • Activision Blizzard’s stock price is $77.63, given the fact that it has $785.513 Million shares outstanding this makes for an impressive marketcap of $61.165B.
  • Activisions Blizzards dividend yield is 0.60%.
  • The 52-week range 56.40 – 99.46 shows considerate volatility which is correlated and likely to be causal with the takeover bid since January.
  • Microsoft has offered $95 per share which corresponds to the upside price volatility, the share price will likely have a downward trajectory once, and if, the deal is off the table.
  • The p/e ratio is 24,69 which is a number within the standard range of stocks on the Nasdaq exchange. However, compared with similar companies EA (56,0) and Ubisoft (45,9) Activision Blizzard seems relatively undervalued to their industry peers.
  • The global games market generated $180.3 billion in 2021, according to market research firm Newzoo, which predicts that gaming revenue will soar to $218.8 billion by 2024..

In our investment analysis below, we first analyze the expected risk/reward of the Microsoft takeover deal, since as with every merger arbitrage opportunities there are also risks involved. Second, we investigate whether investing in ATVI stock seems like a proper investment action based on the fundamentals of Activision Blizzard itself. Lastly, based upon these two combined elements, we conclude our investment analysis.

2. MICROSOFT DEAL

The short-term trajectory of Activision Blizzards stock price is likely to be dependent on the takeover bid of Microsoft. If the deal will blow up, it will be due to legislative issues and not because of cash flow problems. As Warren Buffet, good friend of the founder of Microsoft Bill Gates, said:

‘’We don’t know what the justice department will do. One thing we do know is that Microsoft has the money’’. Warren Buffett has bet that deal will be approved. The billionaire investor’s company, Berkshire Hathaway, increased its position in the company from 2% to 9.5%, a position worth about $6 billion. Buffett made it clear that it was his decision to increase the position. “It is my purchase, not the manager who bought it some months ago,” said Buffett. “If the deal goes through, we make some money.” Occasionally I’ll see an arbitrage deal and do it,” Berkshire’s chairman and CEO said. “Occasionally it looks like the odds are in our favor, but absolutely we can lose money on that company, fairly large sums of money, depending on what happened if the deal blows up.”

If the deal is closed it will definitely help Microsoft gain more IP addresses to their gamer base, which will also contribute to more expected future revenue when the metaverse increases in popularity. However, when assessing Activision Blizzard as a stock we can’t ignore the lawsuits that the company received since 2021. With 2 ’’220 complaints’’, an SEC investigation regarding insider trading and 8 lawsuits over the merger, one can’t ignore the significant risk when investing in Activision Blizzard in these tumultuous times. The investigations and lawsuits can potentially have adverse effects for the stock’s price if a wrongdoing is found and investors pull out. Additionally, the cost of judiciary proceedings can cut down on profits and margins, even more so when considering the Q1 revenue is already declining.

Considering the deal only, we note the following: Microsoft has offered a price of $95 per share and given the current share price of $77.63 this leads to a 17.37% return. Since the deal is expected to close at the ending of Microsoft’s fiscal year in June 2023, this leads to an annual return of 17.37% when the stock is bought and hold untill the deal closes. A 17.37% return in these volatile market conditions seems attractive to have in your investment portfolio. We furthermore note that if the share price is to increase, say to $90, if seems logical to take the profits and look for new opportunities in the market since the investor would reap the rewards of the potential upcoming deal but without the risks associated with a takeover bid. Lastly, we note that before the deal was announced the stock was trading at $65 per share. So if the deal is off the table, this puts our position at a potential downside risk of 16.6%.

3. THE COMPANY ACTIVISION

Besides from the Microsoft takeover deal, is there any logic in investing in Activision Blizzard? Let’s find out together. First, the bad news; Activision Blizzard YoY net bookings in Q1 dropped from 2,07 billion in 2021 to 1,48 billion in the first quarter of 2022. The player overall monthly active users dropped from 435 million to 372 million in the same time span. Also, the latest Call of duty has seen lower unit sales than its predecessor. The company itself says that the cause for the lower results is primarily because of the lack of major releases and the lower sales of Call of duty. It is worth noting that the company has some new launches in the pipeline for this year that could bring Activision Blizzard out of the slum; ‘World of Warcraft Dragonflight’ and ‘Wow classic the Wrath of the lich king’. Additionally, there is already work in progress for a new Call of duty.

Of course, we should not dismiss the resurgence of the ‘’normal life’’ and the dissipation of the pandemic that could be a prime factor that negatively affects the results of the gaming industry as a whole. So how do we determine if the Activision Blizzards results are down due to these undiversifiable events or because of idiosyncratic events? We compare the results of Blizzard with similar companies in the industry. Ubisoft has not yet reported their Q1 results but already have commented that they expect lower profits. EA however has reported their Q1 results and saw a 6% increase in net revenue and gross profit, although the net income decreased 44% from 365 million to 204 million. Nintendo has released its first quarter results and had to absorb a cut in sales of 9,9%, operating profit of 17,3% and net profit of 12,9% year on year. Therefore, it seems like the results for Activision Blizzard are mainly driven by industry wide factors, and thus are expected to level or rise again after 2022. Although the results for the gaming industry seem to be falling short industry wide, still the global gaming market is expected to reach $218.8 billion sales by 2024 from $180 billion sales in 2021.

In addition to the underlying fundamentals, we note the following issues regarding ATVI:

  • The company has net earnings of $1.5 billion to $2.6 billion in the past 4 year period, with an average of $2.05 billion.
  • The comapny has an outstanding balance sheet with $25 billion in assets compared to only $7.4 billion liabilities, leading to a shareholders equity of $17.5 billion.
  • Considering the balance sheet, we notice a Debt/Equity ratio of (7.4 / 17.5 ) = 0.42. The debt-to-equity (D/E) ratio compares a company’s total liabilities to its shareholder equity and can be used to evaluate how much leverage a company is using. Higher-leverage ratios tend to indicate a company or stock with higher risk to shareholders. Therefore, a ratio of 0.42 indicates lower risk to shareholders.
  • The company has a PEG Ratio (5 yr expected) of 1.91, therefore expecting significant growth in sales and earnings in the coming 5 year period.
  • The company has $10 billion cash and cash equivalents at hand or $12.80 per share, showing a significant war chest to investment in the business or reward shareholders.
  • In the 2018-2021 period, the company has earned an average of $2 billion free cash flow, adding to their significant war chest each year.

In summary, Activision Blizzard seems like a great growth stock when considering the long term growth prospects of the global gaming market. At an below industry average p/e ratio, the company is undervalued relative to their peers. Furthermore, we notice that ATVI is able to generate a lot of free cash flows each year and has an outstanding balance sheet. We furthermore notice that a p/e ratio of 24.65 can quickly decrease if the growth in both revenues and earnings remain evident in the future, which seems likely considering the expected growth of the gaming industry and the digitalization/gamification of everyday life.

4. CONCLUSION

Based upon the takeover deal only, the 17.37% annual return seems like a good trade considering the volatile market conditions in 2022. Since there are significant risks in merger arbitrage opportunities we have furthermore studied the Activision company itself and found that the fundamentals, a healthy cashflow, low leverage and the upcoming games are good prospects. It’s also worth pointing out that before the deal was announced, Activision Blizzard shares were trading for just over $65, compared to their 52-week high of more than $99, so we feel that the downside is rather limited if the deal fails. Yet, if the deal fails there is value to be found in Activision Blizzard based upon its own fundamentals, as described in Chapter 3.

Given the Microsoft takeover bid, the promising long-term prospects of the global gaming market in general, the relatively low p/e ratio and the upside stock potential due to the takeover we are adding Activision Blizzard (ATVI) to our portfolio in order to reap the merger arbitrage opportunity. Due to the uncertainty involving the investigations and lawsuits that may be reflected upon the stock price, we notice that we only dedicate a small part of our portfolio towards this merger arbitrage opportunity. If the deal is cancelled, we are happy to hold in our position in a growing gaming business with a solid balance sheet, high free cash flows and growing earnings. It seems, we again must agree with the Oracle of Omaha.

[1] https://www.cnbc.com/2022/05/07/in-microsofts-activision-deal-a-future-world-is-at-stake.html

DISCLAIMER

Eurykleia Investments is not a registered investment, legal or tax advisor or a broker/dealer. All investment/ financial opinions expressed by Eurykleia Investments are from the personal research and experience of the owner of the site and are intended as educational material. Although best efforts are made to ensure that the all information is accurate and up to date, occassionally unintended error and misprints may occur.