Activision Blizzard Has Both Gamers And Investors Hooked – Seeking Alpha

We all knew that video game companies were going to have a blowout quarter in Q2 – but we weren’t exactly sure how good of a quarter. Activision Blizzard (ATVI) just gave us the answer: gamers are more hooked than ever. Helped by a global pandemic that has encouraged us to stay inside, many young people have shifted out of their usual entertainment habits (such as eating out, movie theaters, and the like) and poured the extra time and cash into online gaming. Activision Blizzard, the developer behind huge global franchises like Call of Duty and World of Warcraft, is one of the biggest beneficiaries.

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Data by YCharts

In the immediate aftermath of the earnings release, shares barely moved – but I think investors should use this opportunity to continue riding Activision Blizzard’s momentum upward and increase their stakes. As a reminder, the key bullish thesis for Activision Blizzard can be summarized as follows:

  • Broad game portfolio and proven formula for creating sticky fanbases. Activision Blizzard, made up of three primary brands, has a vast game portfolio covering a wide range of interests and most importantly, both serious and casual gamers. It also has a track record for both developing new titles and investing in current ones to make them global powerhouses.
  • Recurring revenue base – the whole video game industry has pivoted from focusing on the one-time sale of disks to the sale of in-game items. Q2 results have shown just how lucrative in-game sales can be.
  • Huge margin profile – the cost of delivering an in-game item is virtually zero. Activision Blizzard’s huge margin profile has already given it massive operating leverage, and the potential for continued earnings growth is vast.
  • MAU growth creates a virtuous cycle. People want to play games that are popular and competitive. Activision Blizzard’s tremendous coronavirus-driven MAU growth has re-ignited competitive interest in games like Overwatch and Hearthstone, broadening their revenue potential.

One of the key questions heading into the second quarter – not just for Activision Blizzard, but for all internet companies as a whole – is can the increased user engagement be sustained? We’ve seen some companies, like Snap (SNAP) and Netflix (NFLX), already comment that their earlier user strength was a pull-in from future quarters and that they’d expect growth to moderate over the next few quarters. What separates Activision Blizzard from these names, however, is the fact that the company has a huge launch coming up in the Fall to continue to lure in users – a new Call of Duty release, where in-game bookings in Q2 were quintuple that from the prior-year Q2. This sets the stage for a very strong launch cycle where Activision Blizzard can both retain its more engaged user base plus encourage a higher level of in-game spend.

In this article, we’ll take a look at Activision Blizzard’s latest performance, but investors would be wise remain bullish here.

Q2 download: Bookings strength driven by heavy spending on Call of Duty

Let’s now go through Activision Blizzard’s latest results in greater detail. The key highlights are encapsulated in the slide below:

Figure 1. Activision Blizzard 2Q20 resultsSource: Activision Blizzard 2Q20 investor presentation

The key metric here that investors should be watching is the company’s net bookings, and in particular in-game net bookings – which is essentially the amount in dollars that Activision’s users are spending in the games. Net bookings for the quarter soared 72% y/y to $2.08 billion, while in-game net bookings grew 77% y/y to $1.37 billion. These metrics accelerated roughly fifty points from 21% y/y total and 20% y/y in-game net bookings, respectively, in Q1. In other words, Activision Blizzard has reverted to startup-like growth rates, thanks to the coronavirus shuttering us inside our homes with few choices for entertainment.

Note that the strength of this quarter’s bookings far outpaced what even Activision Blizzard itself was originally expecting. The company had guided to only 38% y/y bookings growth in the quarter, and instead nearly doubled that.

The trends in the number of monthly active users (MAUs) is equally important for investors to absorb. Activision Blizzard added 21 million net-new MAUs this quarter, mostly on the Activision side – which, thanks to Call of Duty, is the company’s most lucrative and profitable segment, generating more than half of the company’s operating income. From a y/y standpoint, MAUs grew 31% y/y – up from just 18% y/y MAU base growth in Q1.

Figure 2. MAU trendsSource: Activision Blizzard Q2 earnings release

Let’s now briefly turn our attention to the Activision segment, and namely Call of Duty. As previously mentioned, engagement on Call of Duty has “reached new heights” per the company’s own verbiage in the slide below, with hours played growing 8x y/y and in-game net bookings growing 5x y/y.

Figure 3. Activision key resultsSource: Activision Blizzard 2Q20 investor presentation

What I like most about these results is that they’re replicable. Call of Duty, as a brand, is an incredibly valuable piece of IP that has already generated a number of top-grossing games. The mass following that Activision Blizzard has cultivated around CoD, especially reaching new heights this quarter, positions it well for the upcoming launch.

We note also that while Call of Duty/Activision were the focal points for strength for the company, the entire portfolio performed well. Across all of Activision’s games, game time increased 70% y/y. Management even noted that some stale assets, like Candy Crush, continued to grow its user base.

Also important to note: Daniel Alegre, Activision Blizzard’s president and COO, noted that gaming trends have remained elevated even in regions that have scaled back their lockdown restrictions. This gives us even further confidence that Activision Blizzard’s strong Q2 results can be sustained. Per his remarks on the earnings call:

Turning to the impact of the pandemic on demand. Shelter-at-home conditions boosted reach and engagement for each of our key franchises in the first half of the quarter. These tailwinds moderated in the second half as more countries started to reopen with trend varying across geographies and franchises. India and Asia Pacific saw greater moderation as lockdowns ended with the Americas seeing more sustained tailwinds. And while casual franchises returned to more typical trends more quickly, our core franchises with the greatest emphasis on social, multiplayer gameplay are seeing engagement remain elevated, even as regions reopen.”

We’ll touch as well on the impacts to profitability. Activision Blizzard’s huge bookings strength led to a 10-point bump in operating margins to 42% (we note that many technology companies, especially internet companies that lean heavily on advertising, have reported declines in profitability whereas Activision Blizzard is delivering the opposite). This is one of the advantages of the company’s rich gross margins – because of the low incremental cost to deliver in-game sales, Activision Blizzard’s bottom line scales dramatically alongside its top line.

This is no one-quarter fluke either. Activision Blizzard has guided to the same 42% operating margin for the third quarter:

Figure 4. Activision Blizzard guidance updateSource: Activision Blizzard 2Q20 investor presentation

Key takeaways

Results as strong as Activision Blizzard’s have been exceedingly rare in the wake of the coronavirus, yet the market doesn’t seem to be paying that much attention. It’s amazing for a company at an ~$8 billion annualized revenue run rate to be able to grow net bookings at nearly ~2x and see a nearly tenfold rise in gaming hours spent on its biggest gaming franchise.

To me, this means Activision Blizzard still has a long runway to rise higher.

Disclosure: I am/we are long ATVI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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