A disappointing run for video game publisher Activision Blizzard (NASDAQ:ATVI) continues. Activision stock traded down 6% in after-hours trading Thursday after disclosing it was ending a partnership with Destiny developer Bungie. The decline interrupts a brief bounce in ATVI stock, which had gained 18% from December lows.
Of course, those December lows represented a 45%-plus drop from early October levels. Valuation drove the decline. Investors shifted from pricing in years of impressive growth to pricing in only minimal profit increases.
At the after-hours price, ATVI now trades at just 17x 2019 earnings-per-share estimates. Considering Thursday’s news, those estimates may have to come down, however. So should the ATVI stock price.
I wrote in November that Activision stock, at $50, was trading where it belonged all along. Thursday’s news seems to further prove that thesis — and perhaps argues for more downside. The fact is that investors were wrong to price ATVI above $80 in October. This company simply can’t drive the growth needed to support that type of valuation.
ATVI Stock Returns to Reality
Thursday’s news hardly assuages concerns on the management front. Activision’s Destiny was developed through an alliance with privately held Bungie. In an 8-K filing with the SEC, Activision disclosed that it was transferring “full publishing rights and responsibilities” to Bungie as well.
The move, as the company wrote, means Activision will not “recognize material revenue, operating income or operating loss” from the game in 2019. Essentially, Activision is giving away Destiny. To be fair, the game had struggled of late. Management admitted on the Q3 call that revenue was below expectations, with COO Coddy Johnson citing “community concerns” driving lower player engagement.
But, clearly, neither investors nor analysts thought the game was worthless. Going forward, with Activision Blizzard expecting close to zero profits, that indeed will be the case.
Activision’s Growth Problems
And so the question becomes: How, exactly, is Activision supposed to grow? Per the 10-K, roughly two-thirds of revenue comes from four franchises: Call of Duty, Candy Crush, World of Warcraft and Overwatch.
The first three of those games, in particular, are mature, and largely done growing. WoW is in a multi-year decline. Overwatch revenue is down this year, according to the 10-Q. Hearthstone is down this year and the last.
There’s a case that Activision is struggling with competition from Epic Games’ Fortnite at the moment, as Dana Blankenhorn argued last month. But there’s more going on than just a short-term, single-game problem.
There’s simply not a lot of growth in Activision Blizzard’s portfolio. And so any investor expecting ATVI stock to return to a 20x-plus P/E multiple is likely to be disappointed.
The ATVI Narrative Changes
At this point, the narrative here already has shifted. Investors have gone from seeing massive opportunity in esports to pricing in stagnant growth. The narrative has to shift back for ATVI to rally.
I’m skeptical that’s going to happen. Esports is a real opportunity, but this still is a company valued at $39 billion. Those efforts alone aren’t driving upside.
So the question remains: Where does the growth come from? New games could help. At this point, though, can investors trust Activision or Blizzard to develop those new games?
Meanwhile, peer stocks have fallen as well. Both Take-Two (NASDAQ:TTWO) and Electronic Arts (NASDAQ:EA) similarly rely on legacy games. But neither company has multiple declining games, as Activision does. And at cheaper multiples, both stocks look more attractive.
All hope isn’t lost for Activision. But ATVI’s current portfolio — and management — isn’t cutting it. Activision literally just gave away a popular franchise that’s been entrenched in gamer’s minds for half a decade. That’s something investors aren’t going to forget for a long time.
As of this writing, Vince Martin has no positions in any securities mentioned.
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