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Should Activision Stock Be Bought on Weakness?

Ian Bezek

After years of winning, owners of Activision Blizzard (NASDAQ:ATVI) stock suffered a major loss at the end the year. Activision stock, which jumped as high as $85 this fall, is trading around $47 today.

Of course, Activision is far from the only stock that’s dropped sharply recently. Many tech stocks have gotten punished during this correction, and gaming companies have been hit especially hard. Activision’s rival, Electronic Arts (NASDAQ:EA), is down 45% from its recent highs, for example. So, why has Activision stock been dropping, and is it worth buying despite the risks it’s facing?

Regulatory Issues on the Horizon

One of the biggest fears of investors is potential government regulation. Well, for those who have invested in video-game companies, it’s time to be nervous. Much of the run in gaming stocks over the past few years was sparked by the increased recurring revenues that companies in the sector have been generating. Among the sources of such revenue are subscriptions, downloadable content, and in-game purchases.

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The latter source, which  has been responsible for a large portion of the companies’ recurring revenue, could be coming under fire. A November article in Broadcasting & Cable discussed the Federal Trade C’ommissions’ investigation of in-game purchases in general and “loot boxes” in particular.

Sen. Ed Markey (D-Mass.) asked whether the FTC was looking into the matter. Markey mentioned potentially problematic practices, such as in-game characters who continue to cry if a child doesn’t purchase content, using real money.

Sen. Maggie Hassan (D-N.H.) cited industry analysis suggesting that selling video-game content could grow into a $50 billion industry. She noted that the industry has sought to obtain much of its in-game revenue from children and suggested that loot boxes which offer random payouts could be a form of problematic gambling.

Needless to say, the gaming industry does not want one of its fastest-growing sources of revenues to undergo that type of scrutiny. In particular,discussions about targeting children and creating gambling addictions have to be seen as major threats. Fears about government scrutiny may not hit ATVI stock in 2019, but owners of Activision stock should closely monitor the issue. Once the government goes after a sector, the sector’s stocks are often badly hurt.

Analysts Are Cutting Their Targets on Activision Stock

Perhaps not surprisingly, given the huge drop in Activision stock, analysts are trimming their price targets on the shares. Needham, for example, slashed its price target from $90 to $60, but maintained a “buy” rating on the stock. Predictably, the firm cited reductions in its earnings per share and revenue estimates  as justification for the target reduction.

It’s worth asking just what analysts were baking into the stock when its price-earnings ratio was 30. Activision and other gaming companies have been on a hot streak for years. At some point, the good times had to slow down because the whole industry couldn’t keep growing at its recent, breakneck pace forever.

JPMorgan’s analyst actually upgraded ATVI recently from a “hold” rating to a “buy” rating while at the same time cutting the price target on the shares from $72 to $66.

Esports Are Losing Steam

Cracks are showing in ATVI’s esports business. For one thing, amidst struggling viewership numbers, the company eliminated its Heroes professional sporting league earlier this month. The company wrote:

“We’ve also evaluated our plans around Heroes esports—after looking at all of our priorities and options in light of the change with the game, the Heroes Global Championship and Heroes of the Dorm will not return in 2019. This was another very difficult decision for us to make. The love that the community has for these programs is deeply felt by everyone who works on them, but we ultimately feel this is the right decision versus moving forward in a way that would not meet the standards that players and fans have come to expect.”

This sort of news puts esports in perspective. Bulls have been touting the huge fan interest in and viewership numbers of these esports leagues. They’re not wrong. But they don’t realize that video-gaming communities can come and go very quickly, whereas traditional sports leagues like the NFL and NBA have endured for decades, thereby proving their staying power. Some wildly overly optimistic assumptions about the value of esporting leagues were published earlier in 2018. These estimates required us to believe that these games would remain popular forever.

Instead, it seems that players and fans are willing to embrace new games fairly quickly. Already, it seems that the Fortnight sensation is stealing everyone else’s thunder. Activision has invested heavily in Overwatch, and investors are betting that its professional league will be a major source of value generation. But Overwatch’s streaming numbers are declining amid tough competition from Fortnight.

The Bottom Line on ATVI

When considering whether you should buy Activision stock, it’s important to consider the risks facing ATVI, as we’ve done in this article. But it’s also important to note  that Activision stock has plunged around 40% in the last few months. If you’re bullish on gaming’s long-term trends, and I think there is good reason to have that view, ATVI certainly makes more sense now than in the past.

The selloff of ATVI has a silver lining because it has forced investors to reevaluate their overly optimistic assumptions about things such as the future growth of esports. Trading at 18 times its earnings, Activision stock still isn’t cheap, but it’s reasonably priced for a growth company, and it could bounce back this year. Just remember the risks that the company is facing.

At the time of this writing, Ian Bezek held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.

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