Activision (ATVI) Q1 Earnings Strong Backed By King Digital

Activision Blizzard Inc. (NASDAQ:ATVI) posted impressive first quarter 2016 results driven by the acquisition of King Digital Entertainment, increasing digital revenues and continued strength in the Call of Duty title. Adjusted earnings (including stock based compensation) of 19 cents per share and non GAAP revenues of $908 million easily beat the Zacks Consensus Estimate of 10 cents and $817.7 million, respectively. The company raised its 2016 outlook, sending shares up more than 6% in the aftermarket session.

On a GAAP basis, Activision’s revenues were $1,455 million compared with $1,278 million in the first quarter of 2015. Product sales were $645 million, down 17.7%, whereas subscription, licensing and other revenues increased 64% to $810 million.

On the basis of distribution channels, Activision reported retail channel sales (non GAAP) of $64 million (down 45% year over year) and digital online revenues of $797 million (up 48%). Digital revenues contributed 88% of total revenue in the quarter. Other revenues fell 2% year over year to$47 million.

On a geographical basis, revenues (non GAAP) from North America decreased 30% to $460 million, while that from Europe grew 22% to $327 million. Revenues from Asia Pacific registered growth of 49% to $121 million driven by strong performance.

Operating income (non GAAP) increased 23.5% year over year to $252 million. Operating margin came in at 27.8% compared with 29% a year ago.

Balance Sheet

Activision exited the quarter with $2.87 billion in cash and cash equivalents. Long-term debt was $5.78 billion.

Outlook

For 2016, Activision expects non-GAAP revenues of $6.275 compared with $6.25 billion projected earlier. Non-GAAP earnings are expected to be $1.78 compared with $1.75 per share.

For second quarter 2016, Activision expects non-GAAP net revenue of $1,375 million while earnings are expected to be 38 cents per share.

Our Take

Activision has been benefiting from its deep focus on broadening its franchise portfolio, innovation and initiatives to expand to new geographies. Activision’s offerings like StarCraft, World of Warcraft, Heroes of the Storm and Call of Duty have been widely popular and should continue to contribute to the bottomline.

The company’s strong pipeline of new games should keep investors interested in the stock. It will release an expansion pack for Destiny in 2016 and launch the full game sequel in 2017. It will be launching its first new franchise, Overwatch on May 24, 2016 for PS4, Xbox One, and PC. Moreover, Activision will release the Warcraft movie in June and follow it up with the launch of the much awaited expansion, Legion, on Aug 30, 2016.

Also, analysts observe that the company has been trying to improve its engagement levels by adopting a year-round model instead of a launch based model in which earnings and profits are derived only in a week. This should help to drive long term performance.

Of late, Activision has been making giant strides in its attempts to become a broad based media company. Apart from launching a movie studio, the company is also strengthening its presence in the lucrative e-sports market. It recently acquired Major Gaming League for $46 million to boost its newly established e-sports division.

For Activision, the acquisition of Candy Crush maker King Digital Entertainment (it had announced the acquisition in Nov 2015 for $5.9 billion) seems to have paid off as reflected in solid quarterly results. The buyout was a ploy to enter the lucrative mobile games market where so far Activision has had a limited presence. Moreover, it adds a sizeable female user base to its hardcore male dominated gamer base. With 544 million users, Activision Blizzard has surpassed Twitter (NYSE:TWTR) and Instagram.

However, higher adoption of free-to-play games and significant competition from the likes of Electronic Arts (NASDAQ:EA), Take Two Interactive (NASDAQ:TTWO) and Glu Mobile (NASDAQ:GLUU) remain the near-term headwinds. Also, an uncertain macro-economic outlook is adding to its woes as video games form a part of discretionary spending. Also, the company’s dependence on a handful of mega franchises (Call of Duty, World of Warcraft) for the lion’s share of its revenues makes it highly susceptible to the success of these games.

Currently, Activision has a Zacks Rank #3 (Hold).