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Morningstar | Activision Beats Guidance Yet Again; World of Warcraft Expansion Should Spark Growth in 2H

Activision Blizzard outperformed its guidance once again as second-quarter GAAP results came in above the prior outlook for the sixth straight quarter but only met Street projections. The firm generated strong results without the benefit of a major release in the quarter, highlighting the strength of the core franchises including Call of Duty, World of Warcraft, or WoW, and Candy Crush. Despite the outperformance, management maintained its 2018 GAAP revenue of $7.4 billion and EPS guidance of $ 1.84. We are maintaining our narrow economic moat rating and our fair value estimate of $69. With shares trading in the 3-star range, we would wait for a larger margin of safety before investing.

GAAP revenue for the quarter improved 1% year over year to $1,641 million (versus guidance of $1,555 million). Console GAAP revenue was flat year over year at $817 million. PC GAAP revenue fell 11% to $451 million due to a tough comp as the second quarter of last year benefited from a WoW expansion in the third quarter of 2016. The latest WoW expansion, Battle for Azeroth, will launch in the third quarter and management expects it to help return Blizzard back to year-over-year revenue growth in the second half. Mobile continues to expand, up 13% in the quarter, as King had two games in the top 10 of U.S. app stores for 19th quarter in row. GAAP operating margin for the quarter improved to 26.4% from 20.8% last year as increased revenue from higher-margin digital sales and microtransactions more than offset increased marketing expenses and Overwatch League costs.

As we discussed in our recent Observer, “The Evolution of the Video Game Experience” and follow-up ad-hoc report “The Evolution of Video Games Continued,” Blizzard’s Overwatch League, which launched in January, recently completed its inaugural season. While the league suffered through some growing pains, we believe the venture has largely been a success for the firm. Management appeared pleased with the level of viewership and fan engagement, particularly with respect to the grand final which was held on July 28 at the Barclays Center in New York. While the event drew a relatively weak live rating on ESPN, the Twitch stream was more successful which is too be expected as Twitch viewers receive Overwatch in-game items simply for watching matches.

As we noted in the ad-hoc, the Overwatch League is in the process of expanding to 18 teams from 12 that participated in the first season. We expect that majority of the new teams would be located outside of the U.S. as only three of the original 12 were not based in the U.S. While one of the two franchises awarded on Aug. 2 will be based in Guangzhou, the second franchise will be in Atlanta and owned by Cox Enterprises. The Guangzhou franchise was awarded to the Nenking Group that also owns the Guangzhou Long-Lions basketball team. We expect that Paris will be one of next franchises as Overwatch only has one European team (the newly-crowned champions, the London Spitfire) and the league sold French TV broadcasting rights to the AB Groupe in April. The price for new franchises is rumored to be $60 million, a sharp increase from $20 million fee that the highest-valued inaugural teams paid and an indication that the league's success is attracting more bidders for franchises.