Analysis: ATVI GOOGL

Activision Blizzard (ATVI) after the closing bell on Thursday reported in line and better-than-expected results for its fiscal fourth quarter. 

On the top line, net bookings came in at $2.71 billion (-4.5% YoY), in line with expectations. We should note, however, that some sources set expectations for $2.68 billion -- which would mean ATVI performed better than expected. (But ATVI's number includes the impact of deferred revenue, which increased by $722 million in the quarter. So, back that out and Activision recognized net revenues of $1.986 billion in the quarter. That said, for those members who like to do their own homework on estimates, note that in general, analysts will use net bookings as their sales estimates, which is why our initial focus is on that key metric.)

On the bottom line, adjusted earnings of $1.23 per share (-4.7% YoY) surpassed expectations of $1.19 per share. We also account for the impact of deferred earnings in this number, which increased by 61 cents in the quarter.

"Our fourth quarter results exceeded our prior outlook for both revenue and earnings per share," said CEO Bobby Kotick on the release, adding that recent success in "Call of Duty" shows the "scale of our growth potential, as we expanded the community to more players in more countries on more platforms than ever before."

Kotick also touted what he called the company's strong content pipeline across its franchises and momentum in mobile, esports, and advertising.

Guidance Crushes It for Q1, Gets Zapped for Year

Looking to guidance, we remind members that Activision has a long, multi-year history of under-promising, only to over-deliver down the line (a key reason we opted to trim shares ahead of the release). Recall in our prior earnings analysis, we called out that "actual earnings results have exceeded management's guidance going back more than 12 consecutive quarters and three fiscal years." 

With that in mind, on an adjusted basis, in the upcoming quarter (1Q20), management is guiding for net bookings of $1.275 billion, a beat vs.the $1.25 billion consensus. On the bottom line, management is forecasting earnings of 35 cents per share (including a negative impact from GAAP deferrals of 31 cents per share), a slight miss versus the 38 cents per share expected. Given management's conservative nature, we're thrilled to see the sequential top line guide come in better than expected, especially given that we're already nearly half way through the quarter, allowing management a good deal of insight into how the quarter is going.

That said, for the full year, management is guiding for net bookings of $6.725 billion, a miss vs. the $6.928 billion consensus. On the bottom line, management is forecasting earnings of $2.35 per share (including a positive impact from GAAP deferrals of 13 cents per share), also missing the $2.50 per share expected.

"Bringing all this together," CFO Dennis Durkin said on the call, "our outlook reflects 5% year-over-year growth in net bookings."

Durkin said he expects Activision to see the strongest net bookings growth among it segments, both in dollar terms and on a percentage basis.

"We expect solid net bookings growth from Blizzard for the year, and our outlook reflects the flattish performance again, with year-over-year trends improving in the second half of the year. From a margin perspective, our outlook reflects GAAP and non-GAAP operating margin increasing year-over-year." 

By segment, Activision enters the year with strong momentum for "Call of Duty" across upfront sales in game, mobile and esports, said Durkin.

"Along with a tight retail channel, that should benefit catalog sales. This positions us for strong growth in the franchise, particularly in the first half of the year."

In Q4, the company plans to launch the next premium release of "Call of Duty," he said, adding that Activision is "prudently" assuming lower sell-in for Q4 vs. "Modern Warfare" this past year.

As for Blizzard, Durkin noted that the segment will build on "World of Warcraft" momentum with ongoing content for classic and the "Shadowlands" expansion in the second half of the year.

The "Hearthstone" and "Overwatch" teams, meanwhile, will "support their communities with ongoing content and services that drive engagement and player investment," he said, and "Diablo Immortal" is planned to enter a regional testing later in the year. 

Finally in the King segment, "Candy Crush" remains the focus. But we will be on the look out for additional content as Durkin noted that the company will continue to release content, features, services and events across its portfolio, while still focusing on optimizing reach, engagement and player investment for "Candy." And the advertising business is set to deliver another year of strong net bookings growth. At the same time, King will continue to invest in several promising new titles in its pipeline. And although we expect regional play testing for certain titles, similar to 'Diablo Immortal,' our outlook does not include material revenue from these titles." 

Returning to the Quarter

As for the quarter, by segment, Activision Publishing saw net revenues of $1.426 billion vs. expectations of $1.436 billion. Blizzard Entertainment saw net revenues of $595 million vs. expectations of $511 million. And, King Digital, the company's mobile division, saw net revenues of $503 million vs. expectations of $534 million. The company also realized $217 million in "non-reportable segments" revenue, which includes sales from the studios and distribution business as well as unallocated corporate income and expenses.

Breaking net revenue down by platform, including the impact of deferred revenues, the company realized console net sales (42% of the total) of $1.131 billion, PC net sales (25% of the total) of $686 million, and mobile/ancillary net sales (24% of the total) of $649 million. Activision also realized $242 million (9% of the total) in "other" revenue. 

It is also important to break down revenues by distribution channel as digital online channels yield higher margins compared with physical sales and, as a result, increased share of digital sales will enhance the company's ability to expand margins going forward. On that note, again including the impact of deferred revenues, Activision generated $1.878 billion in sales from digital online channels (69% of the total), while traditional retail channels (22% of the total) generated $588 million in sales. Activision also realized $242 million in sales from "other" channels (9% of the total).

Staying in the Game

On the engagement front, Activision Publishing had 128 million monthly active users (MAUs), up from 36 million in the prior quarter, as the segment benefited from the addition of "Call of Duty: Mobile," which exceeded 150 million installs in the quarter. (Despite being a mobile title, "Call of Duty: Mobile" is housed within the Activision segment.) That said, it wasn't all about the mobile platform, as the company switched from a "season pass" to a "battle pass" model.

"Instead of a certain portion of the audience having certain content, we're focused now on free content for the entire community to drive engagement with the overall community," said management on the call, adding that the "last big change that we made was really focusing on the new battle pass and item shop system in the game, giving players kind of more transparency to the content they are after and obviously focusing more on cosmetic content."

When looking at engagement and daily average unique users, engagement is up significantly year-over-year, added management. "We're also seeing increased attach rates in-game to the new system."

Elsewhere, Blizzard Entertainment came in with 32 million MAUs, a tick down from 33 million in the prior quarter and King sported 249 million MAUs, up sequentially from 247 million. All in, Activision Blizzard saw MAUs surge to 409 million from 316 million in the prior quarter and 356 million in the year ago period.

YouTube & The Google Cloud Platform

As members will recall, Activision and Alphabet's (GOOGL) Google announced a multi-year strategic relationship.

"There are really two big pieces to it: That this is on sort of the global IT infrastructure, and then the second is on what really is just a fantastic content platform in YouTube," said Collister Johnson, Activision's president said on the call about the partnership. "On the first piece, what we have the opportunity to do now is have a more efficient and better delivery of the back-end services and infrastructure handled by a partner, where that is their great expertise. And what it allows us to do is it frees up our resources and developers and mind share to focus on what we do best, which is making the content and getting it out into the hands of our players at a faster cadence." 

"There are 200 million game reviewers on YouTube, and it's just a tremendous opportunity to bring our platform to new audiences there," Johnson added. "We think not only just in a way that players can experience it today with new modes and formats and also YouTube is a great on-demand viewing platform. And we think viewers might be increasingly interested in viewing our content that way."

Other advantages included cloud game streaming, but importantly, Johnson added that while big tech may be moving into the gaming space, Activision views this as an opportunity: "Over the last two years, we've been talking about these large technology players that are coming to our space at scale. What we've said is we see this tremendous opportunity as a content provider, to take advantage of where we sit in the space and this Google deal is an example. It has a large amount of value for us as we go forward. And we think we're only even better positioned for other partnerships as we take next steps." 

Bottom Line

All in, while we would never say to ignore guidance, we believe that in the case of Activision Blizzard, given management's well-known tendency to be conservative -- which makes the first quarter guide all the more impressive -- it is more important to consider the underlying trends of the business. When we come at it from this angle, we are increasingly bullish as management has now firmly demonstrated its ability to reach a wider audience -- and therefore increase monetization opportunities -- by expanding already existing intellectual property to the mobile platform. We believe this bodes well for the pending release of "Diablo Immortal," which is the company's first mobile-first game release, and any other franchise that may end up making their way to mobile.

With the transition year behind us, we believe management has laid the ground work for growth in the future and will look for the company to continue to capitalize on the momentum by further building out its existing franchise ecosystems, develop new content and increase overall engagement and monetization. Speaking of engagement, we remind members that while it may not be impacting the bottom line directly yet, Activision Blizzard's significant investments in esports remains another key differentiator aiding the company's ability to flood the zone with content and keep users engaged. All that in mind, we must acknowledge that shares have had a strong run and we therefore reiterate our Two rating. Our price target is under review.