Activision Blizzard: eSports Will Continue To Surprise – Activision Blizzard, Inc. (NASDAQ:ATVI) No ratings yet.

Activision Blizzard (NASDAQ:ATVI) is expected to perform nicely in 2020, and the market estimates it will be performing relatively well in the following years.

Investing in the company presents a meta-stable risk-reward proposition with quite a low downside and acceptable upside potential. As for its price, it is close to the fair price with some dividends to compensate for the slight overvaluation.

Activision is a large-cap company with a market cap of about $45 Billion and robust financials. Its future will be marked by the growing eSports interest and the ever-increasing number of gaming leagues it is spawning, and if it goes the way the company is planning, the stock will outperform the market.

eSports growth

eSports have been growing in a spectacular fashion, and the growth prospects for the following years will likely dwarf its previous growth.

Companies like Activision that have a strong presence in the eSports industry will benefit enormously from this trend. The business model of eSports places the company who designs the game in a very advantageous position. They own the game, the distribution rights, the league, and can modify rules and parameters at will. As the interest in eSports grows, the company will be able to profit significantly.

(…)Probably the most important thing is that we underestimated things like the demand for the broadcast rights, sponsorships even on the licensing front. I think we also underestimated enthusiasm that we would have from prospective owners, which is why the price of the teams went up so much over the two-year period. – Bobby Kotick CEO Q3 Earnings Call

In the past Q3 earnings call, Bobby Kotick explained that even they underestimated the attention and viewership of the Overwatch League. Undoubtedly, eSports are growing at an outstanding rate and might be the key catalysts that bring the company to the high side of the expectations.

Valuation

In the recent past, revenue growth has had a maximum and minimum of 5.7% and 41.8%, respectively, and the trend has been positive. The assessment considers an average revenue growth of 7.6% compared to the past average of 15.1%. The gross margin has oscillated between 63.8% and 66.4%, and the tendency has been positive. The prediction estimates an average gross margin of 65.1% compared to the past average of 65.2%. Taking a look at R&D as a percentage of revenue, it has ranged from 12.9% and 15.2%, with a tendency to be growing. The assessment estimates an average R&D as a percentage of revenue of 15.1% compared to the past average of 14.2%. Looking at G&A as a percentage of revenue, it has ranged between 24.2% and 30.5%, with a tendency to be negative. The prediction estimates an average G&A as a percentage of revenue of 22.5% compared to the past average of 26.7%. With these assumptions, we have the following chart.

Source: Author’s Charts

These approximations are in line with the market expectations for Activision in the next couple of years, as the image below shows.

Source: Seeking Alpha

I like to use Peter Lynch’s ratio when valuing a stock. This method uses the ratio between the expected earnings growth plus dividends and the P/E of the stock to determine its fair value. A stock that has a 1:1 ratio is reasonably priced. The higher the number, the more underpriced the stock is. With this method, we can construct a fair price forecast of the stock in the following years.

Source: Author’s Charts

This valuation takes into account the assets and liabilities of the company and the expected change in equity the company will have in the future. The growth considered in the valuation is the average yearly growth of the next years, taking as reference non-GAAP earnings. While the assessment considers the dividend to estimate the fair price, it is not taken into account for the average yearly return.

With this valuation, arguably, the stock is at worst overvalued by 37% and, at best, undervalued by 4%. So, the stock is somewhat overvalued.

Source: Author’s Charts

Building an adjusted Beta Pert risk profile for the current fair price of the stock, we can calculate the risk profile for purchasing the stock now.

Source: Author’s Charts

The risk profile shows there is a 92.72% probability that Activision will trade at a lower price than it is today. Considering the potential downside, upside and the likelihood of each, the statistical value of the opportunity of investing now is of -15.3%

Constructing an adjusted Beta Pert risk profile for the long-term prospects of the stock, we can calculate the risk profile for the company.

Source: Author’s Charts

The risk profile shows there is a 42.67% probability that Activision will end up trading at a lower price than it is today. Considering the potential downside, upside, and the likelihood of each, the statistical value of the opportunity of investing now is 0.7%.

Source: Author’s Charts

Adding the dividends to the valuation of the stock, the prospects of the company improve slightly.

Conclusions

The growing eSports interest and the ever-increasing number of gaming leagues it is spawning could deliver a significant result for the stock. If this doesn’t happen, Activision will likely perform in line with the market.

It is undoubtedly a great company that is among the top contenders in the ever-growing eSports segment at a fair price and with a decent chance to outperform the market.

However, the risk-reward proposition and the upside are not significant enough to include Activision in portfolios whose primary goal is to maximize long-term returns. Still, it could be a good fit for conservative portfolios looking to reduce risk while maintaining a chance to outperform the market.

If there is anything in this article, you agree or disagree with or would like me to expand further on; I would sincerely appreciate you leaving a comment. I will address it as soon as possible.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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