For the second straight quarter, ATVI beat street expectations on the top and bottom line and raised full year guidance for both. The strong results were driven by a continuing shift to higher margin digital revenues and ATVI’s increasingly diversified franchise portfolio. The market responded by sending ATVI’s shares up over 10%. Our investment thesis remains on track, and we believe further margin upside and new product launches can push ATVI into the low-$30s.

Results from this quarter clearly demonstrate the value of ATVI’s efforts to expand their portfolio of franchise titles. World of Warcraft (WoW) subscribers declined well below street expectations, which would typically be problematic for ATVI. However, this weakness was offset by a strong launch of Diablo III in China and high expectations for several upcoming franchise titles including but not limited to Destiny: The Taken King, Starcraft: Legacy of the Void, Call of Duty: Black Ops III, and the reboot of the Guitar Hero franchise. By increasing the number of franchises and focusing on player engagement, reliance on any single franchise has decreased dramatically. One investor concern for ATVI had been too much reliance on the World of Warcraft and Call of Duty franchises.  Diversifying the franchise game base reduces this risk and argues for a higher valuation on ATVI shares all else equal.

Additionally, ATVI is benefitting from some secular tailwinds. Sales of video game consoles have been strong, and new console price reductions from Sony and Microsoft should help this trend continue. Gamers are also shifting to buying digital downloads of games instead of physical game discs. This creates an opportunity for videogame producers to increase their margins by reducing production expenses. These secular tailwinds and ATVI’s growing franchise portfolio should allow ATVI to beat their conservative guidance for the remainder of their fiscal year.

ATVI is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.  ATVI is a net long position in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.