Activision Blizzard, Inc. (ATVI) reported disappointing quarterly results with revenue, earnings, and guidance all worse than expected. The shortfall in the fourth quarter was driven by unfavorable foreign exchange rates and weakness in ATVI’s casual franchises on consoles, Skylanders and Guitar Hero. The underwhelming guidance for next year was mainly due to a delayed release date for Destiny 2. ATVI fell sharply in response to the weak results, but we believe the decline is overdone and the stock can trade back into the mid-$30s.

ATVI guided to FY16 EPS of $1.75, well below street expectations of $2.05. However, the guidance was not as bad as it initially appeared. When you include the $0.15 impact from moving the release date for Destiny 2 from FY16 to FY17 and the $0.06 impact from compensation changes for incoming KING employees, the adjusted $1.96 EPS compares much more favorably to street estimates. Additionally, ATVI tends to guide conservatively and regularly outperforms their estimates. For example, there are no synergies from the KING acquisition included in the guidance even though it is likely that ATVI will be able to find cost savings and other upside from the deal. Therefore, we believe it is possible ATVI could earn more than $2 per share in FY16.

ATVI’s core franchises performed well in the quarter and throughout the year. Call of Duty and Destiny continue to show impressive user engagement and strong sales of add-on digital downloadable content (DLC). ATVI also benefitted from high-margin digital sales which grew 20% compared to last year; digital sales accounted for 54% of total revenue and surpassed the less profitable physical retail sales for the first time. We expect this trend to continue with new DLC for Call of Duty, Destiny, and many other titles coming soon.

Looking forward, we believe ATVI has several exciting opportunities to drive growth. This spring, Blizzard will launch its first major new franchise in 17 years, Overwatch, which currently has 8 million people playing the beta test. A new World of Warcraft expansion will launch in June, following the release of ATVI’s first Warcraft film. ATVI’s foray into media production will also lead to a new animated Skylanders TV show. Many of ATVI’s games already have strong e-sports communities, and the acquisition of Major League Gaming will continue to drive upside in this exciting area. Finally, ATVI will continue its geographic expansion following strong growth in China now that most of its major franchises are available in that market. ATVI plans to take advantage of the opportunity to sell their products in virtually every country in the world on every type of device. Although we were disappointed with the most recent quarterly results, we believe the long-term investment thesis in ATVI is intact.

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.