Activision Blizzard (ATVI) reported a strong quarter, beating consensus sales and profit expectations. Full year guidance was increased from prior levels but remained below consensus. In past quarters, ATVI has tended to offer conservative guidance leading to upside surprises when they report actual results. Investors focused on strength in the Blizzard and KING segments, while giving a pass to weakness in the Activision segment due to the disappointing performance of 2016 holiday release of Call of Duty: Infinite Warfare. ATVI continues to benefit from the secular tailwinds we have noted in past quarters, namely the shift to digital game downloads from physical packages and increased in game purchases and add-on downloadable content.

The Blizzard segment saw continued strength as their newest game, Overwatch, nears its one year launch anniversary. ATVI has positioned Overwatch to benefit from the growing e-sports trend by developing professional teams and a competitive league with impressive viewership metrics. The e-sports team initiative at ATVI is just beginning, and they are assembling an experienced internal team with people who have previously worked for ESPN, Fox Sports, the NBA, and other relevant sports organizations. Other Blizzard titles also exhibited strong engagement trends as ATVI ramps up the pipeline of add-on content.

The mobile gaming KING segment demonstrated positive engagement and monetization trends, with players averaging around 35 minutes of game time per day and bookings per player up for the 2^nd consecutive quarter. KING has been carefully testing digital ads in mobile games, and continues to expect that the advertising effort will be profitable this year and scale up meaningfully in 2018. Due to the scale of the KING user base (led by Candy Crush), we believe this opportunity offers significant upside to ATVI. Another exciting development at KING is the recent announcement of a mobile version of Call of Duty. We believe this is just the beginning of KING leveraging ATVI’s large catalogue of intellectual property across the large mobile user base.

In the Activision segment, slightly disappointing results were largely driven by the worse than expected performance of Call of Duty: Infinite Warfare. While the Call of Duty franchise remains extremely important to the success of ATVI, we view the underwhelming reception of the last release as an anomaly. As we look forward to upcoming releases in key franchises including Destiny 2 and Call of Duty: WWII and the pipeline of accompanying add-on content, we believe the Activision segment is on track to return to strong performance. ATVI noted that the reveal trailer for Call of Duty: WWII was the most liked trailer ever for that franchise and the fastest to 10 million views along with extremely low negative social media sentiment, unlike the reveal trailer for the Infinite Warfare. Additionally, Destiny 2 preorders are already tracking as the highest in ATVI history.

In conclusion, we see further upside at ATVI as growth accelerates into next year. Aside from the ongoing secular tailwinds of the shift to higher profit digital downloads and increasing importance of add-on content and digital micro-transactions, ATVI also likely has upside to next year’s current consensus EPS estimate of $2.43 driven by e-sports and digital advertising initiatives. We expect ATVI could trade at 25x 2018 EPS, implying upside to the low-$60s.

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.