Activision Blizzard (ATVI) reported 2Q19 results that were overall slightly better than expected. Guidance for 3Q19 was underwhelming from the typically conservative management team, but 2019 guidance and expectations were largely unchanged. The current quarter faces a difficult comparison to last year, when ATVI benefitted from a strong contribution from the Destiny franchise that is no longer published by ATVI. By reaffirming 2019 guidance with a weaker 3Q19 outlook and limited release slate, the October launch of Call of Duty: Modern Warfare (CoD) becomes critically important. ATVI remains near the lower end of historical valuation, and Northlake continues to expect an improving outlook for 2020 and beyond once the company moves through the toughest part of this transition year. An inflection in growth expectations should help push the stock back toward the upper $50’s based on 22x 2020 EPS of $2.65, with further upside potential as the multiple and estimates increase.

While investors wait to see how the Activision segment will fill the hole left by dropping Destiny, Northlake is encouraged by the seemingly reasonable estimates for CoD sales and positive sentiment ahead of the release. ATVI noted that the newest iteration of the crucial franchise will have more post-launch content than ever before, hopefully boosting micro-transactions to mirror the success and longevity of Take Two Interactive’s Grand Theft Auto franchise. CoD also has an upcoming mobile version that will launch in the near future, including in China, in an attempt to reach new gamers and prove the value of bringing popular console franchises to global mobile audiences.

The Blizzard segment has a limited release schedule this year, but ATVI management sounds excited about the pipeline of games in development. The upcoming August launch of World of Warcraft Classic appears to be on track to reengage the large audience of people who have enjoyed the franchise over the years, and should draw in new players too. BlizzCon 2019 will take place in November, and could excite investors and gamers alike with new announcements about updates to popular franchises including Diablo and Overwatch. ATVI could also announce new franchises, which would be a big positive to the long-term outlook given increased investments required in building high-quality development teams. ATVI will surely tout the ongoing success in eSports initiatives with Overwatch, which can also be applied to other major franchises like CoD in the near future.

The King segment did not repeat the upside surprises on engagement and growth from last quarter, but remains on track to reach $100m in digital mobile advertising revenue this year. This is a key milestone for King and ATVI, as they continue to build the advertising business from scratch to become a meaningful contributor going forward. The Candy Crush franchise remains incredibly strong, and success at digital advertising can be leveraged across all of the other high-quality franchises owned by ATVI as more mobile versions of console franchises are launched in the coming years.

In summary, Northlake believes ATVI will emerge from this transition year in better position to accelerate growth in 2020 and beyond. The company has a vast library of popular franchises, and is constantly developing new ways to engage and monetize audiences. While the current quarter faces some unusual self-inflicted challenges like dropping Destiny and aggressively investing in game development talent, a successful launch of CoD in the fall followed by exciting announcements at BlizzCon should help put ATVI on track to move back toward the upper $50’s with more upside to come.

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. Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.