Activision Blizzard (ATVI) beat expectations for 1Q20 earnings and raised guidance for the remainder of 2020 from $2.35 to $2.60. Last quarter, Northlake noted that ATVI 2020 EPS could climb into the $2.50-$2.70 range as benefits from the well-timed restructuring efforts begin to pay off. Consensus estimates for 2020 have now climbed to $2.74, with analysts expecting $3.01 and $3.49 in 2021 and 2022 respectively. While it is encouraging to see strong execution, especially while many other industries are struggling, ATVI has climbed into a range where upside to our target is becoming more limited. Using our prior methodology, 20-25x 2020 EPS of $2.60-$2.80 implies a target for ATVI of $52-$70. 25x 2021 and 2022 EPS implies targets of $75.25-$87.25, which equates to $65.23-$68.75 discounted back to today at 10% return per year. With strong execution and likely upside to typically conservative guidance offset by a more demanding valuation, Northlake is neutral on the outlook for ATVI shares in the short term.

The restructuring efforts at ATVI began before the COVID crisis stalled the global economy. Despite the headwinds facing companies around the world, ATVI has demonstrated the rationale for and ability to deliver on the goals of the restructure. Last quarter, the launch of Call of Duty: Mobile brought a large new audience into the popular franchise. This quarter, ATVI released free-to-play Call of Duty: Warzone on console and PC, and doubled the franchise audience and in-game spending levels. Successful expansions into new regions such as Brazil and India bode well for continued franchise momentum next fall.

World of Warcraft: Shadowland and Warcraft III: Reforged are expected to further demonstrate the benefits of reengaging lapsed players and expanding the global audience in 2H20. Last quarter, World of Warcraft: Classic doubled the active player base by bringing back gamers who used to play. New and remastered content should continue to drive increased engagement and in-game spending for all of ATVI’s major franchises in time.

Recent strength in King Digital mobile ads took a step back in the first quarter, partially due to less time spent commuting as many people continue to work from home for the foreseeable future. Year over year growth only increased 20% over the prior April compared to 75% growth in 1Q20 overall. Monetization for Overwatch and Hearthstone also appear to be slowing. This trend could change when ATVI releases Overwatch 2 in an attempt to drive engagement similar to the recent success seen in the Warcraft franchise. Diablo Immortal is still being tested for a mobile release, and Diablo 4 is also in the pipeline. These upcoming game launches should help refresh a few more franchises, and the new console cycle should also be a nice tailwind for the video game industry as a whole.

In conclusion, Northlake appreciates the early success demonstrated by ATVI on recent restructuring efforts and the approach to creating more value from existing franchises. Given the ongoing momentum and typically conservative guidance provided by ATVI, we expect upside to consensus estimates can drive the stock higher. Our optimism for the strength of ATVI’s underlying business is becoming mirrored in the more challenging valuation of the stock. Northlake may consider trimming or selling ATVI if it continues to rally above $80 in the near term, but we remain patient to let our winners run in the meantime.

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.