Last quarter we noted that ATVI has been managing the headwinds coming from the employee discrimination lawsuits well.  Looking solely at the results of 3Q21, one would conclude the same thing.  However, the other shoe dropped when the company delayed the release of two important games from 2022/2023 to 2023/2024.  The issues are a loss of key personnel and loss of productivity as a result of the lawsuits.

Stock Reaction:  ATVI traded down another 12% after dropping 20% from 2021 highs due to the lawsuits.  The stock now trades at less than 20 times projected 2021 estimates and the same on 2022 that is now assumed flat year-over-year due to the delayed game releases.

Earnings Analysis:  3Q21 earnings were good with Activison in line, Blizzard underperforming (Blizzard is where the discrimination impacts are being felt), and King’s mobile games outperforming.  Management slightly raised 2021 guidance, passing through some of the upside from the latest quarter.  Guidance could have gone higher, but it appears management wants to play it safe given the imminent launch of the next Call of Duty game.  Performance of this game is critical to the 2022 outlook and is the next big catalyst for the shares.  If Call of Duty meets high expectations from investors, it will make it easier to look at the delayed games as just deferring future profits.  Any shortfall would create an even higher hill to climb to regain investor confidence and shift the focus to 2023.

Target Price:  Last quarter, we reduced our target on ATVI from $115 to $90 because we expected investors to mark down valuation until the headwinds passed.  We did note that $115 was ultimately achievable as earnings power was unchanged and eventually the company would regain the street’s confidence.  It now appears unrealistic to achieve a recovery to $90 in the near future.  We expect the shares to stay range bound +/- 10% against current levels until (1) Call of Duty acts as a catalyst, and (2) management signals progress on now delayed games.

The latest issues may or may not impact long-term earnings power.  At a minimum, the delayed game releases push realization of earnings power out to 2023.  ATVI has encountered and overcome major challenges before.  In fact, that has been the case for peers Electronic Arts and Take Two Interactive as well.  This history makes us willing to hold for now and hope for better news starting with the new Call of Duty game.  A P-E under 20X on base level earnings is historically very cheap for ATVI.  This should limit downside while we wait for a recovery and further datapoints to evaluate the shares.

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.