Activision Blizzard (ATVI) once again beat expectations upon announcing 4Q17 and 2017 results. However, guidance for 1Q18 and 2018 were mixed, with full year guidance generally in line with expectations while 1Q18 guidance appeared a bit light. ATVI has demonstrated a consistent pattern of issuing conservative guidance and then outperforming each quarter. Northlake believes ATVI has followed this approach again for 1Q18, setting up another beat-and-raise opportunity assuming execution remains strong. All three operating segments – Activision, Blizzard, and King – are on strong growth trajectories and industry tailwinds remain intact.

Call of Duty: WWII, the newest installment of the key CoD franchise, has been the best-selling version on the current generation of game consoles since CoD: Black Ops III two years ago. This encouraging news helps to ease fears that gamers were becoming fatigued with the series after lackluster sales of previous versions. Destiny 2 has also performed well, even as news of mild frustration with changes from the original Destiny game mechanics have been reported. These two franchises are expected to drive growth for the Activision segment via constant additions of downloadable add-on content and in-game transactions. The shift to digital full-game downloads has also been a major benefit to the industry, including ATVI, and appears to have room to run as internet speeds and console storage space improve.

The Blizzard segment celebrated a successful launch of the Overwatch League (OWL) in the last quarter. Twelve professional e-sports teams have been sold, and are now competing in the inaugural season. Viewership of OWL started strong, but has tapered off in the subsequent weeks. In comparison to the viewership of the most popular e-sports such as League of Legends, OWL has a long growth opportunity ahead if they can execute on their vision. New league and team sponsors continue to be added, further bolstering the financial performance of OWL. Blizzard is also developing new expansions for Hearthstone and World of Warcraft that should drive ongoing engagement and contribute to profitability.

King Digital has been developing a mobile advertising business since ATVI acquired the company a little over two years ago. Recent developments include further investments in personnel with a focus on building out engineering, sales, and analytics teams. Other investments are being made to improve advertising technology infrastructure. King continues to test various ad formats with a keen eye on the impact to player engagement while still delivering value for advertisers. Although much progress has been made on this front, advertising will only be a modest contributor to profitability in 2018. In the long-term, the investments made to build a durable mobile ad business should substantially reward ATVI shareholders.

Despite Northlake’s confidence in ATVI’s execution and outlook, concerns surrounding valuation leave us considering a sale of some or all ATVI client holdings. The stock has moved close to our mid-$70’s price target, reflecting 25x 2018 EPS of $3. Any further upside will likely be driven by multiple expansion or estimate increases, both of which are possible. Given 25x 2019 EPS of $3.20 only implies upside to $80, the risk-reward balance could be shifting to the downside.

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.