BUY (12 February 2016)

current price : 28.12 Target price : 42

ACTIVISION BLIZZARD (ATVI)

Company Overview Activision Blizzard is an american video games creation company based in Santa Monica in the United States . In 2008 the companies Activision and Blizzard merged for the amount of 18,9 Billions to become one of the top player in the market.

Company Information and Background

Activision : The company is based on multiple platforms such as Playstation , Xbox , PC , Nintendo , including smart phones, and is well known due to its best sellers such as Call of Duty , Guitar Hero , Skylanders and Transformers games.

Blizzard : The company is mainly active on computer gaming.It became a leader in the field with a very special types of games, mostly Massively Multiplayer Online Role-Playing Games, Blizzard developed very addictive games that became well known such as Diablo , World of Warcraft , Starcraft and Heart Stone. These best sellers made the company suc-cessful.

Activision Blizzard : through the merger of these two companies which were already suc-cessful, a giant was born. The game “Destiny”, which was launched in 2014 , already has be-come a best seller with already 25 M players registered currently. “Destiny” still has some ex-pansion plans for 2016 and 2017 which could easily increase its sales by reaching new cus-tomers. The game is also on the “most watched list” on the platform “Twitch” which is the most famous platform where people with real game skills share their videos.

Market sharemarket share was at 19,5% in 2012, and they were the leader mainly due to call of duty

OwnershipASAC II LP (23,52%) An investors consortium lead by CEO Bobby Kotick and Co-Chairman Brian Kelly who bought back shares of the company when Vivendi sold a major Portion of their holdings in the company in 2013

Fidelity investments (FMR LLC)( 7,56%) second largest mutual fund in the world , founded in 1946 and managing more than 2 trillion dollars as funds under management nowadays.

BLACKROCK (6,57%) One of the largest investment management firms in the World.

ManagementThe members of the board of directors have been holding their positions for a decade on ave-rage, which shows consistency and continuity in the company. After the merger, the pre-sident of Vivendi Games René Pénisson left the company,replaced by Jean-Bernard Lévy, another member of the Vivendi group until 2012, when Bobby Kotick took the lead.

BOBBY KOTICK : CEO for more than two decades. He is also a member of the board of Coca Cola DENNIS DURKIN : CFO since 2012 Previously worked for Microsoft Entertainment Team (di-rect competitors) He holds an MBA from Harvard.

ERIC HIRSHBERG : CEO of activision since 2010

BRIAN HODOUS ; Chief Customer Officer : since 2008. He was a VP in Cadbury Schweppes from 1999 to 2006.

CultureNo recent change in the management. As a confirmation of the rewards of their consistent culture, the company was recently ranked in the “100 top companies to work for” in the Fortune Magazine.

Earnings DriversActivision Blizzard has many games that are famous Worldwide. Sales figures grow constantly each time a new version the already existing top seller games comes out. Games such as world of Warcraft also have a monthly based fee charge that generates substantial continuous cash flow. On a year on year basis there is a 23% growth of extra time spent by active users. Furthermore, the growth of ac-tive users is 27% on a monthly basis. This currently represents an average of 2 hours per day per player spent with Activision games over and above the competition, for all the games the company owns.

Business PlanActivision Blizzards core business is coined as Massively Multiplayer Online Role-Playing Games (MMORPG) This basically means that these are games where the player doesn’t start the game every time he logs in, and that all their games are on a massive Worldwide Interactive Platform . This en-hances the entertainment experienced by the players, simply due to the competition it creates all over the World to become the best player. By being so interactive the game also becomes highly ad-

dictive, since it becomes more difficult to beat all your opponents with so many Worldwide partici-pants competing against you. In order to capitalise on this selling point, World Cup Championships are organised among the players for some top games. These competitions such as the platform “Ma-jor League Gaming”, reach millions of viewers during these events and offer cash prizes of up to USD 1 million for the the winners.

Valuation 52weeks high/low/current 39,93 / 22,28 / 28,12

P/E 24,43

EST P/E 16,42 (2016)

EPS GROWTH

1,795,6%

FY 201650%

EV 20’198.4 M

EBITDA - MARGIN 1,8 B 36,9 %

EBIT 1,3 B

ROA 5,9 %

ROE 11,5 %

MARKET CAP 21’584,5M

DEBT 4’471M

CASH 5’392M

Investment CaseActivision Blizzard is a leader in the games marketplace. It has the highest rate of recurrent clients with the highest addiction rate in the gaming business. The consumption of their product lines is consistently growing in North America , Europe and Asia (no figures are available for Africa, Latin America and the Middle-East)

The take over of King Digital Entertainment for 5,9 Billion Dollars, which hasn’t yet been included in the company financial reports,it will be boosting the users numbers and revenue generation substan-tially when the next financial report comes out. Activision Blizzards’ revenue forecast should increase to USD 6.25 Billion by the end of 2016 from a previous estimate of USD 4.62 Billion due to this recent acquisition.

Monthly Active Users are up 25% year to year with currently 80 million users in over 196 countries.

The stock has over-performed the S&P by 300% in the past 25 years.

In 2016 the company is estimating to generate additional income from a new source, movie making. The first project is the story of “Azeroth”. The Warcraft movie is expected to come out in May 2016, with a production cost of USD 100 million. The movie is being produced by Duncan Jones and Thomas Tull.

2016 dividends are expected to be 12% higher than 2015. Furthermore, the company is planning to reduce debt by USD 1.5 Billion during the year. The total outstanding debt of the company is current-ly at 4,5Billion. Therefore, this represents a significant reduction in their total liabilities.

Recent newsNews :When announced on 12th of February 2016, the company missed the 4Q earnings expecta-tions which resulted in the stock price tanking by 7,86%. However, the year 2015 was still better than 2014, in spite of the fact that it was negatively impacted by currency issues and a drop in earnings from the games “Skylanders” and “Guitar Hero”. They hadn’t missed annual earnings expectations since the merger in 2008, so this is the first time ever since Activision didn’t beat the Streets’ quarterly earnings projections.

4th of January 2016 : Acquisition of Major League Gaming (in order to develop E sports) for USD 46 million. This acquisition will reinforce the presence of all the games of Activision Bliz-zard in the marketplace, due to the number of viewers it can reach on a global scale.

15th of January 2016: Vivendi sold its 5,7% stake in Activision Blizzard as a part of a wider shift to focus on Canal Plus. The Vivendi Group had previously sold a majority of the shares they held in the company as the main shareholder.

During the 3rd quarter of 2015 the company acquired for 5.9Billion dollars the leading smart-phone gaming company “King Digital Entertainment” for 5.9 Billion dollars, which will rein-force the presence of the company in this segment. They paid it at a premium price of 18$ per share which is still below the IPO price of 22.50$ per share.

25th of May 2016: The movie Warcraft is scheduled to be released, (production budget of 100 M). The movie is produced by Duncan Jones and Thomas Tull and looking at their pre-

vious track record, we can easily expect the movie to generate substantial revenues. Moreo-ver, the movie will be a perfect way to advertise the new version of World of Warcraft.

September 2016: The release of the version of World of Warcraft is scheduled, which is likely to generate some extra revenues and increase the number of players.

Analysts Expectations / Expected CatalystsBy taking over King , Activision Blizzards expected to have around 500 million monthly users which makes them the biggest company in the sector in terms of number of users.

By coming up with the movie Warcraft the company will win on both sides ,additional income from the movie and the promotional effect the movie will have in advertising the new version of the World of Warcraft which will also bring in new users.

The current market share figures of Activision Blizzard are as follows :

2014 REVENUE % Total Revenue

PC GAMES 503,76M 12,5%

HANDHELD GAMES

395,88 M 9,82%

CONSOLE GAMES 1,97B 48,77%

The total revenue generation of the company was approximately USD 4.62 billion in 2015. The mar-ket share of the company consistently grew from 2015 to 2015 and we expect it will grow consistent-ly in 2016 due to the takeover of King and the expected positive developments during the year of 2016.

Criteria with ratings

Growth profile high average 12% sales growth last 5 years

Pricing power low their product prices are in line with the market

Margin resilience high Big margin around 36.9% / 12month yield 0,72%

Corporate governance low low dividend of 0.26 per share

Financial metrics 5y net growth 8,92% / yield growth 1y 15%

Valuation low undervalued regarding the out coming movie and extensions plus king entertainment

Sensitivity to variables

Cyclicality low stock went down in 2008 but then followed a contango trend after the crisis, we can expect the same scenario after January 2016 market fall.

Earnings visibility high very transparent on reports

Operating leverage low high debt even if its lower than the cash

Dependence on FX movements high Highly influenced by dollar since a big part of the income is generated out of USA (37% europe, 12% Asia Pacific)

Dependence on raw material prices

low no raw materiel are used except for CD’s that are cheap. mostly cost of production is in the game development it-self.

Dependence on key customers low monthly subscriptions have a high effect on revenue generation but as a single person they don’t have any effect on consumption

Dependence on key suppliers low they don’t have much suppliers

Risks to the Investment CaseA recent decrease of players in the games sector due to a decrease in innovation in the overall sector and the “Oculus” technology, which is gaining public attention, that could change the gaming sector.

Corporate Governance

Investor Relations:On a global scale, it can be said that investors relations are relatively weak due to the limited accessi-bility. The department itself is HQ’ed in the USA and doesn’t respond to mails or calls very often. Ho-wever the podcast regarding the quarterly and annual reports are available on the website of the

company, along with other publications.

Track record during previous downturnsStock price went down during 2008 downturn and beginning 2016

Remuneration and Other Management IncentivesIn line with general market practice expect the CEO, who hold 175 million shares of the company, ac-crued over the years as a part of his compensation package, Current market value is $5.25 billion.

Game Highlights :

Divisions (as % of total)

ATVI revenue : 4,62 B EBITDA : 1723M EBITDA % : 36.9

Description

Drivers

Market share/position leader in the market

Competitors EA / sony / konami / sega / valve

Customers

Suppliers

Industry

Existing Players – Direct CompetitorsEA with “Battlefield” vs “Call of Duty”

Valve with “counterstike” “left 4 dead” vs “Call of Duty”

Riot Games with “ League of Legends” vs “ Warcraft”

Super cell with “Clash of clans” vs “Candy Crush”

New Entrants – Barriers to EntryBarriers to entry due to the advanced level of the games already leading the market place such as Call Of Duty and Diablo which have earned their market position through very high capex, therefore making new entrants to challenge them. However, in the smart phone gaming sector there is an op-portunity to develop and succeed in new products such as “Super Cell” or “Rovio Entertainment Ltd”and with games such as Angry Birds.

New entrant: The subsidiary of Amazon , Twitch is a part of the gaming development, with live strea-ming players,live commentators and thousands of people just watching the gamers play on a daily basis. These players live such as amateur athletes would do through peoples donations and brands sponsorships. On daily basis they receive presents from their fans and interacts with them with the live chat.

Power of the Customers Customers have the full power in terms of their decision-making since it’s their personal spending. However since the customer base is very big and very diversified, unless the company falls behind the curve and starts unsuccessful games, or a competitor releases better games, the decisions of the clients have a low risk of impact on the bottom line of the company due to diversification.

Power of the Suppliers No power

SubstitutesEA / Valve with alternative games

Growth cycle of the industry27% growth Y/Y in terms of Monthly Active Users Reaching 500million

International gaming competitions are also in a growing trend. The number of “Gamers events” are growing consistently as well as the number of attendants on average. For instance in 2013 global vie-wers of such competitions reached 71,5 M . In U.S 1 out of 4 gamers watches or participates in E-sports.

Investment Case and RecommendationEven though the number of players went down for the game World of Warcraft the rest of the games developed cover this loss and there have been some recent developments we expect some new launches soon, and we expect these new developments will help the company to recruit many new players, more than making up for any losses. Furthermore, King Digital Entertainment was not present in the 4thQ of 2015 financial reports of the company.

Key PositivesWorld of Warcrafts new version expected to be released in September 2016. Is expect to attract new players and substantial participation from existing players, since people can start to play at level 100 (level max 120)

Acquisition of MLG is an opportunity since the total audience is often bigger than the real events at-tendants, which creates revenues through advertisement and increases the presence of the games on an international scale.

With the acquisition of King , Activision Blizzard will have more engineering capacity regarding the mobile gaming market. Previously the company used to spend 19% of the overall software develop-ment spending in the sector due to outsourcing , now they can mostly do everything internally. Plus they collect the player data base of King entertainment.

Rumours in the gamers community are expecting an upgrade of the famous game Warcraft after twelve years of absence regarding its development. No release date or confirmation has been made by the company however last December Blizzard entertainment was hiring people in a project based around the Warcraft universe. If these rumours are accurate, Activision Blizzard would be taking back shares to the company “ Riot Games” by directly competing with the only successful game “League of Legends”.

Key RisksActivision Blizzard stopped reporting World of Warcraft players’ count at 5.5 M. January 2011 num-ber of player was around 12M

In 3rd Q 2015 the acquisition of King Entertainment was a risky move. However the results turned out to be satisfactory. For the futre, such risky moves may yet put in risk the successful core business of the company.

Pro forma adjustments eliminate companies that would not be on the list if their financial state-ments were adjusted to reflect true operating performance. This will apply to some companies that have recently reported one-time items or have en-gaged in a strategic transaction. In the latter case, reported results may fail to account for the pro forma performance of the combined entity.

Capital reinvestment: avoid companies with virtually no opportunity for high-return reinvestment of capital. Typically, these are companies in industries in long-term decline, such as paper check producers or newspaper publishers.

Threats to key revenue source

avoid companies dependent on a specific customer or contract, if loss of it has become a real possibility. Circumstances may include the acquisition of a major customer, an ongoing rebid process for a large contract, or the loss of critical patent protection.

Cyclicality avoid capital-intensive businesses that generate high returns on capital only during cyclical upswings in their respective industries.

Faddishness avoid companies providing a product or service that has a reasonably high likelihood of being a fad. This may be hard to judge while a fad is unfolding, but if we seem surprised by how quickly a concept or fashion has spread, or if we feel like a product will either take over the world or eventually peter out, we take notice.

Insider selling We avoid companies with heavy recent insider selling, particularly if such selling occurred at prices roughly equal to or below the current market price.

Alignment of interests We avoid companies with major CEO conflicts of interest or corporate gover-nance abuses.

M& A rollups We avoid companies that have meaningful integration risks due to major re-liance on acquisition-driven growth.