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The video gaming industry has been on a tear over the past few years. Activision Blizzard, Inc. (NASDAQ: ATVI ) has fully enjoyed the run. Activision stock is up more than 200% over the past three years. Like Activision's customers, its shareholders have also been playing to win.
Activision's competitors are also surging. Take-Two Interactive Software, Inc (NASDAQ: TTWO ) is up 6x since the beginning of 2014 and 78% over the past 12 months. Electronic Arts Inc. (NASDAQ: EA ) is enjoying an amazing run as well. It is up from 25 in early 2014 to 133 - a new all-time high - this week. In general, I'd say investors are getting overly excited for the sector. But for folks who want to stay exposed to the trade, I'd argue that Activision stock is the best pick at this time. Here's why:
Solid Mobile Strategy for Activision
Gaming purists don't like the way the overall market is evolving. But for investors, the switch to casual and mobile games must be respected. Superdata's 2017 market report found that a stunning 89% of gaming revenues on the mobile and PC platforms came from free-to-play games. In general, these types of games monetize via microtransactions (and to a lesser extent advertising) rather than earning a sales price up front.
This sort of strategy gives a game a lot more revenue durability, rather than front-loading income in the quarter where the game comes out. Superdata found that 2.5 billion people, or roughly one in three humans alive globally, use free-to-play games regularly. Amazingly, console game sales made up just $8.3 billion in revenue out of the approximately $100 billion market. This gives Activision a big leg up versus, for example, Take-Two - which is much more reliant on traditional game sales.
Unfortunately for the U.S. video game-makers, a large portion of the free-to-play game market is located in Asia. These users have largely gravitated to locally-produced games there from the likes of Tencent Holding ADR (OTCMKTS: TCEHY ) and NetEase, Inc ADR (NASDAQ: NTES ). However, of the U.S. game-makers, Activision has potentially the most upside in the mobile market, due to the timely purchase of King Digital .
Activision's King Digital division continues to dominate on the U.S. apps chart ranked by gross revenues. King has had at least two top 10 games for 18 quarters in a row. For the past two quarters, two of its Candy Crush Saga games have ranked No. 1 and No. 2 for highest-grossing games. These microtransaction-based revenue streams have much higher profit margins than other games, driving up Activision's overall profitability, and making the business more consistent and less reliant on new hit releases.
Strong Earnings for Activision Stock
Activision released earnings this past week. They topped expectations, with earnings-per-share coming in at 65 cents. That was way above the consensus estimate of 50 cents. The company's revenues also beat expectations solidly, and posted a 15% year-over-year growth rate.
Activision stock initially dipped 5% on the earnings release. Investors were looking for blowout numbers. But after further reflection, people jumped back into the stock. It's now several points above where it was when the earnings release came out. And it's understandable why. That's the company's fifth-straight earnings beat. Over the next year, analysts expect earnings to nearly triple to $3 per share versus the last 12 months at $1.19.
For the year, Activision raised guidance moderately, although it offered a soft outlook for this quarter in particular. Regardless, the overall earnings momentum here is strong. With a multi-quarter growth story ahead, you'd expect Activision stock to trend higher in the absence of other intervening factors.
Not All Good News for Activision Stock
There's a decent chance that video game stocks, as a sector, will retreat somewhat in coming quarters. They'll all run up a ton, and it seems unlikely that they can all keep rallying simultaneously. Sure, the gaming market is expanding quickly, but so is the competition, especially from overseas firms and independent developers.
Activision stock is the cheapest of the big three American video game producers. But don't mistake cheapest for cheap. Take-Two is at 70x trailing, 24x forward. EA is at 36x trailing, 27x forward. Against those comparisons, Activision wins out at 60x trailing, 24x forward. But they're all vulnerable to a sell-off if investors focus on valuations.
Additionally, as mentioned above, the Asian gamemakers are taking much of the market share in the fastest-growing segments of the industry. Titles such as Fantasy Westward Journey and Arena of Valor are capturing a large chunk of the pie, leaving Activision and other U.S. game-makers out. On top of that, the big viral game of the moment, Fortnite , is produced by privately-held Epic Games . Epic, however, is 40% owned by Tencent.
More specifically to Activision, its legacy money spinner, World Of Warcraft , continues to slowly decline. This is a well-known issue for Activision stock, as World of Warcraft is an old property that's been trailing off for years now. Still, it's a major source of high-quality subscription revenue that will continue to fade out.
Activision Stock Verdict
I view all the American video game stocks as overpriced at the moment. However, if you're inclined to own one of them, despite the stretched valuations, Activision is probably the best bet. Of the big three, Activision has the clearest earnings growth story and is pulling solid numbers in mobile gaming.
That's not to say Activision stock is without risk. It's quite expensive, and should be expected to sell-off sharply in the face of a broader market correction. Additionally, competition from Asian gamemakers for mobile and American ones for the console market is only intensifying. As far as 2018 goes, though, ATVI stock should outrun the competition.
At the time of this writing, the author held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.
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