1. Is the company undervalued?
EV/EBIT: 14.44
Price/Sales: 5.81
Price/Book: 3.08
$ATVI is an excellent business which trades at a nearly 50% discount to the market. The company sold off after announcing delays to their Diablo and Overwatch gaming franchises. Furthermore management is battling an ongoing sexual harassment scandal and recently paid out a $18M settlement. Be that as it may $ATVI offers solid long term growth potential and juicy margins. At current levels, investors could be getting more than compensated for the embedded risks.
2. Can I easily explain what the company does?
Yes, they sell video games. Their most notable games are Call of Duty, Diablo, World of Warcraft, and Candy Crush.
3. Does the cash flow statement line up with income statement?
Yes, cashflows have more or less lined up with reported earnings:
It’s also important to note that $ATVI’s cashflow statement is incredibly difficult to understand. Perhaps this is due to my lack of intelligence, but in the last 9 months they’ve had the following expenses; $303M for software development and intellectual property licenses, $818M in deferred revenues, $117M in accrued expenses, $248M in the purchase of outside investments, and $246M in taxes for the sale of restricted stock units.
I’m looking for businesses that are paying off debt, returning capital to shareholders, and reinvesting back into their business. It’s hard to argue Activision is satisfying that criteria based on the aforementioned expenses, which account for most of $ATVI’s operating income. It’s my belief that there’s a decent amount of pork being buried into these numbers. There could be a perfectly reasonable case for these expenditures and I would have to dig in deeper to know for sure, but a pretty big red flag IMO.
4. Is the Balance Sheet Healthy?
Total Debt: $3.61B
Total Cash: $10B
Current Ratio: 5.56
FORTRESS BALANCE SHEET!!!
5. How profitable is the business?
Gross Margins:72.65%
Net Margins: 29.21%
ROIC: 14.18%
10-yr Revenue CAGR: 6.2%
Candidly these metrics are unreal and reflect an extremely high-quality business. You could nit-pick the revenue growth, which I intuitively thought would be higher. Nonetheless 6% growth is respectable and $ATVI is by no means a melting ice cube.
6. Is management rewarding shareholders?
$ATVI currently offers a 0.7% dividend, but they are a far from being shareholder friendly. In the last year $ATVI issued $134M in new shares, while at the same time awarding $339M in stock-based compensation. While this is only ~1% in dilution, the move makes sense zero to me given that $ATVI printed $2.8B in free cash flow over the last 12 months. Moreover $ATVI has been a net issuer of common stock of since 2014 and I’m like WTF mate (Australian accent)???
7. How does the company stack up against their peers?
Activision’s biggest competitors are; EA Sports $EA and Take-Two $TTWO
$EA Price/Sales: 6.34 $TTWO Price/Sales: 6.46
EV/EBIT: 36.28 EV/EBIT: 28.76
Gross Margins: 73.41% Gross Margins: 58.12%
$EA is by far the most expensive and has grown the slowest, so we can easily eliminate them. Although, it’s much harder to decide between $TTWO and $ATVI. While Activision offers better margins, $TTWO has been growing almost twice as fast. Furthermore $ATVI is priced more attractively, but they also have a perverted/creepy management team. There’s really no clear winner here, $ATVI offers a higher upside potential and $TTWO protects more against the downside.
8. What’s the counter argument?
The counter argument is that Activision’s entire C-Suite is full of scumbags who take advantage of the women who for them.
$ATVI paid out $18M for a sexual harassment lawsuit at the end of September. Moreover management had an entire page on their last earnings press release dedicated to their commitment on a “safe, inclusive working environment”.
The mere fact that $ATVI has to make such a statement is a strong admission of guilt and no innocent person in the history of the world would agree to paying $18M for something they didn’t so. You have to be incredibly naive to buy that line of bullshit. Warren Buffett put it best; “Never is there just one coach roach in the kitchen”
9. Is the company unsexy, uncool, or contrarian?
$ATVI has 8 analysts covering the stock with 4 holds and 4 buy ratings out. Additionally it’s in a growing tech industry, so I wouldn’t consider $ATVI to be either unsexy, uncool, or contrarian.
10. Is there something I think the market may be missing?
$ATVI is trading at its lowest multiple since 2015 and management is guiding for many years of growth to come. I know I just went on a big rant about management being sleazy, but if $ATVI can weed out all the bad actors then the stock could double on a multiple re-rate alone!
Final Thoughts:
$ATVI is no doubt an excellent business with a solid pipeline for growth. However their management team is making all my scumbag Spidey senses tingle. From the cashflow statement, to their capital allocation decisions, to the swirling sexual harassment allegations. There’s absolutely nothing to like about these guys and I certainly wouldn’t trust them with my capital. For these reasons, $ATVI is a hard pass.
***Disclosure: I have no position in the security mentioned above, nor do I have any plans to purchase within the next 72 hours. This article is intended for educational purposes only and in no way should be interpreted as investment advice