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Bottom Line: What is Activision Blizzard’s Actual Business Mix After KING Acquisition?

KING-NYSE

 

Now that Activision Blizzard, Inc. (ATVI) today has reported its first quarterly earnings since its acquisition of King Digital Entertainment PLC (KING) in February, how does its business mix actually look now and does this indicate potential upside going forward?

I predicted a few weeks back that based on KING’s financials, the combined firm’s Mobile segment would now comprise approximately a third of revenue, operating income and distribution channels (latter of which is the means by which customers purchase its products). This would mean that after Activision Publishing, Inc., the firm’s interactive entertainment and games segment that produces titles like Call of Duty and Skylanders, its new KING unit would be the next-largest contributor to overall business. Note that KING is the maker of mobile games like Candy Crush and Farm Heroes. I wasn’t exactly right about this, yet, but keep reading below to see details.

Additionally, I noted that the post-acquisition geographical breakdown would be interesting to see as the two companies presented these classifications differently. After looking at operating units, we will peek at what locales are driving the firm’s new business structure as well.

The results are in for this past quarter, and revenue plus income figures across its units are as follows:

 

ATVI Segmented Revenue & Income 2016Q1

 

For context, I have tabled these actual numbers against my predictions and earlier years below. Note that the earlier figures are fiscal, and they account for KING’s earlier financials inserted alongside ATVI’s original businesses, so focus on the percentages instead of the totals as a comparison:

 

ATVI Actual Revenue & Income 2016Q1 Table

 

You’ll see that my estimates were a bit high, at least for now, as actual revenue contribution by KING is 23% while it accounts for almost 27% of income. I still think that over the next three quarters, this could increase to a third of ATVI’s overall business as mobile grows and Blizzard potentially stagnates. Unless Blizzard’s online FPS Overwatch (releasing 5/24) performs extremely well, but that’s a discussion for a different day.

Now I will present the same exact values as charts showing the percent of each in the context of the overall business. Again, everything prior to 2016Q1 is an illustration using KING’s financials inserted, as was done above:

 

ATVI Actual Revenue 2016Q1 Chart

ATVI Actual Income 2016Q1 Chart

 

The next shot is an overview of Distribution Channels from the earnings report. Quick reminder that this is how consumers purchase content and services provided by ATVI:

 

ATVI Distribution Channels 2016Q1

 

Below are these actual distribution numbers compared with  earlier fiscal numbers. Basically, these are as expected though I believe Mobile is now included in Digital which accounts for the bump:

 

ATVI Actual Distribution Channels 2016Q1 Table

One more perspective which I did not have in my earlier article is revenue by platform. I think it’s especially relevant now after KING’s contribution. You’ll see console is still the dominant platform at 53% of sales:

ATVI Revenue by Platform 2016Q1

 

As for geographical profile, a quick snapshot shows that North America is still the main contributor followed by Europe:

 

ATVI Geographical Segments 2016Q1

 

My last comparison across years, this time for percentages from different geographies:

 

ATVI Actual Geographical Segments 2016Q1 Chart

 

What these figures tell me overall is that despite KING/Mobile still being a smaller contributor than I initially anticipated, I still think it’s a key strategy going forward as its upside is more than Blizzard’s. Digital is already the main means by which consumers purchase the publisher’s games and services, so its diversification into Mobile as an additional revenue source and channel is a natural progression of its business model as a broad software publisher. This is especially relevant given my expected future decline of Blizzard subscriptions and traditional physical retail sales of ATVI’s games and software. And based on its stock price movement since the acquisition’s February close, where its shares are up more than 10%, investors seem mostly positive on this move as well.

 

ATVI Google Finance

 

In my opinion, the $5.9 billion bet on an expansion into mobile via KING is a crucial one despite its high cost. At the current rate of earnings (around $270 million per year, given this quarter’s performance), the breakeven on its KING investment is something like 22 years. However, this is conservatively assuming mobile does not grow; I think it will, which will move up that breakeven point. It will still be well worth it in the long-run. as the company diversifies its revenue streams and continues to finance more traditional projects such as console games (for instance new Call of Duty, Destiny titles) and full-price or subscription-based Blizzard entries (Overwatch, potentially new World of Warcraft content) to keep its core fanbase intact.

(Note that I do not know about any new Call of Duty, Destiny, Overwatch or World of Warcraft content other than what’s already been publicly announced. I’m just stating that new projects can be financed through sales of mobile games now that KING is assimilated into the ATVI structure.)

Do you agree that a foray into mobile was essential for ATVI, or should it have built organically from within and focused on core business such as console and subscription-based gaming platforms?

Sources: Activision Blizzard, Inc., Google Finance

-Dom

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Bottom Line: How Will King Digital Acquisition Impact Activision Blizzard’s Business Mix?

Activision-Blizzard-logoKing Logo (PRNewsFoto/King Digital Entertainment plc)

 

Bottom Line: Activision Blizzard, Inc. (ATVI) derived most of its overall sales and income from its Activition publishing arm prior to its recent acquisition of King Digital Entertainment PLC (KING) in February 2016, while its dominant distribution segment was digital channels and its operations were mainly in North America. Now that the deal is complete, what will be the impact on the business mix of ATVI from both an operational and geographical perspective?

Before the deal, ATVI had two main operating businesses, both well-known as industry leaders in their specific areas, and an additional catch-all category:

Activision Publishing, Inc.: Publishing interactive entertainment software products and downloadable content. Major brands include Call of Duty, Guitar Hero, Destiny and Skylanders.

Blizzard Entertainment, Inc.: Publishing real-time strategy games, role-playing games and online subscription-based games in the MMORPG category. Major brands include World of Warcraft, Diablo, Starcraft and Hearthstone.

Other: Activision Blizzard Media Networks, Activision Blizzard Studios, Activision Blizzard Distribution & Corporate Items.

ATVI Segmented Revenue

 

You’ll see the Activision Publishing arm has been responsible for the most revenue and income for the past three years. This past year it comprised 58% of revenue ($2.7 billion) and 59% of income ($868 million), while Blizzard Entertainment constitutes 34% ($1.57 billion) and 38% ($561 million) respectively. A decline in revenue and income for Blizzard Entertainment was mostly due to bigger releases in 2014 and lower subscriber base for World of Warcraft this past year.

Taking into account KING’s latest statements, my forward-looking estimates for revenue and income including an additional business unit named “King Digital”:

King Digital Entertainment PLC: Developing and publishing mobile games and interactive entertainment, including free-to-play titles and social applications. Major brands include Candy Crush, Farm Heroes, Pet Rescue and Bubble Witch.

KING Revenue

Estimated Revenue Income Post Acquisition 2

 

Using KING’s latest annual figures and aligning them with the other segments within ATVI overall, you’ll see KING could contribute around 33% of sales ($2.26 billion) and 34% of income ($768 million). This indicates that it would move into the second position in terms of contribution, right after Activision Publishing, meaning that ATVI’s mobile business will eclipse its publishing of Blizzard titles and game types. I expect this to fully continue in the future with the increase in popularity of mobile and casual gaming plus the decline in World of Warcraft subscriptions, unless Blizzard releases a new game within one or more of its established franchises.

Digging further, let’s see revenue by distribution channel which is a breakdown of how consumers are purchasing ATVI’s content. The channels before the deal are:

Retail Channels: Physical distribution of games via brick-and-morter and online retail outlets.

Digital Online Channels: Digitally-distributed games and subscriptions, licensing royalties, value-added services, downloadable content (DLC) and related microtransactions.

Other: Same items as above.

 ATVI Distribution Channels

And again, my estimates for after using recent KING reports using a grouping called “Mobile Channels.”

Mobile Channels: Games, services and subscriptions distributed via mobile phones, tablets and other devices.

Estimated Distribution Channels Post Acquisition

 

The trend here first is that last year, Digital Online Channels overtook Retail Channels as the leading distribution type, indicating a more widespread trend toward consumers opting to buy their software digitally. Digital Online Channels contributed 57% of revenue ($2.63 billion). If we insert KING’s revenue under the new Mobile Channels classification, then I estimate it will be the second overall distribution source at 33% of revenue ($2.26 billion). This would be a large shift away from Retail for ATVI, a bet that consumers want to consume their games digitally whether it’s on console, computers or mobile devices.

Lastly, I’ll show a quick glance at which regions are driving ATVI’s business. This is trickier to display as the companies report their geographical breakdowns differently. Before the deal, ATVI reported broad regions:

ATVI Geographic Revenue

While KING classifies according to individual countries:

KING Geographic Revenue

Which leads to a rough estimate, and definitely not a perfect one, because I have to follow KING’s reporting that lumps all countries outside of these three into Rest of World:

Estimated Geographic Revenue Post Acquisition 2

 

Still, it does the job to show that North America will continue to be the driving force behind business operations as half the firm’s sales over the past few years are from this locale.

The highlight overall is that ATVI’s $5.9 billion bet in acquiring KING is a significant shift in the company’s business mix, as its mobile business will overtake Blizzard Entertainment from a games revenue perspective and also will contribute more to revenue than the firm’s retail offerings. Geographic mix for now looks to be unchanged, but that also depends on expansion into new markets and what constitutes the Rest of World classification. By these estimates, it will take around 3 years for ATVI to recoup the almost $6 billion sales price in revenue and even sooner if mobile grows at a faster rate than the firm’s more traditional businesses.

Sources: Activision Blizzard, Inc., King Digital Entertainment PLC, United States Securities & Exchange Commission (SEC)

-Dom