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Activision: "World of Warcraft" Drives a Growing Bear Case


Weakness in Activision's "World of Warcraft" offsets strengh in "Call of Duty."

Shares of Activision (ATVI) hit a high of $14.40 yesterday as investors cheered the release of its blockbuster Call of Duty: Modern Warfare 3. (See Modern Warfare 3: Do Reviews Matters?)

However, the company released its third-quarter earnings results after the closing bell, ending the party as investors looked past strong numbers to focus on weakness in the key World of Warcraft franchise.

Let's quickly go through the headline facts and figures:
  • Activision reported a profit of $0.07 a share, beating consensus by $0.05.
  • Revenues fell 27% to $627 million, but surpassed Wall Street's expectations by 12%.
  • Fourth-quarter earnings guidance is $0.55 a share, a penny ahead of consensus.
  • The company expects fourth-quarter revenues of $2.17 billion, which is slightly above expectations.
  • World of Warcraft subscribers fell by about 800,000 quarter-over-quarter to 10.3 million (ZING!)
  • Cash on the balance sheet sits at $2.9 billion, or $2.53 per diluted share.
Make no mistake about it -- Activision demolished Wall Street's expectations for the third quarter. It's clearly executing well in a tough environment for both the video-game industry and the broader consumer economy. On top of that, the stock appears reasonably valued at 13 times earnings, ex-cash.

But as I mentioned yesterday, I've been hung up on World of Warcraft, which is clearly in trouble.

Not long ago, Activision had by far and away the best product portfolio in the video-game industry -- a 1000% legit murderer's row.

What's happened since then?

On the plus side, Call of Duty, Diablo, and Starcraft all appear well-positioned to continue succeeding in the near-term. But Guitar Hero crashed and burned. And now the highly-profitable World of Warcraft is steadily losing steam, while Electronic Arts (ERTS) is set to turn the heat up with the competing Star Wars: The Old Republic, which is due out in December.

If we really want to take the bear case for Activision further, we could start arguing that the declining review scores for Modern Warfare 3 are a dark omen for the future of that series.

Already, a few folks out in the wild are comparing gameplay stagnation in the Modern Warfare series to EA's weak stretch with Madden a few years ago.

I'm not jumping on that bandwagon just yet, but it is something to keep in mind. Remember, we're playing a game of perception -- it doesn't necessarily have to be true to hurt the stock price!

As it stands now, the analyst community doesn't appear phased by the decline in World of Warcraft. Twenty of Wall Street's finest rate the stock a buy, with three holds, and zero sells.

I'll take the other side of consensus -- I just don't see any reason to buy Activision.

Elsewhere in the video-game industry, Take-Two Interactive (TTWO) also reported September-quarter earnings results after the close yesterday. Take-Two smashed estimates, but issued downside guidance. My preferred strategy with that name is to wait for a release date for Grand Theft Auto V, and then hit the buy button when the game receives an inevitable delay, creating a nice entry point.

Overall, if you're looking to make money in the video-game space, look past the traditional players like EA, Activision, GameStop (GME) and THQ (THQI), none of which are meaningfully benefiting from the fast-growing smartphone/mobile gaming market.

My money is on Apple (AAPL) and Sandisk (SNDK), which directly benefit from the mobile-device boom that is rapidly sucking up a growing slice of the video-game pie.

Twitter: @MichaelComeau

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