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Activision's Struggle to Score
with Investors Again
The video-game maker had its "own little Internet
bubble" in 1996. Now, its earnings are soaring,
but not its stock price
Most CEOs don't grow nostalgic when pondering the huge runup (and
lately, dramatic fallback) of the Internet sector. But Bobby Kotick,
the 36-year-old CEO of Activision (ATVI), a leading video-game
publishing and distribution company, sees parallels in the market's
passion for Internet stocks and its brief love affair with his
industry.
In the mid-1990s, multimedia software stocks were enjoying runs
that, while not nearly as euphoric as Internet gains, were still
pretty spectacular. Investors seemed unconcerned about actual
earnings and focused solely on growth potential. For fiscal 1996
(ended March, 1996), Activision's revenues were only $61
million, and its earnings were $5.5 million, or 36 cents a share.
But it had nearly a $300 million market cap. That fiscal year, its
stock hit a high of $19, or about 50 times earnings. "It was our own
little Internet bubble," recalls Kotick.
Fast-forward three years: Activision is now three times larger in
terms of revenues and earnings. For the fiscal year ended Mar. 31,
1999, revenues increased 40%, to $436 million. Net income was
$15.3 million, or 66 cents a share, up 200% from a disappointing
fiscal 1998. Kotick projects that Activision's revenues can grow
30% a year and earnings 35% a year over the long term.
"RIDICULOUSLY LOW." And its stock? It closed on June 16 at
a modest $12 15/16. Activision is selling for only 20 times
trailing earnings (compared with a trailing price-earnings ratio of
33 for the Standard & Poor's 500-stock index), and 16 times
projected 2000 earnings. Its total market capitalization is just
about where it was in early 1996. Kotick believes that Internet
companies ultimately will go through a similar experience. "Our
company had to grow into its valuation," says Kotick, "just like
Internet companies will have to."
It's true that several analysts think Activision is worth quite a bit
more that its current price. "A lot of the p-e's were ridiculously
high," says Sean McGowan, an analyst with Gerard Klauer &
Mattison, referring to the video-game sector's heyday. "Now I think
the p-e's are ridiculously low." Activision is much cheaper than the
leader in the industry, Electronic Arts (ERTS), which currently
has a p-e of 43 and a projected year 2000 multiple of 23, and is
expected to grow at the same rate as Activision, according to
research from Piper Jaffray.
Activision has in fact held
onto its market value
better than many
video-game companies,
says McGowan. But there
are reasons why its stock
price has remained
between $10 and $15 a
share for the past four
years. The industry proved
more cyclical than
investors anticipated, and
software sales slumped
when new gaming consoles couldn't play old games. Investors and
venture capitalists who had been interested in video games became
enamored of the Internet. And when video-game sales did boom, from
1997 to 1999, Activision missed analysts' expectations for a few
quarters, McGowan says, because it was changing its business
strategy.
More recently, the Columbine High School shootings in Colorado,
where the teenage killers were fans of violent video games, has put a
damper on the industry. But the biggest concern to investors is the
transition to next-generation consoles from Sony, Sega, and
Nintendo over the next 18 months. Some analysts believe that the
changeover won't be as difficult this time, since old games will work
with new systems, making gamers less hesitant to upgrade. "During
the past two transitions there was a dramatic drop-off in terms of
market growth," says James Lin, an analyst with Wedbush Morgan
Securities. "This time around, it will be a lot different." Even so,
Piper Jaffray analysts don't expect growth in game sales to take off
until 2003, after the new consoles have taken hold.
BRAND-NAME GAMES. What investors are missing amid all
the handwringing is that Activision has transformed itself in the
past two years into a much broader company and is now in a much
better position, says Lin. No longer just a publisher that depends on
hit games, it now gets a large percentage of revenues from its
software distribution business. It also has a large international
presence, gained through acquisitions, and it has changed its product
development model so that it uses lots of third-party developers to
produce new titles. Kotick says the company can leverage that
infrastructure without having to add significantly to staff, which
should eventually improve operating margins.
Activision should have its biggest year ever for new releases in
2000, points out Larry Marcus, an analyst with Alex. Brown, in a
May 5 research note in which he reiterated his Buy rating on the
stock. He is impressed that the company is more focused on
brand-name games, which can spawn sequels. The company has
signed licensing deals with Viacom (VIA) to develop titles based on
Star Trek, and with Walt Disney (DIS) to publish titles based on
A Bug's Life, Tarzan, and Toy Story 2.
Meantime the video-game market is growing. Kids who grew up
playing games, continue to play as adults, while new generations of
youngsters -- increasingly, girls as well as boys -- become
players each year. Moreover, video games are appealing to a broader
audience. More casual gamers, who bought PCs because of the
Internet, are playing games tied to their leisure activities, such as
sports or cards. Casual gamers make up the fastest-growing
segment of the market, says Lin.
To further exploit this
opportunity, Activision
has acquired two
"value-priced" software
companies recently --
ExpertSoftware in March
and Head Games a year ago.
Kotick may also start
selling his library of 200
low-memory games and
software titles for
download over the Internet
to the growing hobbies
market, though E-commerce continues to be a challenge for
video-game companies. That's because online gaming is widely
available for free, says Jeremy Schwartz, a senior analyst with
Forrester Research. Activision's Internet strategy also includes
offering multiplayer gaming on the Web and using its database of 1
million E-mail addresses for market research.
"Now they are now poised and ready for tremendous growth," says
Lin, who faults the company only for not doing a better job of
explaining its change in strategy to the investing public. His
12-month price target is $16 to $18 (so is McGowan's). That may
not sound high, but analysts are ready to raise those estimates if
earnings come in stronger than expected. Kotick believes that
passing the $500 million mark in revenues, which Activision will
do this year, will prove to investors that it is ready for the big
time.
A comparison between Activision three years ago and Internet stocks
today is "apples and oranges," Lin believes. "The opportunity for
growth for a lot of Internet companies is significantly greater than
any of the [game] publishers had then," he says. Time will tell how
strong the correlation is between the two industries. And in the
meantime, Activision will have an opportunity to prove that it, as
much as any Net stock, deserves a high valuation.
Amey Stone is an associate editor of Business Week Online |
