Summary Analysis Activision Blizzard, Inc

Horizontal Common-Size Statement of Income (Exhibit 2)

Cost of goods sold follows a similar trend. It slightly rose from 2006-2007 (21%) and then shot up in the following years. It peaked in 2009 when it was 512% higher compared to 2006. In 2010 it dropped 12%. Gross profit follows a similar course, quadrupling in the years analyzed. This increase from 2008 on is probably due to the merger of Vivendi Games and Activision that created Activision Blizzard. It’s disclosed in the company’s 10-K that the merger was treated as a reverse acquisition and as such the financial statements prior to 2008 are Vivendi’s.

Selling, general, and administrative expenses have grown 300% since 2006, but after 2008, they grew at a slower pace and even decreased in 2010 (4%). Management explained this decrease in the Management’s Discussion and Analysis section of their 10-K as a result of favorable foreign exchange effects and lower stock-based compensation expense. (2010 10-K, 59-60) Depreciation, depletion, and amortization in 2010 were 1,104% higher than it was in 2006, down from a peak of 1,404% in 2009. Coupled with the beneficial tax effect the company saw from 2006-2009, I wonder if they sped up their depreciation for tax purposes.

Intangibles grew to $9m from 2007-2008 (nearly 3,000%) and has since dropped by $1.2m. Also in their 10-K, they specifically bring up the impairment of intangible assets on page 60. Special items represent a large expense for the company, coming in as big losses from 2008 on (-$122m to -$456m). In fact in 2009 special items were 10,400% higher than they were in 2006. I believe this expense is where the impairment of intangibles appeared.

The company received beneficial tax effects every year except for 2010. This benefit stems from the company’s expense related to the impairment of its intangible assets according to page 61 of the 10-K. Plus in 2008 and 2009, the company generated a loss from operations. As mentioned in my analysis of the vertical common-size income statement, this benefit actually reversed the company’s negative pretax income in 2009.

As was the case with the vertical common-size analysis of the income statement, Activision Blizzard had a definite trend across the five years analyzed. They grew their adjusted net income from 2006 – 2007 before recording a loss in 2008. Afterwards, they continued the growth that was evidenced by nearly every line item. In the years analyzed the company has two distinct periods: the pre-merger years of 2006 and 2007 and the post-merger years of 2008-2010. As I just stated, nearly every line item of the income statement grew from 2008 on and I think a lot of this is attributable to the merger.

Vertical Common-Size Balance Sheet (Exhibit 3)

Net receivables were a large portion of Vivendi Games’ total assets: 18%-26% compared to 5%-8% post-merger. I believe this implies that Blizzard Entertainment, and World of Warcraft in particular, was a major source of income for Vivendi Games. WoW is a subscription-based video game and revenues generated from it come in at varying rates. Property, plant, and equipment were also a large chunk of Vivendi Games’ total assets, but not Activision Blizzard’s: 30%-35% pre-merger, 3%-4% post-merger.

Like cash, intangibles were an asset that grew as a percent of total sales post-merger. The company breaks down what intangibles are comprised of in note 12 to their consolidated financial statements. (2010 10-K, F-29) Of the $1.3 billion gross total intangibles (excluding goodwill), about $1 billion is derived from license agreements, internally developed franchises, and trademarks. However, nearly half of total intangibles were amortized and impaired to the net carrying amount of intangibles (excluding goodwill): $600 million. These calculations ignored goodwill, which according to the consolidated balance sheet located on page F-2 on the company’s 10-K totaled $7.1 billion. From 2008-2010, intangibles have remained around 60% of total assets.

Examining the company’s liabilities and equity, three things stick out to me. Firstly, the company has no long-term debt. The company has apparently financed itself mostly through operations and equity; after all, since 2008 they’ve been sitting on $3 billion - $3.5 billion of cash and equivalents.

Secondly, Vivendi Games’ accrued expenses in 2007 and 2008 were 34% and 42% of their total liabilities and equity respectively. This amount shrunk after to the merger to 3%-4 but the monetary amounts are in the same ballpark ($275 million - $380 million pre-merger and $463 - $536 post-merger), but now the company is much larger.

The last thing that sticks out to me are the negative amounts in retained earnings from 2006-2009; they were the result of accumulated deficits but the account turned positive in 2010. (2010 10-K, F-2) This makes me believe that Vivendi Games had accumulated deficits for at least 2006-2007 and possibly before then; the balance in this account was -70% of total liabilities and stockholder’s equity in 2006 but dropped to -34% in 2007 so this was possibly larger in 2005.

As was the case with my analysis of the income statements, these financials tell the tale of two companies: Activision Blizzard pre-merger and post-merger. Post-merger the company is a much larger entity and this will be made clearer in the following analysis of their horizontal common-size balance sheet.

Horizontal Common-Size Balance sheet (Exhibit 4)

During the Vivendi Games years (2006 and 2007) there’s not much to bring up because the post-merger years featured a lot of expansion of account balances. Still there are two figures that really stick out in these two years. They are the 450% growth of other assets and the 980% growth of other liabilities, both from 2006-2007.

The 450% growth in other assets resulted in a balance of $30 million, basically the same as it was in 2008. I wasn’t able to determine what this account consisted of in 2007 because the 2006-2007 financial statements are those of Vivendi Games and locating French financials is difficult. However, sourcing Activision Blizzard’s 10-K from 2008 yielded results for contents of the account during that year; considering the balance remained the same, perhaps the contents did as well. I couldn’t determine wholly what the account consisted of, I was able to learn that $10 million of it was put options from UBS and another $5 million of foreign currency derivatives. (2008 10-K, F-42) The 980% growth of other liabilities resulted in the account having a balance of $72 million. I believe most of this growth is from non-current income tax liabilities, that was the case for $81 million in 2008. (2008 10-K, F-40)

The post-merger years solidify the fact that Activision was much larger than Vivendi Games.

Activision Blizzard is sitting on a lot of cash. At the end of 2010, the balance in the cash and equivalents account was 5,200% higher than it was in 2010! I don’t think the $3.5 billion of cash the company is sitting on is too exorbitant either. Idle cash could be invested in short-term instruments to earn a minor return, and with the amount they have, the return might not be insignificant, which is what they’re doing. Of the $3.5 billion, $2.2 billion of it was in money market funds. (2010 10-K, F-22) But, the company is much larger now and cash only makes up 25% of their assets.

Intangibles grew by 3,000% after merger, signifying that Activision relied more on the properties of others for a source of income. Of the nineteen games the company published in 2010 and chose to highlight in the MD&A section of the 10-K, eleven of them were based off of other properties such as James Bond, Transformers, and Cabela’s. (2010 10-K, 41)

The company’s other current liabilities and other liabilities accounts grew to be 1,600% and 2,500% higher in 2010 than their respective balances in 2006. As was the case with Vivendi Games’ growth in other liabilities by 980% from 2006-2007, much of the growth in this account was from non-current income tax liabilities. (2010 10-K, F-38) As for other current liabilities, after taking a look at their consolidated balance sheet for 2010 included with that year’s 10-K, I’m able to pinpoint that much of this account is deferred revenues. (2010 10-K, F-2)

Simply because Activision Blizzard is a much larger company than Vivendi Games was, the horizontal common-size balance sheet can be effectively divided in two between 2007 and 2008. With the exception of the $1.7 billion of deferred revenues, none of the growth I saw led me to dire conclusions.

Five-Year Ratio Comparison (Exhibit 5)

Liquidity

Even with all of the cash that Activision Blizzard has, the current and quick ratios have been declining since 2008. I chalk this decline up to the declining balance in net receivables as well as the growth of the other current liabilities account which contains deferred revenues. Because these ratios are declining, so too is the company’s working capital per share. On the upside, their cash flow per share has risen from $0.21 per share in 2008 to $0.79 per share in 2010.

Compared with 2008, the company is taking more time to turnover inventory: 35 days compared to 40 days in 2010, but they’re doing better than they were in 2009 when it took them 55 days. Similarly, yearly inventory turnover stagnated in 2009 compared to 2008 and 2010 figures. On the flip side, the company is turning over its receivables more in 2010 than they were in 2008: 6.5 times compared to 4.5 times. Accordingly, it’s taking them less time to collect receivables: 56 days in 2010 compared to 82 days in 2008. As these ratios go, so too does the operating cycle; the improvement in the receivables ratios outweighed the decline in inventory ratios and the operating cycle was 95 days in 2010 compared to 117 days in 2008.

Activision Blizzard’s liquidity is good, but some important ratios are trending downwards. Even with all the cash they have, their current and quick ratios declined. Their inventory and receivables turnover ratios improved, but the balances in these accounts fell; it’s easy to turnover product when there’s less of it. Still, they have plenty of cash and liquidity shouldn’t be a concern but I’d keep my eye on their growing current liabilities.

Long-Term Debt-Paying Ability

Because Activision Blizzard has no long-term debt, the related ratios aren’t worth mentioning with the exception of the interest coverage ratio. The company has had interest expense each year ($3 million - $5 million from 2008-2010 but most notably Vivendi Games’ interest expense of $18 million in 2006) and the company has the money to cover these, but they didn’t generate pretax income in 2008 and 2009. The before tax and after tax variations of this ratio were both positive in 2010 though.

Profitability

Post-merger, the total asset turnover for Activision Blizzard has remained around 0.3 times per year, but this is down compared to Vivendi Games’ 1.62 times per year in 2007. The current company probably isn’t as nimble as Vivendi Games was plus they’re now sitting on about thirteen times the assets.

Since the merger, each of the operating, pretax profit, and net profit margins are up. As I mentioned in my analysis of their vertical common-size income statement, the company has held their costs flat or even decreased them while their sales rose.

Vivendi Games had really strong return ratios (return on assets, equity, and investments) ranging from 28%-95% in 2007 and these declined after the merger. Since then though, Activision Blizzard has brought these up from the 2008 negatives to 3%-4%.

Five-Year Ratio Comparison (Exhibit 5) - Continued

Profitability - Continued

Overall, Activision Blizzard’s profitability ratios are very good. Most of them are on the rise. The total asset turnover ratio is the only one I have an issue with, but its low primarily because of the amount of cash the company is holding.

Ratio Comparison with Selected Competitors and Industry (Exhibit 6)

Selected Competitors

The two competitors I picked to compare with Activision Blizzard are Electronic Arts and Take-Two Interactive Software. Electronic Arts was founded in 1982 and like Activision Blizzard, is a global developer, publisher, and distributor of video games. These two companies often have titles that compete directly with each other’s key franchises and anyone familiar with the industry will tell you they’re analogous companies. With assets totaling $5 billion they appear much smaller than Activision Blizzard who has assets of $13 billion, but their revenue is similar: $4.5 billion for Activision Blizzard and $3.6 billion for Electronic Arts.

Take-Two Interactive Software is also a global developer, publisher, and distributor of video games. They also have many titles that compete directly with Activision Blizzard’s and Electronic Arts’, but their bread winner is the Grand Theft Auto series. They are the smallest of the three companies with assets totaling $970 million and revenue of $1.1 billion.

I pulled the ratio reports for Electronic Arts, Take-Two Interactive Software, and their industry from Capital IQ’s Compustat program and where noted, sourced information from the companies’ respective 10-Ks.

Liquidity

One of my sticking points about Activision Blizzard’s liquidity in the previous five-year ratio comparison was their declining current and quick ratios. However, they’re beating the industry and Electronic Arts. Take-Two is faring better here, but they’re a smaller company. Activision Blizzard nearly has better cash flow per share than Take-Two ($0.79-$0.84) but their working capital per share is lower than their competitors and industry.

The portion of Activision Blizzard’s liquidity I liked best was their upward trending receivables turnover and operating cycle. Compared to their competitors and industry though, they don’t look so hot. Their receivables turnover is close to Take-Two’s and the industry’s, but Electronic Arts is mopping the floor with ratios double Activision Blizzard’s. Their operating cycle is twice as long EA’s and 15 days longer than that of the industry. Lastly, their inventory turnover was on the rise from 2008-2010, a negative, and the industry and their competitors are faring better here as well.

Of the four sources of data, Activision Blizzard’s liquidity is usually on the bottom. They’re sitting on $3.5 billion of cash and equivalents so I’m sure liquidity isn’t the biggest problem for them, but they need to improve their inventory and receivables turnover.

Ratio Comparison with Selected Competitors and Industry (Exhibit 6) - Continued

Long-Term Debt-Paying Ability

Here’s one area that didn’t require a lot of discussion in the five-year ratio comparison section and it won’t require a lot of discussion now. Activision Blizzard and Electronic Arts don’t have any long-term debt in their capital structure, or at least an insignificant portion. Take-Two does, although not a lot. 11% of their assets were financed through debt and it was worth 17% of their total equity. In general, the industry doesn’t appear to use much debt. 1% of the industry’s assets were financed through debt.

Profitability

The two stars of profitability are Activision Blizzard and Take-Two. Activision Blizzard’s operating, pretax profit, and net profit margins easily topped everyone, including the industry. Electronic Arts generated a loss from operations for the fiscal year ended March 31, 2011 so they’re automatically excluded from this discussion as well as any discussion regarding return ratios. The industry had an operating margin (after depreciation) of 7% and a net profit margin of 0.3%; Activision Blizzard on the other hand and an operating margin (after depreciation) of 18% and a net profit margin of 9%. The closest Take-Two came to touching any of these margin ratios was their 5% net profit margin.

As for the rest of the profitability ratios, Take-Two had the best results. The industry had low return ratios: return on assets was 0.18% and the return on equity and investment was 0.26%. Activision Blizzard did well with these: 3.12% and 4.1% respectively. Take-Two’s returns were better though: 5.54% for return on assets, 8.74% for return on equity, and 7.45% for return on investment.

Activision Blizzard’s total asset turnover remained flat from 2008-2010, but I thought this was low. Comparing this ratio to the industry proves it, although the industry wasn’t much higher: 0.33 times per year compared to 0.52 times per year. Electronic Arts had a better total asset turnover of 0.75 times per year while Take-Two had the best by turning their assets over 1.15 times per year. Activision Blizzard has a lot of cash and equivalents and intangibles “weighing” down their assets though.

The profitability ratios were divided among Activision Blizzard and Take-Two. Overall though, most of Activision Blizzard’s ratios were beating the industry. They had good margins and their returns were always positive. And yet, Take-Two did a better job of using their assets.

Dividends

The dividends ratios, like the long-term debt-paying, are hardly worth bringing up, even less so than those. But Activision Blizzard did pay a dividend on April 2 and October 22, 2010. For 2010, Activision Blizzard’s dividend payout ratio was 45% while the industry’s was 9%; the 45% means that percentage of current earnings per share was paid as a cash dividend. Electronic Arts did not pay any dividends and neither did Take-Two. Neither anticipate paying them in the near future either. (EA 2011 10-K, 25; TTWO 2011 10-K, 25)

Summary

Among the video game companies in the United States, Activision Blizzard is the largest. This is a recent development thanks to the merger of Activision and Vivendi Games in 2008. (2010 10-K, 41) Through this report I’ve learned the company is sitting on a lot of cash and even though their liquidity ratios aren’t great, they’re fine in this area. That they appear to use no long-term debt can be a positive and a negative. It’s good that they’re not burdened by debt payments, especially in the wake of the economic crisis, but it could be a cheaper form of financing for them. Yet, because they don’t currently use it, they have nowhere to go but up in this regard. They seem to be a very profitable company too. They beat their competitors and even the industry when it came to profit margins, and their returns weren’t shabby either.

Looking at them from a business perspective, Activision Blizzard seems like a safe company for the next few years. They’ve sorted out their post-merger growing pains and their business looks to have improved each year from 2008 on. They’re the largest company in their industry and they have a number of franchises that are incredibly popular. Speaking of which, looking at the company from a fan and devoted watcher of the industry, it’s easy to feel more wary of them.

They rely very heavily on a few franchises and from 2006-2010, Guitar Hero was one of them. This was an incredibly successful franchise, but Activision Blizzard saturated the market with releases in 2009 and decided to drastically slowdown releases in the franchise. (Pereira, Chris) Currently, their Call of Duty franchise is the most popular game series ever, but if the company doesn’t properly manage it, that honey hole could dry up. But they’ve potentially found another goldmine in Skylanders: Spyro’s Adventure. As long as they continue developing quality products and maintain their strong financials, Activision Blizzard is a recommendable company to invest in.

Activision Blizzard 2010

Following the works cited page are a number of Activision Blizzard financial statements that were sourced from Capital IQ’s Compustat program. Not included are the notes to these financial statements. They can be found in the company’s 10-K which is most easily found through the SEC’s EDGAR database.

Works Cited

"Activision Blizzard 10-K - 2008." Www.sec.gov. Securities and Exchange Commission, 27 Feb. 2009. Web. 22 Apr. 2012. .

"Activision Blizzard 10-K - 2010." Www.sec.gov. Securities and Exchange Commission, 25 Feb. 2011. Web. 15 Apr. 2012. .

"Activision Blizzard 10-K - 2011." Www.sec.gov. Securities and Exchange Commission, 28 Feb. 2012. Web. 15 Apr. 2012. .

"Classic Gaming Expo Distinguished Guest: Alan Miller." Cgexpo.com. Classic Gaming Expo. Web. 22 Apr. 2012. .

"Electronic Arts 10-K - 2011." Www.sec.gov. Securities and Exchange Commission, 24 May 2011. Web. 22 Apr. 2012. .

Pereira, Chris. "Activision to Release Far Fewer Guitar Hero Games in 2010." 1Up.com. 1UP, 10 Feb. 2010. Web. 07 May 2012. .

"StarCraft II Shakes Up S. Korea's `National Sport'" Cnn.com. Cable News Network, 27 July 2010. Web. 22 Apr. 2012. .

"Take-Two Interactive Software 10-K - 2011." Www.sec.gov. Securities and Exchange Commission, 25 May 2011. Web. 22 Apr. 2012. .

"World of Warcraft Subscriber Bases Reaches 12 Million Worldwide." Us.blizzard.com. Blizzard Entertainment. Web. 22 Apr. 2012. .

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