Activision Blizzard, Inc.

Transcription

1 Price USF SMIF Investment Report November 15, 2012 NASDAQ: ATVI Activision Blizzard, Inc Target: $ Target: $ Intrinsic Value: $22.39 Key Statistics Price (11/13/12) $10.72 EPS (TTM) $0.77 Div Yield 1.68% Market Cap $11,928 M Price/Earnings (TTM) Beta 0.79 Shares Outstanding 1,112 M Price/Book (MRQ) 1.09 ROE 8.36% 52-Week Range $ $13.00 Price/Sales (TTM) 2.67 ROA 5.07% Business Summary Activision Blizzard (ATVI) is a leading global publisher of interactive software for online, console, computer, handheld and mobile platforms. ATVI focuses on the development, marketing, and sale of top titles for console, handheld, and mobile platforms. Blizzard is primarily focused on production of top massively multiplayer online role playing games (MMO's) and other computer based role playing games (RPG's), with the hit title World of Warcraft (WoW) making ATVI the leading publisher of online gaming software. Thesis Year Historical Stock Price Sep. 8, 2008: Split 2:1 Risk Undervalued: Debt-free profitable firm in an out-of-favor industry, expanding on its ability to generate significant free cash flows. Growth: ATVI is well positioned in all of its regional markets to adapt and generate wealth off a dynamic market. Dynamic: ATVI is able to generate revenue from an increase and expansion of its user base during improving economic conditions and foster loyalty during poor economic conditions Diverse Portfolio: Over 350 current and past IPs on multiple platforms attracting users across demographics Competitive Advantages: In terms of the moat it has created for itself and resources on hand. A decline in popularity of any top franchise can significantly affect revenues. A large portion of revenues come from World of Warcraft subscribers, if numbers of subscribers decline significantly, this will adversely affect ATVI. Failure to adapt to changing technology will negatively affect revenues. New titles demand high development costs, if Titan or similar products fail, ATVI risks being unable to cover costs. Interests of majority shareholder Vivendi may conflict with those of shareholders This report prepared by Evan Burroughs, Santiago Correa, & David Garrett Page 1

2 Company Structure ATVI operates through three segments: Activision Publishing, Inc., Blizzard Entertainment, Inc and Activision Blizzard Distribution. The company was founded in 1979 and is headquartered in Santa Monica, CA. Activision Publishing Activision Publishing is a leading developer and publisher of interactive software and content. Activision sells games both through retail channels and through downloadable content. Games are provided for console systems including Xbox 360, PlayStation 3, and the Nintendo Wii. In addition to these consoles, Activision sells titles for PC, Apple ios devices, handheld Nintendo systems, and other mobile devices. Call of Duty (COD): The release of Call of Duty: Modern Warfare 3 in November of 2011 generated a record $775 million of sales in the first five days after release, becoming the fourth consecutive release from the COD franchise to generate record sales. As of the end of 2011, The COD franchise had generated over 6 billion dollars of revenue. We can expect the November 13 release of Call of Duty: Black Ops 2 to continue to provide strong revenues from the Call of Duty franchise. It is projected to become the bestselling video game ever based on record pre-order sales trending at retailers. Skylanders (SKY): Skylanders: Spyro's Adventure has been the number one selling game thus far through SKY is a new concept that combines video games with toys, creating an entirely new gaming experience. There are currently 98 SKY figures that include regular, limited edition, and giant characters. ATVI is working on the next game in the franchise titled "Universe"; it is currently operating in the beta phase. SKY figurines start at $9.99 and each new character bought opens up new gameplay for the user. Because each toy comes with a specific code, they cannot be duplicated. Blizzard Entertainment Blizzard Entertainment is a subsidiary of Activision that is the leader in subscription based Massively Multi-Player Online Games (MMO s) both in the size of subscription base and revenues generated from subscriptions. Blizzard also develops PC-based strategy games, such as the Diablo and Starcraft franchises. ATVI receives predictable revenues from recurring subscription charges, prepaid cards, and miscellaneous in-game customizations. Sources of revenue also come from retail sales of physical products, online download sales (DLC), and licensing of software to third-party companies who distribute games amongst diverse markets. World of Warcraft (WoW): WoW is the highest selling, and most profitable Multiplayer Online Role Playing Game (MMORPG) of all time, generating approximately 28% of Activision's net revenues and approximately half of OCF. Users pay a $15 monthly fee in order to play, and can pay other fees to make changes in game and access new content (microtransactions). WoW peaked at 12 million users. The number had decreased to 9.1 million as of September However, later in September, The release of the "Mists of Pandaria" expansion pack sold almost 3 million copies in the first day, and boosted World of Warcraft subscribers back over the 10 million mark once again ATVI s ability to sustain titles between releases is exemplified. Activision Distribution Activision distribution maintains warehousing space, logistics, and sales distribution services to third-party distributors, Activision publishing operations, and manufacturers of entertainment hardware on the European continent. Revenue by Division (US$ Millions) 2012 (est.) Activision 2,624 (56%) 2,828 (63%) 2,769 (58%) 3,156 (66%) Blizzard 1,748 (37%) 1,243 (28%) 1,656 (34%) 1,196 (25%) Activision Dist. 343 (7%) 418 (9%) 378 (8%) 423 (9%) Total 4,715 (100%) 4,489 (100%) 4,803 (100%) 4,775 (100%) Page 2

3 Video Game Consumer Profile Competitive Moat Source: ESA Percent of Players by Age >35 37% % <18 32% Age: Contrary to the popular stereotype that most gamers are children and teens, the average gamer is 30 years of age. The average age of the most frequent game purchaser is 35. Gender: Females represent 47% of the gaming population. Of the most frequent game purchasers, 48% are female. Type of Games Played Most Often DLC 14% MMORPG 12% Action, RPG, Strategy 28% Puzzle, Trivia, etc. 46% Gamer preference trends toward top titles that demand high development costs to produce. ATVI maintains an advantage of large cash reserves and high revenues to continue development. ATVI s established titles include several of the highest grossing games on the market in the most popular interactive entertainment segments. ATVI has consistently turned out some of the most innovative titles on the market and is capable of attracting some of the best production talent in the world. ATVI owns over 350 IP and brands, many of which have strong brand recognition. Initial costs to create a franchise from scratch are quite substantial. Maintaining successful a franchise with multiple titles is considerably less capital intensive, if done effectively, as ATVI has continued to do, unrivaled cash flows can result. Licensing fees to produce games for different consoles are expensive, preventing new companies from entering the console gaming market. MMORPG s such as World of Warcraft require expensive server housing and maintenance costs in order to host the millions of active players with a stable gaming experience. Source: ESA Other customer statistics: 42% of gamers believe that computer and console games provide the best entertainment value for their money when compared with DVD s, music, or going to the movies. 78% of gamers who play with others do so for an hour or more per week over what they would otherwise play. The average number of years most gamers have been playing is 12. Page 3

4 Supplier Power Threat of Substitutes Labor in the interactive entertainment industry is non-unionized; however groups such as the International Game Developers Association are actively involved in researching game producer career advancement. ATVI s largest advantage lies in the talent that produces their hit franchises. Activision must continue satisfying worker expectations in order to retain talent. Video game licensers have some power as game producers such as ATVI must pay fees to have their games supported on Microsoft, Nintendo, and Sony consoles. Activision s strong industry profile gives these companies incentive to maintain a positive relationship with ATVI, thus limiting the power of licensers. There is medium threat of substitutes to ATVI, mainly from threat of passive gamers who play leisurely moving to new games rather than sticking with familiar titles. The threat of substitutes for dedicated users is low as they are not likely to abandon a game they have played for several years on account of rival releases. Threat to console games is higher than for MMO s as competition is more intense and the number of top selling competitor titles is higher. The social interaction offered by MMO s far surpasses that offered by most console games. This interaction generally helps create a stronger franchise loyalty among players. Buyer Power Buyer power is transferring from retail outlets to individual consumers as online distribution and DLC grows more popular. DLC generates higher margins for ATVI and competitors and has continued to grow in popularity. Percentage of Game Sales Physical vs. DLC Physical Format Digital Content 20.00% 28.00% 31.00% 80.00% 72.00% 69.00% Source: The NPD Group Standardized pricing of titles across console systems and retailers as well as the higher quality of Activision products that continually attract buyers keep buyer power relatively low. Page 4

5 Macro Implications We believe that it is reasonable to assume that an uncertain future for the global macro economy will trickle down to compressed consumer confidence. Weak consumer confidence is not typically associated with strong consumer discretionary spending; however, we believe that weak consumer confidence also sustains demand for entertainment at a good value. We believe this gives the video game industry a competitive advantage as it provides a cheap per-hour form of entertainment when compared with competing entertainment industries. However, in the near-term, the possibility of a more budget conscious consumer may decrease ATVI revenues in its console segment, as consumers turn to pre-owned gaming that does not contribute to ATVI sales. Relevant Megatrends Digitalization: As more information becomes digitally available we believe gaming will follow the trend, resulting in higher net margin on DLC sales versus retail sales. This will also result in wider availability of products by easing the process of expanding distribution on a global level. Social Media: Online gaming provides massive multiplayer networks that embrace social networking amongst game players; competing for publically displayed achievements, streaming game play for viewing, and encouraging participation. While traditional social networking allows people to stay in touch, the social aspect of gaming, or vice versa, allows people to interact in ways that are otherwise not possible through traditional communication channels. Cloud technology also allows resource intensive games to be used on machines that have low-end processing capabilities as the game can be processed remotely and streamed this technology is considered to be far from perfect and thus will have more effect over the longer-term, as 3D technology will. Emerging Middle Class: Emerging middle classes around the globe result in increased disposable income that can be spent on entertainment. The new middle class in emerging markets primarily congregated in large cities. A city environment lends it-self to indoor entertainment as the size of venue for outdoor activities is less per capita. Cities are often associated with higher crime rates; entertainment that can be enjoyed from the safety of one s home may be favorable. It is also worth noting that that emerging middle classes do not have the disposable income necessary to take lavish vacations or spend carelessly it is reasonable to assume that this increasing demographic will turn to entertainment that offers a value in terms of cost-benefit. Popularity of Mobile Devices: An increase mobile device use for communication, productivity, and entertainment presents both, opportunities and challenges for the video game industry. Opportunities exist in connecting with consumers much more frequently as mobile devices are often more attached to one s person. Challenges are in terms of monetization. Smaller screen size, less compute and graphic power will inhibit certain games that use heavy resources in those areas. Technological Advancements: The expansion of internet in emerging markets and broadband penetration will allow for the continued growth of MMO and cloud based games. Cloud computing affords the ability to save game progress and access games between platforms, be it cell phone, tablet, or PC which seems to have a near-term effect. Page 5

6 The Video Game Industry ATVI Strategy The video game software industry consists of new console games, PC games, online games, and wireless games, as well as advertising within the game. The industry is analogous to the movie studio industry in that sales can be hit-driven and unpredictable. However, ATVI is distinct in that its portfolio of IP provides predictable and significant recurring cash flows from its subscriptions, microtransactions, expansion packs, and add-ons & accessories. PWC research indicated that this industry would increase its global revenue from $58.7 billion in 2011 to $83 billion by The popularity of online and wireless games will hurt the console game market in the near term. The home console and handheld market in North America will continue to realize a year-over-year decline in revenue from $9.6 billion in 2011 to $9.4 billion in The decline can be attributed to aging consoles in the market and new devices on the horizon. The first of which, Nintendo s Wii U will be released this November, followed by Microsoft s next generation Xbox predicted for December 2013, and Sony s PlayStation sometime after. Mobile devices, smartphones, and tablets are increasingly becoming the go-to platforms for casual gaming, driving the demand for wireless games. According to ABI research, the mobile gaming segment is expected to increase its revenue from $5 billion in 2011 to $16 billion by However, monetization of mobile games continues to be an issue. Video game advertising is rapidly growing, driven partly by the growth of social network games and free games. ATVI s stated objective is to maintain global leadership in the development, publishing, and distribution of interactive entertainment software, online content and services that deliver a highly satisfying entertainment experience. ATVI owns the IP of multiple record setting franchises. ATVI intends to continue development of owned franchises in the future. ATVI plans to maintain and build their MMORPG genre by frequently providing new content, game features and online services, as well as to expand the global game footprint to new geographies. ATVI has entered into multiple agreements with IP owners to publish products based on franchises owned by Hasbro Properties Group, MGM Interactive and EON Productions Ltd., Mattel, Inc., and Marvel Entertainment, Inc. ATVI has also entered into an exclusive long-term alliance with Bungie a developer of successful game franchises such as Halo, Myth and Marathon to bring their next big action game universe to market. ATVI is currently developing an expansion pack to its record setting sequel released earlier this year in the Diablo franchise. Additionally, a new MMO game Titan is in the works. ATVI intends to increase its presence in markets that have been traditionally dominated by software piracy such as Asia and monetize former illegitimate players, from traditional PC gaming (easy to pirate) to subscription based content (impossible to pirate). ATVI also intends to expand online gaming content in markets that have not been highly penetrated by consoles, but offer a large PC installed base and growing broadband availability. Page 6

7 The North American Market Regional Summary: The North American market is experiencing robust growth in the wireless game segment. Social Networks and micro transactions are leading drivers. The traditional PC gaming segment is deteriorating as online gaming gains ground. Advertising is expected to grow as it is still considered to be in its infancy in the world of gamin ATVI Regional Highlights: Activate is a new mobile-social platform that will allow gamers to log into Activision's mobile games with either their Facebook account or a separate, Activate-specific account. Activate will offer cloud storage, allowing users to access their saved games on any ios device at any time, as well as conventional social features like friend lists, leaderboards and achievements. New mobile games will have this service and previously release will phase in. ATVI has recently teamed up with Flurry, an analytics firm. ATVI Publishing will release games made by outside developers under the Activision Mobile Publishing brand. The outside developers will retain full control of their intellectual property and Flurry will provide its mobile analytics and advertising platform; ATVI will collect revenues on distribution. ATVI is collaborating with Amazon to offer games for the new Kindle Fire. Skylanders was the first release on this platform. Users have the ability to buy the physical toy figures via microtransaction within the application to unlock the digital characters via Amazon s 1- click purchasing. The physical toy for this franchise will be shipped to the user from Amazon. Continued release of content expansion packs, in-game upgrades, & add-on merchandise across all platforms bridge, what would be a cash-flow gap, between new game releases. A new MMO in the works will eventually release to be alongside the existing WoW franchise. North American Market by Component (US$ Millions) Component E 2013E 2014E 2015E 2016E CAGR Console/Handheld 9,445 11,988 10,836 10,237 9,672 9,474 9,339 9,666 10,105 10,625 % Change Online games 1,747 1,993 2,136 2,329 2,559 2,842 3,150 3,419 3,693 3,932 % Change Wireless games ,024 1,115 1,203 1,287 1,370 1,474 1,574 % Change PC Games % Change Total End-User 12,589 15,630 14,687 14,347 13,880 14,021 14,261 14,923 15,723 16,565 Spending % Change Advertising ,035 1,177 1,328 1,493 1,653 1,828 2,004 % Change Total 13,181 16,404 15,584 15,382 15,057 15,349 15,754 16,576 17,551 18,569 % Change Page 7

8 Europe, Middle East, and African Markets Regional Highlights: The console segment is being challenged by a shift to online and mobile gaming. The online game segment is being driven by increased broadband penetration, growth of social online gaming, and increased digital distribution of content. The wireless market is being driven by the explosion of smartphones and tablets. Retail PC game sales are deteriorating as DLC expands. Advertising is increasing on the popularity of social network gaming. Current Initiatives: ATVI s newest studio in the UK, The Blast Furnace, is polishing dusty IP. Franchises such as Pitfall are being redeveloped for ios. This marks the beginning of the publisher's significant push into tablet and smartphone games development. ATVI has used global celebrities in the past, however, they have recently picked The Intouchables star Omar Sy to appear in the trailer for its Call of Duty: Black Ops II video game to appeal specifically to European fans. On November 17th, Activision will cut the ribbon on the very first Skylanders popup store in Copenhagen, Denmark. In the words of Ian McClellan, Activision's European Marketing Director, ATVI s success in this model will leave the door open for additional franchise-specific stores in the future. EMEA Market by Component (US$ Millions) Component E 2013E 2014E 2015E 2016E CAGR Console/Handheld 9,212 11,180 10,328 9,883 9,534 9,374 9,252 9,520 9,914 10,453 % Change Online games 1,976 2,510 3,021 3,569 4,002 4,550 5,140 5,689 6,274 6,832 % Change Wireless games 948 1,197 1,342 1,467 1,614 1,764 1,927 2,084 2,252 2,421 % Change PC Games 2,653 2,520 2,312 2,298 2,245 2,197 2,162 2,127 2,090 2,060 % Change Total End-User 14,789 17,407 17,003 17,217 17,395 17,885 18,481 19,420 20,530 21,766 Spending % Change Advertising % Change Total 15,087 17,796 17,445 17,736 18,008 18,586 19,261 20,275 21,460 22,760 % Change Page 8

9 Asian Pacific Market Regional Summary: Console segment is currently in transition phase between old consoles beginning a long sunset and new on the horizon. Growth of microtransactions and increased broadband penetration is expected to continue the drive of the online segment. Growing smartphones and tablet penetration is creating healthy wireless demand. The PC game market will continue to decline due to competition from the other segments, most notably online gaming. Advertising on social network games and online games is driving the advertising segment. ATVI Regional Highlights: Earlier this year, ATVI and Tencent Holdings Limited, a leading Internet services provider in China formed a strategic relationship to bring Call of Duty Online to Chinese game players. This is a free-to-play version of the game with intent on capturing microtransaction revenue and hooking consumers on this highly successful franchise. ATVI has also positioned itself to capitalize on the massive gold-farming market by competing directly; utilizing microtransactions. Goldfarming is a practice in which in-game achievement is purchased in exchange for realworld money this is fairly common and lucrative. Developed market customers who wish to save time in earning in game currency of achievements, may be willing to pay considerable sums to the developing country gold farmers who have time on their hands. In 2009, a report issued by Infodev valued the annual gold-farming industry at $4.9 billion. Asian Pacific Market by Component (US$ Millions) Component E 2013E 2014E 2015E 2016E CAGR Console/Handheld 7,742 8,136 8,256 8,188 7,673 7,639 7,648 7,875 8,212 8,691 % Change Online games 4,150 6,282 7,698 9,043 10,121 11,944 13,777 15,786 18,015 20,418 % Change Wireless games 2,519 3,361 4,119 4,929 5,619 6,446 7,244 8,046 8,782 9,495 % Change PC Games % Change Total End-User 15,054 18,407 20,680 22,741 23,958 26,562 29,188 32,213 35,506 39,090 Spending % Change Advertising % Change Total 15,215 18,624 20,942 23,059 24,313 26,982 29,664 32,751 36,099 39,739 % Change Page 9

10 Latin American Market Regional Summary: High piracy rates and expensive consoles will limit the console game market over the near-term. Consoles were released much later in this market than others. The PC game market will be limited by piracy and the increased digital distribution of games. This is the only market where PC gaming is expected to grow, this can be attributed to lower broadband penetration, as broadband penetration grows, it would be reasonable to expect a shift toward online gaming resulting in the monetization of former software pirating. Increased penetration by smartphones as well as improvements to wireless networks will help the wireless game segment. The online segment is being propelled by the increase in broadband penetration, the growth of social network games, and increased DLC. Video game advertising is growing as a result of the increase in the online game market. ATVI Regional Highlights: ATVI maintains sales offices in Buenos Aires, Mexico City, and Sao Paulo. In 2008, WoW was expanded to include localized versions Argentina, Mexico, and Chile, in late 2011 a Brazilian Portuguese-language version was released. Expansion packs are slated to be released in these markets going forward. Players of North American WoW have the option to download the Latin American Spanish language pack and transfer characters to the new Latin American realms this allows for Latin American migrants to connect and play with family and friends back home. Latin American Market by Component (US$ Millions) Component E 2013E 2014E 2015E 2016E CAGR Console/Handheld % Change Online games % Change Wireless games % Change PC Games % Change Total End-User 951 1,175 1,203 1,252 1,307 1,389 1,476 1,584 1,705 1,840 Spending % Change Advertising % Change Total 966 1,198 1,230 1,282 1,345 1,432 1,527 1,641 1,768 1,908 % Change Page 10

11 Analyst Following Current News Activision is currently covered by 38 companies with 26 offering recommendations. These companies include Goldman Sachs, Bank of America Merrill Lynch, Citigroup, Deutsch Bank, Lazard Capital Markets, and Morgan Stanley. Recommendation Buy 15 Buy/Hold 7 Hold 4 Weak Hold - Sell - Source: Standard & Poors Number of Ratings Analyst Consensus vs. Price Performance Analyst consensus has consistently shown positive expectations of future performance, while Activision stock has remained at a fairly stagnant price since price bottoming out at $8.76 per share in January 2009, and reaching a high of $13.49 in October 2011 after the introduction of the Skylanders title. We believe that much of this is attributed to negative news about the industry. Our research concludes that this negative trend is likely a resultant current transition period in an industry that will otherwise experience healthy growth in the long term. 7 November 2012: Activision Blizzard announced better than expected financial results for Q Non-GAAP revenue of $751 million increased 20% YOY from $627 million to led by strong World of Warcraft sales. Q3 EPS of 15 cents rose from 7 cents in Q October 2012: Activision Blizzard announced that Board member Boyd Muir resigned from the company's Board of Directors. Effective as of October 22, 2012, Jean-Yves Charlier was elected as member of the Board. Mr. Muir was a Vivendi designee within the meaning of the company's Bylaws, in accordance with those Bylaws, Mr. Charlier was appointed to the Board by the Vivendi Nominating Committee, a subcommittee of the company's Nominating and Corporate Governance Committee comprised solely of Vivendi Designees. 16 October 2012: Activision Blizzard announced that Board member Stephane Roussel resigned from the company s Board of Directors. Effective as of October 12, 2012, Jean-Francois Dubos was elected as member of the Board. Mr. Roussel was a Vivendi designee within the meaning of the company's Bylaws, in accordance with those Bylaws, Mr. Dubos was appointed to the Board by the Vivendi Nominating Committee, a subcommittee of the company's Nominating and Corporate Governance Committee comprised solely of Vivendi Designees. 3 August 2012: Activision Blizzard announced better than expected Q earnings. Non-GAAP revenues of $1.05 billion increased 51% YOY from $699 million primarily due to record Diablo III sales. Q2 EPS of 20 cents rose from 10 cents in Q July 2012: Activision Blizzard announced Jean- Bernard Levy provided notice of his resigning from the Company s Board of directors effective 29 June Page 11

12 Management Controlling Interest and Institutional Activity Robert Kotick, President and Chief Executive Officer: Mr. Kottick served as CEO of Activision, Inc. from 1991 to 2008 when he became President and CEO of Activision-Blizzard. Under his leadership the merger of Activison and Blizzard created the largest and most profitable interactive entertainment software publishing company. Mr. Kotick s 2011 total compensation was approximately $8.3 million. Thomas Tippl, Chief Operating Officer: Mr. Tippl was appointed to the position of COO in March Mr. Tippl served the purpose of both CCO and CFO from March 2009 to March 2010 and was CFO of Activision publishing from October 2005 until July He has also served in several executive positions at Procter and Gamble Erick Hirshberg, Chief Executive Officer at Activision Publishing: Mr. Hirshberg became CEO at Activision Publishing in September 2010 after serving as Co-CEO at Deutsch LA. Brian Hodous, Chief Customer Officer: Mr. Hodous has served as CCO at Activision since July 2008 in connection with the Activision and Vivendi games. Michael Morhaime, President and Chief Executive Officer at Blizzard Entertainment: Mr. Morhaime was one of the founders of Blizzard Entertainment in 1991 and became President of the company in He served on the committee of Vivendi games from 1999 until 2008, when Vivendi and Activision merged. He became CEO of Blizzard in July ATVI is controlled by Vivendi SA (VIV). VIV is a French multinational mass and telecommunication company. Currently VIV holds 61% of ATVI shares and has publically announced its intention to sell all or some of its holdings of ATVI if it can find a suitable buyer as it is considered a non-core business. In 2011 VIV sold 35 million shares at an average price of It should be noted that the sale of a substantial number of shares on the open market by Vivendi within a short period of time could cause the stock price to decrease, at the least temporarily. Institutional Ownership % Shares Owned: 34.85% # of Holders: 495 Total Shares Held: 387,832,429 3 Mo. Net Change: +10,457,051 # New Positions: 27 # Closed Positions: 23 # Increased Positions: 96 # Reduced Positions: 94 # Net Buyers: 2 Source: NASDAQ Insider Activity There has been no unusual insider trading in the last 12 months. In September of 2011, there was a sale of 1.67 million shares which was the last large sale of insider shares. Since then the majority of insider trading has been new acquisition of shares, while other trades have been in negligible numbers. Insiders hold a total of million shares Page 12

13 Valuation Assumptions Scenario Analysis Two models were used to derive a value for ATVI. A market-risk premium model developed by Aswath Damodaran was used to estimate risk premium. The risk-free rate is based on the 10 year Treasury bond. Beta was calculated by regression of volatility of stock price to the S&P 500 over a 5 year period. Using this information we calculate the cost of equity to be 6.49%. A value for the company was derived using a price to earnings expansion model, in which the latest TTM P/E is expanded upon at a modestly 5% per annum to account for expected market excitement in regard to industry growth for 2014 forward. Using EPS from our forward looking statements while discounting dividends estimated from a conservative payout ratio of.10, this model calculates an intrinsic value of $ This model estimates a target price of $16.13 for 2014 and $21.46 for A value for the company was also calculated by discounting free cash flows to equity. The applicable discount rate is the aforementioned rate of 6.49%. Cash flows to equity were calculated using information from our forward looking statements in conjunction with conservative forward looking estimates of depreciation and liberal capital expenditure s forecasts. A terminal growth rate of 3% was used. This model lent is self to an intrinsic value of $ Pessimistic Probability 25% Revenue Growth -1.78% 2016 EPS $0.91 PE Multiple Price Target $10.93 Expected Probability 50% Revenue Growth 7.78% 2016 EPS $1.28 PE Multiple Price Target $22.48 Optimistic Probability 25% Revenue Growth 10.78% 2016 EPS $1.31 PE Multiple Price Target $27.18 Supplemental Information The objective for this report was to identify and evaluate a firm that we consider to be a Deep Value at today s price. We conducted a bottom-up analysis and identified several firms in industries such as technology, housing, financial, automotive and defense with potential for deep value. Within the technology industry, we identified the PC, semiconductor, and software segment were experiencing a transition phase. We identified ATVI within the software segment and determined the company had strong fundamentals and a depressed price. We attribute this s to the console transition and the growing mobile user base. We think the industry is underestimating ATVI s ability to generate recurring revenue from its devoted followers, and the ability to attract new users by providing an exciting and engaging user experience on multiple platforms. Page 13

14 Income Statements Fiscal year ends in December. In $million E 2013E 2014E 2015E 2016E Revenue Cost of revenue Gross profit Operating expenses Research and development Sales, General and administrative Restructuring, merger and acquisition Other operating expenses Total operating expenses Operating income Interest Expense Other income (expense) Income before taxes Provision for income taxes Net income from continuing operations Net income Net income available to common shareholders Earnings per share Basic Diluted Weighted average shares outstanding Basic Diluted Page 14

15 Balance Sheets Fiscal FYE DEC In $Millions E 2013E 2014E 2015E 2016E Assets Current assets Cash Cash and cash equivalents Short-term investments Total cash Receivables Inventories Deferred income taxes Other current assets Total current assets Non-current assets Property, plant and equipment Gross property, plant and equipment Accumulated Depreciation Net property, plant and equipment Equity and other investments Goodwill Intangible assets Deferred income taxes Other long-term assets Total non-current assets Total assets Liabilities and stockholders' equity Liabilities Current liabilities Short-term debt Accounts payable Accrued liabilities Deferred revenues Other current liabilities Total current liabilities Non-current liabilities Long-term debt Deferred taxes liabilities Other long-term liabilities Total non-current liabilities Total liabilities Total stockholders' equity Total liabilities and stockholders' equity Page 15