Wednesday, June 16, 2010

Some Financial Facts...and some Speculation

Financials: Known as the various kinds of financial reporting instruments both required by law and required by usefulness. Not a textbook definition, but a practical one. Accountants and Management look at and analyze financials and use them as a tool for both understanding what has worked for the company but also how to proceed as to operations and strategy for the future.

We recently learned that Blizzard has drastically changed the upcoming Cataclysm feature Path of the Titans. It’ll still be there, but not really. This and a couple other omissions have left some people wondering whether Blizzard is pushing too fast to release Cataclysm, while others stand by Blizzard’s PR people in saying that the expansion “will be released when it’s ready.”

So what’s the truth? If you’re smart you must realize that the truth is always somewhere on the spectrum between two extremes. Maybe a better question is: How much influence does ActivisionBlizzard’s (I’ll use ATVI, it’s stock symbol for the rest of the post) upper management have on the development and release of Cataclysm? To get close to the answer, I believe, will require us to understand their Financials. So let’s get to it. (All my data comes directly from ATVI’s financial statements on their website and from

A rather common but erroneous measure of a company’s financial position is its stock price. I’ve put in a graph of their stock price over the past 12 months. What do you notice?

For one it appears that the stock price as been A) Trending lower and B) Volitile. That is until you realize that over a five year period it’s gone from 6.87 to 14.85 to 8.64 to around 11.20 today. Their stock price has always been volatile, but during that same period there has definitely been a significant RISE in player subscriptions. So just looking at a stock price won’t tell us if Management is putting the pressure to release.

I like that show, but it’s moving to Sunday night on TNT so I don’t know if I’ll remember to watch. Oh, not that Leverage, financial leverage or debt. ATVI is actually in a good position. They actually do not incur any long-term debt, and their current ratio is a solid 2.91. Current Ratio measures the ability of a company to pay off short-term debt. Calculated by dividing Current Assets / Current Liabilities (Current = less than one year).

What this means that in the short term if ATVI ran into some small financial trouble, they would have sufficient assets to pay off what they owed and keep themselves afloat. ATVI also maintains a significant cash reserve, but even according to admitted risk factors, a significant drop in subscribers could easily completely use up their loss reserves, which is an undesirable event. But overall their leveraged positions are strong, there’s not much there to worry management.

Now we’re getting to the meat of the issue. Earnings and all the factors and measurements off earnings are a tool managers use to strategize and make decisions. Not to say earnings are the sole factor, any analyst knows that you actually use ALL financial data and relevant reports to reach any conclusions. But expected future earnings are a factor in stock prices, which is good for shareholders.

AVTI breaks down their revenue into two categories: 1) Product Sales, and 2) Subscription, Licensing and Other Revenue. #2 is a broad range of income and consists of income generated through their relationships with retailers and other outlets and developers. Product sales are pretty self-explanatory, I hope; they sell a box of WotLK and they call that “Revenue”.

The Net Revenue over the past five years looks like this (in Millions):
2009 - $4,279
2008 - 3,026
2007 - 1,349
2006 - 1,018
2005 - 780

Consequently their Net Income (Loss) for the same time period looks like this:
2009 - $113
2008 - 107
2007 - 227
2006 - 139
2005 - 45

Per AVTI’s financial reports:

Cash Flows from Operating Activities
The primary drivers of cash flows from operating activities have typically included the collection of customer receivables generated by the sale of our products and our subscription revenues, offset by payments for taxes and to vendors for the manufacture, distribution and marketing of our products, third-party developers and intellectual property holders, and to our workforce. A significant operating use of our cash relates to our continued investment in software development and intellectual property.

AVTI even exceeded Q1 2010 expectations by posting $1.3B in Revenue (1.1B expected), with total cash and investments totaling $3.4B (3.3 expected). They anticipate $700M for Q2 and $4.2B for the entire year 2010. Additionally, their EPS (or earnings per share) have also exceeded expectations. So financially speaking, they are reaching their goals for revenue and even recently exceeding their expectations. That’s got to have management in a good mood. As part of their expectations they still anticipate to release Cataclysm in 2010, so whatever revenues generated from those product sales are included into their $4.2B estimate.

Unfortunately, AVTI’s P/E Ratio is not one of the best in their industry. Yes, there are future expectations of revenue, but there are significant risks to AVTI’s products and operations. In their own words, let me share what they see are some, just some of those risks. These may seem obvious, but to see them written and admitted to makes them legitimate and worth consideration.


* A continuing deterioration of general economic conditions could result in a reduction in discretionary spending by consumers that could reduce demand for our product.
* We depend on a relatively small number of franchises for a significant portion of our revenues and profits. (i.e. Call of Duty, Guitar Hero, and World of Warcraft account for approximately 68% of all net revenues for the year ended Dec 31, 2009. Additionally, revenues associated with the World of Warcraft franchises accounted for 98%, 97%, and 97% of Blizzard’s consolidated net revenues for the years ended Dec 31 2009, 2008, and 2007 respectively)
* A substantial portion of our revenue and profitability will depend on the subscription –based MMORPG category. If we do not maintain our leadership position in this category, our financial results could suffer. To remain a leader in the MMORPG category, it is important that we continue to refresh World of Warcraft or develop new MMORPG products that are favorably received by both our existing customer base and new customers.
* The future success of our business depends on our ability to release popular products in a timely manner.
* If our products contain defects, our business could be harmed significantly.

Bored yet?

I hope not, because simply by looking into their financial reports we see a few interesting things. First is that without WoW, Blizzard would fail…at least as we know them now. Unless they introduced something else to take it’s place, they still rely on product sales and continued subscriptions of WoW to keep their business a viable business. They are very interested in making a good product. VERY. They realize that if they send Cataclysm to the retail floors of Wal-Mart, Target, GameStop, whatever that it needs to be a product with as few defects as possible and a gaming experience worthy of the subscribership they need to remain financially viable.

I’ve thought a lot about this, and I think I realize that the truth definitely is in the middle on this one. Yes, top brass is whispering in the ears of the developers to get the product launched in the time they set forth who knows how long ago. In the meantime, the devs are working their brains off to get it done…THE RIGHT WAY. I don’t envy them in the slightest. It can’t be an easy job to satisfy enough people to earn over 4 billion a year in revenue. Yet each year they seem to meet or exceed their revenue goals. Now there are other financial factors that are incredibly boring to discuss at the moment, so I won’t ever go there.

But I think it’s clear that they are trying. I don’t think they scrapped PotT because they couldn’t meet a deadline, financially speaking it’s better for them to put out a good product than to put out a product by X date. So in a way I believe it when they say that it “will be released when it’s ready”…as long as it’s this year so that the shareholders get their money’s worth!


LarĂ­sa said...

I'm not an economist at all, and not deeply intrested in numbers either, but this was still a good read. Thanks for diving into those numbers! I wouldn't mind if you kept mining a bit more, maybe you can find some more nuggets that we miss out since we normally don't read any further than the latest patch notes...

Gronthe said...

@ Larisa: I didn't want to go over anyone's head, I realize not everyone is proficient in finances, so I kept it super-simple. The thing is, there's A LOT to be inferred from Financial Reports. Investors often know more of what's going on in a company than we, the end user.

I'll definately dig more and try to present stuff in a way that's easy for people to understand.

Ruhtra said...

Well written article and completely true with what you said.

Gronthe said...

@ Ruhtra: Thanks :)

I can't wait for their Q2 financials to hit the market. They have about two weeks after Q2 close to disclose initials to the SEC, so the data coming out of that will be significanly more relevant than anything we have so far.

Anonymous said...


I think that it is interesting to note that with such good revenue for FQ'10 ($1.3B) and anticipated revenue for 2Q'10 of approx. $700M that ATVI has/will have almost made 1/2 of their YE goal revenue of $4.2B in the first 2 quarters (right on pace). Arguably, 2Qs are probably the worst revenue cycle period for MMOs (at least in the US) as people take hiatuses (hiatusi?) to do real life things like vacation, kids home, etc. I think, if anything, due to the successful 1Q, developers are now in a better position than the bean counters to dictate release date. What this indicates to me, and goes against my original prediction of a black Friday CAT release date, is that if revenue numbers continue to trend for ATVI as they are, it would not be totally unheard of for ATVI to take a slight revenue hit for FY 2010 and open up with a highly polished CAT in 1Q'11 and, quite frankly, have potentially unheard of revenue income that could easily carry the company for a year to 18 months. Again, however, this is just idle speculation from an armchair financialist.


Gronthe said...

@ Anonymous: You do make good points. Is, as you know, really difficult to predict anything. I admit that all my presumptions could be wrong, but I attribute that to not having analyzed every line of all their balance sheets and income statements and every note made by every auditor and staff accountant.

WoW's contribution to net income in 2009 could very well be different in 2010 (but not drastically). Most assuredly their contribution to net income will most likely decline in Q2 & Q3 since, as ATVI states, WoW's revenue is seasonal.

If they are not factoring in Cataclym's release their numbers may or may not hold to expectations. However, even though I did not list it here, in their financial reports they do clearly and definatively state that Cataclysm will be released in 2010, which means that it's safe to conclude that their revenue figures include that release for all FY 2010.

Thanks for your contributions, very welcome on the subject.

Talarian said...

I was looking at the net revenue chart and thinking to myself, "When did Activision and Vivendi merge?" Oh, it closed partway through 2008. Now, I dunno when exactly their fiscal year lands on, but that explains the massive jump in Net Revenue from FY07 to FY08, though interestingly enough Net Income went *down*, and more importantly, stayed down. I'm curious as to what explains that particular anomaly. I'm not economist, so I may be interpreting it incorrectly, but either ATVI decided to start throwing large amounts of money at something, or Blizzard was not actually making that much money over operating costs to begin with.

Gronthe said...

It's difficult to understand unless you're looking at the segmented income statements. Segmented meaning they split the Activision Revenue and Expenses from the Blizzard Revenue and Expenses. Blizzard's gross revenue from 2007-2009 actually didn't change very much.

The effect on AVTI's net revenue is in large part due to a few factors. 1) A massive increase in product development costs, 2) increases in costs of royalties and amortization, and 3) intellectual property licensing. There was also a pronounced increase in marketing and advertising, which is expected in a merger where the combined forces are spreading the word on their power-deal and superior, combined products. The increases weren't necessarily from the Blizzard side, although Blizzard's segmented expenses did increase during this period as well. With increased costs, even with increased revenues, leads to little change in Net Income.

Another thing that you need to consider is there is a difference between Net Income and Cash Flow. Two very different things from an accounting perspective. Blizzard has always maintained significant cash reserves and keeps their assets liquid to better combat short-term and seasonal variances in cash flows.

The financial data is HUGE, just enormous to wade through and give a real, true, in-depth analysis. With more time and the soon to be released Q2 numbers, hopefully I'll be able to give more clear and pointed information that can help us see into the decision making process of Blizzard from a financial point of view. What I posted in this article is peanuts compared to the data available.

Anonymous said...

A very interesting read, thanks for drilling the numbers. I'm very curious to find out what impact the Celestial Steed has made to their figures. On the face of it this is practically money for nothing, minimal development costs and if the sales figures which have been rumoured are to be believed it puts a sizable amount onto the bottom line. I would expect to see similar releases on at least an anual basis going forward.
Any idea whether we would expect the revenues for the steed and the paid for pet to show in Q1 2010 or Q2?

Gronthe said...

@ Arleff: Being a public company AVTI has deadlines to meet in reporting to the SEC, and by extension, the market (i.e. us, the waiting public).

It may be difficult to get drill-down data on things like Celestial Steed, but it may be possible. Once Q2 financials are posted I'll do all the research I can to find that.

Q2 should be due within 1-3 weeks in July. Each company has a different deadline and each company has a different strategy in reporting it to the public. I'll stay on top of it.