Wednesday, August 18, 2010

Blizzard Made How Much on the Celestial Steed?

The answer may astound you: I have no idea.

You're so full of crap! I wanted to see how much they made on the sparkling pony and now you tell me you have no idea!!!

First of all, I never promised to be able to discover how much ATVI made on sparkling pony sales in Q2, the purpose of taking a look at their financial position is to try and guess how their current financial state will affect their decision making.

The problem I'm faced with in trying to analyze these numbers is that although ATVI is a public company, they are not required to divulge line item expenses from every account within their Chart of Accounts (COA). What the SEC requires them to do they do...nothing more other than a Q&A with high-powered investors. By the way, who knew that Bank of America was an investor in ATVI? Raise your hand if that surprises you.


Still, the figures themselves aren't what are necessarily important, but how those compare with what "the market", or smarty-pants mutual fund managers, thinks they will be. ATVI beat out their own internal figures for Q2 2010 by posting a GAAP net revenue of $967M and $0.17 EPS, but those figures fell short of what "the market" expected. So while on one hand ATVI applauds itself for having a better-than-expected quarter, their stock price takes a hit because it didn't meet market expectations.

That must suck for a company, right? To do better than you expected and knowing that you didn't meet expectations. It reminds me of doublethink, being able to hold two completely opposite viewpoints at the same time and believe in both of them equally. On Aug 2 their stock price was at $11.95 close, and by Aug 6, after the Q2 numbers were released it closed at $10.99.

Students of the stock market will realize that stock prices fluctuate for both fundamental and psychological premises. Investors really do look at revenue, expenses, development costs, leverage ratios (ATVI is in good standing there, they have always had little to no debt), and other metrics to make decisions. But investors are prone to psychological overreactions as well, speculation that the worst is inevitable only to remember that it probably won't happen, but by then it's too late, the stock dropped 10% and they just lost their vacation for the wife and kids. Ooops!

ATVI did something in Q2 that they had never done, they paid out a dividend to investors. Think of it this way, you go to the store to buy some shoes and socks, you come home with some change in your pocket, you kid wants some money to buy an icecream cone so you look through your change and give him some of it to satisfy him/her for the moment. The kids maybe doesn't get the cone they wanted, but they get to buy a stick of gum with a comic on it, how nice. That's sort of how a dividend works, sort of.

Of all that happened during the announcement of the Q2 financial results, the most intriguing was the Q&A with investors. They voiced concerns over assumed high development costs that were to show up in Q3 & Q4 of 2010, which would ultimately lead to less than expected net income figures. In this year end time frame there were to be 3 major releases, Starcraft II, Call of Duty: Black Ops, and WoW: Cataclysm. SC II is supposedly a huge success already, setting all sorts of records. CoD: Black Ops is the most expensive investment they had ever made in a console game...ever, set to be released on Nov 9. Cataclysm, they maintain, is still set to release in 2010.

But haven't they spent money already in devloping these games? Why so many development costs now, right before launch?

I don't pretend to know exactly how they do business, nor specific accounting methods, but I can guess at a few things. The first thing to understand is that unlike your personal finances, where when you go to the store to buy milk, bread, and eggs you call that an expense. A business can spend money, cash even, and call it an asset, expensing it on a later date.

Uh, what? I still don't get it.

Example: You start a business, and you rent office space. The landlord says that rent for January is due December 20. On Dec. 15 you write a check and send it to the landlord. The landlord gets the check, deposits it, and the money comes out of your bank account in December. But this is supposed to be January's rent, not December's. How is this handled by an accountant?

Accountants are master balancers, that is to say that everything they do is based on a formula they try to balance. Your cash is an asset. Rent is an expense. Expenses show up on Income Statements, Assets on Balance Sheets. In December the accounting will look like this for your rent:

Cash Asset Lowerd by $1,000
Pre-Paid Expenses Asset Raised by $1,000

See there, the Pre-Paid Expenses category is an asset, not an expense. In January it will look like this:

Pre-Paid Expenses Asset Lowered by $1,000
Rent Expense Raised by $1,000

At the end of December, that money you paid for January rent is considered an Asset, it has future value. But in January, you lose the future value and you "expense" the rent, which lowers your assets on your balance sheet and raises your expenses on your income statement.

It's the income statement that shows Net Revenues, Expenses, and finally Net Income

Revenues - Expenses = Net Income

What I'm getting at is that there may very well be significant expenses that are still on the balance sheet and have not been "expensed" yet, and won't be until some event happens in the future (i.e. the release of the game) where those expenses are moved and show up on the income statement, affecting the EPS, the net income, and in turn the stock price. Stock prices are future predictors, so if a stock price goes down today it's because the future isn't as hopeful as predicted.

What this means is that although Q2 was good for ATVI, according to their internal figures, outsiders see risk in Q3 & Q4 despite the massive game releases. Expenses will be...expensed, lowering net income, potentially harming dividends and their ability to buy ice cream.

Cataclysm WILL be released in 2010, ATVI can't affort to NOT release it. Despite any deferred income or expenses that will affect the net revenue and net income, there are investors to think about and keep happy. Stock prices are, after all, part psychological, and if the investors are happy stock prices go up.

I was going to put up all these figures today, and compare this number this time of year to the numbers at the same time last year. You can still find them here and here. I'm open for any questions on those boring numbers any time you like. I felt like it was important to look at not only how some financial figures are arrived at, but what the different parties (investors, internal managment) looks at them.

I will never know how many sparkling ponies were sold. I do know this, in a short answer in the Q&A they made a tiny reference in how pleased they were in some of the value-associated transactions, or transactions outside of subscriptions. Given that there were no major game releases in Q2, what is left, aside from intellectual property income, are many of these micro-transactions. So, if you want to know, it seems that the server transfer, pet, sparkle mount transactions brought in some good money to ATVI. Good for them!

The next time I do any sort of major financial analysis will be when I get my hands on the year end Annual Report. I may report some Q3 stuff, but will keep any analysis short. It's my opinion that management is feeling the pinch of high-investment costs in their big releases, and need the revenue that will come with a Cataclysm 2010 release. I don't see any way that it won't be released in 2010. If I'm wrong, then I guess I need to get a new line of work. If I'm right then I'll act like I did when I found out Bank of America was an ATVI investor...not surprised one bit.


LarĂ­sa said...

It would have been interesting to get the pony figures, but I suppose it's business secrets. Anyway: thanks for your analysis. And I too still believe in a 2010 release.

Tobold said...

That's sort of how a dividend works, sort of.

That comment makes me doubt your otherwise remarkable financial knowhow. I own shares whose share price doesn't go up very much, nor does it fluctuate a lot. But the company pays dividends every year, and the annual dividend is nearly 6% of the share price. Thus dividends in cases like that isn't pocket change, but the principal income you get from holding those shares. And seeing how hard it is right now to get a 6% return with low risk, some companies with good dividends might be one of your best available investment opportunities.

The idea that you only make money on shares through the share price going up continuously has no basis in reality, not if you consider the stock markets in the last 25 years instead of selectively quoting just the golden periods.

The Chilly Hollow Needlepoint Adventure said...

What do you make of the fact that Activision paid out their first dividend ever last quarter? For me this is a flag but I have no idea what it means.

Gronthe said...

@ Larisa: Yep, it's difficult to impossible to get the real detailed figures, but from their conversation with investors it sounded like they were happy with those sales.

@ Tobold: I do realize that it does not require continually rising stock prices to make money on shares, I really do. You can make money on shares via dividends, long or short selling, all ways are potential income streams from stocks.

There are many companies which regularly pay annual dividends, and some that never do. Dividends are a luxury enjoyed by stockholders, however, and are quite different than the interest payments received by bond holders (who take priority over stock holders). If a company pays a dividend, I do understand that it the only relation to the stock price is the percentage of the share price that's paid out, but also that whether or not a dividend is paid is based on other various factors, one being liquid, short-term assets such as cash.

You are very fortunate to receive a dividend, and in today's economy to find a company that has a history of paying dividends may be a reason to invest in those stocks. If I, personally, wanted a steady income stream I'd invest in the bonds, which have contractual interest payouts, once or twice a year. Dividends can start and stop at the will of management, there are no contracts, like there are with corporate bonds, that says dividends must be paid, and the company can stop paying you dividends any time they want, regardless of their share price, if other fundamentals of the company could not withstand a dividend payout.

Some companies actually do follow a residual method of dividend payout. If they have a project and they plan to finance it with equity, if there is equity left over after the project is completed the residual equity can be paid out as dividends. Which means, my "pocket change" example is not all that bad nor completely untrue, but admittedly it may not have been the best example or means to explain things. Residual dividend payment is not the "only" method or reason of dividend payout. It seems that the company you've invested with wants to reassure their stock holders that the business is strong, has good cash flow, and hasn't over-leveraged themselves on their investments. So they pay you a dividend because they can, the stock price not being the reason they pay, but to keep you happy because they have the resources to do so.

By the way, did you know you're paying more taxes on those dividends than you would with capital gains or interest? 6% less taxes = real rate you’re getting on those dividends. I'd love to discuss this further; but I may be running out of room. Thanks for stopping by, it's good seeing you in my little cubby hole of the internet.

@TheChilly...: That ATVI paid a dividend for the first time ever tells me a few things. Most importantly, however, is that they may be trying to get a jump on making their investors happy knowing that they'll have to expense many of their development costs in the upcoming quarters. For a company who's never paid a dividend, paying one is supposed to be an assurance to the investment community that "hey, look at us, we're doing really well and wanted to share the love. Please keep pouring in the equity to finance our ever-growing-expensive projects."

It can be taken as both good and bad. Good that they have the resources to do it, and bad because it's coming at the doorstep of the biggest half year probably in the history of their company, in both revenue and expenses. It's good to be skeptical.