“Motley Fool’s #1 Stock… overdue for more dramatic growth?”

By Travis Johnson, Stock Gumshoe, December 15, 2009

The Foolies are really ramping up their advertising again, it seems — I haven’t had this many questions about a teaser in quite a while. The ad now is for their flagship Stock Advisor newsletter, and it teases “The Motley Fool’s #1 Stock”. Here’s how they get us started:

“While America is captivated by the Twilight craze — the holiday blockbuster that’s breaking box office records — another craze has quietly blown these records out of the water! Handing The Motley Fool’s #1 company $555 million in just 5 days!

“Though you won’t hear about it on the Today show, members of our community of individual investors know this company’s name well — because it’s made them very wealthy! Discover this incredible opportunity and why it’s overdue for even more dramatic growth…”

Hotter than Twilight? Color me intrigued! As usual, they provide lots and lots and lots of blather to back up their teaser pick (without, of course, naming the stock — but don’t worry, after I make you sit through my blather for a moment I’ll be happy to reveal the company’s name and ticker, no charge!)

Here’s the preamble:

“To do this amazing story justice, I must start at the beginning…

“Back in the summer of 1979, four men made a startling discovery that would forever change their lives…

“One day while eating lunch, they read over an internal memo that revealed their company’s top selling products of the year.

“After some quick math, they figured out that the products they created were responsible for about 60% of the company’s total revenue — just four guys generated 60 million dollars!

“These four gentlemen now had concrete evidence of their value to the company. So they went to the CEO seeking a fair share of the profits or at the very least, a raise.

“But, amazingly, the CEO was not impressed — not even a little bit.

“He called them a bunch of “prima donnas.” And said they were no more important to his company than the people on the assembly line who put the product in the box.

“He refused to give them a penny more than their $20,000 salaries.

“It was then that these four men – who would become known to industry insiders as the ‘Gang of Four’ — did something most of us only dream of doing…

“They quit their jobs and went into business for themselves – as a direct competitor to their previous employer!”

The American dream, right? Take your ideas, make your millions, throw your success in your former employer’s face … good stuff. And more or less true in this case (I don’t know the specifics — like, whether or not the CEO actually called them “prima donnas”).

And we go on to get into some specifics, and some additional temptation to get you to subscribe to their newsletter and buy this stock:

“I’m talking about investing in an innovative company that will go on to dominate this new industry and continue to grow for years and years.

“I’m talking about the chance to earn enough money to pay off your mortgage or send your kids to any college they want!

“And The Motley Fool’s #1 Stock is this opportunity. In fact, The Motley Fool is actively recommending our members pick up more shares right now — and you can join us for the ride!

“Because it’s the very best stock in a sector that has tremendous growth potential in the months and years ahead. As the CEO of this industry’s trade association says, this is…

“An ‘unprecedented opportunity — one that must be grasped.’

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“Listen, I wouldn’t waste your time with a company that didn’t have a lot of room to run. Or without specific catalysts to get it moving. Well, this company’s potential is threefold…

“It’s cheap: Barron’s calls it “inexpensive” despite record sales and the company buying back nearly $300 million in stock last quarter. It’s trading for less than 15 times 2010 earnings — amazing for a company that’s projected to grow its earnings 18% a year over the next 5 years!

“It has blockbuster potential: The $555 million sales record I mentioned earlier was just the beginning. This company has three more product launches coming down the pike. Our analysts estimate these launches will move 35 million units — handing this company over $2 billion in sales in the next 12 months!

“It’s acquisition hungry: According to Bloomberg, this company’s management is on the hunt for acquisitions. It has billions in cash reserves and $0 in debt — making it easy for this company to gobble up a competitor or rising start-up.

“Plus, not to mention, this company is the dominant player in an industry that’s projected to double in size by 2012. Making this the perfect investment for right now. All you have to do is hold on to it and watch it compound your wealth year after year — handing you an incredible return!”

So which company are they teasing? Well, just to be sure I tossed all that exciting info into the Gumshoe’s mighty Thinkolator … but as I suspected, this is indeed a stock that I’ve been following for a while:

Activision Blizzard (ATVI, click here for a free trend analysis on ATVI by MarketClub — they don’t think the technicals look so compelling right now)

Frankly, like the Fools I’m also surprised that the stock is still this cheap. This was a stock I profiled for the Irregulars as my “Idea of the Month” just over a year ago — and it’s essentially priced the same now as it was then, which means it’s trailing the S&P 500 pretty significantly.

The four “prima donnas,” who were the guys developing games for Atari’s revolutionary 2600 and their other machines (Atari was then owned by what is now Time Warner), were David Crane, Larry Kaplan, Alan Miller and Bob Whitehead, and they left to form Activision in the late 1970s, becoming the first third-party developers for console video games — a reaction, in part, to the corporate dominance that had Atari making all the games for its own consoles, and not crediting the game developers at all, either intellectually or financially, for the huge success of hit titles. (You can read up on Activision history at Gamasutra here if you’re curious about the “Gang of Four” details.)

It was terrible timing, in retrospect — Atari effectively collapsed a few years later (though the name has been bought, re-bought and rejuvenated a number of times since), and the video game industry almost disappeared within a few years and drove lots of companies into bankruptcy thanks, in part, to massive oversaturation of the market in 1983 (which itself may have been brought on indirectly by Activision, which won its court case to open up development of console games in 1982, released the huge hit Pitfall in that same year, and perhaps opened the floodgates to other developers).

And there have been many other game publishers that have come and gone in the decades since. Activision Blizzard, which took its current corporate form after merging with Vivendi’s Blizzard gaming unit about a year and a half ago, is still the largest third party game developer and has created some massive recurring hits like Guitar Hero and the “Twilight-beating” hit they tease, the most recent release in the Call of Duty franchise (Call of Duty Modern Warfare 2). That one indeed shattered sales records — I’ve seen reports of that $550 or 555 million in the first five days, but the big number that jumped out for me was $310 million in the first day of sales in the US and UK, dramatically outpacing the opening weekend of any Hollywood hit movie … and the game seems destined to be one of the few entertainment properties in history to end up with sales over $1 billion — it’s obviously easier to get there at $50 a pop than it is selling $15 records or $10 movie tickets, but still impressive.

But to add to that hit-making ability, which has led them to pour development money into creating and expanding big game franchises like Guitar Hero (and now DJ Hero), Call of Duty, Tony Hawk, James Bond and others, Activision Blizzard is now also benefiting from what I expect is probably still the largest online subscription game platform in the world, Blizzard’s World of Warcraft, which along with Call of Duty is their largest franchise, and which creates a much more stable, ongoing cash flow from huge numbers of players who subscribe and pay a monthly fee to play the game and develop their characters, socialize with other avatars, and complete their quests, or whatever it is WoW folks do. And as a bonus, this kind of PC-based multiplayer online gaming is dominant in China and elsewhere in Asia, so ATVI is perhaps better positioned in those markets than are the firms that have more of a console-only focus.

ATVI was a little bit difficult to value a year ago when I first profiled the stock, but it’s far easier now that they’ve been a corporate entity for more than a year. The financial sites tell us that their trailing PE is 44, but that’s largely due to an accounting loss in the December 2008 quarter, when they usually make most of their annual income — analysts expect them to earn an average of 64 cents in the current calendar year and 77 cents in 2010, so, if that’s accurate, the current year PE might be about 17, and the 2010 estimated PE about 14 — a significant value if the analysts (and the Motley Fool) are right and the company (and industry) can grow by between 15-20% a year.

ATVI is much bigger than its largest pure-play competitor, Electronic Arts (ERTS) — ATVI has a market cap of almost $14 billion, ERTS is closer to $5 billion. The two have similar forward valuations, though ERTS did more poorly in earnings over the last twelve months and may be more of a turnaround story. Electronic Arts is still identified primarily as a makers of sports games, particularly the Madden NFL franchise that’s a perennial hit, and sales have disappointed for some of their newer games and they were perhaps slow to get on board in developing casual games and Wii games, but they do have a broad stable of games for all the consoles and, like ATVI though less prominently, they do also have subscription-based games that are doing well in China.

ERTS is cheaper than ATVI based on price/sales (1.4 versus 3.3, perhaps partly because Blizzard’s subscription revenue is more valuable), but ATVI is substantially cheaper when priced as a multiple of book value and cash flow — ATVI is priced at 1.2X book value and 23 times cash flow, ERTS shares change hands now at 2X book and 50X cash flow. ERTS stock has done slightly worse than ATVI over the past year, but the two have mostly traded in some sympathy with one another. Smaller competitor Take Two Interactive (TTWO) has performed a bit worse still, and served as a cautionary tale about relying on just one or two games (in their case, Grand Theft Auto and Major League Baseball). ERTS was also covered in this space a couple months back, when it was teased as a “Pit Bull” pick by the folks at Mt. Vernon.

Activision Blizzard is one that I’m probably quite biased about, still, because I still think it’s silly that the shares are this cheap — but I don’t personally own the stock. I might have to remedy that situation at some point in the future, though of course I won’t trade in the shares for at least three days per my own disclosure and conflict rules.

On the downside, of course, this is a hit-driven industry, and ATVI is very hit-focused for such a large company, with a definite predilection for throwing more money and development behind proven concepts and franchises and cutting short development of games that don’t find an audience, so if Guitar Hero or Call of Duty collapses on the next sequel, that’s a big part of their income … and if World of Warcraft loses it’s legendarily loyal fans, that’s a lot of cash flow that falls quickly off the books. But frankly, I don’t see any evidence that video gaming will slow significantly as a global business, or that the dominant game publishers like Activision will stop churning out popular hits — with perhaps the occasional glitch.

There is also an argument that the increasingly ubiquitous casual games on your iPhone and facebook, or even the Nintendo Wii, will nudge out the real “gamer” consoles, and that publishers will suffer as games get better and have longer playing lives so they have to be updated less often — in fact, one of the other Motley Fool analysts recently reiterated this anti-publisher argument, so perhaps that can give you fuel for some of the skepticism that I’m apparently not providing this time around.

And now’s probably a good time for some of you to supply the jaundiced eye that I usually turn to teaser stocks, and reveal my blind spots in looking at Activision Blizzard — have at it, the comment box below awaits your contributions.

P.S. Lest we forget, the Stock Gumshoe Reviews site is eager to hear what subscribers think of this or any other Motley Fool newsletter — click here to share your thoughts, or see the opinions of current subscribers


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Timothy I
Guest
Timothy I
December 16, 2009 8:53 am

Technically, ATVI has been in a consolidation channel for about 6 months. Right now it’s sitting right on support at 10.80, so this would be a low-risk entry for a bounce to the top of the channel. Target 12.50, stop loss 10.20.

If it breaks out above the channel this time, target is ~$15.

Stevie B
Guest
Stevie B
December 16, 2009 9:22 am

My 15 year old son has been looking at ATVI to add to his portfolio – he & I think its quite cheap and was wondering if there was some underlining problem like Pfizer – nothing in the pipeline. And as always Travis the pleasure is all ours!

SageNot
Member
SageNot
December 16, 2009 10:56 am