Activision- Blizzard - Multiples Analysis

What is Multiples Valuation?

It's time to finally come back to doing some more technical analysis. Since it's been a while, I decided to started of with a simple Multiples valuation to get the ball rolling.Multiples Valuation or the multiples approach to valuation is a method of valuating companies based on the belief that similar assets sell at similar prices. In the case of companies, financial ratios that are calculated by dividing the market value of estimated value of a stock by a specific item in the companies' financial reports. Common ratios used in this approach are: Equity value & Enterprise value ratios. Enterprise value multiples include the Enterprise value to sales ratio, EV/EBIT, and EV/EBITDA. Equity multiples are ratios that examine a company's share price with values that underline the company's performance like earnings,or sales. Common ratios include P/E (price-to-earnings ratio), and P/S (price-to-sale ratio). I learned of these ratios and the multiples approach though Investopedia, an invaluable resource in my finance journey. 

 

Why Activision-Blizzard?

I decided to do a valuation for Activision-Blizzard because as an avid video game fan, I have a chaotic relationship with this company. One on hand, they have contributed to some of my favorite gaming experiences like Overwatch, Hearthstone & Prototype. However, on the other hand, I have grown increasingly pessimistic of the video games industry over the years, and that is in due no part to Activsion-Blizzard's business practices. One example of note is of Activision-Blizzard firing 800 employees in early 2019 after making $7.5 billion in revenue and $1.8 billion in profits, a record high for them at the time. This event is even more egregious when I realized that Bobby Kotick, CEO of Activision-Blizzard, in 2019 made about $30 million in salary. Making him one of the most overpaid CEOs in America. The situation is so bad that even shareholders of the company have staunchly stood against him getting paid even more through equity packages. This is because Activsion-Blizzard continue to not communicate pertinent information on performance targets on its Short Term Incentive Plan. 

Why these companies?

I think that's enough on my opinion on the company, now let's get back to the topic on hand. The companies I used to make this comparison are: Electronic Arts (EA), Ubisoft, Take Two Interactive, & Square Enix. Activsion-Blizzard and EA make sense in a comparison because they are the largest video game publishers in the US, and directly compete with each other in multiple genres. Call of Duty is one of Activsion-Blizzard's biggest breadwinners and it directly competes in the FPS (First-Person Shooter) genre with EA's Battlefield series. Another apt comparison can be made with Activision-Blizzard's  Overwatch, a multiplayer FPS game where you play as a unique Hero of your choice, and EA's Apex Legends, a game catering towards a similar niche. Both these games take advantage of a monetization technique known as misconstructions, or specifically loot boxes, an item that player's purchase with real money to buy skins for their favorite characters among other things. Ubisoft is a bit less of a direct comparison to Activsion-Blizzard like EA. However, I think Ubisoft are still a strong competitor to Activision-Blizzard. Firstly, Ubisoft have annual or at least  biannual franchises in Assassin's Creed. AC is much more catered towards a single-player experience unlike Call of Duty, which is a multiplayer-franchise. But, Call of Duty is also released on a similar schedule. Also, AC is Ubisoft's biggest franchise, thus making them the most money. 

Take Two Interactive and Activsion really don't have any game franchises that directly compete with each other, but Take Two is the third largest publicly traded video game company only behind Activsion-Blizzard and EA respectively. Square Enix is one of the biggest video game publishers in Japan with only Bandai Namco being larger. I decided to use Square Enix, because Square Enix and Activsion-Blizzard directly compete with each other in the MMO (Massively Multiplayer Online) genre. Final Fantasy XIV, owned by Square Enix, & World of Warcraft, owned by Activsion, are some of the biggest games in the genre and are direct competitors to each other. 

Multiples Valuation Breakdown

I found all the respective values from either Yahoo finance or financial reports. I made sure to convert the currencies used in the financial statements of Ubisoft & Square Enix, who used Euros and Japanese Yen, respectively. Before I begin with the analysis, I need to disclose two important pieces of information, that definitely had an affect on the analysis. First, I had to use Square's 2019 debt values to calculate its Enterprise Value ( Market Capitalization + Total Debt - Cash). Secondly, in calculating the mean and median values of the multiples, I decided to not include Ubisoft's multiples because they stood out too strongly as outliers. Ubisoft's EBIT and EPS values were negative, thus resulting in large negative values for EV/EBIT & P/E, which strongly contrasted to the positive values of the other companies used in the analysis. Perhaps, I should have just switched to another company after that, such as Bandai Namco, next time such an issue occurs, I'll definitely switch the firm out to ensure that I have a good amount of firms to use in my analysis. 

Multiple Analysis

Looking at the P/E ratio of Activision-Blizzard (32.7x), we can see that it is slightly smaller than the average (36.9) and median (36.4x). This seems to be the case, because EA has a significantly larger P/E ratio of 49.4x, which could either mean that EA has a higher expectations of higher earnings growth for investors, in comparison to it's competition like Activision-Blizzard. On the other hand, it could also be the case that currently EA's stock is overvalued as it can't keep up with the higher expectations that its shareholders have for them. As can be discerned from what has just been written, the lower P/E value of Activision-Blizzard could be a good thing or a bad thing. In the good situation, the company has tempered expectations about its future earnings, thus allowing for them to have a better chance of exceeding their expectations unlike, EA. Hypothetically, let's say that Activsion-Blizzard believe that their stock is currently undervalued, they could buy back more of their shares, if they're confident in their future performance. What this does is that it allows Activision-Blizzard to improve it's financial ratios such as its P/E, as by buying back more shares, the number of outstanding shares falls, thus increasing its EPS. 

In comparison to its competitors, Activsion-Blizzard has a lower EV/EBITDA value of 21.1x, which is slightly lower than the mean and median values of 22.5x and 22.1x. This means that in comparison to its competition, Activsion-Blizzard  doesn't have as much debt, as when calculating EV you have to add debt while subtracting cash & cash equivalents. Therefore, a lower EV/EBITDA is sign that a company has a healthy amount of earnings less non-cash expenses in comparison to the total value of a company, including it's debt. This also leads to a cheaper valuation, which makes sense as Activision-Blizzard's stock price of $96.76 is substantially cheaper than EA's ($141.81) & Take-Two Interactive's ($185.08).In this light, Activsion-Blizzard is a lot a more attractive stock option to potential investors than either EA or Take-Two Interactive. The same principle applies to the EV/EBIT value of 24.3x as the lower the value is the more healthy the firm is as it will have less debt and higher amounts of cash.

EV/Sales represents how much it would cost to purchase a company's value in its sales. The lower the EV/Sales value, the more potential attraction it has to inquisitive investors, as the company may be undervalued. This is because the company's revenue generation is strong, while maintaining relatively low levels of debt. However, it should also be noted that a lower EV/Sales ratio could mean that future sales prospects aren't very attractive, thus being fairly valued instead of undervalued. 

I feel that to improve my multiples analysis for the future I need to dive deeper into a company's financial history in order to better compare it to industry peers. Also, I need a more fleshed out understanding of these multiple values, so that I can have a better idea if a certain value is good or bad. At the end of the day, I should still note the progress I have made with this analysis, as it is still more in depth in comparison to my previous multiples analysis posts. 

I hope anyone who has read this has gained a better insight on how to quickly analyse firms within certain industries using multiples analysis. It isn't a full proof tool, but it can serve any investor well when analyzing companies that they potentially want to invest in.