Aveneu Park, Starling, Australia

I the business-as-usual scenario. Afterwards, two other

I assume ATVI reaches steady-state in 2025. NOPLAT is forecast to be $2.495 million in 2025. Moreover, WACC is projected to remain at 6,7% since I do not forecast any significant changes in the company’s target capital structure or business risk.

As mentioned in section 4.4.1, the video games software industry is tending towards the film industry. Nowadays, the investment needed to produce a game greatly compares with the one needed to produce a “blockbuster” film and this trend is expected to be maintained in the future. ATVI is also moving towards this industry. Not only does it focuses on creating “blockbuster” games targeted at large audiences, but it also released its first “blockbuster” film in 2016, Warcraft, based on its WoW franchise and Skylanders Academy, an animated TV series debuted on Netflix. Going forward, the company plans to copy the success of media giants by investing in opportunities to drive player investment through films, television, and eSports to potentially promote its franchises. Further, ATVI’s ROIC is projected to tend towards 21% in 2024. This value is based on the average ROIC across the companies in the Movies & Entertainment industry for 2016.1 ATVI’s proven capability to create highly successful franchises will allow it to have competitive advantages over its competitors and consequently achieve returns above its cost of capital in the long-run by emulating the successful model of companies such as Walt Disney. Therefore, I set the return on new invested capital (RONIC) after 2024 at 21%.

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Finally, although worldwide long-term nominal GDP growth rates are expected to be around six percent, I assume NOPLAT’s growth rate will mirror the nominal U.S. GDP growth rate of 3,6% for 2025 in perpetuity.2 Therefore, ATVI will reach a steady-state in 2025, with constant revenue growth at 3,6%, stable EBIT margins at 24% and ROIC at 21%.


5.1.6 Results

To complete ATVI’s enterprise-DCF model, value per share is first calculated for the business-as-usual scenario. Afterwards, two other scenarios are analyzed to help model uncertainty: an optimistic scenario (bull scenario) and a conservative scenario (bear scenario). Table 6 summarizes the results and Appendix 9 shows the main assumptions for each scenario. Additionally, I only consider the line items that have a major effect on valuation. Therefore, since I do not forecast changes in the balance sheet in comparison to the business-as-usual scenario, I do not use it for scenario analysis. Business-as-usual

The value of ATVI’s operations is calculated by discounting FCFF at WACC. Table 7 details this process and shows how to reach value per share. The value of ATVI’s operations is $56,6 billion. Afterwards, enterprise value is calculated by adding excess cash and other financial assets, which are estimated at book value, to the value of operations. To reach equity value, debt and employee stock options3 are subtracted from enterprise value. Dividing equity value by the number of shares outstanding gives ATVI’s value per share of $73. Bull scenario  

The bull scenario assumes better-than-expected performance of core titles and a higher mix of digital sales. Also, ATVI will be able to achieve 6,9% revenue growth rate on average derived primarily from its mobile games and consumer engagement towards its franchises in eSports. Further, since management plans to increase profitability, I also forecast product development and sales and marketing to trend to their historical averages by 2024. However, the release of more titles will slightly increase software royalties, amortization, and IP licenses expenses, as well as game operations and distribution costs, relative to the business-as-usual scenario. The key takeaway from this scenario is that reducing operating expenses-to-revenues will greatly increase the company’s value.

Overall, this will increase ROIC to 20% on average over the years leading to 2024, versus 18% in the business-as-usual scenario. Value per share is, therefore, $90. Bear scenario

The bear scenario assumes that the company will continue updating its current franchises, increasing the risk of revenue concentration and competition around a few number of core franchises. This, in turn, will not attract new customers. Also, the mobile business may fail to gain traction. Another major concern will be the declining subscriber base in WoW which has been one of the last remaining subscription-based online games on the market and a large source of revenue for ATVI. WoW has reached the peak of its popularity in 2010 with 12 million subscribers. However, over the last few years the subscriber numbers have been decreasing, only increasing slightly when a new expansion pack launches. The last reported figure for the number of subscribers was 5,5 million in the third quarter of 2015. 4 After this date, ATVI no longer reports subscriber numbers. All these factors may contribute to a slower revenue growth at 4,1% on average from 2017 to 2024. Also, since revenues will grow slower, product costs-to-revenues will decrease to 10% in 2024 versus 9% in the bull scenario. Further, the company is projected to grow at 2,5% in perpetuity.

Nonetheless, due to the high loyalty of some customers, RONIC will still be greater than WACC at 18%. Product development, software amortization, game operations and distribution costs will decrease due to the lack of investment in new IP’s.

Overall, this will result in a 17% ROIC on average over the years leading to 2024 and to a value per share of $58.

5.1.7 Sensitivity Analysis

Sensitivity analysis allows the recognition of the potential value creation or erosion that the change of some parameters has in the model. Table 8 shows the sensitivity analysis for CV growth rate and WACC

CV accounts for a large part of the company’s valuation. Therefore, CV growth rate is a crucial assumption in the model. I believe assuming that ATVI will grow together with the U.S. economy is a sound estimate. If the levels of GDP rise, customers will enjoy higher levels of disposable income, potentially increasing the purchase of video games.

Further, the choice of WACC also has a significant effect on valuation. For a 3,6% CV growth rate, the target price can be as high as $81 or as low as $66. Given ATVI’s capital structure, its estimated WACC of 6,7% is very close to the cost of equity of 6,8%. Thus, the choice of beta and market risk premium highly affect valuation. Additional parameters are sensitized in Appendix 10.


5.2 Economic Profit 

EP is an alternative method to value ATVI’s operations. Nonetheless, this method yields the same result as the enterprise-DCF model. To compute CV, Formula 9 must be rearranged

Table 9 shows EP calculation and Table 10 shows CV assumptions and reconciliation with enterprise-DCF CV by summing 2024 invested capital to CV using Formula 20.

By discounting EP the same way FCFF is discounted, the present value of EP is reached. Summing 2017 invested capital to the present value of EP gives the same value of operations obtained in the enterprise-DCF model (see Table 11). Following the steps detailed in Table 7 results in a value per share of $73. ATVI’s high ROIC leads to an operating value that greatly exceeds the book value of its invested capital ($56,6 billion versus $10,7 billion). Since ATVI’s ROIC is greater than its WACC, the company generates significant economic profits.

5.3 Relative Valuation

5.3.1 Data and Methodology

To select an adequate peer group for ATVI, I first start with the peers provided by the company’s fillings. Second, I use the Global Industry Classification Standard (GICS), under which ATVI belongs to the broad Home Entertainment Software industry, to ensure that no potential companies have been overlooked.

After defining a complete group, the list must be narrowed down. I decrease the number of companies on the list by only choosing the ones that share the same core business as ATVI. Therefore, I exclude companies whose video games do not represent a threat to ATVI’s products due to its different audience reach. These include small Chinese and Korean companies that generally have a diverse product mix. Also, I exclude companies with no available consensus estimates for revenue growth, ROIC, and multiples. This filtering method yields twenty companies.

Hereafter, I benchmark the companies against one another to determine their relative strength by spreading key statistics and multiples for each firm. Additionally, multiples, ROIC and revenue growth rates are based on forward-looking consensus figures for 2018. All data is extracted from Thomson Reuters.

5.3.2 Results

Instead of removing outliers altogether, I divide the companies into three tiers based on their market capitalization: small, medium and large capitalization. ATVI’s capitalization is in line with large-cap players’. Therefore, to select the final peer group, only large-cap players are considered. Table 12 shows this process.

As can be seen, large-cap players, on average, trade at a premium to medium and small-caps in terms of EV-to-EBITDA. Beyond that, ATVI’s multiple is similar to the average multiple for large-cap players (19,4x). This implies a $75 price for ATVI. Further, the average price-to-earnings multiple of 28,7x implies a $74 share price.5 The fact that the price-to-earnings multiple yields a similar result as the EV-to-EBITDA multiple is not surprising. Companies in this industry tend to use very little debt. Therefore, the effects of capital structure within the price-to-earnings multiple are, most of the times, nonexistent. Nonetheless, I still decide to focus on EV-to-EBITDA as it allows a better comparison across firms’ operating activities. Additionally, I believe that narrowing down the large-cap group can yield a better estimate for ATVI’s fair value.

First, consistent with industry rankings, ATVI trades at a premium to Electronic Arts (EA) and NetEase. The three companies are ranked first, second and third worldwide in terms of market share, respectively.6 Moreover, ATVI has an identical market capitalization to these firms and similar revenue growth rate to EA. Compared to EA, ATVI receives more compliment in the industry due to its capability to create original franchises. Also, the two companies have some competing franchises within the same genre such as Battlefield (EA) and CoD (ATVI), two widely-popular first-person shooters. Further, NetEase is known for its PC and mobile games and it is the company that owns Fantasy Westward Journey, the top-ranked brand in terms of worldwide market share (see Table 1). Also, ATVI and NetEase have partnered on the distribution and operation of Blizzard games in China. Herewith, in order to target the Chinese audience, ATVI relies on NetEase for the operation of Blizzard games in that region. Therefore, the two firms share some business risk, especially in China.

Second, it is also noticeable that Microsoft shares similar ROIC and revenue growth expectations with ATVI. However, Microsoft is much larger than ATVI and the scope of its business is much wider. Beyond that, Microsoft main focus is the manufacturing of its console hardware, the Xbox, and not so much the development and publishing of video games. The same reasoning applies to Nintendo and Sony, which trade at 34,3x and 5,9x, respectively.

Third, although Tencent acquired a 92,8% equity interest in Riot Games, the developer of the second-ranked brand, League of Legends, its market capitalization and business scope are much

larger than ATVI’s. The same reasoning applies to Time Warner, the multinational mass media conglomerate.

Due to the aforementioned reasons, I decided only to include EA and NetEase in the final peer group. This results in a $70 price, implying a 2% upside to the current share price. Table 13 summarizes the results.

. Valuation Comparison

This last section provides a source of comparison for the valuation methodologies presented in this dissertation. As such, the following presents a summary of a similar exercise developed by Morgan Stanley (MS) and published on November 3, 2017. Table 14 summarizes the key differences between both parties and Appendix 12 shows MS’s income statement assumptions

Since MS does not provide any information regarding its relative valuation method apart from the fact that it uses a price-to-earnings multiple of 25x based on 2018 EPS, the rest of this section will only focus on the differences between DCF models.

A remarkable difference emerges in profitability forecasts. On average, for the period between 2017 and 2024, MS assumes a 40% EBIT-to-revenues ratio, while I assume 25%. This difference is the result of a more conservative approach regarding the estimation of COGS and operating expenses. MS assumes a faster decrease in COGS-to-revenues in the first forecast years, while I assume this decrease to be gradual over a longer period of time until 2024. Consistent with this dissertation, MS forecasts this ratio to decrease mainly due to the line item “Product costs”. According to MS, the shift from selling physical games through retail stores to selling games digitally will expand margins. Therefore, as revenues from digital channels increase, product costs, and ultimately COGS, are projected to decrease.

Additionally, MS estimates WACC at 7,1%, based on 1,15 beta, risk-free rate of 2,26%, expected market return of 6,7%, pretax cost of debt of 4% and tax rate of 24%.

Finally, MS reaches a target price of $72 by using a CV growth rate of 2,3%. The key difference between both parties, however, is the distribution of value between the explicit forecast period and CV. On the one hand, MS optimistically assumes that ATVI will create more value during the explicit forecast period, by greatly expanding its EBIT and gross profit margins, and assumes that the company will grow at a slower pace in the future.  On the other hand, I assume otherwise. In my view, MS’s estimates would greatly increase ROIC up to a point where its levels would not be consistent with a steady-state representation. Therefore, I assume ATVI will grow faster in steady-state, at the speed of the U.S. economy, in comparison to MS’s estimates.


This dissertation intended to provide the outcome of an equity research exercise on ATVI. This exercise made clear that ATVI’s has competitive advantages that sets it apart from its peers, namely brand loyalty amongst customers and internal financing power.

Three valuation exercises were carried out. The enterprise-DCF and EP models propose a target price between $58 and $90, considering all scenarios. Regarding relative valuation and considering the final peer group and the average of all large-cap players, market multiples value ATVI between $70 and $75, respectively. Figure 17 displays the “football field” showing ATVI’s valuation according to the different methodologies and parties

In conclusion, due to the aforementioned characteristics of each model, the proposed target price is the one originated by the enterprise-DCF and EP models, specifically the one provided by the business-as-usual scenario. Therefore, I reiterate a buy recommendation on ATVI, implying that its common stock should be valued at $73 per share, a 6,2% upside from the current market price.

1 Appendix 7 shows the average ROIC for the companies in the Movies & Entertainment industry.

2 Appendix 8 shows GDP forecasts.

3ATVI offers its employees stock options as part of a compensation program. Therefore, the value of outstanding employee stock options is subtracted from enterprise value as a nonequity claim. ATVI provides the aggregate intrinsic value of these options in its annual report.

4 Source: Company data.

5 See Appendix 11, Exhibit 21.

6 Source: 2017 Video Games Report, Euromonitor.


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