Two big events caused a flurry of trading in game stocks today. Game publisher Activision Blizzard’s announcement of its $8.2 billion Vivendi buyout drove the company’s stock up 15 percent on Friday, while social-games maker Zynga fell 14 percent after its loss report and its decision to withdraw from making online gambling games for the U.S. market. That may very well mean that shareholders sold Zynga and bought Activision.
This tale of the two stocks says a lot about what is happening in the video game business right now. Activision Blizzard, which has pooled its resources behind three giant game properties (Destiny, Call of Duty, and Skylanders) is enjoying the benefits of being focused on blockbusters. Zynga, meanwhile, is being punished for its lack of focus and is moving fast to double down on what it is good at: social games. Concentrating on successful properties is evidently the way to succeed in this hit-driven part of the entertainment world.
The Activision Blizzard deal came about because major shareholder Vivendi tried to extract a large dividend from its game holdings. That would have been good for Vivendi, but it would have taken a lot of cash out of the game company.
To avoid that, Activision Blizzard co-chairmen Bobby Kotick and Brian Kelly led a buyout of Vivendi’s shares, reducing its holdings from 60 percent to 12 percent. Activision raised $1.2 billion from its own cash and $2.34 billion from new investors such as Tencent to pay off Vivendi. It also borrowed $4.6 billion. After the buyout, Activision will be about 63 percent held by the public, 12 percent by Vivendi, and 25 percent by Kotick, Kelly, and its investor group. And Activision Blizzard will still have access to its $3 billion cash hoard.
Ben Schachter, an analyst at Macquarie Capital, wrote, “The most widely anticipated deal in the video game industry has finally happened. From an Activision perspective, this is clearly a positive outcome for many reasons.” He noted that the management group was able to do the buyout at a discounted price of $13.60 a share (Activision closed at $17.48 a share today). He also noted it was important to get Kotick and Kelly recommitted to the company, as they personally put in more than $100 million into the deal. It also gets them financial independence to allow it to do more strategic maneuvering, like buying other companies. Having Tencent as an investor also gives the big Western company more opportunity to expand in Asia. And the distraction of having the big transaction hanging over its head is finally gone.
Zynga, meanwhile, shocked the street by not only reporting further deterioration of its monthly active users for its mostly casual social games. It also said that it would no longer apply for licenses in states in the U.S. to allow it to create real-money online gambling games. Zynga’s David Ko, chief operations officer, noted that Zynga’s core casual poker game lost users in the quarter and that the company really had to focus on getting that game and other social games back on track, rather than expand into real-money gambling.
Scott Devitt, an analyst at Morgan Stanley, wrote that newly appointed chief executive Don Mattrick said on the analyst call on Thursday that Zynga may have two to four quarters of volatility ahead as it refocuses on its core opportunities in free-to-play social games. Devitt lowered estimates to reflect the lower-than-expected guidance. He wrote, “Zynga no longer appears to be the leader in U.S. web social gaming, but its audience is still significant at 39 million daily active users.” He said the company appears to be losing share to competitors.
Doug Creutz, analyst at Cowen, wrote, “Activision will now be a fully independent company … eligible for inclusion in the S&P 500.” That will enable it to benefit from a wider pool of potential investors who could buy its stock. He noted that the company’s massively multiplayer online role-playing game (MMORPG) World of Warcraft lost 600,000 users in the second quarter, with paying subscribers falling to 7.7 million (from 10 million at the end of 2012), but most of the losses appear to be confined to Asia.
Sean McGowan, an analyst at Needham, removed his buy rating on Zynga, as “the company has eliminated much of the potential upside for the stock, while the weakness in poker could indicate that the once ‘untouchable’ pillars of the company are weakening.’”
Sterne Agee analyst Arvind Bhatia also noted that Zynga’s third-quarter guidance was a lot weaker than expected, and the move out of U.S. gambling will disappoint the Zynga bulls. He said the success of FarmVille as a franchise is encouraging, but older games are continuing to underperform. He thinks management is getting its spending under control and is becoming more strict on what it greenlights in terms of new titles.
Schachter at Macquarie said that Zynga’s turnaround is going to take time and he remains cautious on it. Regarding the move away from gambling, he said, “While we don’t necessarily think this is a bad idea, nor had we built any revenue into our money from real-money gaming, the fact is many investors owned the stock almost solely for their belief in the real-money gaming potential.” Meanwhile, he says Zynga’s problem is it has no sustainable advantage in mobile, the hottest of the game markets.
Colin Sebastian, an analyst at Baird Equity Research, said Zynga runs the risk of having “negative network effects” settling in, with losses driving further losses. Analyst Michael Pachter at Wedbush Securities, said of Mattrick that he “knows when to hold ‘em, knows when to fold ‘em.” Pachter is optimistic that Mattrick will bring about meaningful changes at Zynga.