Activision Blizzard, Inc. (ATVI) April 12, 2019 Communication Services – Video Game Publishing

Spencer Hall John Koach Spencer-hall@uiowa.edu john-koach@uiowa.edu

We recommend a buy rating for Activision Blizzard, the video gaming company known for putting out multiple additions to their franchises yearly. Activision Blizzard is transitioning to a developmental stage where they plan on building upon their current successful franchises and cutting costs where they do not forecast strong growth.

Drivers of the Thesis • Revenues have continued to grow each year with 2018

being the highest since inception. Activision Blizzard did not meet their expected 2018 projections signaling a red flag.

• ATVI cut 8% of their labor force at the start of the year which led us to reduce selling and administrative expenses by 3% from 2018-20191.

• Competitive gaming has more than doubled in the last three years with Overwatch, Call of Duty and Hearthstone having a large competitive environment.

• Candy Crush Saga and Call of Duty are very large revenue drivers for ATVI, both holding an enormous fan base and revenue stream.

Risks of the Thesis • The S&P 500 has a close correlation with ATVI. If the S&P

takes another dive, then ATVI stock will be showing similar results. Sales may be affected by external forces.

• ATVI has more competition by the year. Fortnite and Apex Legends are in direct competition with ATVI. All are competing for gamer’s attention. Even Netflix wants to take the eyes of the consumer and bring them to their products.

Activision Blizzard (ATVI) is a company based in Santa Monica, California. Activision is one of the leading developers and publishers of interactive gaming content with a broad platform geared towards gaming consoles, computers and mobile devices. There are three distinct segments; Activision publishing, Inc., Blizzard Entertainment, Inc., and King Digital Entertainment. Each segment is responsible for different gaming platforms. Activision and Blizzard both are primarily console based with large successful franchises, while King is a leading developer of the mobile entertainment segment1.

DCF Model $58.76 DDM $43.77 Price Highlights 52-Week High $84.68 52-Week Low $39.85 Market Cap. (B) $36.11 Shares Outstanding (M) 763.83 Key Statistics 3 Year Beta Value 0.92 Average (3 Month) Volume (M) 12.41 EPS 2.35 P/E Ratio 17.56 Dividend Yield 0.78% Dividend Payout Ratio 14.47% Company Performance ROA 6.84% ROE 17.42% Sales (B) $7.50 Financial Ratios Current Ratio 2.31 Debt to Equity 23.52

The Krause Fund Spring 2019 Report

Current Price $47.28 Target Price $50-55

Recommendation: Buy

Analysts

One Year Stock Performance

Investment Thesis

Company Description

Source: Yahoo Finance2

Earnings Forecast

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We recommend a buy for ATVI stock. We used a mix of financial information, external forces and macroeconomic events like the trade war with China to make our main decisions in forecasting Activision Blizzard. We also incorporated many of ATVI’s competitors to show where ATVI excels and where they have potential weaknesses that they need to correct during their restructuring this year.

We projected Activision Blizzard at a $50-$55 price per share. This is an upside of about a 15% of ATVI’s current price. Real Gross Domestic Product (GDP) The Real GDP measures the entire United States economy while the Federal Reserve adjusts its monetary policy based on the GDP and other economic factors. It is an excellent indicator for the entertainment industry since it would be considered a discretionary goods industry which relies on a strong economy. Activision Blizzard relies on a strong economy for consumers to be able to spend money on in-app purchases like Candy Crush Saga and Overwatch. In-app purchases are an important revenue stream for Activision Blizzard and other gaming companies since it provides for a continuous flow after the initial sunk cost of buying the game1.

Source: TradingEconomics3

Within the next year, we estimate that the Real GDP growth rate will remain relatively constant. Historically, GDP is highest in July at about 4% and then settles within the 2% range4. We believe this will continue to occur if the economy can remain stable. This is what our model is based on. With a relatively stable GDP, consumers will have the ability and desire to spend more discretionary income. Looking within the next two to three-year term, we believe that the market and GDP growth will settle to an average of 2.8% growth rate as seen in previous quarters. Activision Blizzard’s revenues have continuously increased since their inception, but recent figures suggest that they will be entering a steady growth rate after their restructuring incentive that is currently taking place and will continue throughout 2019. Even with a strong GDP growth rate, we do not foresee a big negative impact on game sales due to the higher labor force participation rate.

Consumer Price Index

The consumer price index is an indicator that includes the purchases of goods and services and all the sales taxes that are associated with it. The CPI is a great measure of inflation and is a measure of whether companies are raising their prices for their products5. The unadjusted 12-month end as of March was 1.9%6. This could be a useful indicator for the economy in general because the Federal Funds rate has also remained constant at 2.50%. This indicates economic stability and gives a good indication that inflation is not a major threat right now.

This is great news for Activision Blizzard because an increase in consumer confidence will allow consumers to purchase more of Activision Blizzard’s products. Consumer confidence is extremely important for discretionary goods since consumers will be more comfortable spending their hard-earned money. We believe that the CPI will hold strong for the current year and near future. Our 2019 growth rate is predicted to be -10% due to Activision Blizzards restructuring initiatives for 2019. We do believe

Economic Analysis

Executive Summary

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that after the restructuring, and if the CPI remains strong, the growth rate will increase to around 7% in the following two years to ultimately level out at a 2% growth rate in the stable growth stage. Unemployment Rate

Source: TradingEconomics7

The unemployment rate is at 3.8% as of March 2019. Above is a chart depicting the unemployment rate over the previous year. The unemployment rate has declined since the start of the year, which signals that more people are getting jobs and have more discretionary funds to spend. This is good news for the gaming industry since people will be more inclined to purchase games.

Unemployment has both pros and cons in the gaming industry. With unemployment being low, people have more money to spend on video games but less time to play them. Higher unemployment rates would give individuals more time to play and make in-game purchases. Low unemployment rates are good for the economy and are reflected in revenues for Activision Blizzard. Relatively speaking, unemployment will not drastically affect sales for Activision Blizzard, therefore we did not heavily consider this while estimating the company’s growth rate.

The Trade Treaty

Since the beginning of December 2018, the S&P 500 has plunged to levels it had been at the previous year. Analysts estimate that this is mainly due to the trade war America has imposed on China. This is one of the biggest macroeconomic issues that Activision Blizzard must face since it is so closely correlated with the S&P 500. A treaty has been in the works over the past few months that will hopefully result in a compromise between the US and China. This has helped the S&P 500 return to what it previously was at pre-December. Although the treaty with China is still being worked on, investors enjoy the positive news.

Source: BBC news8

The additional tariffs took effect in September 2018. The United States imposed $200 billion additional tariffs on top of the $53 billion already in place pre-2018 (as shown in the figure above). This causes investors to be weary of US markets expecting a retaliation from China to impose additional tariffs against the US9. China has a large gaming market. With issues between China and the United States, there is a possibility that the Chinese will not consume Activision Blizzards products. Instead, they will remain loyal to original Chinese products. The United States recently announced that they would push back the March 1st deadline to halt tariffs. The US is

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pushing this deadline back in hopes of coming up with a fair treaty with China.

The Yield Curve

Source: Atlas21

The chart above shows the yield curve up to two years ago. The Fed has been raising rates on the short end while there has been little change to the 30-year Treasury bond. This means that there is almost a flat interest rate in the US Treasury yield curve. Historically, if there is an inversion to this yield curve there has been a recession to follow. Fortunately, Activision Blizzard has been repaying their debt so that if there is an impending recession, ATVI will not be subject to extensive interest payments. Activision Blizzard is still required to pay 1.65 billion in debt as of 2023 as stated in their 10-K1.

Referencing back to the unemployment rate, if a recession were to occur, then Activision Blizzard would most likely see an influx of consumers. This is due to consumers having more time to play videogames if the recession causes the consumers to lose their job. We believe that a recession has two main benefits: An increase in consumers and low interest rates if Activision Blizzard remains ahead in debt repayments.

Introduction

Activision Blizzard is in the interactive home entertainment industry which consists of interactive gaming products such as mobile games, PC games, and console games. This also includes educational software used in schools and colleges around the world. Consumer preferences are cyclical and constantly changing, so being a company that is constantly innovating and making top notch products is crucial to Activision Blizzard1. Activision Blizzard remains competitive by continuously innovating and adding to their portfolio to grow their customer base. Technology is constantly changing, and with 5G becoming more prevalent on devices, the industry will experience a rapid growth stage due to technological improvements10. New markets are developing with age groups ranging from very young to old. Not only do gaming companies need to compete against each other, they compete against other streaming services for consumer’s free time.

Age of Consumers

Source: Statista11

Young children are being raised with tablets and consoles, so target markets are becoming even younger than they already were. The Candy Crush franchise is a hit with both the young and the old consumers which is why it is so successful. As you can see from the graph above, people of all ages are purchasing and using

Industry Analysis

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mobile devices. This further explains why Activision Blizzard is focusing their efforts on expanding their mobile experience and market.

Source: Statista12

Additionally, in the graph above, consumers of all ages are engaging in video games. The older generation is being replaced with a large group of tech-savvy consumers which is very beneficial for the gaming industry. If they can engage an older audience, they would have a consumer base that has a large amount of free time and typically have the discretionary means to pay for new subscriptions, games, and micro-transactions.

Industry Trends

The gaming industry is heading towards a period of tablet and smartphone game growth. Since 2015, revenues have been shrinking for segments such as casual web games, console games, handheld games, and PC games. As you can see from the graph below, analysts predict that handheld and PC games will continue to decrease at a continuous rate as these other platforms outperform them.

Source: WEPC13

This will be great for Activision Blizzard since they focus their efforts on developing software rather than consoles. Competition such as Sony and Nintendo will begin to see diminishing revenues due to changes in consumer preferences.

Another trend that is changing the gaming industry is the transition from physical copies to online downloadable content. Competition among firms is changing in response to the online trends. Marketing and shelf space at a traditional retailer are very limited, so companies need to fight for the space to market their products. This is still the case, but the fight is moving towards premium online placement. This will increase the marketing expenses for each firm since they will need to promote their new products heavily to gain the consumer’s attention. Additionally, since there are going to be fewer physical copies of these games, producers will need to have good estimates of how many copies they will send to physical retailers to avoid excessive costs from overproduction.

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Newer generations of gaming consoles and smartphones allow for downloadable content that generally was purchased from Best Buy or GameStop. When a game is downloaded, there is a one-time charge and then Activision relies on the consumer to make microtransactions during their interactions with the game. Microtransactions tend to happen more than once and offer a higher profit margin than the initial sunk cost when buying the game. These smaller transactions can also engage the consumer more because of their incremental investments into the game. Many players will spend a substantial amount of time and money unlocking new content and progressing in the game’s storyline. Since microtransactions are relatively new, they are in the early stages of this and are projected to have greater revenues from these sources in upcoming years.

Competition

Activision Blizzard’s main competitors are Electronic Arts, Sony, and Take-Two Interactive14. The chart below shows the market value and sales of each company in 2018. As expected, the companies that specifically develop software had less sales than Sony, who develops software and devices. This is because Sony inevitably has more products to sell and different markets to sell to.

Data from: Factset15

Electronic Arts develops games, content, and online services for Internet-connected consoles, mobile devices, and PCs. This is one of Activision Blizzard’s main competitors since they specifically develop content for devices. Sony engages in the development, design, manufacture, and sale of electronic equipment, instruments, devices, consoles, and software. Their market is much broader than Activision Blizzard who is specifically developing games and software15.

This could be both a negative and positive for Sony since they have so many different segments to focus on, whereas Activision Blizzard can focus their efforts on creating the best content and games on the software market. We believe that the trend of digital downloads and sales is putting them at risk of more competition. Digital downloads require much less capital to produce, so new entrants and competition could create a potential problem for them. Although this is a possibility, we are confident that Activision’s reputation and current franchises will continue to flourish in the market. Take-Two Interactive engages in the development, publishing, and marketing of interactive software games1. Their delivery services are much like Activision Blizzards which is through physical retailers, online platforms, and cloud streaming services.

Threat of New Entrants: High and Increasing There is a potential for new competition to enter the industry and contend with Activision Blizzard. There is a large initial startup cost associated with this industry, so that prevents many from being successful. A lot of technology is required which causes a huge amount of upfront costs to be incurred right away. New entrants are many times bought by reigning giants as well. Activision Blizzard has made many acquisitions over the years which expands their grasp on the interactive gaming industry. With the gaming industry growing substantially, more competition is arising. In particular, the mobile gaming segment has seen substantial growth and will continue to contribute heavily to Activision Blizzard’s sales for upcoming years. There is a constant need for companies to stay current with new trends, technology, and consumer preferences. Historically, Activision Blizzard has been at the front line of developing new games, graphics, and markets, so we are confident they will continue being a giant in the industry.

Porter’s Five Forces

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Power of Suppliers: Moderate Suppliers of the consoles that run Activision Blizzard’s games have a lot of power to set certain prices, time frames, and constraints. Since Sony, Nintendo, and Microsoft make the gaming consoles, they have a lot of power over when and what is released. Activision Blizzard needs to respond to new products on the market, quickly and with quality products to pair with the new consoles. Suppliers can decrease the margins that Activision Blizzard can potentially earn. Negotiating powers extract higher prices from firms in the Multimedia and Graphics Software field. Business partners are also given access to highly sensitive material that is central to their success. Partners could accidentally leak information by not keeping their security up-to-date on their network. Information leaks could also intentionally occur by insiders giving sensitive information to unauthorized individuals. These risks pose a huge problem to a company’s business model. Rivalry: Moderate and increasing Competition is moderate and increasing because companies are seeing how much the gaming industry is growing. With companies turning more towards mobile gaming, rivalry will increase substantially due to the low costs associated with it. Relatively speaking, it is much cheaper to develop mobile games than it is to develop PC and console games. Therefore, there is less initial capital required. Companies also need top employees that can perform at levels that exceed the competition. That way, they will continue to have a competitive advantage over the industry with leading software designers. Competition among other franchises is very high as well. Nintendo and Electric Arts each have very successful franchises in their portfolios. Nintendo has Super Mario, Zelda, and Metroid, while Electric Arts has Madden and Battlefield16. Activision Blizzard will need to continuously outperform and pull in new consumers if they want to stay ahead of the competition.

Threat of Substitution: Low/Moderate We believe the threat of substitution is low to moderate because of how unique the gaming industry is. Although there may be a lot of competitors in the industry, there are not a lot of substitutions for games that will take over a popular genre. Activision Blizzard’s Call of Duty is a specific shooter game that other companies attempt to replicate but fail to attain a higher position in popularity. The quality and level of prestige that goes into the Call of Duty franchise is unparalleled by other companies attempting to replicate it. Hence, why Call of Duty has been the number one seller of console games worldwide for 9 out of 10 years20.

Company Overview

Activision Blizzard is a videogame production company based out of Santa Monica California. Activision Blizzard contains three main segments including: Activision, Blizzard and King. Activision and Blizzard base the majority of all their games on console while King is one of the leading developers in the mobile industry. ATVI also makes a portion of revenue in eSports competitive online gaming as well as limited edition fan gear. Activision Blizzard is competing for your time. While ATVI’s products are not expensive, they look to reel customers in by creating addictive franchises that keep consumers excited to purchase upcoming additions.

Corporate Strategy

Activision Blizzard is known for having massive franchises that rank high above other videogame development companies. The corporate strategy is to continue being one of the leading developers, publishers, and distributors of high-quality interactive content. ATVI wants to keep that standard as they transition to the

Company Analysis

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development stage in plans of creating quality content. Activision Blizzard does not plan on any major releases in 2019. They will be devoting most of their expenses in developmental costs. Activision Blizzard plans on cutting back and reinvesting in themselves to deliver the quality that they are known for.

Three key selling activities that Activision Blizzard has historically done to develop their brand are expand audience reach, drive deep consumer engagement, and provide more opportunities for player investment. Some of these selling activities will be cut back during their transition to developing more products. We believe that this is important because Activision Blizzard will need to keep consumers at bay. Activision Blizzard will not be pushing products as hard this year as there will be no major releases. Also, in the recent earnings call, Activision Blizzard announced that they have fired 8% of their total staff. Much of the fired staff was in selling and administrative expense. We believe this is a positive as Activision Blizzard transitions to microtransactions which will require less need for employees to push product. This will instead incentivize a need for coming up with creative ways to extract money from the consumer by creating a want for consumers to download content.

Life cycle

The life cycle of a company that develops videogames includes the production of the game, the marketing and advertisement for the game to grow hype, then the release of the game followed by additions to the game with in-game purchases. In Activision Blizzard’s case, they have three of their top revenue segments all in different stages of the life cycle.

It was reported in the fourth quarter earnings that Call of Duty was once again the number one selling console franchise worldwide in 201820. This is the ninth year out of the last ten years that Call of Duty has been number one. Activision is reentering the development stage to continue

producing quality additions to the Call of Duty franchise.

Blizzard is transitioning from their developmental stage to their growth stage. With the 2018 release of World of Warcraft: Battle for Azeroth, Blizzard will be continuing to grow their recent release with new in-game content. Blizzard also contains two major titles, Overwatch and Hearthstone, in the eSports competitive atmosphere. Blizzard develops these games by adding in mini-games and downloadable content that can give players an aesthetic appeal. Overwatch and Hearthstone are not titles that would require new additions to become a franchise. Blizzard intends on keeping these games updated with new content within the game to keep it relevant in the competitive environment.

King was recently acquired by Activision Blizzard in 2016. King contains one very popular mobile game: Candy Crush Saga. King recently released a competitive version of the game called Candy Crush Friends. Like Overwatch and Hearthstone, King intends on keeping Candy Crush Friends updated and growing in popularity. We believe this is a sign that King is in a trial stage to see if Candy Crush Friends will be successful. In the 2018 10-K, Activision Blizzard reported King to have $2.09 billion in revenues all through in-game purchases and merchandise that Candy Crush Saga produced1.

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ESports

Source: Newzoo22

The figure above shows global revenues generated by eSports. In 2016, there was $493 million generated in global sports revenue. Newzoo predicts that in 2019, eSports will generate $1.12 billion in global sports revenue22. This would more than double what eSports would have been generating three years ago.

Source: Newzoo23

The figure above lays out how much of eSports’ revenues go to the publisher of the game. Roughly 10% of all eSports revenue is returned to the developer. Activision Blizzard will benefit more than just charging a fee for streaming their product. Advertising is roughly 20% of eSports’ total revenues which helps popularize the games23. Activision Blizzard will receive free media attention just from professional players of

eSports playing their games. Professional players stream their daily gameplay on twitch.tv. Twitch is a website that allows users to stream videogames live from their monitors at home. This is free media attention for all videogame developers. We recognize that there are pros and cons to this. Activision Blizzard may lose the attention of gamers by having their potential consumers watch other people play their games rather than playing the game themselves. At that point, Activision Blizzard is basically Netflix by streaming their content. The main difference is that Activision Blizzard isn’t charging a monthly subscription.

Audience Reach

Source: Statista17

In the graphic above, we compared Activision Blizzard revenues by comparing foreign with domestic for the previous three years. As shown, foreign markets are at about half of what domestic markets are reaching. It is important that Activision Blizzard remains prevalent in foreign markets. We believe that it is crucial to pay equal attention to revenues overseas as they compare heavily with domestic markets.

In order to expand their reach, Activision Blizzard has different techniques to grab their audience’s attention and keep them intrigued. One tactic they use is to offer free-to-play games, which allows for the player to initially play for free, but then offer microtransactions throughout the experience for new downloadable content. This is becoming streamlined on mobile devices since

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there is the ability to pay through services such as Apple pay which makes the process of checking out very simple and time efficient. Drive Deep Engagement

Activision Blizzard keeps their audience engaged by releasing high quality material that captures an audience and keeps them intrigued for a long period of time. This can be seen through their huge success with their Call of Duty series. Each new release was highly anticipated and reached extremely high sales volumes. The recent release of Call of Duty: Black Ops 4, generated a sell- through of more than $500 Million in revenues. It also set a franchise sales record for “most combined players, average hours per player and total number of hours played, on current generation consoles18.” Deep engagement in the Call of Duty is evident in how successful it has been over the years. Activision Blizzard has a franchise model, meaning they rely on a low number of popular franchises such as Candy Crush, Call of Duty, and World of Warcraft. That being said, we think that it is a great idea that they are taking the time to restructure and cut out unpopular segments to focus their efforts on the ones that give them the most sales. Those three franchises alone accounted for 58% of their net revenues in 201819. This is a huge amount of money derived from a relatively small selection of products, so making sure that their quality is phenomenal is key to a constant growth18.

Consumer Purchases

Along with microtransactions, Activision Blizzard offers subscription services for players in their World of Warcraft franchise. This is a great way to receive a continuous revenue stream regardless of player involvement. This tactic is like Netflix because essentially, their main concern is getting people to purchase the subscription and continue to pay the monthly/yearly fee. Microtransactions will be beneficial for this type of service as well because

it increases the cash flows from different franchises.

Activision Blizzard forecasts consumers to be purchasing products online. This will require less need for employees to be pushing the product. This helps explain another reason to Activision Blizzard’s firing of 8% of their total staff. Mostly related to the selling and administrative costs. We believe that this 8% reduction in staff is a way of moving to the future. Activision Blizzard recognizes that they will be unable to keep a larger selling and administrative staff when transitioning to microtransactions. These microtransactions will remove the need for human interaction in sales. It will allow the consumer to purchase goods online at an easier access. We believe that this will increase development costs that allow for these microtransactions to occur.

Catalysts for Growth

• We predict the major growth catalyst will come from their restructuring. After their restructuring, they will have more time and money to spend on their most profitable segments.

• Current trends are focused on mobile platforms. This will allow them to not only get revenue streams from current franchises that switch to mobile, but they can create new content specifically for the mobile device.

Investment Positives

• ATVI already has a large audience for their current franchises. As the restructuring occurs, they will be bringing their most popular games onto a mobile platform to conform with current trends. They recently announced their plans to bring Call of Duty on a free mobile application24.

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• With so many successful franchises, they have a diversified portfolio. They aren’t reliant on just one franchise which is good for investment purposes in case one franchise fails.

• With their restructuring incentive, they will be able to cut out underperforming segments and focus on building their top performers. Although this will affect revenues for 2019, growth over the next few years will be growing.

• It seems as if trade between the US and China is going to be resolved soon. This is beneficial since they are such a large market for Activision Blizzard.

Investment Negatives

• If ATVI’s restructuring efforts don’t go as planned, it could cause their stock price to plummet. Uncertainty is present because we don’t know what the effects of this restructuring will be. We are projecting it to be positive, but there is a chance that it could be negative.

Summary

Our forecasted growth rates are based mainly on the announcements made in Activision Blizzard’s fourth quarter earnings call. Activision Blizzard is transitioning into the development stage of their business cycle. Activision Blizzard plans on developing their current, successful franchises and cutting costs in their less profitable ones. These franchises would include growth in their recently acquired company, King as well as their most successful and worlds most successful video game franchise Call of Duty. Despite Activision Blizzard hitting record setting highs in revenues as well as profits, they failed to meet expectations. There will be no game additions brought to franchises in 2019 which is a main

driver to analysts’ forecasts in negative growth in the 2019 year.

Revenue Drivers

Data source: Activision Blizzard19

The figure above displays our revenues by segment breakdown in 2018. Activision Blizzard is divided into three main revenue segments: Activision, Blizzard, and King, with a sub-category as “other”. Activision, being the largest division, will have the most change in total revenues due to its weight when forecasted out. Blizzard is second in weight. Blizzard just released a new addition to one of their franchises and Activision Blizzard was not pleased with their results when one of their new additions to their World of Warcraft franchise was not as successful as they had hoped. King includes the Candy Crush Saga as its main franchise which introduces Activision Blizzard to more user friendly and popular mobile games unlike their less successful mobile Call of Duty game. We forecasted King to be positive throughout the model. King shows promise for lots of growth in the mobile market. Activision

The Call of Duty franchise is the main sales driver of the entire Activision Blizzard Company. Activision Blizzard will not be bringing new game additions to the Call of Duty franchise in 2019 but will be adding in game content that will allow Activision Blizzard to continue bringing in revenues from the franchise. The Activision segment lost one of their new franchises Destiny,

Valuation Analysis

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to one of their co-developing companies Bungie. This is a new franchise that was started in 2013 and Activision Blizzard expects there will be costs reduced which will help them focus on their more successful franchises. This is a very optimistic outlook to not be upset about losing a new and popular franchise. We believe this will affect revenues greater than what Activision Blizzard expects.

Our expected revenues for the Activision segment are -13% for the year of 2019 followed by a 4% growth rebound to a steady state of 2% growth for years following. We predicted a large decline in growth due to Activision losing their side franchise Destiny as well as not adding any game additions to their most successful franchise. Call of Duty is a giant amongst the other franchises in the Activision segment. When Activision Blizzard announced they will be stepping back from their historical trends of releasing 1-2 Call of Duty games per year, analysts can only pullback on their forecasts of growth. This is also why we gave the Activision segment a 4% boost in growth compared to their 2% growth in years following. The 4% growth shows that we predict Activision will be returning to their Call of Duty franchise with quality content.

Blizzard

Blizzard is expected to have negative growth for the following year. We forecasted Blizzard to have a -21% growth rate for 2019. This is mainly due to Blizzard having slight success in releasing World of Warcraft: Battle for Azeroth but not nearly meeting their expectations. Also, Activision Blizzard has not released any new titles to Blizzard games. Blizzard’s other two online competitive games, Overwatch and Hearthstone remain mainly constant with in-game purchases as Blizzard updates these games with downloadable content.

We believe that Blizzard is the most volatile Segment of the three major segments based on historical change year over year. We believe that

Blizzard will grow their popular console franchises by releasing additional downloadable content but will not be releasing any new developments. Blizzard draws a lot less attention to itself due to it targeting a niche market of consumers which may be a direct result to its high revenue volatility. We predicted Blizzard’s continuing growth of 5%. We are confident that Blizzard can retain their consumer base. We think it is important to keep in mind that Blizzard tends to release new content much less frequently than the Activision segment.

King

King is the newly acquired addition to Activision Blizzard and shows significant room for growth. King recently released a competitive version of their main game franchise, Candy Crush Saga. Activision Blizzard as a whole is in the developmental stage. When looking at King as a segment aside from Activision Blizzard, we believe that King is in their expansion stage. The Candy Crush Saga is exploring new opportunities for growth with their introduction to a competitive environment in mobile gaming. There is an increase in the gaming trend that there are more mobile users than ever. King exemplifies this with 268 million monthly active users1. In comparison to the other segments, King has 3.5 times as many users as both Activision and Blizzard combined.

Activision Blizzard is a diversified company and King stands out significantly, which is why we expect King to grow at 1% in 2019. This is because we predict that King will have to work around the new addition of competitive gaming. We predict King will grow at 6% year over year until the 2024 continuing revenue growth rate of 4%.

Selling and Administrative Expense

Activision Blizzard announced that they cut 8% of their total workforce. This is a total of 9,600 employees being reduced to approximately 8,800. This is directly correlated to their selling

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and administrative expenses. We forecasted selling and administrative expenses to decline to 8 percent of sales as opposed to their historical average of 10 percent of sales. We believe this is an important decision in transitioning to develop more content. It is important that Activision Blizzard acknowledges and has prepared for reducing their costs when they are planning on bringing in less revenues.

Drivers

Our drivers to our analysis include a net operating profit less adjusted taxes calculation divided by the previous years invested capital calculation. We predicted that Activision would need to retain a sizeable amount of capital to enter this development stage in 2019. Thus, we calculated Normal Cash as 50% of sales to have leeway in the possibility of hiring more software engineers.

Valuation Models

We created a discounted cash flow model (DCF), economic profit model, a dividend discount model (DDM) and a relative valuation model. All these models include a price estimate or P/E ratio estimate.

The model that we will be using to help us with giving an estimated target pricing on the stock will be the DCF/EP model. We think this model is the best because it includes the income statement as well as the balance sheet to predict the price per share. We completed the DCF/EP model with a stock price of $58.63.

The dividend discount model uses only income statement items. This is less favorable because it is less diversified by using less of the available financial statements. This model does not include the fact that Activision Blizzard is paying back their debt in sizeable amounts. The dividend discount model could also be more skewed based off analysts’ predictions on the increase in dividends year over year. Our dividend discount model helped us predict an estimated $43.77

stock price. We set our target price at a spot favoring the DCF/EP model but also taking the dividend discount model into account.

For our relative valuation model, we incorporated six companies that compare to Activision Blizzard. These companies include EA, TTWO, MSFT, AAPL, NTDOY and UBSFY. All these companies produce videogames, and most are within the same industry. Microsoft and Apple are the two outliers that we thought we would include to compare Activision Blizzard to a much larger and diversified company. Microsoft and Apple do not skew the mean by a sizeable amount. In fact, they are fairly similar to Activision Blizzards P/E ratio.

We ran different sensitivity tests using different betas, market risk premiums, continuing growth percentages, and return on invested capital to determine how the price of Activision Blizzard would move with these different economic scenarios. Market Risk Premium vs. Beta

We ran an analysis with different market risk premiums and firm specific betas to figure out how the implied price of the stock would change. The price is very sensitive when the beta moves up or down. The current raw beta is 0.92, but as it rose so did the price. With more systematic risk, the price will continue to decrease to entice investors to buy the stock. The market risk premium doesn’t have a huge effect on the intrinsic value of the company. Currently, our market risk premium is 4.95%. The Federal Funds Rate has steadily been rising by 25 basis points

Sensitivity Analysis

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each move. It has remained constant recently but would cause the market risk premium to go down.

CV Growth vs. CV ROIC

Testing to see how changes in the long-term continuing value and return on invested capital is very important because it can cause a significant movement of the target price. Our model suggests a 2% continuing value growth by 2024. Our steady state ROIC is predicted to be 68%. As we ran our table analysis, we noticed that an increase of 10% had little to no effect on the price. An increase in the growth rate will increase the price by around 200 basis points. This shows that the growth rate is far more important in our analysis than ROIC. Risk Free Rate vs. Beta

The risk-free rate and beta both had similar effects on the value as they were changed. We thought it would be important to analyze the risk-free rate since it is highly correlated with interest rates and the rest of the economy. It is important to see how these variables change with the treasury yields. As the risk-free rate increased by 10 basis points, the price dropped by around $3 when there was a low beta. This shows how sensitive Activision’s price is to the movement of the yield curve. With the current beta of 0.92 and increasing the risk-free rate by 10 basis points, the price drops by much less. The

beta is a more drastic change which would cause the price to change by a much greater amount. The Federal Reserve has signaled that it would attempt to keep rates at 2.50% for upcoming years. There have been concerns about a financial crisis arising, so it is important to see how the price can change with the Federal Reserve manipulating the short end of the yield curve. Product Development Expense vs. WACC

When the product development expense as a percentage of sales goes up, the price goes down. This inverse relationship is important to keep in mind especially in upcoming years when many new products are being released. The development of mobile games is relatively cheaper than PC or console games. This could ultimately decrease their expenses and raise the target price. The WACC has a greater impact on the target price. With the current product development expense of 14.96%, the target price ranges from $93-$42 with different WACC percentages.

15

This report was created by students enrolled in the Applied Equity Valuation (FIN: 4250) class at the University of Iowa. The report was originally created to offer an internal investment recommendation for the University of Iowa Krause Fund and its advisory board. The report also provides potential employers and other interested parties an example of the students’ skills, knowledge and abilities. Members of the Krause Fund are not registered investment advisors, brokers or officially licensed financial professionals. The investment advice contained in this report does not represent an offer or solicitation to buy or sell any of the securities mentioned. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Krause Fund may hold a financial interest in the companies mentioned in this report.

Important Disclaimer

16

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https://www.wepc.com/news/video-game-statistics/

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References

Activision BlizzardRevenue DecompositionAll figures in millions of US DollarsFiscal Years Ending Dec. 31 2016 2017 2018 2019E 2020E 2021E 2022E 2023E CV 2024ERevenues by Segment Activision 2,220 2,628 2,738 2,382 2,477 2,527 2,577 2,629 2,682 % change -17.78% 18.38% 4.19% -13.00% 4.00% 2.00% 2.00% 2.00% 2.00% Blizzard 2,428 2,139 2,266 1,790 1,880 1,974 2,132 2,302 2,417 % change 55.14% -11.90% 5.94% -21.00% 5.00% 5.00% 8.00% 8.00% 5.00% King 1,586 1,998 2,090 2,111 2,238 2,372 2,514 2,665 2,772 % change N/A 25.98% 4.60% 1.00% 6.00% 6.00% 6.00% 6.00% 4.00% Other 365 410 459 464 528 560 594 629 655 % change 2.53% 12.33% 11.95% 1.00% 14.00% 6.00% 6.00% 6.00% 4.00% Total Net Revenues 6,608 7,036 7,500 6,747 7,123 7,433 7,817 8,225 8,525 % change 41.68% 6.48% 6.59% -10.04% 5.58% 4.34% 5.17% 5.23% 3.64%

Sales % by segment Activision 33.6% 37.4% 36.51% 35.31% 34.78% 34.00% 32.97% 31.96% 31.46% Blizzard 36.7% 30.4% 30.21% 26.53% 26.39% 26.55% 27.27% 27.99% 28.35% King 24.0% 28.4% 27.87% 31.29% 31.41% 31.91% 32.16% 32.40% 32.51% Other 5.5% 5.8% 6.12% 6.87% 7.42% 7.54% 7.60% 7.65% 7.68%Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Growth % Activision -21.62% 15.53% 4.02% -14.94% 3.85% 1.96% 1.96% 1.96% 1.96% Blizzard 35.54% -13.51% 5.60% -26.58% 4.76% 4.76% 7.41% 7.41% 4.76% King N/A 20.62% 4.40% 0.99% 5.66% 5.66% 5.66% 5.66% 3.85% Other 2.47% 10.98% 10.68% 0.99% 12.28% 5.66% 5.66% 5.66% 3.85%Total net revenues growth % 29.42% 6.08% 6.19% -11.17% 5.28% 4.16% 4.92% 4.97% 3.51%

Activision BlizzardIncome StatementAll figures in millions of US DollarsFiscal Years Ending Dec. 31 2016 2017 2018 2019E 2020E 2021E 2022E 2023E CV 2024EIncome Statement - As ReportedNet revenuesTotal net revenues 6,608 7,017 7,500 6,747 7,123 7,433 7,817 8,225 8,525 Growth 41.68% 6.19% 6.88% -10.04% 5.58% 4.34% 5.17% 5.23% 3.64%

Costs and Expenses Cost of revenues—product sales: Product costs 741 733 719 641 677 706 743 781 810 Software royalties, amortization, and intellectual property licenses 331 300 371 202 214 223 235 247 256 Cost of revenues—subscription, licensing, and other revenues: Game operations and distribution costs 851 984 1,028 698 737 769 809 851 882 Software royalties, amortization, and intellectual property licenses 471 484 399 291 308 321 338 355 368 Product development 958 1,069 1,101 1,009 1,065 1,112 1,169 1,230 1,275 Sales and marketing 1,210 1,378 1,062 1,140 1,204 1,256 1,321 1,390 1,441 General and administrative 634 760 832 537 570 595 625 658 682Total costs and expenses 5,196 5,708 5,512 4,519 4,774 4,982 5,239 5,513 5,714

Operating income 1,412 1,309 1,988 2,227 2,349 2,451 2,578 2,712 2,811 Interest and other expense (income) net 214 146 71 32 (5) (51) (113) (156) (199) Loss on extinguishment of debt 92 12 40 Income (loss) before income tax expense 1,106 1,151 1,877 2,195 2,354 2,502 2,691 2,869 3,010 Income tax expense (benefit) 140 878 64 220 235 250 269 287 301Net income (loss) 966$ 273$ 1,813$ 1,976 2,118 2,251 2,421 2,582 2,709Earnings per common share Basic 1.30$ 0.36$ 2.38$ 2.59$ 2.76$ 2.93$ 3.14$ 3.33$ 3.49$ Weighted-average number of shares outstanding Basic 740 754 762 764 767 769 772 774 777Shares outstanding Number of shares outstanding 745,486,598 757,505,195 763,051,000 765,567,446 768,083,893 770,600,339 773,116,786 775,633,232 778,149,678 Dividends per share 0.26 0.3 0.34 0.37 0.40 0.43 0.46 0.49 0.52

Activision BlizzardBalance SheetAll figures in millions of US DollarsFiscal Years Ending Dec. 31 2016 2017 2018 2019E 2020E 2021E 2022E 2023E CV 2024E(in Millions)Assets Current Assets: Cash and cash equivalents 3,245 4,713 4,225 7,074 9,362 12,258 14,447 16,639 20,899 Accounts receivable, net of allowances 732 918 1,035 922 973 1,015 1,068 1,124 1,165 Inventories, net 49 46 43 41 44 46 48 51 52 Software development 412 367 264 337 312 325 342 360 373 Other current assets 392 476 539 500 500 500 500 500 500 Total current assets 4,830 6,520 6,106 8,874 11,191 14,144 16,406 18,674 22,989

Software development 54 86 65 71 75 78 82 86 89 Property and equipment, net 258 294 282 290 302 315 329 346 361 Deferred income taxes, net 283 459 403 217 233 248 266 284 298 Other assets 401 440 482 675 712 743 782 823 852 Intangible assets, net 1,858 1,106 735 525 456 445 438 433 433 Goodwill 9,768 9,763 9,762 9,762 9,762 9,762 9,762 9,762 9,762 Total assets 17,452 18,668 17,835 20,414 22,731 25,735 28,065 30,407 34,784

Liabilities and Shareholders' Equity Accounts payable 222 323 253 269 284 296 312 328 340 Deferred revenues 1,628 1,929 1,493 1,599 1,688 1,762 1,853 1,949 2,020 Accrued expenses and other liabilities 806 1,411 896 970 1,024 1,068 1,123 1,182 1,225 Current portion of long-term debt 0 0 0 0 0 650 400 0 1,650 Total current liabilities 2,656 3,663 2,642 2,838 2,996 3,776 3,688 3,460 5,236 Long-term debt, net 4,887 4,390 2,671 3,312 3,497 3,649 3,837 4,038 4,185 Deferred income taxes, net 44 21 18 54 57 60 63 66 69 Other liabilities 746 1,132 1,147 1,060 1,119 1,168 1,228 1,292 1,339 Total liabilities 8,333 9,206 6,478 7,264 7,669 8,652 8,816 8,856 10,828

Shareholder's Equity Common stock/Additional paid-in capital 10,442 10,747 10,963 11,063 11,163 11,263 11,363 11,463 11,563 Less: Treasury stock (5,563) (5,563) (5,563) (5,563) (5,563) (5,563) (5,563) (5,563) (5,563) Retained earnings 4,869 4,916 6,558 8,251 10,063 11,983 14,050 16,252 18,557 Accumulated other comprehensive loss (income) (629) (638) (601) (601) (601) (601) (601) (601) (601) Total shareholders' equity 9,119 9,462 11,357 13,150 15,062 17,082 19,249 21,551 23,956 Total liabilities and shareholders' equity 17,452 18,668 17,835 20,414 22,731 25,735 28,065 30,407 34,784 All figures in millions of U.S. Dollar.

Activision BlizzardCash Flow Statement(in millions)Fiscal Years Ending Dec. 31 2012 2013 2014 2015 2016 2017 2018Cash flows from operating activities:Net income (loss): 1,149 1,010 835 892 966 273 1,813 Deferred income taxes (10) 161 (44) (27) (9) (181) 20 Depreciation & amortization 120 108 90 95 829 888 509 Loss on disposal of property & equipment 1 0 1 0 0 0 0 Amortization of capitalized software development costs & intellectual property licenses 208 207 256 399 321 311 489 Amortization of debt discount, financing costs, & non-cash write-off due to extinguishment of debts 0 0 0 0 50 24 0 Amortization of debt discount & financing costs 0 1 7 7 0 0 6 Share-based compensation expense 126 108 104 92 147 176 209

Other adjustments 0 0 0 0 4 28 1Accounts receivable, net (46) 198 (177) (40) 84 (165) (114)Inventories (62) 6 (2) (54) 32 (26) (5)Software development & intellectual property licenses (301) (268) (349) (350) (362) (301) (372)Other assets 88 (67) 18 21 (10) (97) (51)Deferred revenues 153 (275) 475 (27) (35) 220 122Accounts payable (54) 7 (12) (25) (50) 85 (65)Accrued expenses & other liabilities (22) 64 90 233 83 945 (574)

Net cash flows from operating activities: 1,345 1,264 1,292 1,192 2,155 2,213 1,790Proceeds from maturities of available-for-sale investments 444 304 21 145 0 80 116Proceeds from auction rate securities called at par 10 0 0 0 0 0 0Proceeds from sale of available-for-sale investments 0 98 0 0 0 0 0Purchases of available-for-sale investments (503) (26) 0 (145) 0 (135) (209)Acquisition of business, net of cash acquired 0 0 0 (46) (4,588) 0 0Release (deposit) of cash in escrow 0 0 0 (3,561) (3,561) 0 0 Capital expenditures (73) (74) (107) (111) (136) (155) (131)Decrease (increase) in restricted cash (2) 6 2 2 0 0 0Other investing activities 0 0 0 0 (14) 13 (6)

Net cash flows from investing activities: (124) 308 (84) (3,716) (1,177) (197) (230)Proceeds from issuance of common stock to employees 33 158 175 106 106 178 99Excess tax benefits from stock option exercises 5 0 0 0 0 0 0Tax payment related to net share settlements on restricted stock units (16) (49) (66) (83) (115) (56) (94)Dividends paid (204) (216) (147) (170) (195) (226) (259)Excess tax benefits from stock awards 0 29 39 67 0 0 0Proceeds from debt issuances, net of discounts 0 0 0 0 6,878 3,741 0Repayment of long-term debt 0 (6) (375) (250) (6,104) (4,251) (1,740)Premium payment for early redemption of note 0 0 0 0 (63) 0 (25)Debt financing costs related to debt issuances 0 (59) 0 (7) (7) 0 0Repurchase of common stock (315) (5,830) 0 0 0 0 0Proceeds from issuance of long-term debt 0 4,750 0 0 0 0 0Proceeds received from shareholder settlement 0 0 0 202 0 0 0Other financing activities 0 0 0 0 0 (10) (1)

Net cash flows from financing activities: (497) (1,223) (374) (135) 500 (624) (2,020)Effect of foreign exchange rate changes on cash & cash equivalents 70 102 (396) (366) (56) 76 (31)Net increase (decrease) in cash & cash equivalents 794 451 438 (3,025) 1,422 1,468 0Net increase (decrease) in cash & cash equivalents & restricted cash 0 0 0 0 0 0 (491)Cash & cash equivalents at beginning of period 3,165 3,959 4,410 4,848 1,823 3,245 0Cash & cash equivalents & restricted cash at beginning of period 0 0 0 0 0 0 4,720Cash & cash equivalents at end of period 3,959 4,410 4,848 1,823 3,245 4,713 4,229Cash paid for income taxes, net of refunds 159 138 34 20 121 176 560Cash paid for interest 2 19 201 193 209 145 150

Activision BlizzardCash Flow Statement(in millions)Fiscal Years Ending Dec. 31 2019E 2020E 2021E 2022E 2023E 2024ECash flows from operating activities:Net income (loss): 1,976 2,118 2,251 2,421 2,582 2,709 Depreciation & amortization 337 200 147 149 153 156

Accounts receivable, net 113 (51) (42) (53) (56) (41)Deferred taxes 222 (13) (12) (16) (14) (12)Inventories 2 (2) (2) (2) (3) (2)Software development & intellectual property licenses (79) 22 (17) (21) (22) (16)Other assets 39 0 0 0 0 0Deferred revenues 106 89 73 91 97 71Accounts payable 16 15 12 15 16 12Accrued expenses & other liabilities 74 54 44 55 59 43

Net cash flows from operating activities: 2,805 2,431 2,455 2,640 2,812 2,920

Cash flows from investing activitiesOther long-term assets (193) (38) (31) (38) (41) (30)Capital expenditures (135) (142) (149) (156) (165) (170)

Net cash flows from investing activities: (328) (180) (180) (195) (205) (200)

Cash flows from financing activitiesProceeds from issuance of common stock to employees 100 100 100 100 100 100Excess tax benefits from stock option exercises 0 0 0 0 0 0Tax payment related to net share settlements on restricted stock units 0 0 0 0 0 0Dividends paid (283) (307) (331) (355) (379) (404)Excess tax benefits from stock awards 0 0 0 0 0 0Proceeds from debt issuances, net of discounts 0 0 0 0 0 0 Other liabilities (87) 59 49 60 64 47 Change in current portion of LT debt 0 0 650 (250) (400) 1,650 Repayment of long-term debt 641 185 152 189 201 147

Net cash flows from financing activities: 371 37 620 (256) (415) 1,540Effect of foreign exchange rate changes on cash & cash equivalents 0 0 0 0 0 0Net increase (decrease) in cash & cash equivalents 2,849 2,288 2,895 2,190 2,192 4,260Cash & cash equivalents at beginning of period 4,225 7,074 9,362 12,258 14,447 16,639Cash & cash equivalents at end of period 7,074 9,362 12,258 14,447 16,639 20,899

Activision BlizzardCommon Size Income Statement(as a % of sales)Fiscal Years Ending Dec. 31 2016 2017 2018 2019E 2020E 2021E 2022E 2023E 2024ETotal net revenues 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%Costs and Expenses Cost of revenues—product sales: Product costs 11.21% 10.45% 9.59% 9.50% 9.50% 9.50% 9.50% 9.50% 9.50% Software royalties, amortization, and intellectual property licenses 5.01% 4.28% 4.95% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% Cost of revenues—subscription, licensing, and other revenues: Game operations and distribution costs 12.88% 14.02% 13.71% 10.35% 10.35% 10.35% 10.35% 10.35% 10.35% Software royalties, amortization, and intellectual property licenses 7.13% 6.90% 5.32% 4.32% 4.32% 4.32% 4.32% 4.32% 4.32% Product development 14.50% 15.23% 14.68% 14.96% 14.96% 14.96% 14.96% 14.96% 14.96% Sales and marketing 18.31% 19.64% 14.16% 16.90% 16.90% 16.90% 16.90% 16.90% 16.90% General and administrative 9.59% 10.83% 11.09% 7.96% 8.00% 8.00% 8.00% 8.00% 8.00%Total costs and expenses 78.63% 81.35% 73.49% 66.99% 67.03% 67.03% 67.03% 67.03% 67.03%

Operating income 21.37% 18.65% 26.51% 33.01% 32.97% 32.97% 32.97% 32.97% 32.97% Interest and other expense (income) net 3.24% 2.08% 0.95% 0.47% -0.07% -0.68% -1.45% -1.90% -2.34% Loss on extinguishment of debt 1.39% 0.17% 0.53% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Income (loss) before income tax expense 16.74% 16.40% 25.03% 32.54% 33.04% 33.66% 34.42% 34.87% 35.31% Income tax expense (benefit) 2.12% 12.51% 0.85% 3.25% 3.30% 3.37% 3.44% 3.49% 3.53%Net income (loss) 14.62% 3.89% 24.17% 29.29% 29.74% 30.29% 30.98% 31.39% 31.78%

Activision BlizzardCommon Size Balance Sheet(as a % of sales)Fiscal Years Ending Dec. 31 2016 2017 2018 2019E 2020E 2021E 2022E 2023E CV 2024E(in Millions)Assets Current Assets: Cash and cash equivalents 49.11% 67.17% 56.33% 104.85% 131.44% 164.92% 184.82% 202.29% 245.15% Accounts receivable, net of allowances 11.08% 13.08% 13.80% 13.66% 13.66% 13.66% 13.66% 16.66% 16.35% Inventories, net 0.74% 0.66% 0.57% 0.61% 0.61% 0.61% 0.61% 0.75% 0.74% Software development 6.23% 5.23% 3.52% 5.00% 4.38% 4.38% 4.38% 5.33% 5.24% Other current assets 5.93% 6.78% 7.19% 7.41% 7.02% 6.73% 6.40% 7.41% 7.02% Less: Intellectual property licenses Total current assets 73.09% 92.92% 81.41% 131.54% 157.11% 190.30% 209.87% 276.78% 322.74%

Software development 0.82% 1.23% 0.87% 1.05% 1.05% 1.05% 1.05% 1.28% 1.25% Property and equipment, net 3.90% 4.19% 3.76% 4.30% 4.24% 4.23% 4.21% 5.12% 5.06% Deferred income taxes, net 4.28% 6.54% 5.37% 3.22% 3.27% 3.33% 3.41% 4.21% 4.18% Other assets 6.07% 6.27% 6.43% 10.00% 10.00% 10.00% 10.00% 12.19% 11.97% Intangible assets, net 28.12% 15.76% 9.80% 7.78% 6.40% 5.99% 5.60% 6.42% 6.08% Goodwill 147.82% 139.13% 130.16% 144.69% 137.05% 131.34% 124.88% 144.69% 137.05% Total assets 264.10% 266.04% 237.80% 302.58% 319.12% 346.24% 359.03% 450.69% 488.34%

Liabilities and Shareholders' Equity Accounts payable 3.36% 4.60% 3.37% 3.99% 3.99% 3.99% 3.99% 4.86% 4.77% Deferred revenues 24.64% 27.49% 19.91% 23.70% 23.70% 23.70% 23.70% 28.89% 28.36% Accrued expenses and other liabilities 12.20% 20.11% 11.95% 14.37% 14.37% 14.37% 14.37% 17.52% 17.20% Current portion of long-term debt 0.00% 0.00% 0.00% 0.00% 0.00% 8.75% 5.12% 0.00% 23.16% Total current liabilities 40.19% 52.20% 35.23% 42.06% 42.06% 50.81% 47.18% 51.28% 73.50% Long-term debt, net 73.96% 62.56% 35.61% 49.09% 49.09% 49.09% 49.09% 59.85% 58.75% Deferred income taxes, net 0.67% 0.30% 0.24% 0.80% 0.80% 0.80% 0.80% 0.98% 0.96% Other liabilities 11.29% 16.13% 15.29% 15.71% 15.71% 15.71% 15.71% 19.16% 18.81% Total liabilities 126.10% 131.20% 86.37% 107.67% 107.67% 116.41% 112.78% 131.27% 152.02%

Shareholder's Equity Common stock/Additional paid-in capital 158.02% 153.16% 146.17% 163.98% 156.72% 151.54% 145.36% 169.90% 162.33% Less: Treasury stock -84.19% -79.28% -74.17% -82.46% -78.10% -74.85% -71.17% -82.46% -78.10% Retained earnings 73.68% 70.06% 87.44% 122.30% 141.27% 161.23% 179.74% 240.89% 260.52% Accumulated other comprehensive loss (income) -9.52% -9.09% -8.01% -8.91% -8.44% -8.09% -7.69% -8.91% -8.44% Total shareholders' equity 138.00% 134.84% 151.43% 194.91% 211.45% 229.83% 246.24% 319.43% 336.32% Total liabilities and shareholders' equity 264.10% 266.04% 237.80% 302.58% 319.12% 346.24% 359.03% 450.69% 488.34%All figures in millions of U.S. Dollar.

Activision BlizzardValue Driver EstimationAll figures in millions of US DollarsFiscal Years Ending Dec. 31 2016 2017 2018 2019E 2020E 2021E 2022E 2023E CV 2024E

NOPLATTotal net revenues 6,608 7,017 7,500 6,747 7,123 7,433 7,817 8,225 8,525 Cost of revenues—product sales: - Product costs 741 733 719 641 677 706 743 781 810 - Software royalties, amortization, and intellectual property licenses 331 300 371 202 214 223 235 247 256 Cost of revenues - Game operations and distribution costs 851 984 1,028 698 737 769 809 851 882 - Software royalties, amortization, and intellectual property licenses 471 484 399 291 308 321 338 355 368 - Product development 958 1,069 1,101 1,009 1,065 1,112 1,169 1,230 1,275 - Sales and marketing 1,210 1,378 1,062 1,140 1,204 1,256 1,321 1,390 1,441 - General and administrative 634 760 832 537 570 595 625 658 682 + Operating lease interest 57 60 50 80 80 80 80 80 80 EBITA Oper Inc 1,412 1,309 1,988 2,227 2,349 2,451 2,578 2,712 2,811

EBITA plus OP lease interest 1,469 1,369 2,038 2,307 2,429 2,531 2,658 2,792 2,891

Adjusted Taxes + Income Tax Expense 140 878 64 220 235 250 269 287 301 + Tax shield on interest expense 21 15 7 3 0 -5 -11 -16 -20Total adjusted taxes 171 894 75 223 235 245 258 271 281

Plus: Change in deferred taxesDeferred Tax Liabilities Year 1 44 21 18 54 57 60 63 66 69 - Deferred Tax Assets Year 1 0 0 0 0 0 0 0 0 0Change Year 1 44 21 18 54 57 60 63 66 69Deferred Tax Liabilities Year 0 10 44 21 18 54 57 60 63 66 - Deferred Tax Assets Year 0 0 0 0 0 0 0 0 0 0Change Year 0 10 44 21 18 54 57 60 63 66Change in Deferred Taxes 34 -23 -3 36 3 2 3 3 2

NOPLAT 1,275 392 1,910 2,041 2,117 2,208 2,323 2,444 2,532

Invested Capital Accounts receivable, net of allowances 732 918 1,035 922 973 1,015 1,068 1,124 1,165 Inventories, net 49 46 43 41 44 46 48 51 52 Software development 412 367 264 337 312 325 342 360 373 Other current assets excluding short-term investments and intellectual property licenses 0 0 0 0 0 0 0 0 0Normal Cash (Estimated at 50% revenues) 3,304 3,509 3,750 3,373 3,562 3,716 3,908 4,113 4,262Operating current assets 4,497 4,840 5,092 4,674 4,890 5,103 5,366 5,647 5,853

Accounts payable 222 323 253 269 284 296 312 328 340 Accrued expenses and other liabilities 806 1,411 896 970 1,024 1,068 1,123 1,182 1,225 Deferred revenues 1,628 1,929 1,493 1,599 1,688 1,762 1,853 1,949 2,020Non Interest-bearing current liabilities 2,656 3,663 2,642 2,838 2,996 3,126 3,288 3,460 3,586

Property and equipment, net 258 294 282 290 302 315 329 346 361

Other assets 401 440 482 675 712 743 782 823 852 PV of operating leases 287 329 296 305 317 331 346 363 379 Intangible assets, net 1,858 1,106 735 525 456 445 438 433 433Other Operating Assets 2,546 1,875 1,513 1,505 1,486 1,519 1,566 1,619 1,665

LESS: Other liabilities 746 1,132 1,147 1,060 1,119 1,168 1,228 1,292 1,339Other Operating Liabilities 746 1,132 1,147 1,060 1,119 1,168 1,228 1,292 1,339

Invested Capital 3,899 2,213 3,098 2,571 2,563 2,642 2,746 2,859 2,953

Return on Invested Capital 96.19% 10.06% 86.29% 65.86% 82.35% 86.17% 87.91% 89.02% 88.56%(NOPLAT yr 1/Invested Capital yr 0)

Free cash flow -1,298 2,078 1,025 2,568 2,125 2,128 2,219 2,331 2,439(NOPLAT yr 1-(IC yr1-IC yr0))

Economic Profit $1,186 $128 $1,760 $1,831 $1,943 $2,035 $2,144 $2,258 $2,338(NOPLAT - (Beginning IC * WACC))

Activision BlizzardWeighted Average Cost of Capital (WACC) Estimation 6.78%

Risk-Free Rate (Rf) 2.41%Market Return (Rm) 7.36%Equity Risk Premium (MRP) 4.95%Raw Beta 0.92MV of Equity 36137Cost of Equity (re) using CAPM 6.96%

Pre-tax cost of debt 5.00%MV of debt 2967Tax shield on int ex 10.00%

Equity weight 92.41%Debt weight 7.59%WACC 6.78%

Cost Of Equity (re)

Cost of debt (rd)

WACC Calculation

Activision BlizzardDiscounted Cash Flow (DCF) and Economic Profit (EP) Valuation Models

Key Inputs: CV Growth 2.00% CV ROIC 68.19% WACC 6.78% Cost of Equity 6.96%

Fiscal Years Ending Dec. 31 2019E 2020E 2021E 2022E 2023E 2024CV

DCF ModelNOPLAT 2,041 2,117 2,208 2,323 2,444 2,532 Change in Invested Capital (528) (8) 80 103 114 93 Free Cash Flow 2,568 2,125 2,128 2,219 2,331 2,439 Discount Periods 1 2 3 4 5 5Discount Rate (Using WACC) 1.07 1.07 1.07 1.07 1.07 1.07PV of Free Cash Flow 2,405 1,864 1,748 1,707 1,679 1,757PV of Annuity forecast 9,404

Contuniuing ValueNOPLAT 2,532Free Cash Flow 2,458CV at yr -1 51,455Discount Periods 5Discount Rate 1.07PV of CV 37,071

Enterprise Value 46,475 + Excess Cash 1,823 - LT Debt (2,671) - PV of Operating Leases (296) - Other Liabilities (1,147) - ESOP (246)Value 43,938Shares Outstanding 762Target Price as of 12/31/2019 57.66Partial Year Stock Price 58.63

EP ModelForecast PeriodEconomic Profit 1,831 1,943 2,035 2,144 2,258 2,338Discount Periods 1 2 3 4 5 5Discount Rate (Using WACC) 1 1 1 1 1 1PV of EP 1,715 1,704 1,671 1,649 1,627 1,685PV of Forecast Period 8,366

Continuing Value PeriodEconomic Profit 2,338Discount Periods 1 2 3 4 5Discount Rate (Using WACC) 1.07 1.07 1.07 1.07 1.07 1.07CV at yr 2023 48,595PV of Continuing Value 35,011

Enterprise Value 43,377 + Value of IC at 2018 3,098Value of Op. Assets 46,475

Value of Operations 46,475Plus: Excess Cash 1,823Less: LT Debt (2,671)Less: PV of OP leases (296)Less: Other liabilites (1,147)Less: ESOPs (246)Value of Equity 43,938Shares Outstanding 762Implied Price Per Share 57.66Partial Year Adjusted 58.63

Activision BlizzardDividend Discount Model (DDM) or Fundamental P/E Valuation Model

Fiscal Years Ending INCLUDE DATA AS OF 4/12/2019 2019E 2020E 2021E 2022E 2023E 2024CV

EPS 2.59$ 2.76$ 2.93$ 3.14$ 3.33$ 3.49$

Key Assumptions CV growth 2.00% CV ROE 11.31% NI/Shareholders Equity Cost of Equity 6.96%

Future Cash Flows P/E Multiple (CV Year) 16.58 EPS (CV Year) 3.49 Future Stock Price 57.82 Dividends Per Share 0.37 0.40 0.43 0.46 0.49 Future Cash Flows 0.37 0.40 0.43 0.46 0.49 57.82Discount Periods 1 2 3 4 5 5Discount Rate 1.07 1.14 1.22 1.31 1.40 1.40Discounted Cash Flows 0.35 0.35 0.35 0.35 0.35 41.30Intrinsic Value 43.05$ Partial Year Adjustment 43.77$

Activision BlizzardRelative Valuation Models

EPS EPSTicker Company Price 2019E 2020E P/E 18 P/E 19EA Electronic Arts Inc. $100.44 $3.91 $4.40 25.69 22.83 TTWO Take-Two Interactive So $98.16 $4.81 $4.97 20.41 19.75 MSFT Microsoft $119.71 $4.43 $4.99 27.02 23.99 AAPL Apple $195.28 $8.14 $9.46 23.99 20.64 NTDOY Nintendo Co. $36.57 $1.39 $1.44 26.31 25.40 UBSFY Ubisoft Entertainment S $17.97 $0.98 $0.56 18.34 32.09

Average 22.72 22.25

ATVI Activision Blizzard $47.28 $ 2.38 $2.59 19.87 18.29

Implied Relative Value: P/E (EPS19) $ 54.07 P/E (EPS20) 57.53$ PEG (EPS19) 54.07$ PEG (EPS20) 57.53$ P/B 114.02$ P/Tangible BV 95.02$

Activision BlizzardKey Management Ratios

Fiscal Years Ending Dec. 31 2016 2017 2018 2019E 2020E 2021E 2022E 2023E CV 2024E

Liquidity RatiosCurrent ratio (Current Assets / Current Liabilities) 1.82 1.78 2.31 3.13 3.74 3.75 4.45 5.40 4.39Quick Ratio (Current Assets - Inventories)/Current Liabilities 1.80 1.77 2.29 3.11 3.72 3.73 4.44 5.38 4.38Cash ratio (Operating CF/Current Liabilities) 1.22 1.29 1.60 2.49 3.12 3.25 3.92 4.81 3.99

Activity or Asset-Management RatiosReceivables Turnover (Sales/Average Accounts Receivable)) 9.37 8.51 7.68 6.90 7.52 7.47 7.50 7.51 7.45Day Receivables (365/Average Accounts Receivable) 38.97 42.91 47.52 52.93 48.55 48.83 48.64 48.63 48.99Total Asset Turnover (Sales/Total Assets) 0.38 0.38 0.42 0.33 0.31 0.29 0.28 0.27 0.25

Financial Leverage RatiosDebt to Equity (Total Debt/Total Equity) 0.54 0.46 0.24 0.25 0.23 0.21 0.20 0.19 0.17Equity Multiplier (Shareholders' Equity/Total Assets) 0.52 0.51 0.64 0.64 0.66 0.66 0.69 0.71 0.69Debt Ratio (Total Liabilities/Total assets) 0.48 0.49 0.36 0.36 0.34 0.34 0.31 0.29 0.31

Profitability RatiosReturn on Assets (Net Income/Total Assets) 5.54% 1.46% 10.17% 9.68% 9.32% 8.75% 8.63% 8.49% 7.79%Return on Equity (Net Income/Shareholders' Equity) 10.59% 2.89% 15.96% 15.03% 14.06% 13.18% 12.58% 11.98% 11.31%Profit Margin (Net Income/Sales) 14.62% 3.89% 24.17% 29.29% 29.74% 30.29% 30.98% 31.39% 31.78%

Payout Policy RatiosDividend payout Ratio (Dividends Paid)/EPS 0.20 0.83 0.14 0.14 0.14 0.15 0.15 0.15 0.15

Present Value of Operating Lease Obligations (2018) Present Value of Operating Lease Obligations (2017) Present Value of Operating Lease Obligations (2016)

Operating Operating OperatingFiscal Years Ending Dec. 31 Leases Fiscal Years Ending Dec. 31 Leases Fiscal Years Ending Dec. 31 Leases2019 80 2018 81 2017 652020 70 2019 70 2018 592021 53 2020 61 2019 522022 45 2021 48 2020 442023 38 2022 41 2021 32Thereafter 60 Thereafter 88 Thereafter 92Total Minimum Payments 346 Total Minimum Payments 389 Total Minimum Payments 344Less: Interest 50 Less: Interest 60 Less: Interest 57PV of Minimum Payments 296 PV of Minimum Payments 329 PV of Minimum Payments 287

Capitalization of Operating Leases Capitalization of Operating Leases Capitalization of Operating Leases

Pre-Tax Cost of Debt 5.00% Pre-Tax Cost of Debt 5.00% Pre-Tax Cost of Debt 5.00%Number Years Implied by Year 6 Payment 1.6 Number Years Implied by Year 6 Payment 2.1 Number Years Implied by Year 6 Payment 2.9

Lease PV Lease Lease PV Lease Lease PV LeaseYear Commitment Payment Year Commitment Payment Year Commitment Payment1 80 76.2 1 81 77.1 1 65 61.92 70 63.5 2 70 63.5 2 59 53.53 53 45.8 3 61 52.7 3 52 44.94 45 37.0 4 48 39.5 4 44 36.25 38 29.8 5 41 32.1 5 32 25.16 & beyond 38 44.2 6 & beyond 41 63.9 6 & beyond 32 65.6PV of Minimum Payments 296.4 PV of Minimum Payments 328.8 PV of Minimum Payments 287.2

Effects of ESOP Exercise and Share Repurchases on Common Stock Balance Sheet Account and Number of Shares Outstanding

Number of Options Outstanding (shares): 17,137,000Average Time to Maturity (years): 6.81Expected Annual Number of Options Exercised: 2,516,446

Current Average Strike Price: 39.73$ Cost of Equity: 6.96%Current Stock Price: $47.28

2019E 2020E 2021E 2022E 2023E 2024CVIncrease in Shares Outstanding: 2,516,446 2,516,446 2,516,446 2,516,446 2,516,446 2,516,446Average Strike Price: 39.73$ 39.73$ 39.73$ 39.73$ 39.73$ 39.73$ Increase in Common Stock Account: 99,978,416 99,978,416 99,978,416 99,978,416 99,978,416 99,978,416

Change in Treasury Stock 0 0 0 0 0 0Expected Price of Repurchased Shares: 47.28$ 50.57$ 54.09$ 57.86$ 61.89$ 66.20$ Number of Shares Repurchased: - - - - - -

Shares Outstanding (beginning of the year) 763,051,000 765,567,446 768,083,893 770,600,339 773,116,786 775,633,232Plus: Shares Issued Through ESOP 2,516,446 2,516,446 2,516,446 2,516,446 2,516,446 2,516,446Less: Shares Repurchased in Treasury - - - - - - Shares Outstanding (end of the year) 765,567,446 768,083,893 770,600,339 773,116,786 775,633,232 778,149,678

VALUATION OF OPTIONS GRANTED IN ESOP

Ticker Symbol ATVICurrent Stock Price $47.28Risk Free Rate 2.41%Current Dividend Yield 0.81%Annualized St. Dev. of Stock Returns 18.90%

Average Average B-S ValueRange of Number Exercise Remaining Option of OptionsOutstanding Options of Shares Price Life (yrs) Price GrantedRange 1 17,137 39.73 6.81 14.34$ 245,796$ Total 17,137 39.73$ 6.81 16.36$ 245,796$

58.63 4.75% 4.80% 4.85% 4.90% 4.95% 5.00% 5.05% 5.10% 5.15% 58.63 10.96% 11.96% 12.96% 13.96% 14.96% 15.96% 16.96% 17.96% 18.96%0.52 100.055 99.196 98.352 97.521 96.704 95.900 95.110 94.331 93.565 5.05% 94.129 94.052 93.975 93.898 93.821 93.743 93.666 93.589 93.5120.62 86.346 85.578 84.822 84.080 83.350 82.632 81.926 81.231 80.548 5.48% 82.099 82.022 81.945 81.868 81.792 81.715 81.638 81.561 81.4840.72 75.866 75.171 74.488 73.818 73.159 72.511 71.874 71.248 70.632 5.91% 72.716 72.639 72.563 72.486 72.410 72.333 72.257 72.180 72.1040.82 67.592 66.959 66.337 65.726 65.126 64.537 63.957 63.387 62.827 6.34% 65.193 65.116 65.040 64.964 64.888 64.812 64.735 64.659 64.5830.92 60.895 60.314 59.743 59.183 58.632 58.091 57.560 57.037 56.524 6.77% 59.027 58.951 58.875 58.799 58.723 58.647 58.571 58.496 58.4201.02 55.364 54.827 54.299 53.781 53.273 52.773 52.283 51.801 51.327 7.20% 53.881 53.806 53.730 53.655 53.579 53.503 53.428 53.352 53.2771.12 50.718 50.218 49.728 49.247 48.775 48.311 47.856 47.408 46.969 7.63% 49.523 49.447 49.372 49.297 49.221 49.146 49.071 48.996 48.9201.22 46.760 46.294 45.836 45.387 44.946 44.514 44.089 43.671 43.261 8.06% 45.783 45.708 45.633 45.558 45.483 45.408 45.333 45.258 45.1831.32 43.348 42.911 42.482 42.061 41.648 41.242 40.844 40.453 40.068 8.49% 42.539 42.464 42.390 42.315 42.240 42.166 42.091 42.016 41.942

58.63 1.60% 1.70% 1.80% 1.90% 2.00% 2.10% 2.20% 2.30% 2.40% 58.63 1.60% 1.70% 1.80% 1.90% 2.00% 2.10% 2.20% 2.30% 2.40%28% 53.520 54.224 54.955 55.717 56.511 57.339 58.203 59.105 60.049 5.05% 84.524 86.640 88.886 91.275 93.821 96.539 99.448 102.569 105.92538% 54.219 54.981 55.773 56.598 57.458 58.354 59.290 60.267 61.289 5.48% 74.741 76.364 78.075 79.881 81.792 83.815 85.962 88.244 90.67448% 54.628 55.424 56.252 57.114 58.012 58.948 59.925 60.946 62.014 5.91% 66.912 68.189 69.527 70.933 72.410 73.965 75.603 77.332 79.16058% 54.896 55.714 56.566 57.452 58.375 59.338 60.343 61.392 62.490 6.34% 60.505 61.530 62.600 63.718 64.888 66.113 67.397 68.745 70.16168% 55.086 55.920 56.788 57.691 58.632 59.613 60.638 61.708 62.827 6.77% 55.166 56.002 56.873 57.779 58.723 59.708 60.736 61.810 62.93378% 55.227 56.073 56.953 57.869 58.823 59.818 60.857 61.942 63.077 7.20% 50.647 51.340 52.059 52.805 53.579 54.384 55.221 56.093 57.00188% 55.336 56.191 57.080 58.006 58.971 59.977 61.027 62.124 63.271 7.63% 46.773 47.355 47.956 48.578 49.222 49.889 50.581 51.299 52.04498% 55.423 56.285 57.182 58.116 59.089 60.103 61.162 62.268 63.425 8.06% 43.417 43.909 44.417 44.941 45.483 46.043 46.622 47.221 47.842

108% 55.494 56.362 57.265 58.205 59.185 60.206 61.272 62.386 63.550 8.49% 40.480 40.901 41.334 41.780 42.241 42.715 43.205 43.711 44.233

58.63 2.01% 2.11% 2.21% 2.31% 2.41% 2.51% 2.61% 2.71% 2.81% 58.63 1.60% 1.70% 1.80% 1.90% 2.00% 2.10% 2.20% 2.30% 2.40%0.52 110.958 107.025 103.354 99.922 96.704 93.682 90.839 88.158 85.627 2.01% 59.543 60.533 61.567 62.647 63.775 64.956 66.193 67.491 68.8530.62 93.829 90.977 88.289 85.750 83.350 81.076 78.919 76.871 74.923 2.11% 58.365 59.313 60.302 61.333 62.410 63.536 64.715 65.950 67.2440.72 81.187 79.025 76.971 75.018 73.159 71.386 69.695 68.079 66.533 2.21% 57.232 58.140 59.085 60.071 61.100 62.175 63.299 64.475 65.7070.82 71.473 69.777 68.158 66.609 65.126 63.706 62.344 61.036 59.780 2.31% 56.139 57.009 57.915 58.858 59.842 60.868 61.941 63.062 64.2360.92 63.775 62.410 61.100 59.842 58.632 57.468 56.348 55.268 54.228 2.41% 55.086 55.920 56.788 57.691 58.632 59.613 60.638 61.708 62.8271.02 57.525 56.403 55.321 54.279 53.273 52.302 51.364 50.458 49.581 2.51% 54.069 54.870 55.702 56.567 57.468 58.407 59.386 60.408 61.4761.12 52.350 51.410 50.502 49.624 48.775 47.953 47.156 46.385 45.636 2.61% 53.088 53.856 54.655 55.484 56.348 57.247 58.183 59.160 60.1801.22 47.993 47.196 46.423 45.673 44.946 44.241 43.556 42.891 42.245 2.71% 52.140 52.878 53.644 54.441 55.268 56.129 57.026 57.960 58.9351.32 44.276 43.590 42.924 42.277 41.648 41.036 40.441 39.862 39.298 2.81% 51.223 51.933 52.669 53.433 54.228 55.053 55.912 56.806 57.739

Sensitivity Analysis

Risk Free

Market Risk Premium Product Development Expense % of Sales

WACCBeta

CV Growth

Risk free rate CV growth NOPLAT

CV ROIC WACC

CV Growth

Beta