Activision Expands in China

Activision Blizzard Inc.(ATVI - Snapshot Report) recently announced that it has entered into a partnership deal with Chinese Internet service provider Tencent Holdings Limited to launch its new game Call of Duty Online in Mainland China. As per the agreement, Tencent will exclusively operate the game in China. The financial terms of the deal were kept under wraps by both the companies.

Call of Duty has been Activision’s one of the most profitable operating franchises so far and the latest installment is a free to play game. Activision expects to earn significant revenue from the sale of in-game items going forward.

Moreover, the partnership with Tencent gives Activision a better online penetrative capacity in China. According to BOCOM International, Tencent accounted for 43.6% of China’s online gaming market in terms of revenue in the first quarter of 2012, driven by strong performance from its role playing game (RPG) Crossfire.

On the other hand, Activision’s massively multiplayer online game (“MMO”), World of Warcraft, operated by NetEase (15.0% market share) failed to cheer up the company’s top-line, due to the substantial decline in subscriber base. In such a scenario, we believe that the new game will boost Activision’s prospects in the lucrative Chinese online gaming market (particularly in the role playing game segment) going forward.

According to Analysis International, Chinese online gaming market soared approximately 33.0% year over year to $1.78 billion in the first quarter of 2012. A study by Markets Research Reports suggests that the online gaming market in China is expected to grow at a CAGR of 40% (2009-2015), which we believe justifies Activision’s decision to expand its footprint in the country.

With licensing agreements with two of the leading internet providers in China, Activision is sure to make inroads in the online gaming market in the country banking on its popular titles and a solid portfolio of games that are slated to release in 2012. Its initiatives to strengthen its portfolio through the launch of new versions and content packs would be beneficial over the long run.

However, strict Chinese government regulations on foreign video game makers and competition from the Chinese video game publishers are the potential headwinds going forward. We also believe that Tencent’s top-selling Crossfire game may cannibalize Activision’s Call of Duty Online sales going forward.

Additionally, softness in the video game industry and Activision’s limited presence in the social gaming market coupled with significant competition from Electronic Arts Inc. (EA - Analyst Report) and Take-Two Interactive Software Inc. (TTWO - Snapshot Report) are the near-term headwinds. The lack of new titles (not sequels or downloadable contents) and over-dependence on old franchises, particularly on Call of Duty and World of Warcraft, are the other challenges going forward.

We have a Neutral recommendation on Activision in the long term. Currently, Activision has a Zacks #3 Rank, which implies a Hold rating in the short term.