Bernstein: Why Video Game Publishers Could Be 'The Perfect Media Companies'

When investors think of a "studio," the first thought that might come to mind is a movie studio. But a video game publisher is very much a studio, and a compelling one that investors are underappreciating, according to Bernstein. 

The Analyst

Bernstein's Todd Juenger initiated coverage of:

• Electronic Arts Inc. EA's stock with an Outperform rating and $139 price target.
• Activision Blizzard, Inc. ATVI's stock with a Market Perform rating and $74 price target.

The Thesis

A video game publisher should be considered a studio that builds intellectual property for a large, global, young and growing market, Juenger said in the initiation note. (See the analyst's track record here.) 

Video game publishers are "not only media companies, they may actually be the perfect media companies at this point in time" for at least four compelling reasons, the analyst said:

• A distribution platform with the most popular and growing types of devices.
• Increased engagement across all ages and genders.
• An improving business model through advertisement and digital downloads.
• A significant "option value yet untapped" from e-sports, virtual and augmented reality.

Both EA and Activision have been taking advantage of these tailwinds, as evidenced by their consistent mid-single-digit revenue, high-single-digit operating income and double-digit earnings per share growth, Juenger said.

Looking forward, there's no reason to assume the metrics won't continue to improve, Juenger said. Of the two names, EA is "less sexy" but is the better investment, he said. 

EA: Dependable Growth

EA offers investors a "lower risk, lower reward" profile, since the company mostly relies on third-party IP, Juenger said. For example, the NFL, NHL, FIFA and other sports franchises ultimately control the rights to their respective IP. Coupled with a very close relationship with the "Star Wars" franchise, the company boasts a "highly believable" path to growth that's undervalued by the market, according to Bernstein. 

EA's recent monetization scandal involving the "Star Wars" game should be viewed as the result of "natural growing pains," rather than as a change to its monetization opportunity over time, the analyst said.

EA's P/E stock multiple peaked at 1.5x in 2017 and is now trading near 1.3x. Bernstein expects the stock to re-rate back to a more "appropriate" multiple of 1.5x, especially as the monetization controversy fades, Juenger said. 

Related Link: Electronic Arts Upgraded After 'Star Wars' Backlash: Here's Why

Activision: Everything Bulls Want

Activision's business boasts "everything a bullish video game investor would want," Juenger said:

• IP content it owns.
• No dependencies or encumbrances
• Eight different $1-billion franchises.
• No. 1 mobile titles.
• The highest amount of upside from advertising.
• A proven ability to launch new original franchises.

The problem: all of these factors are well-known and already priced into the stock, the analyst said.

A scenario where the stock gains 20 percent would imply that the stock re-rates to a new all-time high of 1.55x, which it can't "come close to justifying" with a discounted cash flow model, Juenger said. 

While it's possible Activision is sitting on another hit franchise, the analyst said he does not have enough confidence to include a hypothetical new franchise in the valuation model. 

Price Action

Shares of EA were up more than 2 percent in Thursday afternoon trading, while Activision shares were down 0.74 percent. 

Related Link:

Low 'Star Wars' Sales Drive Electronic Arts Downgrade, Says Morgan Stanley

Photo courtesy of Electronic Arts.