Video Game Wars Heat Up in Courtroom Battle

It has been a news-filled week at video game publisher Activision Blizzard (ATVI) as they fired two top executives at Infinity Ward, the subsidiary responsible for the ultra successful Call of Duty: Modern Warfare 2. In the company’s annual report filed with the SEC, they alluded to “an internal human resources inquiry into breaches of contract and insubordination by two senior employees at Infinity Ward.” Earlier this week, Activision parted ways with Jason West and Vince Zampella, the president and CEO respectively of the wholly owned subsidiary responsible for the blockbuster Call of Duty. Now, the executives are fighting back in court claiming that their canning constitutes a breach of contract and that they are due around $36 million in royalties from the game.

Infinity Ward’s creation was one of the lone bright spots in the video game industry last year. It sold 4.7 million copies on the release date, and became the first game to cross more than $1 billion in sales. The loss of talent at this important division has some investors nervous regarding the future of these games. Activision will devote a division just to this franchise of games and has plans to expand online offerings, and will release a new version of Call of Duty in 2011 from another studio. Thankfully for Activision, they have other blockbuster game franchises that should be able to cushion the blow should Call of Duty sales suffer as a result of these firings.

At this point, details are scarce in terms of the reasoning for the firings in the first place, but it is clear that Activision Blizzard believed it was a serious offense. The executives think they were fired in order to avoid performance compensation, but that is for the courts to settle. So far, the market has been rather quiet towards the shake-up, as the stock has barely moved and certain analysts have said it should not have a material effect on earnings.

At Ockham, we are reiterating our Undervalued stance on ATVI, as the company has experienced huge revenue growth in the past year. The stock is up less than 10% in the last year even as revenue growth was 41% (thanks in large part to Call of Duty and Guitar Hero games). Earnings growth has been more subdued but has become more consistent recently despite the rough gaming environment. With strong growth, zero debt and nearly a quarter of the market cap in cash on the balance sheet; there is intriguing underlying value in ATVI. The shake-up at Infinity Ward is certainly something to keep an eye on, especially if there is any further defections, but it is extremely likely Activision will continue to be one of the premier game producers across a variety of formats.

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