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Motley Fool Issues Rare “All In” Buy Alert
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Shares of video games maker Activision Blizzard (ATVI 1.70%) fell more than 4% on Friday in response to news that the Federal Trade Commission (FTC) may be preparing to file suit to block Activision’s acquisition by Microsoft (MSFT -2.31%) in the next few weeks. Today, the stock is bouncing back a bit, rising 2% immediately after opening for trading this morning. It’s still up 1.5% as we round the 10 a.m. EST mark.
The reason: Wall Street thinks the FTC will not in fact block the merger.
Tic-tac-toe, three in a row, Wall Street analysts JP Morgan, Morgan Stanley, and Wells Fargo unanimously assigned $95 price targets to Activision stock this morning — not coincidentally, the precise dollar value of the all-cash bid that Microsoft made for Activision in January. (A fourth analyst, Truist, said it has a “bull case” valuation of $95 on Activision stock, but its mid-range valuation, accounting for risks that the merger will not go through, is closer to $81, according to ratings-watcher TheFly).
Of the three more bullish analysts, Morgan Stanley and Wells Fargo were most bullish, upgrading Activision stock to “overweight.” While unable to predict whether the FTC will succeed in blocking the deal, both bankers insisted Activision is worth owning even if it remains independent. Wells even assigned a $76 valuation to the stock in that scenario, hinting that with Activision stock selling for $74 today, it sees essentially no risk in buying the stock at these prices.
JP Morgan, in contrast, was a bit more cautious. While its $95 price target hints at which way it sees this thing going, the analyst declined to raise its rating on Activision stock past “neutral,” while it waits to see which way the FTC will jump.
Personally, I’m even more cautious than JP Morgan, however. While the potential for winning a 28% windfall if and when the Microsoft merger closes is certainly enticing, in the event the FTC forbids Microsoft from buying Activision, I think this stock could be worth a lot less than the $74 it fetches currently.
Consider this: With trailing earnings and trailing free cash flow (FCF) are essentially equal at $1.7 billion, Activision’s current $57.5 billion market capitalization values the stock at nearly 34 times both earnings and FCF.
That might be fine if Activision were growing its profits at strong, double-digit percentile rates. But according to data from S&P Global Market Intelligence, Activision has only managed to grow earnings at an average rate of 8.5% per year over the last five years and, according to analysts polled by S&P Global, will only grow earnings at 4.2% per year over the next five years!
That’s not a lot of growth with which to justify a 34 times price-to-earnings (P/E) ratio, unfortunately. Unless you’re reasonably certain that Microsoft will succeed in buying Activision, it’s probably best to avoid this stock.
Rich Smith has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Activision Blizzard and Microsoft. The Motley Fool has a disclosure policy.
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