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With a market cap of over $41 billion, Activision Blizzard (NASDAQ:ATVI) is one of the most important interactive software and content developers, holding the keys to some of the biggest video game franchises. Year-to-date, Activision Blizzard stock is up about 17%. The group is expected to report quarterly earnings on Nov. 7. So what kind of price performance can we expect from the company around its earnings release?

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Although I would not bet against Activision Blizzard stock’s future, between now and the earnings release date, I expect to see further volatility in ATVI and would urge long-term investors to proceed with caution.

Here is why:

ATVI and the Trends Affecting the Gaming Industry

Fueled by digital streaming trends and new technologies, the global gaming market has been growing at a rapid rate. This interactive entertainment industry is expected to generate over $150 billion in 2019.

Mobile gaming, which includes smartphones and tablets, grew over 10% year over year, so far in 2019 and is the largest segment.

Some analysts expect that with an annual growth rate of over 18%, esports will increasingly become a disruptive force within the industry. Recent research by Joseph Macey and Juho Hamari from Tampere University has concluded that “[t]echnological developments have not simply changed the content of games, offering sophisticated immersive environments for example, but more significantly they have changed the way that games are played.”

Globally “more and more individuals are engaged [in esports] as players or spectators.” Most of the revenues for the companies in this segment currently come from North America and China. Data suggests that especially younger generations are becoming increasingly interested in esports.

In 2018, Activision Blizzard officially launched the Overwatch League and became one of the first movers in esports. The league generates revenue from advertising and sponsorships from a wide range of companies, including Intel (NASDAQ:INTC), T-Mobile (NASDAQ:TMUS) and HP (NYSE:HPQ). Going forward, ATVI shareholders are hopeful that the league will increasingly contribute to the company’s earnings.

Increased Competition Is Affecting Activision Blizzard Stock

As a growth industry, gaming inevitably attracts global competition that may also challenge the business models of companies like Activision Blizzard. For example, Fortnite, an apocalyptic survival video game developed and marketed by the privately held Epic Games, generated $2.4 billion in revenue last year, more than any single game in 2018. The free-to-play game has become a worldwide champion among gamers of all ages.

In recent quarters, earnings of ATVI stock, as well as those of major industry players like Electronic Arts (NASDAQ:EA) and Take-Two Interactive (NASDAQ:TTWO), have suffered because of Fortnite’s success. On Oct. 22, Electronic Arts shares were downgraded as Jefferies analyst Timothy O’Shea cut the price target for EA stock from $139 to $95.

Inevitably, the whole industry suffered on the day of the downgrade as shares of these companies traded down. Should ATVI shareholders expect a similar downgrade for the company in the coming days?

Investors in gaming companies like Activision Blizzard are not exactly sure how management can succeed against these competitors. Which new game titles should ATVI rely on the most to increase revenue? It is becoming increasingly crucial for these companies to release and update game content regularly so that players stay engaged longer.

Activision Blizzard is currently franchise-reliant, whereas competition like Fortnite tends to focus on video game volume. In other words, if ATVI’s core franchises were to lose popularity, the company would face fiscal and market consequences and the stock price would suffer.

The Mixed Reception of ATVI Q2 Results

ATVI is one of the largest gaming companies globally in terms of revenue and market cap. The company operates through three main segments:

Activision Publishing, which produces franchises such as Call of Duty and focusing on console gaming;

Blizzard Entertainment, which produces franchises such as World of Warcraft and Overwatch and focuses on online PC games with an emphasis on subscription-based business models; and

King Digital Entertainment, which produces mobile games.

On Aug. 8, ATVI released Q2 results. Revenue came at $1.4 billion compared to the $1.32 billion that management had earlier indicated. Although Activision Blizzard beat revenue expectations, YoY revenue tumbled nearly 15%, and earnings per share dropped more than 17%.

Furthermore, in Q2, Activision saw 37 million monthly active users (MAUs), Blizzard had 32 million and King had 258 million. Those numbers meant a considerable decrease from the previous quarter when respective numbers were 41 million, 32 million and 272 million, respectively.

Management now expects Q3 revenue to be about $1.1 billion, well below expectations of $1.36 billion.

What to Look For In ATVI Stock’s Q3 Results

During the summer, management released new content for Call of Duty, World of Warcraft and Overwatch. Also on on Oct. 1, ATVI released Call of Duty Mobile on mobile platforms. However, this is a free-to-play title. Thus unless players spend money on in-app content purchases, the game cannot make a meaningful revenue contribution. Through these purchases, players can unlock in-game content, such as upgrades for weapons.

When the company next reports earnings, Wall Street would like to see ATVI dispel fears of Fortnite and other competition. Analysts will therefore pay attention to the number of monthly active users.

In addition to audience and engagement levels, investors will also take a closer look at ATVI’s operating expenses, especially sales and marketing costs, which may keep margins under pressure.

They also would like to see popular franchises like Call of Duty and Overwatch to have had high in-games spending, thereby driving top-line growth. It is important to highlight the importance of in-app purchases for ATVI stock as in Q2 it generated about two-thirds of the quarterly revenue from in-game spending.

Where the ATVI Stock Price Is Now

After being a darling among investors from 2014 to the last quarter of 2018, ATVI stock dropped more than 50% from its early October 2018 highs of around $85 to around $40 by January 2018.

ATVI stock’s 52-week price range has been $70.95 (Oct. 22, 2018) – $39.85 (Feb. 11, 2019).

Following the release of Q2 results, Activision Blizzard stock initially fell for several trading days, possibly because of the weak guidance expressed for Q3. On Aug. 8, the share price had closed at $49.33. On Aug. 15, the stock saw an intraday low of $44.91. Now, it is hovering around $54.

Between now and the release of earnings in early November, I expect Activision Blizzard stock to trade in a range. While long-term investors would like to see the shares and stay over the $55 level, traders are likely to keep the range between $45 and $55.

Ultimately, the price of ATVI stock will need to stabilize and build a base again before a long-term sustained uptrend can occur. And it needs the momentum of a strong earnings result to be able to make a new leg up.

If you already own ATVI stock, you might want to hold your position. However, within the parameters of your portfolio allocation and risk/return profile, you may consider placing a stop loss at about 3%-5% below the current price point.

After the upcoming earnings call, if you still believe in the bull case for Activision Blizzard stock, then you might consider waiting for a better time to buy, such as when the share price is around the mid or even low $40’s.

The Bottom Line on ATVI Stock

With its strong franchise focus, Activision Blizzard is an important company that is likely to weather the ebbs and flows of the industry. The rise of the digital gaming revolution is here to stay, and I believe the long-term fundamental story of ATVI stock is still intact.

However, due to tough competition in the industry, Activision Blizzard is no longer a high growth stock. Therefore, long-term investors may want to re-visit their growth expectations.

Investors who are interested in companies in the interactive software, entertainment or communication services but do not want to commit all their capital to a single stock, such as ATVI, may also consider investing in various exchange-traded funds (ETFs) that have Activision Blizzard as a holding. Examples of such funds would include the Invesco Dynamic Software ETF (NYSEARCA:PSJ), the VanEck Vectors Video Gaming and eSports ETF (NYSEARCA:ESPO) or the Communication Services Select Sector SPDR (NYSEARCA:XLC).

As of this writing, Tezcan Gecgil holds INTC covered calls (Oct. 25 expiry).

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