Moody's Upgrades Activision Blizzard's (ATVI) Unsecured Notes Rating to 'Baa3' Amid Move to Acquire King
Moody's Investors Service upgraded Activision Blizzard, Inc.'s (Nasdaq: ATVI) senior unsecured notes rating to Baa3 from Ba2, upgraded the company's senior secured credit facilities to Baa2 from Baa3, and withdrew the company's Ba1 Corporate Family Rating and Ba1-PD probability of default rating. The upgrade reflects Activision Blizzard's leading position in the growing and fragmented gaming industry, strong diversification across multiple genres and gaming platforms, and strong track record of developing profitable and sustainable franchises with international appeal. The upgrade occurs at the same time the company has announced its agreement to acquire King Digital Entertainment plc ("King") for nearly $5.9 billion, with a combination of cash on hand and debt financing. We do not expect the transaction to have a material effect on Activision Blizzard's credit metrics as approximately 60% of the acquisition will be funded with cash on hand and we anticipate that the company will reduce debt quickly over the next two years. The outlook is stable.
Activision Blizzard intends to acquire all of the outstanding shares of King for $18.00 cash per share for cash consideration of $5.7 billion and $0.2 billion of rollover unvested equity awards. The company intends to finance the transaction with $3.4 billion of offshore cash on hand and with proceeds from a new $2.3 billion term loan. The transaction is expected to close by March 2016 pending King shareholder approval and various international and domestic regulatory approvals.
Issuer: Activision Blizzard, Inc.
Upgraded:
....Senior Secured $250 million Revolving Credit Facility due 2018 (undrawn as of 9/30/2015): Upgraded to Baa2 from Baa3 (LGD2)
....Senior Secured $2,500 million Term Loan B due 2020 (roughly $1.9 billion outstanding as of 9/30/2015): Upgraded to Baa2 from Baa3 (LGD2)
.$1,500 million 5.625% Senior Notes due 2021: Upgraded to Baa3 from Ba2 (LGD5)
.$750 million 6.125% Senior Notes due 2023: Upgraded to Baa3 from Ba2 (LGD5)
Outlook Actions:
....Outlook, changed to Stable from Positive
Withdrawn:
.Corporate Family Rating (CFR): Withdrawn Ba1 rating
.Probability of Default Rating (PD): Withdrawn Ba1-PD rating
.Speculative Grade Liquidity Rating (SGL): Withdrawn SGL-1 rating
RATINGS RATIONALE
Activision Blizzard's upgrade to a Baa3 senior unsecured rating reflects its leading position in the growing and fragmented gaming industry, strong diversification across multiple genres and gaming platforms, and strong track record of developing profitable and sustainable franchises with international appeal. The ratings and stable outlook take into account our expectation that management has the ability to make strategic investments to create new intellectual franchise properties to replace aging ones which face the potential risk of decline over time, and leveraging existing ones across various platforms.
Activision Blizzard's expected acquisition of King, creators of the popular mobile game franchise Candy Crush, increases scale and cash flow, increases the amount of monthly active users ("MAUs") to roughly 547 million as of October 2015, creates potential for cross-promotion of games across platforms, and expands the company into the fast growing mobile market, particularly in international markets. Moody's notes that at around the time of expected closing of the King transaction, leverage will likely rise to around 3.2x due to normal volatility due to differing annual release cycles, but we believe that Activision Blizzard is well positioned to improve credit metrics pro forma for the King transaction as it applies excess cash to rapidly deleverage by the end of FY2016 to between 2.8x and 2.5x debt-to-EBITDA. A continued commitment from management to sustain credit metrics commensurate with an investment-grade rating will be important to maintain the investment grade rating.
[The] company's rating is moderately constrained by revenue concentration among key titles and the risk of failing to predict changing consumer preferences. Although the company is able to generate meaningful recurring revenue, there is significant exposure to concentration risk in its largest franchises, which is why development of new potential franchises like Destiny and Heroes of the Storm is important. Revenues associated with Activision Blizzard's top 3 franchises, Call of Duty (originally released in 2003), World of Warcraft (2004), and Skylanders (2011), accounted for 67% of consolidated net revenues for the 2014 fiscal year and a significantly higher portion of operating income. The King acquisition will reduce concentration as a percentage of total revenues and King's Candy franchise will become the second largest revenue generator after Call of Duty.
Offsetting this risk is Activision Blizzard's ability to sustain the popularity of franchises more than 11 years old and to continuously develop new, profitable, and award-winning franchises. Risks associated with the expected King acquisition include franchise concentration with approximately 43% (for the last twelve months ended June 30, 2015) of total gross bookings coming from their most popular game, Candy Crush Saga. These risks are compounded by King's recent MAU declines, primarily associated with Candy Crush Saga. King has diversified its game offerings and must continue to do so to offset declines in older games. "We believe that King's games possess high risk as compared to those of Activision Blizzard, given their short franchise history and lower level of game immersion," stated Neil Begley, a Moody's Senior Vice President. However, the acquisition catapults the company into the rapidly growing mobile platform where it did not have a significant presence, and King's network could provide avenues for cross pollination to create new mobile games. "Despite the risk associated with the King games, we believe that Activision Blizzard has demonstrated well its franchise creation capabilities and it generates significant free cash flow which could be used to reduce debt to offset any unexpected decline in King game revenues in order to sustain its investment grade ratings," added Begley.
The business risks are balanced with moderate and improving leverage, excellent liquidity, strong management oversight, and fiscal discipline with a focus on operating margins and free cash flow generation. The company is able to engage and transact with its loyal user base through multiple platforms, as well as its own Battle.net online platform for Blizzard games, providing it reliable insight into consumer preferences and visibility into the success of future releases. Furthermore, Moody's expects that international penetration, particularly in regions like China, continued strategic partnerships with other companies such as with Bungie (creators of the hit franchise Halo) and Tencent Holdings Limited (A2 stable), and improvements to broadband services worldwide, will help boost the company's audience reach and diversify revenue streams further.
We have notched the secured bank facility ratings up from the Baa3 senior unsecured notes rating to Baa2 due to the present existence of security. The upnotching is due to our anticipation that the Term Loan B will be repaid within the next two years and we expect that all outstanding funded debt will become unsecured, pari passu, and the ratings unified at Baa3.
Upward pressure on the ratings could occur in the case of a material increase in business diversity through the development of new, successful, long-lived franchises that results in more stable, recurring, and predictable revenue and cash flow and increasing domestically available cash balances without decreasing total cash balances, along with leverage sustained under 2.25x (incorporating Moody's standard adjustments). Liquidity would also need to remain excellent.
Downward pressure on the ratings could occur if the company's liquidity position becomes pressured due to degradation of its existing game customer base and inability to replace weakening franchises with new ones, leverage is expected to be sustained over 3.00x (with Moody's standard adjustments), or a material shift in the direction of the company that does not balance the interests of debt holders with equity holders and that increases credit risk.
The principal methodology used in this rating was Business and Consumer Service Industry published in December 2014. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.