Video game maker Activision thinks it can build the next ESPN

Business Insider / Matt Johnston

Activision-Blizzard is at the forefront of a tremendous opportunity, one that could boost its operating income by a factor of a five.

Today, the firm derives virtually all of its revenue from the sale of video game products. Video game discs, digital downloads, online gaming subscriptions, and Skylanders toys generated approximately 100% of Activision's revenue in 2015. But the company could look substantially different in the future. On the company's February earnings call, CEO Bobby Kotick identified a new market the company is gearing up to target. A new market that could generate as much as $5 billion in operating profit over the coming years, and put it in competition with the likes of larger and far more established media giants, including Walt Disney.

Activision wants what Disney has
The market for video games has grown tremendously in recent decades, as consumers have embraced more engaging forms of entertainment. Increasingly, however, it looks as though the future of video games could resemble more traditional forms of media. eSports, or video games played competitively for the enjoyment of spectators, has emerged as a popular pastime. In a report released last month, PwC said the market for eSports would jump 43% this year, becoming a $463 million business in the process. Activision makes many of the most popular eSports titles, including Call of Duty, StarCraft II, and Hearthstone.

But in addition to making the games, the company wants to own the audience. Last October, Activision announced the creation of a dedicated eSports division. Then in January, it bolstered its efforts through the acquisition of Major League Gaming, paying about $46 million for the eSports network.

During the company's February earnings call, management was asked about its eSports ambitions. CEO Bobby Kotick wasn't shy: He believes Activision could build a business on par with ESPN.

...[what we] look at is ESPN. And when you look at ESPN, with 80 million subscribers...and the opportunities that we see there is roughly $5 billion of operating profit there, $4 billion of League payments for the broadcast rights. And we have 80 million of our own players. And over a long period of time, we think that watching a video game competition is going to be a tremendous opportunity....when you look at what the opportunity is for the future to enhance engagement, to build and strengthen our franchises, to celebrate our players, to provide rewards and recognition for our players, these initiatives are really important for the building of engagement and enhancing the value of our franchises.

Walt Disney owns ESPN, and though the network has come under pressure in recent quarters, it's still a major profit driver for the media giant. Last year, Disney's cable networks generated nearly $6.8 billion of operating income for the company, the bulk of which comes from ESPN and its sister stations. For comparison, Activision's entire business generated just over $1.3 billion of operating income in 2015, and expects to generate about $2 billion in 2016. Developing a business with the profit profile of ESPN could increase Activision's earnings by several hundred percent.

Business Insider / Matt Johnston

Not investing significant resources
It's not clear if Activision will attempt to construct a network of cable channels based on eSports, or focus on other methods of distribution. Kotick specifically cited ESPN's large base of subscribers. But ESPN's customer base has declined in recent quarters -- over the last two years, the company has shed some 7 million subscribers as consumers have chosen to spurn the traditional cable bundle.

For now, it's not a major driver of Activision's business, and it may not be for many years. Activision CFO Dennis Durkin said the company's investments in media, including eSports, would be minimal this year, only amounting to a few pennies on an earnings per share basis. "It doesn't require a very big investment today," Kotick said.

In the near term, eSports won't have much of an effect on Activision's business -- but for long-term shareholders it could offer significant upside potential in the years ahead.

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