The 10th Man

General:

• Have we waited at least 3 months since we first developed our thesis and valuation expectations before deciding to buy the stock? • Have we bounced our investment thesis off of an industry expert, or someone capable of providing a dissenting opinion? • Have we conducted a pre-mortem? • Does reporting consistently change and/or is it opaque?

Value Proposition & Customer:

• What value is the business providing? o Create video game content for PC, console and mobile gaming platforms. Top titles include: (CoD) and Overwatch for console; World of Warcraft (WoW), Diablo, and StarCraft for PC; and Candy Crush for mobile. • How does the business make money? o There are three ways that ATVI monetizes their content: ▪ 1) Traditional paid games, where consumers pay a single upfront fee to acquire a game. A single customer interaction. • Note that physical video games have historically been purchased in- store (at Walmart, GameStop, etc.). Most games are now purchased through a digital medium (80-85% of PC games, 50-55% of console games, and ~100% of mobile games are sold digitally) ▪ 2) Microtransactions (MTX)/downloadable content (DLC). MTX are small in- game transactions, typically in the $1-$5 range. Free-to-play games (e.g. CoD Warzone) can be very profitable with MTX, but paid-games can also benefit from higher ARPU through MTX. DLC is additional content (e.g. map expansion pack) that can be sold to existing user base. These tend to be repeat transactions. ▪ 3) Monetization through (league rights, advertisement and merchandise revenue, etc). This is still in its nascency. • Can we define exactly who the customer is? o The customer is anyone with access to a smart phone, computer, or console. Traditionally, the stereotypical gamer was an 18-35 year-old male, but those demographic boundaries are disappearing. ▪ PC/Console: customers are generally more enthusiastic gamers. Barriers-to- entry are higher than Mobile (cost of the console or PC), and PC/Console games typically require a large time commitment. ▪ Mobile: virtually anyone with a smartphone. o Is this a need-to-have, or a nice-to-have? Is this product or service critical to the customer?

The 10th Man

▪ Video games are a nice-to-have. It’s worth mentioning that video games are 1) becoming more social; and 2) it’s a relatively cheap form of entertainment. These two things make the customer base and ARPU relatively resilient. o What is the share of that customers wallet? Is this offering a small percentage of the customer budget? ▪ It’s difficult to get exact numbers on this, but our conclusion is that overall, it’s 1) generally a small part of the customers wallet (see below figure for ATVI ARPU); and 2) a cheaper form of media entertainment vs. other options. ▪ Including hardware and content, our guess is that the cost of gaming on PC/Console is ~$150-$200/year. PC/Console gamers probably average >7 hr/week, which is then equivalent to a cost of well under $1.00/hr. ▪ Cost to play video games on mobile is much less than console/PC. The incremental hardware costs for mobile is essentially ~nil, and there are a lot of F2P mobile games.

▪ • Is there a substitute for the product or service? If it didn’t exist, what would the customers or users need to do instead? o Basically, any other form of entertainment can be viewed as a substitute, but the most direct competing service is television. • Does any single customer represent more than 10% of revenue? o No (customer base is extremely fragemented). It’s worth mentioning that revenue through Apple, Google, and Sony accounted for 17%, 13%, and 11% in 2019, respectively (concentrated distribution). o It’s also worth mentioning that three titles in 2019 made up 67% of revenue: CoD, WoW, and Candy Crush. • Are any of their customers or customer cohorts ‘unhealthy’? o No.

The 10th Man

• How are the customer end-markets evolving? o See our Industry piece (Part 1) for details. In short, Free-to-play, improving social aspect of gaming, smart-phone penetration, and eSports are a few examples of how the customer’s needs are evolving. • What is the customer life-cycle? Do you touch them once every twenty years, or is it a monthly or yearly recurring touch-point? o Some games get released annually (e.g. CoD), and some are based on subscriptions (WoW). MTX and DLC revenue is more consistent throughout the year, and in-game purchases are becoming a larger chunk of ATVI revenue. Besides some seasonality and some titles being released ever few years (instead of annually), ATVI revenue is fairly stable. • What is the customer retention rate? o On key franchises, we believe it to be very high, although we can’t really measure this. • Can we find any customer feedback or commentary? Are there any recurring themes? o We can read game reviews and pull Metacritic scores. See below for CoD franchise scores. We can also pull Twitch viewership/popularity. Our take-away for CoD is that the franchise continues to perform well, and ATVI continues to release good content here. From what we can tell, this seems to also be the case for ATVI other key franchises – WoW, Candy Crush, Starcraft, Diablo, etc.

The 10th Man

Competitive Advantage:

• Can we identify a competitive advantage like network effects, brands, patents, regulated monopolies, high switching costs, first mover benefits, or scale? o Competitive advantages include brand, high switching costs, and scale. ▪ Core brands have been built over decades. Call of Duty, World of Warcraft, Diablo, Starcraft, etc, all benefit from this: easily recognizable content, likely leading to lower CAC. ▪ Social gaming, online multiplayer modes, and MTX all contributing to formation of communities which leads to psychological switching costs. ▪ Good brand and content will also attract new gamers, and lead to scale. Scale has its obvious benefits, but also improves the social aspect of gaming: if all of your friends play a certain game, you more likely to join them so that you can play together. CoD is a good example of this, it consistently ranks as one of the most popular games on Twitch. o If we can’t clearly identify a competitive advantage today, can we identify signs that the business might develop one? ▪ n/a o If the company’s CEO left tomorrow, how long would it take, if ever, to create a successful competitor? Are there any major barriers to new entrants? ▪ In our opinion, it would be extremely difficult, if not ~impossible for a new entrant to replicate this business model. IP can be hit or miss, but new IP would still need scale to be competitive, and this is very difficult to achieve. AAA games can also be quite costly. ▪ Note that mobile would be easier to compete in for new entrants, but is also much more competitive. • Who does the company compete with? Can their competitors copy/replace what the company is offering over time?

The 10th Man

o For console and PC, ATVI mainly competes with the other large content publishers – EA, TTWO, MSFT, Riot Games, Epic Games, etc… Great AAA content is really hard to create, and it’s extremely difficult for a competitor to copy ATVI’s success in any given franchise/genre. o Mobile is much more fragmented, and much more competitive. Candy Crush has ranked as a top mobile game for a decade+, but new hit mobile titles are created constantly. • Does the company have pricing power? How elastic is demand? Can we find examples in the past to illustrate demand elasticity or lack thereof? o We believe that the publishers do have some pricing power, but they haven’t seemed to have exercised it until the roll out of the next generation of consoles. ATVI is increasing pricing on some games, and we don’t expect to see any notable hit to unit sales.

Industry:

• What are the key drivers for the industry? o Essentially, the two top-line key drivers are: 1) total gamer growth/penetration; and 2) average revenue per user (ARPU). Total gamer growth is driven by: mobile and casual gaming (smart phone penetration); how eSports and streaming, and the increasing social aspect of gaming are improving video game popularity; demographic shift in gaming enthusiasts, etc. ARPU is a function of increasing video game popularity, and evolving monetization strategies (e.g. free-to-play and MTX/DLC). o Other drivers in the industry that will impact publisher profitability include the shift towards digitization and pressure on digital platform fees, subscription offerings, etc. ▪ See Industry piece (Part 1) for more in-depth discussing on industry drivers.

The 10th Man

o How has the industry evolved over time? ▪ Video game popularity is increasing: gaming is becoming more social, and eSports/Streaming is becoming more popular. ▪ See Industry piece (Part 1) for more in-depth discussing on how industry has evolved over the past decade+. • Is the total addressable market (TAM) expanding or shrinking? o Expanding. See Industry piece (Part 1).

The 10th Man

o Are there long-term positive or negative secular themes that will change the opportunity set? ▪ Many positive secular trends that should improve the publisher’s profitability and support above-average growth. See Industry piece (Part 1). • What does the competitive landscape look like? o What is the businesses market share?

o Is there extreme fragmentation or concentration? ▪ Console and PC are much more concentrated among the top publishers (ATVI, EA, TTWO). Mobile is relatively fragmented. o Is the same number of businesses competing in the space today as there was 5 and 10 years ago? ▪ For PC/Console, it’s largely the same big publishers competing today as 10 years ago. Mobile is evolving very quickly, and new mobile developers pop up every year. There is some consolidation, but it remains competitive and evolving quickly. o Can we identify a business in this industry that has failed in the last 10 years, and why? ▪ Not really complete failures. There are some companies, like Amazon, that have reallllllly struggled to enter the business, but we can’t think of an established developer/publisher failure. o How do industry participants compete: capital, service, price, etc? ▪ Participants mostly compete on content quality. • Has there been a flood of new capital into the space? o No, besides some small mobile IP, and development of new third-party video game engines (Epic and Unity). o Has there been an increase in IPO activity in the sector? ▪ No. o Are businesses issuing more equity than in the past?

The 10th Man

▪ No. o Is leverage for the industry much higher than the 10Y historical average? ▪ No. • How cyclical is the industry? o Not cyclical. Revenue will fluctuate YoY given each publishers game slate for that year. E.g. TTWO has much higher revenue in years with GTA releases. However, video game revenue seems to be relatively stable through economic cycles. • Is this a profitable industry? o What has been the minimum and maximum ROIC for the industry over the last 20 years? What is the range of ROIC within the industry today? ▪ ROIC is not a perfect metric to use for this industry due to large off-balance sheet assets (e.g. brand and some R&D costs). However, ROIC does screens well, and seems to be improving for all participants, which we expect to continue.

o What was peak-to-trough ROIC/margins/sales in previous recessions? ▪ Most of the publishers don’t seem to be impacted in a material way during recessions. Cost/hour of entertainment is low, and despite being more of a consumer discretionary offering, the customer base seems to be relatively sticky. We’re not worried about the impact to the publishers during recessions. o How do these characteristics compare to the overall market? ▪ Much better ROIC/ROE than market, much more resilient revenue stream, and exposure to secular themes that should support much higher growth than the market. o Has the rank order of relative profitability (ROIC) changed meaningfully in the last 5 and 10 years? ▪ Yes. Other publishers have been generating higher ROE’s than ATVI for a number of years now. • Does the company operate in any geographies with volatile legal, political, or regulatory environments? Do any of these represent more than 10% of sales?

The 10th Man

o No. Worth noting that Apple, Google, and Sony accounted for 17%, 13%, and 11% in 2019, respectively. We expect that any regulatory pressure in this industry is likely to benefit the publishers. o Is there a regulatory body that can meaningfully impact industry profitability? ▪ No. o Are there any outstanding legal or political risks? ▪ No. • Is this a business that can pass on inflation to customers? o In some parts of the business, yes, but we haven’t seen much of that. Some new releases this year on console/PC are being sold at higher prices (e.g. $70/game vs $60/game). We imagine once the industry stops growing that the publishers will likely increase prices with inflation, but we don’t see that happening for a long time. • Are employees unionized or not? o Not unionized.

Strategy:

• How do they deliver on the value proposition? o Maintain high quality content, especially on core AAA franchises (e.g. Cod, WoW, Overwatch, etc.). Some titles are released annually, and some are released every few years. ATVI also releases new content (MTX and DLC) throughout the year, and has introduced eSports to core franchises to increase customer engagement. o Is the business generating an upfront payment or recurring revenue stream? ▪ Historically it was an upfront payment for PC/Console: paid-games. With F2P and MTX/DLC, revenue is much less dependent on the release cycle – >50% of revenue comes from in-game net bookings. o How do they try to understand their customer needs? ▪ Metacritic scores and other gaming reviews help them gauge customer satisfaction. MAU on streaming platforms like Twitch also help ATVI gauge the popularity of their content relative to peers. They also have droves of data and feedback from existing players to help update games (through patches/new seasons) to address their customer demands. o How do they think about strengthening their position? Can they build on their competitive advantage? ▪ Offering CoD: Warzone for free has increased CoD popularity – ATVI is likely going to experiment with other F2P options to gain market share. ▪ eSports will also improve some of their brands, and help grow these communities. • How do they acquire customers? o Advertisement, which includes conventional advertisement (physical and digital), and through video game streamers. ATVI also offers CoD: Warzone for free, which has led to some gamers upgrading to the paid game.

The 10th Man

o Do they rely on an internal sales team? Partners? Do customers come to the business directly? ▪ ATVI has their own marketing and sales team and strategy. Customers technically buy the content through the distributors (physical/digital), but the customer acquisition responsibilities are mostly in the hands of ATVI. • Note that video game streamers are now a larger part of ATVI marketing strategy, and should be considered as partners. o How do they approach marketing? ▪ Commercials, advertisements, and, more recently, video game streaming (e.g. Twitch). o Do they offer customer incentives? ▪ No, but they do run sales, particularly on older content. • How do they operate the business? o How do they approach manufacturing? ▪ Most of ATVI content/IP is owned, and is developed in-house. Some is owned by third-parties. ATVI has also developed their own video game engine(s) in-house. o How do they approach distribution? ▪ Through physical distribution (e.g. Walmart, GameStop, etc.) and digital distribution (Apple, Google, Sony, etc.). Similar to the other large publishers. o Can they reduce input costs by changing suppliers, bringing processes in-house, etc? Is there a road map to do so? ▪ They could standardize their gaming engines, but this would take years, and also comes with risk. Not likely. ▪ They can push to sell more DTC (particularly PC), but this would probably result in loss of revenue or increases in other expenses (traditional marketing vs. platform fee) o Is any single supplier their only option for a given input to the product or service? How do they manage procurement? ▪ The digital distributors for all types of video games (PC, console, and mobile) have ~oligopolies in distribution. E.g. CoD for PlayStation can only be purchased through the PlayStation Store. • How do they manage risk? Do they use natural or financial hedges to reduce volatility in cash flows? o ATVI uses some currency hedges. Revenue/cash flow is relatively stable though, and therefore probably doesn’t need to think too much about this. • Capital allocation o Is the company willing to return cash to shareholders if they can’t find accretive ways to deploy it? ▪ ATVI carries a significant amount of cash on their balance sheet, but doesn’t seem afraid to pursue share buybacks – ATVI repurchased a third of their outstanding shares in 2013. Cash has consistently been a drag on ATVI, but it

The 10th Man

has allowed them to be more opportunistic with share buybacks/M&A ( in 2016). We believe that if cash on the balance sheet continue to grow, and accretive M&A opportunities aren’t present, that ATVI will likely initiate an NCIB. ▪ Has the company repurchased stock in the past, and if so has it been opportunistic or mechanical? • ATVI repurchased a third of their outstanding shares in 2013. ATVI share repurchase strategy has so far been very opportunistic vs. mechanical. o Is M&A a likely contributor to future growth? If so, what criteria does the management team use to evaluate transactions? ▪ What type of M&A are they pursuing (roll-ups, transformational, etc)? • From ATVI 2015 Annual report: o …we employ five principles to evaluate an acquisition or an investment. They are: ▪ Great management with a long-term orientation ▪ A proven history of profitable operations ▪ Proven franchises or a proprietary technology (preferably both) ▪ Accretive to our operating model ▪ Non-dilutive (preferably accretive) for our shareholders o On King acquisition: We wanted a company as committed to product excellence as we are. We wanted a great management team that has the right balance of creativity and commercial sensibility and operates with the same integrity that is the hallmark of our culture. We waited for the “fat pitch,” as Warren Buffett likes to refer to investment opportunities that only come with patience. With King we hit the ball out of the park. When we first met the management team of King a few years ago, we were impressed. We watched as they operated their business since that first meeting, and we were even more impressed ▪ What drives synergies: costs or revenue? Can competing acquirers achieve the same synergies, or do they have other advantages? • Synergies seem to be typically on the cost-side: e.g. consolidate back- office, commercial, and marketing functions. ▪ What is their M&A track record? • It’s been great over the past decades+ : o Purchased , the creator of Call of Duty, in 2003 for $5 mln. The franchise now generates +$1,000 bln of revenue every year.

The 10th Man

o Merged with Blizzard in 2008, the gaming division of Vivendi, and then bought out Vivendi in 2013 for what turned out to be literally pennies on the dollar. The Blizzard PC IP is some of the best on the planet. o Purchased King in 2016 for a measly 5-6x EBITDA, and now own one of the most popular mobile games in the world, and have an internal developer team to help roll out new mobile games with their existing IP. ▪ Does the company look to retain key people at the entities that they acquire? • Yes. The most valuable asset in these acquisitions are the people. o How does the business rank order investment opportunities, organic or otherwise? Is it clear that they rank opportunities on the best performance metrics, like life-cycle ROIC instead of cash on cash yield in year one? ▪ Management clearly weighs ROE heavily vs. near-term cash/cash impact – they also seem to weigh opportunities over time, not just point-in-time (hence building cash balances). • Is there approach to any of the above points consistent? Or have they pivoted in the past? o Seems consistent

Performance:

• Is there a sufficient historical track record to evaluate? o Yes. A few acquisitions (e.g. King in 2016) make the historical comparison slightly more difficult, but generally speaking adequate disclosure and sufficiently long-track record for us to evaluate ATVI performance. • Does, or has, the company earned a ROIC or ROE in excess of their cost of capital? o ATVI’s ROE increased to ~10% in 2010 and was relatively flat until the King acquisition in 2016, and now sits in the mid-teens range, which is good (consistently exceeds cost of equity) but not exceptional. However, if we adjust for the large cash balance, ATVI’s ROE has generally been greater than 20% for a decade.

The 10th Man

o If so, for how long have they generated excess returns? ▪ Decade+ o If not, do we see a path to that happening? ▪ n/a. o How does this return compare to the peer group? ▪ Slightly less than peers, but generally in-line.

▪ • What has the cash conversion ratio been for the last five years? o Much higher than 1.0x, not worried about this. • Is there a history of asset impairments/write-downs? o No. • Is there any capital that is a drag on returns, and should have been utilized differently? o Possibly. Through one lens, the cash balance could be viewed as a drag on total returns. but through another, it’s enabled ATVI to opportunistically pursue very accretive buybacks and M&A, which seems to be increasing unadjusted ROE over time.

The 10th Man

o • Do asset-specific KPI’s meet expectations? o Not exactly – MAU/ARPU has been flat in multiple categories. Seem to be underperforming versus internal expectations, although that appears to be changing in the last 12-24 months. • Have they historically managed their financial position well? o Yes

Financial Position:

• How do their debt metrics compare to their peer group and to history? o n/a. ATVI and peers have net positive cash positions, and are all mostly in the same position.

o o Is leverage higher then peers, or average levels for the business? ▪ Immaterial. o Are their financial covenants the business must maintain? Will the company breach those covenants in a recessionary environment? ▪ Immaterial. o What is the rating agency outlook? Is it likely that the company will need new external equity?

The 10th Man

▪ S&P has ATVI at A- credit rating. Will not require additional equity. o Are debt maturities staggered? If not, is there a looming refinancing, and how will the company manage it? ▪ Notes are staggered, but are immaterial anyway. • Are there any off-balance sheet liabilities? o Immaterial. • Does the company have any long-term contracted obligations? o Immaterial. • Is there a dual class share structure? o No. o Are there any obligations to other holders, like Incentive Distribution Rights? ▪ No • Does the company have preferred share and/or hybrid capacity? o No. • What is the potential impact from dilutive securities? o Immaterial • Is non-cash NWC a big part of the business? ▪ It’s about -20 to -30% of revenue. A big part of this is deferred revenue. o Is it large as a percentage of revenue? Is it shrinking or growing as a percentage of revenue? ▪ It’s relatively stable at about -25%. o If it is negative, is there a large potential cash outflow if revenue falls? ▪ Potentially, if deferred revenue was impacted. However, ATVI has >3.0x cash on hand vs. non-cash NWC, and Total Debt/EBITDA of ~1.0x. This isn’t much of a concern. • Do they pay a dividend, and if so, what is the payout ratio? ▪ Annual dividend of $0.41/share, ~15% DPS/EPS payout ratio. o Do they have a DRIP? ▪ No. o Have they been funding the dividend through asset sales or increased leverage? Ultimately, is it sustainable with internally generated cash flow? ▪ Dividend is sustainable, but is relatively insignificant anyway (~0.5% dividend yield). • Are sustaining capital requirements in-line with DD&A? Is there a reason they might be different? Can they meet these spending requirements in a recession? o Sustaining capital requirements are ~in-line with DD&A. We expect Intangibles assets to fall a bit as a percentage of total assets/revenue, but expect PP&E and software development assets to continue to grow. ATVI can easily meet their spending requirements in a recession. • Is the business capital intensive? How do they plan to fund incremental capital expenditures?

The 10th Man

o Not really. Most of the R&D and brand spend is expensed. All incremental organic capital can be easily funded with cash flow from operations in mostly any environment.

Management & Governance:

• Does the management team have some competitive advantage, as people? Do they bring unique experience? Can we identify any shortcomings? o As large owners in ATVI (and in many ways, founding fathers), guys like Robert Kotick and Brian Kelly have demonstrated that they can take a really long-term stance when managing the business, particularly capital allocation decisions. The tenor and perspectives that this team brings to ATVI is very valuable in our view: ▪ Robert Kotick has been CEO for 30 years. Him and a group of investors bought a floundering (then Mediagenic) for a measly $500k in 1990, and went on an M&A bender for thirty years to build the biggest independent video game publisher in the world. We think that Robert has great experience in this space that’s nearly unrivaled. ▪ CFO Dennis Durkin worked at Microsoft for 12 years in the corporate development group and as the CFO/COO of Xbox, before joining ATVI in 2012 as the CFO with an increasing breadth of responsibilities. Microsoft is simultaneously a competitor and a partner in the gaming ecosystem, and the perspective that Dennis brings is undoubtedly valuable. ▪ Brian Kelly joined the company with Bobby in 1990 (when they were both in their mid-20’s), joined the board in 1995, and has been the Chairman since 2013. There’s not much information on Brian, but he is the single largest insider owner of ATVI stock, with nearly 5.0 mln shares valued at ~$380 mln, has no other public board seats. o What is their previous track record running a business or business unit? ▪ Good, but not great. M&A track record is phenomenal, but execution on core strategy has been mediocre in recent years. ATVI’s strategy has been to increase reach (more players and viewers), engagement (more time per player/viewer), and player investment, by reinvesting in proven existing franchises and adding new franchises. A number of metrics indicate that they’ve done a poor job achieving some of these goals: PC and console MAU have hardly changed, ARPU has remained effectively flat in both categories, and global PC and console market share was therefore lower in calendar 2019 than any other point in the last 8 years. ▪ However, In 2018, ATVI made adjusted their and went on to A) increase developer headcount by 20% at their best existing franchises, B) incubate a narrower range of high-potential new franchises, C) eliminate investments in periphery games/initiatives, and D) consolidated a number of back-office, commercial, and marketing functions to better serve the highest potential content teams.

The 10th Man

o What is the consensus view of management? ▪ Generally a positive view of management team and board. ▪ However, there are a few e.g. of negative feedback on Bobby. E.g. Tim Schafer, a game designer and CEO of Double Fine Productions: “His obligation is to his shareholders. Well, he doesn't have to be as much of a dick about it, does he? I think there is a way he can do it without being a total prick” ▪ Glassdoor reviews for ATVI overall, and of the CEO, have been falling, and are substantially worse than the other publishers. This is partially due to recent layoffs; ATVI cut 800 staff in early 2019 despite record EPS in 2018. For context, there are only 193 review on glass door.

• Are they more comfortable with succeeding unconventionally than failing conventionally? o A bit of both. Between 2014-2018, ATVI was pursuing three new initiatives: consumer products, television and film, and eSports. Clearly consumer products and television/film have been flops, and ATVI has de-emphasized those initiatives over the last year while ramping up what’s working: eSports. ATVI also has shifted focus towards key franchises – onto what’s working, and away from too much innovation. o Can we observe behavior that sacrifices on near-term profitability for the long-term benefit of the business? ▪ eSports was certainly this – likely cash flow negative for a few years, roughly neutral for a few years, and at the inflection of being more obviously directly profitable. • What metrics are management compensated on? Are these appropriate drivers of shareholder value? If ROIC/ROE/EPS growth aren’t one of those metrics, are we confident that management has an incentive to most efficiently allocate capital? o Management is compensated on adj. operating income, adj. EPS, and adj. free cash flow, as well as strategic objectives:

The 10th Man

o Do insiders own a significant amount of stock? ▪ All current directors and executive officers own ~1.1% of outstanding shares. • Bobby Kotick owns ~2.4 mln shares, ~$200 mln • Brian Kelly owns ~4.6 mln shares, ~$400 mln o Have insiders sold any stock in the last year? More broadly, how has insider ownership changed over time? Can we find good justifications for insider selling? If not, this is a brown M&M? ▪ No. insider ownership seems to have marginally increasing over the past few years. o Does management use non-GAPP metrics in guidance, and if so, is that reasonable? ▪ Revenue largely GAPP-based, or easily understandable (revenue/net bookings) • How does the management team allocate their time? o Are they obsessed with stock price and constantly meeting with investors? Or; ▪ No evidence of this o Are they intently focused on running their business? ▪ Bobby Kotick has been with ATVI for ~30 years, and seems to be passionate about the business and products. Hard to tell how he allocates his time. ▪ In an interview earlier this year, he was asked if he’d like to keep running ATVI or explore something new like running for public office, and he said: “I couldn’t imagine doing anything different… for the next 30 years, if I had the opportunity to keep doing what I’m doing, I would love doing that”. • Is the founder still running the business or on the board? Is this a good or bad thing? o CEO Bobby Kotick and Chairman Brian Kelly joined ATVI in 1990. We think Bobby has executed relatively well as CEO, and has exceptional experience in running this company. • Is the business run in a centralized or decentralized way, both financially and operationally? o A little bit of both. Most development teams seem to have autonomy on content creation. Some ancillary functions appear to be moving toward a more centralized model, but the core “creative” functions are being left alone. Capital

The 10th Man

allocation/budgeting etc all seem to be managed centrally, which is a good thing – we don’t think that creative teams care as much about optimizing ROIC as they do about creating the best game (and vice versa). o What are employee incentives? ▪ Development studios share in game success (bonuses), which is important. SBC is also a fairly large line-item, so many employees share in total ATVI success as well. • Is there “key man” risk? o With Bobby Kotick there might be (although hard to tell). Fortunately, he’s quite young and there are no indications that he intends to leave the company. • Can we gauge employee turnover? What about management turnover? Board turnover? o Management/Board turnover is relatively low. Hard to gauge employee turnover – recent restructuring would have meaningfully reduced headcount in some areas. • What do employees have to say about the company through Glassdoor or other channels? Can we gauge company culture through another channel? o Glassdoor reviews have deteriorated meaningfully since the restructuring and subsequent layoffs – hard to gauge if this is indicative of current perspectives within ATVI versus perspective of laid off employees. • Are the skills and diversity matrices for the board of directors appropriate? o Yes. • Do board directors have sufficient financial interests in the company? o Yes. Chairman Brian Kelly owns ~4.6 mln shares, ~$400 mln. All insiders own ~1.1% of outstanding shares. • Are board directors distracted by too many other professional endeavors? o Three out of the 11 board members have a fair amount of other commitments, but generally we aren’t too concerned about this. • Is there an unhealthy relationship between any board directors and management? o Brian and Bobby have a 30+ year relationship, and are probably very close. No reason to believe that governance is a problem is a result though.

Valuation:

• Have we identified the key drivers? o Top line growth modestly higher than industry (share gains & eSports success), gross margin expansion, even higher operating margin expansion, and utilization of balance sheet – lots of underlying drivers. o Where do our expectations differ from what we think the market price implies? ▪ Don’t believe we have a meaningfully differentiated view from the market. o Why do we think we have an edge, and/or can we understand why the market is wrong? ▪ n/a o Are any of the key drivers impossible to forecast, ie. is uncertainty incredibly high?

The 10th Man

▪ Top-line growth is difficult to gauge but we feel comfortable with the goal posts. Likewise, range of outcomes are wide for what ATVI might do with excess cash, but the range is understood. o What is the source of the data that impacts our view of the key drivers? Is that source reliable? ▪ Industry data is sometimes conflicting, but generally good. We mostly care about changes, and less so the absolute values anyway. • Have we done a bear and bull case scenario analysis? Is risk skewed to the upside? o Very modestly skewed to upside (from current price), but not meaningfully. • Is the business fully cash taxable? If not, when will they be? o More-or-less • Are there any unusual accounting policies? • Does the business expense anything that in principal is actually a capital item? Is this well understood by the market? o Yes, they expense many things that we view as growth capital, but we think this should be well understood by the market. • What percentage of costs are fixed? Is operating leverage high? o Effectively all of ATVI’s COGS are variable, while a significant portion (>50%) of R&D, S&M, and G&A are variable. • What is FCF conversion? Is it consistently above or below 100%? o At or above 100% • Is there a capital expenditure cycle, and if so, where are we in the cycle? How does this compare to their peers? o n/a • Is there any large unfunded liabilities, like pensions? o n/a