Zynga Inc (ZNGA), Electronic Arts Inc. (EA), Perfect World Co., Ltd. (ADR) (PWRD): What Will They Do?

What They Probably Should Do
While potential acquisitions are interesting to talk about, I’m a much bigger fan of companies either buying back shares or paying better dividends. If Activision-Blizzard wants to reward shareholders on a permanent basis, either a large share repurchase plan, or a higher regular dividend would be the way to go.

I know that many people get excited about special one-time dividends, but these are short-term events. A one-time dividend is great if you bought before it was announced, but usually the stock’s value drops back to earth once the ex-dividend date passes. Large share buybacks and regular dividends provide a longer-term benefit.

Buyback Or Dividend Increase?
With 1.115 billion shares outstanding, what could the company afford if they instituted a share repurchase program? In the last year, the company’s cash and investments increased $850 million. At current prices, this amount would repurchase about 59 million shares. This would be the equivalent of 5.29% of the company’s diluted share count. The problem with this approach is, the stock is already more expensive compared to where it was most of last year. It seems this would just be another example of management waiting for the stock to rise and then repurchasing shares.

The best idea might be a boost in the company’s regular dividend. While this requires a longer-term commitment, Activision-Blizzard can afford this action. In the last four years, the company has generated over $1 billion in free cash flow on average, but paid out less than $200 million in regular dividends. In the company’s current quarter, their free cash flow payout ratio was just 17.06%. If the company boosted their payout to just 40% of free cash flow, this would mean total dividends of $0.36 per year versus the current payout of $0.19. This would increase the company’s yield to 2.52% at current prices, and still leave Activision-Blizzard a lot of flexibility.

In the end, the only phrase that scares me in Activision-Blizzard’s comment about their plans is the part about potential, “significant debt financings related thereto.” It’s one thing to spend cash on the balance sheet to reward shareholders with a higher dividend or share repurchases. We get into a whole different situation if the company decides to make an acquisition that requires debt financing. I have confidence that the company’s management will make the right move, but I’m a little worried that this stock price increase could be short lived. Only a large share repurchase or higher regular dividend would be guaranteed to create long-term value for shareholders.

The article What Will They Do? originally appeared on Fool.com and is written by Chad Henage.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.