Disclosure: I am long Activision Blizzard, Inc. (NASDAQ:ATVI) and Microsoft Corporation (NASDAQ:MSFT).
Q4 2021 hedge fund letters, conferences and more
Gates Capital Management's ECF Value Funds have a fantastic track record. The funds (full-name Excess Cash Flow Value Funds), which invest in an event-driven equity and credit strategy Read More
Big news in the gaming world. Microsoft (MSFT) agreed to buy Activision Blizzard (ATVI) in an all-cash deal valued at about $75 billion (net of cash $68b), or $95 per share . This is the largest gaming industry acquisition ever, which crushed the previous record established last week when Take Two bought Zynga for $11 billion. The deal is also Microsoft’s biggest ever.
Microsoft offered a 45% premium. This is a hefty premium compared to where ATVI traded in recent months, but ATVI traded at higher prices one year ago (52-week high $104). The recent scandals have hurt ATVI.
At the moment, ATVI trades ~$82 per share. This implies that the market is skeptical that the deal will close. There’s an arbitrage opportunity here. If the deal goes through, it offers a 16% upside. ATVI also distributes a small dividend once a year. Let’s discuss this arbitrage opportunity. .
Disclosure: I am long ATVI and Microsoft. I’ve been a shareholder of both companies before the announcement. I’m pleased with the offer. I’m biased. I don’t see the risk the market does and that’s the issue. It’s not the capacity to pay. Microsoft has the cash and won’t dilute shareholders. So it sounds like possible antitrust issues. Is there anything else I’m missing?
Here’s a brief background on both companies:
It’s no secret that the company behind blockbuster games like Call of Duty, Candy Crush, Overwatch, World of Warcraft, Starcraft, and Diablo is going through a rough patch, to say the least. I’m not going to rehash everything that happened (years of sexual harassment, discrimination, and misconduct). But what happened and how it was handled is business/PR 101 on what not to do.
ATVI’s reputation is damaged. Talent is leaving. There’s probably more skeletons in the closet. Bobby Kotick built a great company, great games, and rewarded shareholders very well along the way. But Kotick mismanaged the crisis and lost the trust of the gamers, public, employees, and the market. We don’t have the full story. I suspect more internal problems, more culture and development issues with games. And it’s not just the scandal, ATVI has made some missteps in the past.
The thing is the scandal would have followed the company for a long time. These things don’t go away easily. The media and the Internet will keep bringing up. And if you underperform operationally, game quality and growth is affected, the pressure will just keep going up. Your culture might be so tainted that gamers don’t want to be associated with your games. A crisis like that would have taken years to fix and in the process possibly lose your competitiveness and sales. Who knows if the stock would ever recover.
With this background, I understand why ATVI accepted the $95 cash offer. It’s probably better that ATVI is under a different home. Fix the issues away from the public. It’s been reported that Kotick will leave if and once the deal closes. In a sense it gives him a graceful exit.
Microsoft has been making a lot of deals lately. WSJ reported that MSFT had long been interested in ATVI and had discussed a potential acquisition in the past.
If you are going to spend $75 billion for a business, you have big plans. It’s also telling of their gaming ambitions. For the last ten years MSFT has been boosting their gaming portfolio.
For the last ten years Microsoft has been boosting their gaming assets. Microsoft has been working on building the “Netflix” of gaming. A subscription based cloud gaming service. Cloud gaming is an emerging technology that allows people to stream games via nearly any internet-connected device (issue is that game requires a lot of data to run smoothly). And because Microsoft owns Azure, they have the cloud infrastructure to support such a strategy.
The strategy is to persuade gamers to abandon their expensive hardware and play on the cloud. If Microsoft could convert some of Activision’s close to 400 million monthly active users into subscribers, it could significantly bolster its cloud-game business.
I believe it comes down to antitrust. But because I’m set to benefit I don’t fully see the risk the market does. John Hempton from Bronte Capital brought up some of the same issues on a thread on Twitter. But I don’t see anything substantial in the Twitter comments. I share some of his views. Here’s what I think and please let me know what I don’t see:
- Is there a precedent where the Gov/Justice Department/FTC blocked a gaming transaction?
- The deal is not expected to close for a while (ATVI Fiscal 2023) but that is still a big gap.
- I think the #1 factor is Lina Khan, the chair of the FTC. She’s been very vocal about taking on big tech. She’s writing papers about. That’s why she got the job. The 32-year-old antitrust scholar and law professor is not Microsoft’s ally.
- This deal poses an important test of the Biden Administration’s generally unfriendly view of large technology acquisitions.
- However, from a regulatory perspective, Microsoft is not under the same level of scrutiny as other big tech (Amazon, Apple, Facebook, Google).
- Microsoft will pay a $3 billion breakup fee if the deal doesn’t go through. This indicates to me that they are confident the deal will go through.
- The games will need to be on multiple platforms (Playstation, PC, Nintendo, mobile etc…). If not it’s a deal breaker. The deal won’t get approved and you will get a gamer mutiny. And gamers are crazy.
- Keeping the games multi-platform also makes business sense. If you fence off Call of Duty to only Xbox, you will kill part of the gamer community and hurt the branding. If you pay $75b you want to see some returns at the end of the day.
- If these get hairy they might have to sell a couple titles.
- I don’t think there’s too much concentration. In terms of gaming sales (excluding hardware) Microsoft is #4. Tencent, Sony and Apple have more gaming revenues. ATVI is #7. The deal will make Microsoft the third largest gaming company in terms of revenue.
I think the deal will go through. Let’s hear other views and why (this post is on Twitter).
Article By Brian Langis