On January 19, 2022, Microsoft Corp. announced plans to acquire Activision Blizzard Inc, a leader in game development and interactive entertainment content publisher. The acquisition will accelerate the growth in Microsoft’s gaming business across mobile, PC, console, and cloud and will provide building blocks for the metaverse.
Companies Overview
Microsoft
Microsoft Corporation is a technology company founded in 1975. It generates revenue by developing, licensing, and supporting a wide range of software products and services, designing and selling hardware devices, and by delivering online advertising.
Microsoft offers suites of products and services, which include operating systems for computing devices, servers, phones, and other intelligent devices, servers, productivity and business solution applications, desktop and server management tools, video games, and online advertising. It also designs and sells hardware devices including Surface RT and Surface Pro, the Xbox 360 gaming and entertainment console, Kinect for Xbox 360, Xbox 360 accessories, and Microsoft PC accessories.
In the past decade, Microsoft has leveraged its ability to generate cash from its core activities (cloud, Microsoft Office, and Windows) to fund an ambitious M&A strategy. It acquired both iconic business (Linkedin, Nuance, Skype, Github) and consumer (ZeniMax, Mojang, Nokia’s phone business unit) companies.
Microsoft is showing an increasing effort in expanding its gaming platform, having a vertically integrated approach combining hardware (HoloLens, Xbox), cloud capabilities (via Microsoft Azure), content (with leading gaming studios and IPs), and a subscription (Game Pass). In comparison, Sony (its biggest competitor, together with Tencent, in the gaming sector) has no cloud capabilities and no subscription.
Activision Blizzard
Activision Blizzard (ATVI) is a global entertainment holding company that develops and publishes interactive video content and services. It’s best known for franchises such as World of Warcraft, Call of Duty, StarCraft, and Bubble Witch. Founded in 2008 from the merger of Activision and Vivendi Games, the company develops and distributes its video games and services on game consoles, personal computers (PCs), and mobile devices. Activision Blizzard also operates eSports leagues and sells digital advertising.
The company conducts its business through the following three segments: Activision Publishing Inc. (“Activision”), Blizzard Entertainment Inc. (“Blizzard”), and King Digital Entertainment (“King”).
Activision: Activision develops and publishes interactive software products and entertainment content, which it delivers through both premium and free-to-play offerings. It generates revenue from full-game and in-game sales as well as from subscriptions and licensing software to third-party or related-party companies that distribute its products. Activision’s key product franchise is Call of Duty.
Blizzard: Blizzard develops and publishes interactive software products and entertainment content, which it delivers through both premium and free-to-play offerings. It generates revenue from full-game and in-game sales, subscriptions, and licensing software to third-party or related-party companies that distribute its products. The business also maintains a proprietary online gaming service, Blizzard Battle.net. Blizzard’s key product is World of Warcraft
King: King develops and publishes interactive entertainment content and services, particularly for the mobile platform. It delivers content mostly through free-to-play offerings and generates revenue primarily from in-game sales and in-game advertising. Its key product franchise is Candy Crush.
Market Overview
The gaming industry can be considered to be part of the vast and heterogeneous giant that is tech. With its 198.4 billion USD of market size as of 2021 and its expected CAGR in the time span 2022-2028 equal to 13.20%, it is one of the fastest-growing sectors at the moment. Its boom has certainly peaked in the last couple of years, fostered by the covid pandemic, of which it has been one of the greatest beneficiaries: in 2020, it registered a 23% growth compared to the previous year. This growth was matched by an equal uprise in games watching: to give an idea, last year the equivalent of 214,000 years was spent streaming Grand Theft Auto, more or less the same time covered by a world history encyclopedia.
This trend is expected to slow down a little, as people have now almost returned to their pre-2020 lives. Nonetheless, the future of the gaming industry appears to be bright, despite the threat of competitive pressures. Adopting the latest technologies is essential to stay ahead of the competition: cloud gaming in particular is a good strategic move for those searching for new opportunities. Cloud-based streaming uses remote servers in data centers to allow users to play video games. It does not require hefty installations or consoles, just a reliable internet connection, meaning that the rollout of 5G is a big incentive for gaming businesses to move in this direction. Indeed, much of the future growth is expected to come from the mobile segment. This will result in a transition in the revenue model adopted by most game producers. In fact, whilst one-off purchases will still make up a considerable portion of the gaming industry revenues, much of the industry’s growth will come from other forms of monetization that are more compatible with the mobile format, namely recurring subscriptions, in-game purchases, transaction fees, etc.
More and more entrants are joining the club, and because of how appealing it is, venture capitalists are investing greater amounts of funds into it (PitchBook reports a doubling in VC investments in the worldwide gaming industry, reaching a total of USD 11.2 billion in 2021). However, they are not the only interested party. Big players from the tech industry are also looking for opportunities to acquire promising gaming studios and technology, in a race to not lose their market predominance. Microsoft targeting Activision Blizzard is not the only example of this. Some tech giants already have significant stakes in the gaming world. Before January, the Chinese gaming giant Tencent acquired Supercell, and not much later Sony went after Bungie. M&A activity tripled from 2020 to 2021, and expectations for 2022 are not that different. This trend of consolidation makes perfect sense as new worlds opened up in later years, like the metaverse and NFTs. Whether this wave of consolidation will slow down, or cause a complete reshaping of the industry, is hard to say for now.
In this sense, it is expected that the continued development of the metaverse will be an important driver of growth in the coming years. Indeed, the transition of social interactions to digital platforms will benefit the Gaming industry in multiple ways. For instance, it will become more and more socially acceptable to spend a considerable portion of one’s time online. Moreover, it is likely that video games will increasingly become platforms that enable the development of the metaverse (e.g. Roblox). In fact, gaming companies already have vast user bases that are willing to partake in metaverse projects.
In practical terms, the metaverse will heavily rely on Augmented Reality and Virtual Reality to enable the high level of social interactions it seeks to obtain. Any improvement that will be obtained in the VR and AR tech stack can be easily applied to the gaming industry. Moreover, there is a strong argument to be made that what many metaverse companies are trying to do, has already been partly accomplished by some game publishers: for instance, Epic Games (the producer of titles like Fortnite and Rocket League) already allow users to create their own avatars and socially interact while they play. This indicates that there are strong synergies between the gaming and the metaverse industries, which means that there is a strong possibility of having a high degree of consolidation between these two industries in the coming decades – as we are already starting to see.
Deal Rationale
2021 has been a great year for M&A transactions, proving that external growth is a huge tool for companies’ necessities. Even in the Covid-19 years, M&A transactions grew and 2022 doesn’t seem to be changing this trend. Microsoft’s acquisition of Activision Blizzard is a big step forward for the American company in the gaming industry.
With this acquisition, Microsoft will be able to get closer to its gaming competitors, such as Sony, Nintendo, and Electronic Arts.
The acquisition synergies are hard to quantify perfectly, but what is certain is the fact that Microsoft, after this acquisition, will become the world’s third-largest gaming company by revenue, behind Tencent and Sony. Another reason for the acquisition is explained directly by Satya Nadella, CEO of Microsoft: “Gaming is the most dynamic and exciting category in entertainment across all platforms today and will play a key role in the development of metaverse platforms”. These words explain the innovative nature of Microsoft projected towards the long term.
Another interesting fact is the timing of the acquisition. Microsoft is going to pay $95 per share, a price that seems unreasonable for a company valued at $65 per share. Given the fact that the synergies could cover well the extra price paid, the highest price of Activision was $105 per share, just before the scandal involving CEO Robert Kotick. Microsoft’s idea could be that not only the long-term synergies are going to be high, but also the American company believed Activision was undervalued.
The graph above shows the price of Activision Blizzard from February 2021 to February 2022. It’s important to note that Microsoft announced the acquisition at one of Activision’s lowest prices. As everyone can expect, after the announcement the price was raised again because of the possible synergies Activision could have derived from the acquisition.
Considering the possible long-term advantages and the situation of the target at the moment of the deal announcement, we believe the price paid is fair and the deal represents a good opportunity both for Microsoft and Activision.
Deal Structure
On January 18th, Microsoft announced its acquisition of Activision Blizzard at $95.00 per share in an all-cash transaction of $68.7bn (including Activision’s net cash). The deal will allow Microsoft to slim down its cash reserves, particularly large due to the record sales recorded during the pandemic. At the end of 2021, Microsoft had the third-highest cash reserves of all companies in the S&P 500.
Microsoft placed a 45 percent premium on Activision Blizzard’s shares. It will pay an implied P/E multiple of 26 times. The Seattle-headquartered giant has benefited from a discount on Activision’s stock price, which has fallen 37 percent from its peak last February. This fall is due to many reasons: first, the titles due this year that have been delayed (Call of Duty), but more importantly, the allegation of misconduct that characterized the company’s recent history.
Recently, the company has been sued for creating a job culture of “constant sexual harassment.” In a shocking report, the Wall Street Journal denounced how Activision chief executive Bobby Kotick wasn’t just aware of the situation, but he was also involved in it. At the time chief of Xbox, Microsoft Gaming’s CEO Phil Spencer, responded to those accusations in an email to its staff, saying how he was “disturbed and deeply troubled”, and that Microsoft was “evaluating all aspects of our relationship with Activision Blizzard and making ongoing proactive adjustments.” In this context, the initial conversation between Spencer and Kotick about the deal started on November 19th.
After the deal’s announcement, Activision’s shares jumped by 36%, whereas Microsoft’s stock ended the day down by 2.5% from its opening price. Activision’s stocks are now trading at around $80.00 per share, some 19% below Microsoft’s $95-a-share offer. This price is unusual since target mergers tend to trade at a lower spread of 5% or less.
Investors are particularly concerned about regulatory authorities’ role in the transaction. The FTC is set to scrutinize the deal, and its result is highly uncertain. Both companies are leaders in their respective industries, and there might be a significant risk of anti-competitive behavior. Moreover, tech deals are historically in regulators’ crosshairs, and recent history has been unfavorable, seen the failure of the Nvidia-ARM deal.
Besides the controversies, Bobby Kotick is set to continue to serve as CEO of Activision Blizzard during the deal. However, according to people familiar with those plans, he is expected to leave after the acquisition closes. After the deal, the Activision Blizzard business will report to Microsoft Gaming chief executive Phil Spencer.
It will be essential to see how Activision will be integrated into Microsoft’s activities. Usually, the big-tech company allows the big companies it buys to operate independently (as has been the case for LinkedIn). However, seeing the recent problems in Activision’s workplace, Microsoft might change its approach. Undoubtedly, the deal will represent a new start for Activision’s business.
The deal is expected to close in the fiscal year 2023 (between July 2022 and June 2023). The transaction has already been approved by the boards of directors of both Microsoft and Activision Blizzard.
Advisors
Goldman Sachs & Co. LLC serves as a financial advisor to Microsoft, whereas Simpson Thatcher & Bartlett LLP serves as legal counsel. On the other hand, Allen & Company LLC is following the deal for Activision Blizzard as a financial advisor, and Skadder, Arps, Slate, Meagher & Flom LLP is serving as legal counsel.
Authors: Edoardo Zanetta, Giovanni Candiago, Giulia Duca, Stefano Stompanato, Marco Cavalieri, Giulio Pampaloni
Sources: Microsoft, Financial Times, The Wall Street Journal, Investopedia, Activision Blizzard, Sec, The Verge
Bocconi Students M&A Circle 
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