Activision Blizzard: What If The Microsoft Deal Fails? (NASDAQ:ATVI)

Activision Presents The Ultimate Fan Experience, Call Of Duty XP 2016

Rich Polk

Thesis

On January 18, the tech giant Microsoft (NASDAQ:MSFT) announced it was buying video game developer Activision Blizzard (NASDAQ:NASDAQ:ATVI) for $68.7 billion. The fact of the next major purchase of Microsoft did not surprise investors since the company makes acquisitions several times a year and has a large amount of cash on its balance sheet just for such cases. The deal is expected to be the biggest deal in the video game industry in history.

The Most Expensive Gaming Company Acquisitions of All Time

visualcapitalist.com

Microsoft will pay $95 per share at the close of the deal. However, ATVI stock is trading well below these levels as investors are worried that the deal might collapse under regulation pressure.

In this article, I will be discussing not so much the fate of the deal itself, but the fate of Activision Blizzard if it won’t become a part of the Microsoft gaming segment.

The deal collapse

At first glance, it may seem that fears that the deal will be blocked are exaggerated, since:

  • Activision and Microsoft’s gaming revenue last year accounted for just 13.9% of total global video game spending ($16.28 + $8.8 billion vs. $180.3 billion). Microsoft itself noted that the combined company will take only third place in the market, behind China’s Tencent and Japan’s Sony Group.

total gaming revenue

chart by author (NewZoo data)

  • Regulators are keeping a close eye on all major acquisitions, while the Microsoft-Activision deal is the biggest so far in 2022.
  • Even if the regulators will try to block the deal, it will be almost impossible for them to justify this decision in court due to the small market share of both companies.

While these are all fair points, regulators still have room to maneuver. The thing is FTC, CMA and others might argue that Microsoft is not allowed to promote its games in its store. Besides, the corporation may want to give its products exclusive rights to, for example, early access to Activision Blizzard games. That might also cause dissatisfaction with regulators.

It is important to remember that despite the size and vast experience of Microsoft in such acquisitions, the deal with Activison Blizzard will be the biggest deal in Microsoft history and its success cannot be guaranteed.

Back to fundamentals

The market is now living in expectations and completely ignoring the fundamental part of Activision Blizzard. Investors are only interested in the deal itself as fundamental factors will not affect the result of the acquisition in any way.

This will certainly change, however, if both companies will go their separate ways.

The most efficient gaming company

The business model is built primarily around in-game purchases. This creates additional benefits for the company.

The operating margin of 36% is well above the sector average of 18% (author’s estimates).

Chart
Data by YCharts

The net profit margin is also significantly higher than that of competitors, confirming the success of the strategy.

Chart
Data by YCharts

Growth rates

Activision also shows high growth rates as it showed the highest revenue and profit growth over the past 5 years with only Take Two (NASDAQ:TTWO) running ahead.

Chart
Data by YCharts
Chart
Data by YCharts

Valuation

Although it is hard to predict how deep ATVI will fall if the deal fails, it would be fair to proceed from the price before the announcement of the deal (-18.3%).

Thus, the forward P/E ratio would be around 22, which is a bit higher than the industry average.

Chart
Data by YCharts

It is more likely though that Activision will also be caught in the middle of a market panic and fall another 15%-20% as the NASDAQ 100 Index is down from January 15200 points (-17%). Given the profitability of the company, this price might be very attractive. So, this might be a good deal in the long run.

Business model

Activision has one of the most reliable and profitable games in the industry. The cumulative sales of the Call of Duty franchise reached phenomenal 425 million copies worldwide. 19 years have passed since the first “Call of Duty” game was released. Activision is set to release another premium game “Call of Duty: Modern Warfare II” this fall.

game franchse sales

tweaktown.com

As said earlier, the business model is built primarily on in-game purchases. Talking specifics, two free-to-play games were released, “Call of Duty: Warzone” and “Call of Duty: Mobile” in the first quarter of 2020 and the fourth quarter of 2019 respectively. In Q1 2021, Activision segment revenue grew 72% YoY, driven by in-game purchases of these two games, while operating income almost doubled.

Sales of Activision products are growing much slower than in-game sales. It is faster and far more efficient to make games without global changes, which will more than pay off with in-game sales.

All major companies in the industry are now trying to switch to in-game sales systems, as this is a much more stable source of income. This approach removes dependence on specific products. But none of the competitors are as efficient as Activision Blizzard.

Coupled with successful names that have huge fanbases, which in turn are one of the biggest sources of income, the business model is incredibly sustainable, successful and far more efficient than the competitors’ one.

While the deal with Microsoft will give Activision access to almost unlimited development resources, the company remains one step ahead of lagging competitors that rely more on product sales than successful franchises with sustainable in-game revenues.

Reputation risks

In 2021, the scandal erupted causing Activision Blizzard stock to plummet.

A lawsuit was filed, accusing employees of discrimination against employees, sexual harassment against them, unfair pay, and other manifestations of harassment.

For years, women workers of Activision Blizzard, have been forced to put up with unacceptable policies, facing career barriers, unfair layoffs, and humiliation, according to data compiled by the department.

Activision Blizzard fired 30 employees, punished 44 more, and paid $18 million to victims. The main risks are reputational as it will be more difficult in the future to attract new employees.

If the deal with Microsoft is closed, then the corporation itself will reorganize the game studio. However, if the deal falls through, then Activision will have to clear its own name. I believe that a successful reorganization is more than possible, as this is not one of those scandals that will stigmatize a company for the rest of its days. Most likely, Bobby Kotick, who, according to the WSJ investigation, allegedly covered up cases of inappropriate behavior and harassment, and also threatened employees, will have to leave the company. This may cause medium-term panic among investors. However, I believe that the company will be able to solve the problems and rush into a brighter future.

Conclusion

Since there is a chance that the deal will fail, I felt it necessary to look at the future of Activision Blizzard outside of Microsoft’s gaming segment. I believe that Activision will still be a successful huge corporation with a stable successful business model.

Of course, the purchase of the company by Microsoft will give Activision access to huge resources and new projects, but the company itself will feel good and continue to be the best choice among gaming companies.

I would rate a non-Microsoft’s Activision as a quality long-term buy.

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