Disney (NYSE:DIS) has become an unstoppable media juggernaut over the past 13 years with its acquisitions of Pixar, Marvel, Lucasfilm, and Fox's media assets. The House of Mouse was already massive, but those takeovers gave it plenty of room to grow in the decades ahead.
But should Disney expand that empire into the video game market by buying Activision Blizzard (NASDAQ:ATVI)? That's what Gerber Kawasaki's Nick Licouris, whose firm owns a $22 million stake in Disney and a $4.3 million stake in Activision, recently recommended to Bloomberg.
Licouris claimed that Disney could integrate Activision's esports business into its media networks, and that it could launch more first-party games for its massive portfolio of franchises. That sounds logical. But I think it could never happen for three simple reasons.
1. Disney doesn't want to make video games
Disney once published first-party video games through its interactive unit, but it has gradually exited that market over the past six years. In 2013 it shut down its internal studio Junction Point, which it acquired in 2007, as well as Lucasfilm's game publishing arm LucasArts.
The downsized unit focused on the development of Infinity, a toys-to-life product line similar to Activision's Skylanders. Those toys, which were equipped with chips, placed their digital counterparts into a companion video game. Infinity was initially a big hit for Disney, but sales cooled off by 2016 and the line was discontinued -- which effectively killed off the interactive unit. Disney subsequently shuttered its multiplayer online game Club Penguin Island and sold its mobile puzzle game Emoji Blitz.
Earlier this year, CEO Bob Iger admitted that Disney never demonstrated "much skill" in publishing games. He said Disney was satisfied with its multi-year partnership with Electronic Arts (NASDAQ:EA), which holds the exclusive license for Star Wars, and other licensees.
2. The licensing business has lower risk with higher margins
Modern video games are expensive to produce, with high-end "triple-A" titles regularly exceeding $100 million in development and marketing costs. Like movies, some of these games bomb and dent a publisher's earnings.
A $60 game today costs much less than a $60 game a decade ago thanks to inflation. However, rising production costs are making it tougher for publishers like Activision and EA to squeeze out profits without piling on DLCs (downloadable content), controversial loot boxes, and other extras.
Therefore it makes more sense for Disney to license its IP to game makers instead of shouldering all that risk with a first-party studio. The financial terms of Disney's partnership with EA aren't known, but the House of Mouse reportedly charges Hasbro a whopping 20%-25% royalty on its sales of Marvel and Star Wars toys, so it could be taking a comparable bite out of EA's game sales.
For Disney, that stable stream of high-margin licensing revenue would be much more lucrative than unpredictable lower-margin revenue from a first-party gaming division. Buying Activision would wreck that business model and likely lead to a messy divorce with EA.
3. Disney doesn't need to pile on more debt
Disney ended last quarter with $52 billion in debt, mainly due to its $71 billion takeover of Fox's media assets. That debt load doesn't represent a significant risk to Disney, since it's spread out over nearly eight decades, but it's already suspended its buybacks to conserve more cash to extinguish its debt.
Earlier this year, Disney revealed that its push into the streaming market already resulted in a $1 billion loss, and those losses will widen with the rollout of Disney+ later this year.
Faced with these challenges, it's irrational for Disney to make a bid for Activision Blizzard, which has an enterprise value of $34 billion as of this writing. A reasonable acquisition premium could bump the value of a deal to about $50 billion -- which Disney simply can't afford unless it wants to shoulder even more long-term debt.
Investors should ignore the noise
As a Disney investor, I seriously doubt that the company will pursue more massive acquisitions so soon after the Fox deal. I also doubt that Activision Blizzard is on its long-term shopping list, and investors should take such claims with a grain of salt.