Microsoft (MSFT 0.46%) stunned the gaming industry on Jan. 18 by announcing that it would buy Activision Blizzard (ATVI), one of the world's largest video game publishers, for $68.7 billion.
The all-cash deal values Activision at $95 per share, which represents a 43% premium to its closing price on Jan. 14. Microsoft expects to close the deal in fiscal 2023, which starts this July, and immediately become accretive to its adjusted earnings. It will also become the world's third-largest video game publisher by annual revenues after Tencent and Sony (SONY 0.32%).
Image source: Microsoft.
Microsoft's purchase of Activision Blizzard will add iconic gaming franchises such as Call of Duty, World of Warcraft, Overwatch, Diablo, StarCraft, and Candy Crush to its library of first-party video games. Turning those games into Xbox exclusives could significantly widen its moat against Sony while providing more content for its subscription-based, all-you-can-play Game Pass service, which currently has over 25 million subscribers.
This marks Microsoft's second massive gaming purchase in less than a year. Last March, it closed its $7.5 billion takeover of ZeniMax Media, which owns Doom, Fallout, and The Elder Scrolls, through its Bethesda subsidiary.
This deal seems to make strategic sense for Microsoft, which has constantly trailed behind Sony in terms of console sales and exclusive games, but I think it's an ill-advised move for three simple reasons.
1. Inheriting Activision Blizzard's problems
Before Microsoft swooped in, Activision's stock had declined nearly 30% over the previous 12 months as it struggled with a sexual discrimination and harassment lawsuit, employee walkouts, executive resignations, and delays for two of Blizzard's most eagerly anticipated sequels -- Overwatch 2 and Diablo 4.
In addition, it was repeatedly criticized for milking aging franchises dry and failing to take risks on new ones. Like many other gaming companies, it also faced tough post-lockdown comparisons as people played fewer games. Activision Blizzard's audience hit a peak of 435 million monthly active users (MAUs) across all three of its publishers (Activision, Blizzard, and King) in the first quarter of 2021, but that figure had tumbled to 390 million by the end of the third quarter as all three divisions lost active users.
Activision also expects its bookings to drop 9% year over year in the fourth quarter as it faces difficult comparisons to the previous year's holiday shopping season. Analysts expect its net bookings to grow less than 4% for the full year, compared to its 32% growth throughout the pandemic in 2020.
On its own, Activision was facing a bleak year ahead. Overwatch 2 and Diablo 4 have been delayed to at least 2023, its sexual harassment issues remain unresolved, and Blizzard's aging franchises -- especially World of Warcraft and Hearthstone -- are still losing their momentum. But now, Microsoft has decided to inherit all those problems.
2. Microsoft could have waited for a lower price
Microsoft can cover the entire $68.7 billion bid with cash, but that still accounts for more than half of the $130.6 billion in cash, cash equivalents, and short-term investments it was sitting on last quarter.
The market certainly wasn't bullish on Activision Blizzard, and its market cap would likely have continued to shrink as interest rates rose. A messy Q4 earnings report in February (which was already hinted at last November) would likely have exacerbated that sell-off.
Simply put, Microsoft could just have waited a few months to buy Activision at a lower price. But instead, its abrupt bid for Activision feels more like a knee-jerk reaction to Sony's rumored development of a Game Pass competitor for PlayStation owners instead of a well-timed acquisition.
3. Regulatory challenges and a big breakup fee
Microsoft's bid for Activision will inevitably attract the scrutiny of antitrust regulators. In addition to ZeniMax, Microsoft owns Rare, 343 Studios, The Coalition, Mojang, Ninja Theory, Playground Games, Compulsion Games, Obsidian Entertainment, InXile Entertainment, and Double Fine.
If the deal is struck down, Microsoft will need to pay up to $3 billion in breakup fees to Activision Blizzard. That's equivalent to 1.5% and 34.4% of Microsoft and Activision's projected revenues, respectively, for their current fiscal years.
Even if the deal isn't struck down, Microsoft could be barred from turning Activision Blizzard's games into exclusive titles for Xbox consoles, Windows PCs, and Game Pass subscribers. That clause would make the deal a lot less attractive -- and might even force Microsoft to walk away.
Biting off more than it can chew
It makes sense for Microsoft to inorganically expand its gaming business. But buying an aging, troubled, and poorly diversified game publisher like Activision at eight times next year's sales doesn't seem like the best move.
Microsoft still needs to resolve Activision's toxic workplace issues, revive its aging franchises, halt its loss of MAUs across all three publishers, and get Overwatch 2 and Diablo 4 back on track. That's a lot to handle, and I think Microsoft's Xbox division could be biting off a lot more than it can chew.
