Microsoft's (MSFT -1.96%) $68.7 billion offer to buy leading game maker Activision Blizzard (ATVI) has a long way to go to receive regulatory approval. But assuming it does, Microsoft could potentially be getting a great value for Activision.
The offer amounts to a price-to-earnings (P/E) ratio of 25 times Activision Blizzard's expected earnings for 2021. On the surface, that looks like a fair valuation -- but the potential for Microsoft to monetize 1,483 titles in Activision Publishing's game catalog going back to the 1980s would clearly make Activision more valuable in Microsoft's hands.
Here's why Xbox Game Pass and Activision's monthly active users are about to take a huge leap forward.
Crash, left, and Coco Bandicoot are characters from the "Crash Bandicoot" series of video games. Image source: Activision Blizzard.
Activision has a major new distribution channel
In a recent interview with the Washington Post, Microsoft Gaming CEO Phil Spencer expressed excitement about bringing back Activision's older titles like King's Quest and HeXen. It's also interesting he mentioned Guitar Hero, a game that Activision discontinued after the final installment in the series in 2010.
But a title like Guitar Hero could be more lucrative in the hands of Microsoft. Unlike Activision, Microsoft has a growing cloud gaming subscription service in Xbox Game Pass. Activision doesn't have its own cloud gaming platform, so it would be cost-prohibitive to bring back a bunch of older titles from its catalog as stand-alone releases on mobile or console.
Microsoft disclosed it now has 25 million Game Pass subscribers. Investors might remember that Netflix had about the same level of subscribers before it started investing in original content in 2012. That strategy opened the floodgates to more than 200 million subscribers through 2021. The same could happen for Xbox Game Pass, especially since Activision's older titles would appeal to a wider gaming audience on mobile devices.
Bloomberg reported in December that Sony was preparing to launch a more robust PlayStation Now gaming service in the near future. Accelerating subscriber growth at Xbox Game Pass is fundamentally what this deal is all about. During a recent call with analysts, Microsoft CFO Amy Hood outlined how the company is evaluating the value of this transaction:
Key measures of our success include accelerated revenue growth from Activision Blizzard's game portfolio as we extend content to more devices, resulting in increased engagement and monetization across the Xbox platform; as well as additional growth in Game Pass subscribers as we attract new players wherever they play and continue to build one of the most compelling and diverse lineups of AAA content available.
Activision is worth more to Microsoft
Activision Blizzard has previously stated its long-term objective is to reach 1 billion monthly active users. It ended the third quarter with 390 million, but Activision can more easily achieve its long-term goal with Microsoft as a partner.
Just looking at the Blizzard side of Activision, most notably franchises like Overwatch, World of Warcraft, and Diablo. These games could reach a much larger player base by simply being included in the Xbox Game Pass subscription service. Microsoft CEO Satya Nadella said as much on the recent call to discuss the merits of the deal:
Through the cloud, we are extending the Xbox ecosystem in community to millions of new people, including in global markets where traditional PC and console gaming has long been a challenge. And when we look ahead and consider new possibilities like offering Overwatch or Diablo via streaming to anyone with a phone as part of Game Pass, you start to understand how exciting this acquisition will be.
For an individual investor, a P/E of 25 is a fair price to pay for a share of Activision. But Microsoft's ability to unleash Activision's library and new releases to grow Xbox Game Pass will produce additional revenue opportunities that Activision wouldn't have been able to accomplish on its own.
On top of that, with the upcoming blockbusters like Diablo IV and Overwatch 2 in the next few years, there is more value in the $68.7 billion offer than meets the eye.
