When one company announces the acquisition of another and there isn't much uncertainty about whether the deal will go through, there's usually little reason for investors to stick around. The stock of the acquired company soars, leaving at best a small gap between the stock price and the deal price.
Microsoft's (MSFT -0.15%) pending acquisition of video game giant Activision Blizzard (ATVI) is not a normal acquisition. Investors were never all that confident that the company behind the Xbox would be able to successfully acquire the company behind Call of Duty and a host of other mega-franchises. Microsoft is set to pay $95 per share in cash if the deal goes through, but Activision stock currently trades right around $75 per share after fluctuating around $80 per share for much of this year.
It looks somewhat likely that the acquisition will be challenged by the U.S. Federal Trade Commission, so a gap between the stock price and the deal price is certainly warranted. But the size of the gap, and Activision's prospects if the deal falls through, makes the stock a compelling buy.
A big gain if the deal goes through
If Microsoft manages to thread the needle and close this deal without lawsuits, or if it successfully fights off any legal challenges from government agencies, Activision investors will receive $95 per share. That's about 25% above the current Activision stock price.
The caveat here is that it may take a while. According to the merger agreement, the deadline for closing this deal can be extended to July 18, 2023. If Microsoft does have to fight in court, you can expect it to be a months-long process. It's unlikely that this deal will close soon, unless by some miracle all regulatory agencies around the world decide to let it pass without a fight. It's possible, but not likely.
Still, a 25% gain in about seven months is pretty good, especially considering the beating many stocks have taken so far this year.
A solid investment if the deal falls apart
If Microsoft fails to acquire Activision because the deal gets shut down by regulators, Activision will receive a reverse termination fee between $2 billion and $3 billion from Microsoft, depending on when the deal is terminated. At the very least, that's a sizable consolation prize.
Activision's stock will almost certainly decline temporarily as those who own the stock solely as a bet on the deal going through dump their shares. But in the long run, paying around $75 per share looks reasonable.
The video game market is a bit dicey right now following the pandemic boom, but Activision has one of the best collections of time-tested franchises in the industry. Call of Duty, World of Warcraft, Diablo, StarCraft, Candy Crush, and a slew of other franchises spread across PCs, consoles, and mobile devices will help ensure the company's staying power, regardless of industry conditions.
In terms of valuation, Activision stock isn't overly expensive. With analysts expecting adjusted earnings per share of $3.04 this year and $3.91 next year, the stock trades for 25 times and 19 times those estimates, respectively. Those price-to-earnings ratios don't seem unreasonable.
Again, Activision stock will likely suffer for a while if the deal collapses, so if you do invest in the company, be prepared for some short-term volatility. But the risk-reward trade-off for long-term investors looks positive. Either the deal goes through and you get a 25% gain in less than a year, or it doesn't, and you own a piece of one of the best video game companies for a reasonable price. That looks like a bet worth making.