Back in January, Microsoft (MSFT 0.04%) agreed to buy Activision Blizzard (ATVI) for $68.7 billion (or $95 per share). Activision Blizzard's investors approved the deal three months later, while Warren Buffett's Berkshire Hathaway acquired nearly 10% of the video game maker as an arbitrage play.

For a while, it seemed like a good idea to follow Buffett's lead, since Activision's shares consistently remained below $95. But as of this writing, its stock trades at roughly $75 and the deal faces a growing number of regulatory hurdles. China's antitrust regulators rejected Microsoft's initial request for approving the deal, European regulators launched a new probe, and the U.S. Federal Trade Commission sued Microsoft to block the acquisition.

All of these regulators believe Microsoft's takeover of Activision would give it an unfair advantage in the video game market. Do all of those headwinds indicate it's too late to buy Activision Blizzard as an arbitrage play?

A person plays a video game on a PC.

Image source: Getty Images.

How is Activision Blizzard faring on its own?

Before Microsoft placed its bid for Activision Blizzard, the video game maker's stock had already declined nearly 30% over the previous 12 months. Like most of its industry peers, it faced a tough post-pandemic slowdown as people played fewer games and spent more time outside again.

However, many of Activision's wounds were also self-inflicted. Its brand had been tarnished by a sexual discrimination and harassment lawsuit, it faced employee walkouts in response to those troubling allegations, and Blizzard postponed two of its eagerly anticipated sequels: Overwatch 2 and Diablo 4. One of Blizzard's newly appointed leaders, Jen Oneal, also resigned last November after spending just three months on the job.

Last month, Activision shut down most of its game services in China after failing to renew its 14-year licensing partnership with NetEase. It generated about 3% of its revenue in China last year.

Activision Blizzard's net bookings rose 32% in 2020 but fell 1% in 2021. In the first nine months of 2022, its net bookings dropped another 16% year over year. It ended the third quarter with 368 million monthly active users across all three of its publishers (Activision, Blizzard, and King), which represented a 6% decline from the previous year. That slowdown can be attributed to tough year-over-year comparisons to the robust growth of Activision's flagship Call of Duty franchise over the previous years, as well as the sluggish growth of Blizzard's aging World of Warcraft.

But on the bright side, its bookings growth is expected to accelerate significantly in the fourth quarter -- driven by Activision's successful launch of Call of Duty: Modern Warfare II in October, Blizzard's long-awaited launch of Overwatch 2 as a free-to-play game, fresh expansions for World of Warcraft, and its ongoing rollout of Diablo Immortal for mobile devices.

As a result, analysts expect Activision's net bookings to rise 29% year over year in the fourth quarter and only decline 3% for the full year. Next year, they expect its net bookings and earnings to increase 19% and 29%, respectively, as those newer titles gain more momentum. We should take all those estimates with a grain of salt, since Activision stopped providing guidance after agreeing to be bought by Microsoft. But based on those forecasts, Activision Blizzard's stock looks reasonably valued at 20 times forward earnings and 6 times next year's net bookings.

Could Microsoft still pull off this deal?

Activision Blizzard might look like a viable investment at $75, but it could be tough to rally nearly 30% to $95 on its own if Microsoft walks away. It would arguably make more sense to simply invest in Microsoft, which operates a more diversified business and trades at 26 times forward earnings, instead of betting on Activision's long-term recovery.

But Microsoft won't simply abandon this deal. To show that it won't turn Activision's top franchises into Xbox and Windows exclusives, it recently signed a 10-year distribution deal for Call of Duty with Nintendo and offered the same terms to Sony. It could make even more concessions to appease the regulators, who believe Microsoft's massive portfolio of first-party publishers -- which already includes Zenimax (Doom, Fallout, Skyrim), Mojang (Minecraft), and 343 Industries (Halo) -- shouldn't be allowed to grow larger and make it the world's second-largest gaming company after Tencent.

This deal isn't dead yet, but I wouldn't buy Activision's stock simply because it might bounce back to $95 if the acquisition is approved. Its downside might be limited at these valuations, but the video game sector could remain out of favor for the foreseeable future. There are also plenty of more promising tech stocks to choose from in this bear market.