Shocking news dropped this week in the gaming world when the United Kingdom's Competition and Markets Authority said it is blocking Microsoft's (MSFT -2.45%) proposed $75 billion acquisition of Activision Blizzard (ATVI). Wall Street was blindsided by the news, and investors sent shares of Activision down over 10% on the day of the announcement.
Even though Microsoft and Activision leaders are saying they will fight to get the deal approved, it is now likely that this deal will never reach the finish line and Activision Blizzard will remain an independent publicly traded company.
Cloud gaming? Yes, cloud gaming
This decision from the U.K. regulator was shocking for investors, as it was just a month ago that the agency said it had found no problems with the deal in regard to the console gaming market. After Microsoft signed multiple deals to keep Activision's popular Call of Duty franchise available on all platforms for at least 10 years, there was no reason to think Microsoft's Xbox console platform would have any anticompetitive advantages over other industry participants.
So what was the problem? According to the authority, it cannot approve the deal because of the anticompetitive threats to the cloud gaming market, in which Xbox is a leader. Cloud gaming involves products or services that allow players to stream their favorite games without a dedicated computing device like a gaming console (the computing is done in the cloud).
But the decision shows little understanding of the dynamics of the gaming market.
Technology companies have been investing in the cloud gaming market for years with little success. Alphabet's Google recently threw in the towel with its Stadia service and Amazon has been floundering with no commercial progress. Xbox is still many years away from bringing a mainstream cloud gaming service to market, as its current service only works with extremely fast internet speeds. Cloud gaming makes up less than 1% of video game industry sales and is an inconsequential part of Xbox's and Activision Blizzard's businesses.
It is likely that the management teams were surprised and frustrated to see this be the reason the deal is getting blocked. How can a company promise not to be anticompetitive within a subsector when nobody knows what that subsector will look like three years from now, let alone 10?
An appeal is coming, but the juice might not be worth the squeeze
The United States Federal Trade Commission (FTC) noted in December that it is looking to block the Microsoft-Activision Blizzard deal over concerns that it would "enable Microsoft to suppress competitors to its Xbox gaming consoles and its rapidly growing subscription content and cloud-gaming business." This shows little understanding of the video game space. Xbox significantly trails Sony's PlayStation, Nintendo, and Steam in active players and has virtually zero presence in the mobile gaming market, which makes up half of industry revenue and is dominated by Apple and Google. Adding Activision Blizzard would not harm competition; it would actually increase it by helping Xbox better compete with these dominant platforms in console, PC, and mobile games.
But even if the facts are on the side of the companies, this may not matter if the two regulatory bodies force this deal to get dragged through the courts. If the deal doesn't close by July 18, Activision can decide to walk away and receive a sizable $3 billion breakup fee from Microsoft. If it is unlikely that the deal will get approved within the next few quarters, I think it is plausible that Activision will decide to just go it alone as a public company again.
How is Activision Blizzard doing on its own?
On the same day of the U.K. announcement, Activision Blizzard released its first-quarter 2023 report. Its financials looked strong, with revenue growth across its key franchises like Call of Duty and Candy Crush. Mobile bookings were up double digits year over year as well. Numbers for its upcoming blockbuster Diablo IV game, which is releasing in June, look strong. The last Diablo game was released more than 10 years ago and racked up over 30 million unit sales for the Blizzard studio. If the game succeeds commercially, it will help Activision Blizzard reach its long-term guidance of generating more than $3 billion in cash flow annually over the next four years.
The company also has tons of optionality with its growing cash pile, which sat at $12.6 billion at the end of the first quarter. Add on the potential $3 billion breakup fee and all the cash that will be generated with the launch of Diablo IV, and Activision's balance sheet could have $17 billion to $18 billion in cash by the end of this year, or a net cash position of around $14 billion when including its long-term debt. Subtract this from the stock's market cap of $60 billion, and it has an enterprise value of $45 billion. For a company in a growing industry set to generate $3 billion in cash or more each year for the foreseeable future, I think Activision Blizzard trades at a cheap price and can be a good investment over the long term, even if the Microsoft deal fails to close.
