After nearly two years of regulatory proceedings, Microsoft (MSFT +0.63%) finally completed the acquisition of leading game producer Activision Blizzard. The U.K. Competition and Markets Authority was the final holdout, but it granted approval of the deal in October.
The $68.7 billion acquisition is one of the largest in Microsoft's history. In exchange, the Xbox business gains an infusion of $8.7 billion in revenue from best-selling titles, including Call of Duty, Diablo, Overwatch, and World of Warcraft, in addition to some valuable mobile franchises, such as King's Candy Crush.
However, Microsoft didn't get everything it wanted. To get approval, it had to make some compromises. In July, Microsoft agreed to make one of the all-time best-selling franchises, Call of Duty, available to Sony and Nintendo's game consoles for 10 years.
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It also agreed to let Ubisoft Entertainment buy Activision's cloud gaming rights. This means all the cloud gaming rights for Activision's PC and console content produced over the next 15 years will be owned by Ubisoft.
These compromises were needed to win the prize, but can Microsoft still reap enough growth out of Activision to justify the steep price tag?
Microsoft is building a large base of players
This won't be Microsoft's last acquisition of a video game company. Sony and Microsoft have been in an arms race to acquire studios in recent years to gain scale in the $200 billion video game industry. Microsoft previously paid $7.5 billion for Bethesda Softworks owner ZeniMax Media in 2020, so it's not surprising to see Microsoft swing for the fences with billions in cash resources.
Still, given the size of this transaction, shareholders will want to see good returns on this investment, especially after Microsoft just spent most of the $111 billion in cash and short-term investments it spent the last 30 years accumulating on its balance sheet.
MSFT Cash and Short-Term Investments (Quarterly) data by YCharts
Microsoft's gaming business just became one of the largest in the world. In fiscal 2023 (which ended in June), Microsoft's gaming revenue came to $15.5 billion, according to Statista estimates. Activision will add $8.7 billion to that total to bring Microsoft's gaming revenue to over $23 billion.
Activision will also contribute roughly $2.4 billion of free cash flow. But that means Microsoft paid a high price-to-free cash flow multiple of 28, which is expensive considering Activision's growth.
Over the last 10 years, Activision grew revenue by just 4.5% per year, with free cash flow growing 5.3% annually. Unless Microsoft can squeeze more growth out of this business, it might have overpaid.
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When Microsoft originally announced the deal in January 2022, it spent as much time talking about the opportunity to expand into mobile gaming -- a $92 billion market -- as it did about cloud gaming opportunities. Although it doesn't have exclusive cloud gaming rights to Activision's future content, it should be able to grow Xbox Game Pass, which had 25 million subscribers in early 2022.
Game Pass has trailed Sony's 47 million subscribers in PS Plus, according to Statista. However, Microsoft now has a large pool of 356 million monthly active users to market new games and content to. This will satisfy one of Microsoft's top priorities, which is to build a community of players and increase the time players spend across a large portfolio of games. Those are the key ingredients that will create profitable growth opportunities in the video game industry.
Another overlooked opportunity for Microsoft is access to the intellectual property Activision has released going back to the 1980s. Microsoft will look to mine Activision's library for titles it can revive, and perhaps turn into valuable mobile properties. One that stands out is Guitar Hero, which Xbox head Phil Spencer has previously said he wants to revisit. Activision discontinued this franchise years ago, but the advantage of being part of Microsoft is that Activision can now take risks it couldn't before.
To answer the original question, no, I don't believe Microsoft wasted its cash. At least, it's too early to make that call. If Microsoft can help Activision release more new games at a faster pace and innovate with new ideas, the growth it could generate would go a long way toward justifying the cost of the acquisition. Depending on how much profit it can squeeze out of these franchises, this deal could look like a great value in a few years from now.
