Since we last published on Activision Blizzard (ATVI), the company agreed to be purchased by Microsoft for $95 per share in cash.  The deal is expected to receive heavy scrutiny by regulators and Microsoft has suggested a deal close in mid-2023.  The $95 buyout price is above our target of $90, which we had lowered from $115 following the problems ATVI ran into involving personnel and human resources issues.  We had also suggested that achieving the new target would take time as ATVI worked though its issues, so a $95 deal price in 2023 is not too far off the reality if regulators approve the deal.

ATVI shares are trading just above $80 after rallying slightly in the last few days.  The discount to the $95 buyout price is significant and suggests investors are concerned that the deal could be blocked.  Depending on what price you assume ATVI would trade at without a deal, the current price indicates only about a 50/50 chance of regulatory approval.  We think that is too pessimistic.  Regulators will look at this deal from a horizontal and vertical perspective.  Horizontally means analyzing Microsoft’s market share when combining its own video game publishing efforts with those of ATVI.  Given many very large competitors including Sony, Take Two Interactive, Ubisoft, Tencent, and Electronic Arts, we see little to worry about from this perspective.  Vertical integration is where the deal could get tripped up as Microsoft controls one of the two major online platforms outside of China for distributing and playing traditional published video games.  Sony owns the other platform.  The concern would be that Microsoft could restrict competition by limiting the new games it is acquiring from ATVI to its own platform.

ATVI owns just a few massive games including its Call of Duty and World of Warcraft franchises.  Each franchise is among the most popular games in the world.  Call of Duty is particularly popular on Sony’s Playstation platform.  In Northlake’s opinion, it would be idiotic for Microsoft to restrict Call of Duty to its own platform and walk away from over half of the current revenue the game provides.  Microsoft will surely offer assurances to regulators that it will not restrict distribution of its newly acquired games for a period of at least several years.  Whether this will be good enough for the new regulators at the FTC that were recently appointed by President Biden is where the questions lie.  The Biden administration is clearly looking to regulate major tech companies much more and it is politically popular to do so.  The new regulators have been vocal in their desire to crackdown on major tech mergers and have indicated less interest in approvals with conditions such as an agreement by Microsoft to not restrict distribution.  Microsoft would likely go to court if regulators block the deal and the court rulings allowing the merger of AT&T and Time Warner set a very favorable precedent for Microsoft to win.

ATVI reported weak 4Q21 results with terrible performance from the new Call of Duty game and weakness at World of Warcraft.  There had been fears that the controversies enveloping ATVI would hurt game development and lead gamers to punish the company by avoiding its games.  These fears appear to have been well placed.  The outlook for ATVI’s earnings over 2022 and 2023 fell by about 10% although the company did outline an ambitious plan to reinvigorate growth. 

The downside in the shares without the deal might be around $60 against upside to the $95 deal price.  With the stock at $80 this presents a mixed risk-reward tradeoff.  Thus, we will hold ATVI shares now as there is virtually zero initial downside since regulatory review has not even begun.  Should we find a new idea to add to client portfolios, it would have a better risk-reward tradeoff, so ATVI is a likely source of funds over the next few months.

ATVI is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.