Atai Capital – Activision Blizzard: A Great Business Riding A Gaming Secular Tailwind

Summary:

• Activision Blizzard is being acquired by Microsoft at $95/share.
• Throw in the gaming secular tailwind, I consider ATVI to be a great business.
• Valuation-wise we have Activision trading at ~16x our 2023E earnings estimate today.
• We didn’t originally purchase Activision for the merger arbitrage.
• At this point, it’d be nice to see the deal go through , but in the event it doesn’t, and the stock drops materially, we’ll happily add to our position in Activision.

The following segment was excerpted from this fund letter.

Activision Blizzard Inc. (NASDAQ:ATVI)

Those familiar with Activision Blizzard will quickly realize this is by no means a small-cap stock and boasts a rather large $66B market cap. While our focus is firmly on small-cap stocks, there will be occasions when I see something in large-cap land that piques my interest.

For those unfamiliar with Activision Blizzard, they are a video game developer and publisher being acquired by Microsoft at $95/share. They develop and own IPs such as Call of Duty, World of Warcraft, Diablo, Overwatch, Hearthstone, and Candy Crush. These are some of the most valuable IPs in gaming, from both a business perspective and a popularity perspective. I’ve been an avid gamer for years and am not a fan of most of their games (quite the opposite actually), but I can still appreciate how valuable these IPs are. Activision games have some of the lowest expectations in the industry but still sell millions of copies. They are currently churning out a new Call of Duty every other year with practically no differences between the titles, and yet gamers consistently buy these “new” releases, every, single, time. In fact, the most recent release (MW2) was the fastest-selling COD game ever, amassing over $1B in sales in the first ten days after release. Candy Crush has been the top-grossing game franchise in the U.S app stores for twenty-two quarters in a row, and Diablo 4 is very likely to out-sell its predecessor Diablo 3 (30M+ copies over its lifetime) while being just as monetized via in-game skins and DLC’s if not better. Throw in the gaming secular tailwind, a highly competent CEO – Bobby Kotick, and I consider Activision to be a great business (what I’ve stated here is just high level of course).

Valuation wise we have Activision trading at ~16x our 2023E earnings estimate today (accounting for cash and assuming the deal breaks). In my opinion, this business deserves a multiple in excess of the market and has averaged an earnings multiple of ~22x over the prior ten years. If we apply what I consider to be a fair 20x multiple and give them credit for their net cash that gets us to ~$101/sh (or ~20% from today and ~36% from our original purchases). We have not sold any Activision and don’t plan to unless it’s apparent the deal is going through, and that’s accurately reflected in the shares price. Given the difficulty in valuing video game developers, we believe our estimate to be fair and see significant upside potential in the name looking out a few years.

I am by no means an arbitrage/anti-trust expert, and we didn’t originally purchase Activision for the merger arbitrage either. However, it was on my watchlist at the start of the year, so in mid-January when news came out that the EU would likely deliver an antitrust warning that sent the stock to sub $74/sh I quickly got back up to speed and made our initial purchases (this warning I thought was 100% anticipated, so the stock’s reaction was kind of surprising). Then in early February, news started to circulate that the CMA (The UK’s antitrust authority) was expected to publish its provisional findings the upcoming week, citing fears that the deal may “significantly reduce competition” – Once again, an expected development, so when the stock dropped on the news, we bought more at ~$72/sh. Fast forward to February 8th and the CMA provisional findings were released, and the stock fell yet again. After taking the time to read their provisional findings and comparing them to recent deals like Facebook (META) acquiring Giphy (which had no behavioral remedies offered, while the Activision deal did), I thought the CMA’s comments were better than anticipated, and Microsoft (MSFT) was being offered a real opportunity to plead their case. Given the company’s solid earnings a few days prior, we subsequently took advantage and made our final purchases later that day at ~$73/sh. Skip ahead to March 24th, and the CMA dropped its concern around console gaming competition being “substantially lessened” by the deal.

Having considered the additional evidence provided, we have now provisionally concluded that the merger will not result in a substantial lessening of competition in console gaming services because the cost to Microsoft of withholding Call of Duty from PlayStation would outweigh any gains from taking such action.” – Chairman conducting the CMA investigation.

It’s important to note that the CMA hasn’t ruled on cloud gaming yet, but that should be a smaller hurdle to get over. Another interesting development is that the CMA recently queried seven market participants to get their opinion on the matter, and only one was in opposition – Sony (SONY), a real shocker I know! At this point, it’d be nice to see the deal go through (It should, in my opinion), but in the event, it doesn’t, and the stock drops materially, we’ll happily add to our position in Activision (I have it sized closer to a special situation right now opposed to a higher conviction idea for this specific reason).

I’ll end this part of the letter with a recent interview of Bobby Kotick where he had a funny quip stating, “If deals like this can’t get through, they’re not going to be Silicon Valley; they’ll be Death Valley” in reference to the U.K.

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.