Everything You Need To Know Ahead Of CMA’s Final Report On The Activision Deal

Summary:

• The CMA now says the deal likely will not lessen competition in the console space.
• Microsoft revealed that part of its strategic rationale is to promote subscription gaming and create a universal app store.
• Activision remains a buy; even if the deal falls through, it will be because it has a monopolistic position in the gaming space.

The Competition and Markets Authority (CMA) initially (page 4) said that it provisionally concluded that the proposed merger between Microsoft Inc. (MSFT) and Activision Blizzard Inc. (NASDAQ:ATVI) may be likely to lessen competition in the gaming space and harm UK consumers.

They discussed three (page 3) possible remedies: 1) Blocking the merger. 2) Divesting essentially the majority of Activision Blizzard’s business. 3) Implementing some behavioral remedies.

The case is even more interesting because the CMA said that the divestiture option was feasible, meaning it is not considering behavioral remedies to approve the deal.

The CMA in its latest statement, announced it was narrowing its concerns regarding the deal, acknowledging that Microsoft would indeed lose money if it were to restrict access of Call of Duty. As a result, the CMA updated its provisional findings to say “overall, the transaction will not result in a substantial lessening of competition in relation to console gaming in the UK.”

All the info were obtained from the official CMA page dedicated to the merger. You can find the documents here: Microsoft / Activision Blizzard merger inquiry – GOV.UK (www.gov.uk)

Why the CMA is Against the Merger

In the original provisional findings, the CMA argues that Microsoft acquisition of Activision could lead to a lessening of competition.

The CMA said that Call of Duty (CoD) represents a significant amount of the time spent on PlayStation (page 174), and so limiting access to the game could severely hurt the console’s popularity. They also argued that it could limit choice for consumers, who in some instances decide which console to buy based on the content available to the consoles (page 13). The CMA also highlighted that Microsoft’s behavior following previous acquisitions in the space reflects a business strategy that favors making games exclusive. They also argued that, even though Microsoft would be hurt initially from limiting access to the game, CMA’s models showed that the company would benefit financially in the long run from having the game exclusive to them (page 166).

CMA’s reservations applied to both gaming consoles and cloud gaming. Microsoft offered CoD deals to its console rivals, but there was no mention of how that would be incorporated in case cloud gaming replaces consoles as the prominent method of playing games.

The authority updated its provisional findings to acknowledge that Microsoft’s losses from a total foreclosure of CoD makes it less likely the company will make the game exclusive to Xbox. The CMA stressed however that they still believe that there are strategic benefits from foreclosing, but that they place less weight on it as before (page 2).

What the CMA Proposes as A Remedy

The CMA prefers the prohibition of the merger or the divestiture of Activision’s key assets to behavioral commitments from Microsoft. They said that the only way they would consider the latter is if the divestiture is not feasible or if the losses incurred on the divestiture far outweigh the potential gains gamers could get from the merger. They added that their view is that a prohibition or divestiture options are feasible, but acknowledged that they haven’t fully considered in detail how behavioral commitments could preserve relevant customer benefits. CMA prefers structural remedies (prohibition/divestiture) because it is easier to oversee.

On why the CMA does not favor a behavioral remedy, this particular paragraph stood out (page 9):

The circumstances in which the CMA might select a behavioural remedy as the primary source of remedial action are not present in this case. The two markets in which the CMA has provisionally found SLCs are multi-faceted and continue to develop. This is particularly the case in cloud gaming, where the customer offerings and business models of market participants are evolving rapidly. We are of the initial view that any behavioural remedy in this case is likely to present material effectiveness risks. We invite the Parties to provide evidence on how these risks could be appropriately managed to ensure that any behavioural remedy is effective.

So Microsoft needs to convince the authority that any developments in the cloud gaming space will not impact the competition’s access to Activision’s games. This is one of the areas that Microsoft failed to cover in its defense of the merger. Even in the updated provisional findings, there was no update regarding competition in the cloud-gaming space. So, despite narrowing the scope of its concerns, it might still not approve of behavioral remedies.

What Sony Said About the Merger

Sony essentially agreed with the CMA’s initial assessment, saying Microsoft would have the incentive to withhold access to Activision’s games. Sony said Microsoft’s strategy would harm competition, gamers, and developers. Sony cited Microsoft’s behavior on previous gaming acquisition (ZeniMax, Obsidian, inXile, Ninja Theory to name a few), and highlighted that Microsoft itself did not deny that it plans to make some of the games exclusive (albeit not Call of Duty). The company wondered why Microsoft would spend almost $70 billion on Activision, if the latter’s games weren’t vital to gaming consoles. Sony revealed that Microsoft only offered it to keep the game available to PlayStation until 2027 (page 8). It also said that Microsoft’s proposal did not include offering Activision’s games on PlayStation Plus. The company also warned that making Call of Duty exclusive to Game Pass would threaten competition in the space.

How Microsoft Responded

Microsoft built its case on three main points. The first is that denying access to one game cannot amount to a foreclosure strategy, pointing out that consoles like Nintendo managed to be very successful without access to the game. The company said that the usage of Activision’s flagship game Call of Duty was rather small for PlayStation (between 10-20%) and that the game’s status as an important input was dubious. Sony said Microsoft’s numbers were inaccurate, and provided its own internal numbers to the authority. Those numbers however were redacted so it’s unclear how big is the difference. Microsoft highlighted that Call of Duty was rarely chosen as game of the year, as another example of why the game isn’t crucial to competition (page 3).

Call of Duty gamers are neither ‘special’ nor ‘unique’ in terms of either their spending or user engagement as compared to gamers that favor other popular franchises. Call of Duty does not drive spend on PlayStation and accounts for only (redacted) % of Sony’s digital revenues worldwide. In 2022, Call of Duty gamers spent essentially the same time on Xbox as FIFA, Fortnite, Grand Theft Auto, Minecraft, NBK 2K, and Rocket League gamers. Importantly, they also spent around the same proportion of time playing other franchises. This is inconsistent with Call of Duty having a greater ability to drive consumption of non-Call of Duty content on consoles than other popular franchises.

The second was that Xbox was much smaller than PlayStation. It said that Sony is a gaming publisher with its own powerful franchises like Uncharted and The Last of Us. It also said that PlayStation has more than double the Monthly Active Users (MAU) that Xbox has.

The third, and in my opinion most importantly, is that the acquisition of Activision is a classic case of the elimination of double marginalization. Microsoft says its acquisition is user friendly, given it will bring Call of Duty to its gaming-subscription service (Game Pass), which will make it cheaper for gamers to enjoy Activision’s titles. Microsoft added that Activision wouldn’t be able to do this as an independent company as it wouldn’t make financial sense. But as part of a bigger Microsoft, the advantages the parent company would make from growing its subscription service (and making the game available to Nintendo gamers) would far outweigh the financial hit Activision would take from the forgone sales of the standalone game (page 6).

A key benefit of the Merger for gamers lies in Xbox’s plan to make Activision content available on Game Pass on the day of the game’s release (i.e., “day and date”). The difference between the two scenarios is stark. With the Merger, Activision content will be available on at least one subscription service day and date, without the Merger, on none. This matters from a consumer welfare perspective, because the more content consumers can access through subscription services, the lower the average prices of individual games. Absent the Merger, every consumer who wants to play Call of Duty or another Activision title would need to purchase the game at full price.

Final Thoughts

I think the battle between Microsoft and Sony over the Activision acquisition will boil down to who can sway the CMA; is the acquisition an illustration of the elimination of double marginalization like Microsoft says? Or is it a case of attempting to foreclose competitors like Sony claims.

Microsoft argues that the CMA must bear in mind that its proposed remedy should not affect business outside its jurisdiction. I’m not sure what that means for the authority’s ability to rule, given the acquisition was approved by European regulators. The CMA now seems to tentatively agree with Microsoft that the deal may not lead to a significant lessening of competition. It is unclear what its final decision will be despite the latest release.

In my opinion, Microsoft is a buy if it gets the merger approved. The prospects of establishing a universal store that sells on Xbox, PlayStation, iOS, and Android could be a huge boon for profits (page 12).

As Mr. Spencer explained because of (redacted) In particular, the concept of a nextgeneration game store that operates across a range of devices (“Universal Store”) is risky…Moving consumers away from the Google Play Store and Apple App Store on mobile devices will require a major shift in consumer behaviour. Microsoft hopes that by offering well-known and popular content, gamers will be more inclined to try something new. But this is far from guaranteed and also depends on proposed regulations and legislation in the U.S., and around the world, that would require Apple and Google to make their platforms and app stores more open to third-party stores and commerce platforms.

Activision is also a buy in my opinion regardless of the ruling. If the merger is approved, shareholders would realize a 13% gain on their investment. But even if they don’t, it is only because it is an extraordinary business with a sustainable competitive advantage according to the three parties involved in the battle. It will have close to $14 billion in cash it could use to buy back shares, plus the free cash flow it produces.

The CMA’s final decision will be on April 26.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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