- Microsoft has already declared it will seek to build a case in court revolving around the acquisition of Activision Blizzard being a vertical merger.
- There is little legal precedent for blocking vertical mergers, meaning the FTC likely has an uphill task in court.
- The stock is a great buy at these levels, although going to trial would significantly lower ARR.
The FTC’s decision to challenge the acquisition of Activision Blizzard Inc. (NASDAQ:ATVI) by Microsoft Corporation (MSFT) was somewhat expected by the market, given the large gap between the agreed price of $95 a share in cash and where Activision’s stock is trading now. As a result, some analysts now estimate the chance of the deal closing at 30%. On the other hand, Warren Buffett’s Berkshire Hathaway (BRK.B) (BRK.A) bought more than 7.5% of the company following the announcement of the deal, probably betting the deal will close. So who’s right?
The FTC Offered Nothing New in Challenge of Activision Acquisition
In my previous article, I discussed what the FTC will look for in evaluating whether the merger could lessen competition, and why the merger will likely close.
The very first issue was this:
the agencies would seek commitments from Microsoft that it would not use its acquisition of Activision to advantage Xbox over other competitors. One example of such practices would be to make the Call of Duty franchise available exclusively on Xbox.
There are other issues I thought the FTC would look at, like privacy and working conditions of Activision Blizzard’s employees. I thought the exclusivity question was the easiest for Microsoft to deal with, but it was precisely what the FTC focused on in its complaint:
The Proposed Acquisition is reasonably likely to substantially lessen competition or tend to create a monopoly in multiple markets because it will create a combined firm with the ability and increased incentive to use its control of Activision titles to disadvantage Microsoft’s competitors. The Proposed Acquisition also may accelerate an ongoing trend towards vertical integration and consolidation in, and raise barriers to entering, the relevant markets.
The FTC is basing its case essentially on the premise that Microsoft will use Call of Duty to preference Xbox over Sony. The complaint says that Microsoft could do that thanks to its ability to:
withhold or degrade Activision content through various means, including manipulating Activision’s pricing, degrading game quality or player experience on rival offerings, changing the terms and timing of access to Activision’s content, or withholding content from competitors entirely.
A lot of the issues raised in the complaints raised by the FTC were already addressed by Microsoft, which makes its decision to challenge the merger even more puzzling to me.
Why FTC’s Complaint Isn’t Likely to Win in Court
The first point raised, is that Microsoft can make Call of Duty exclusive to Xbox. This was already covered in my previous article; Microsoft President Brad Smith said the company has no intention to take games off platforms:
We’d like to bring it to Nintendo devices, we’d like to bring the other popular titles that Activision Blizzard has, and ensure they continue to be available on PlayStation, and that they become available on Nintendo.
Since then, Microsoft agreed a deal with Nintendo to bring Call of Duty to its console for the next 10 years. This shows clearly that the company has no intention to withhold games from competitors. Microsoft reportedly offered the same deal to Sony, but the Japanese giant rejected it.
Another point, which was not mentioned in the original article, is that Microsoft could change the terms in an advantageous way for the company. One way this would make sense, is if the company included Call of Duty in its Game Pass subscription service. This would certainly preference Xbox, because its users would get the game for $10-$15 a month along with many other games, while PlayStation users would pay as much as $100 just to buy one game.
But as it turned out, Microsoft offered Sony the chance to sell Call of Duty on its own PlayStation Plus. To be perfectly honest, I have no idea why Microsoft would pay $69 billion for Activision. I don’t see a clear strategic rationale for the acquisition. Surely entry into mobile gaming and improving the company’s gaming subscription service aren’t worth that much. Luckily there is no need to figure this out, all that’s needed for this investment to workout is for Microsoft to pay the $95 a share to Activision shareholders.
Then the final point, unlike the FTC’s claims, Microsoft actually has a history of expanding access to games after acquisitions. The FTC said that Microsoft has a past of making games exclusive despite offering commitments that it won’t, citing the company’s acquisition of ZeniMax. The European regulator, to which the alleged commitment was made, had to essentially deny the statement, saying Microsoft never offered them such assurances.
Microsoft actually expanded the access to Minecraft, making the game available on Netflix (NFLX) as well as many other platforms and consoles. This will be an easy case for Microsoft to make in court.
What Happens Next in the Microsoft-Activision Merger?
So far, I think the FTC’s decision to try and block the merger is meaningless. The trial is set for August 2 of 2023, but the two companies say they expect to close the merger in the first half of 2023, at least two months before the trial. The trial itself doesn’t prevent the two companies from closing the merger, for that the FTC has to file for pausing the merger until the original trial is concluded. That is yet to happen.
There are three big risks in my opinion; the first is that Microsoft might willingly decide to walk away from the deal to avoid the headache. The second is that the deal takes longer to close, lowering the merger arb’s ARR. If the case goes to court before the two companies can close the merger, then it will likely take another year before there is a verdict, pushing back the merger-close date to August 2024 from June 2023. The third is that one of the regulatory bodies in Europe or China blocks the deal.
Cushioning these blows is the fact that Microsoft will have to pay Activision a break-up fee of $3 billion. That would leave Activision with net cash of more than $10 billion. At a market cap of $60 billion, there is plenty management can do with the cash to make it up for shareholders.
The other reassuring factor is that the stock already seems to be pricing-in the merger not going through, so there might not be much downside at the current price. The stock fell 1.5% on Dec. 8 when reports came out that the FTC will block the deal. A survey from Seeking Alpha showed that 14 analysts believe the stock would be at $71 if the deal fails to go through, which isn’t the worst risk-reward.
The FTC’s challenge of the Activision-Microsoft merger, if successful, will set a new legal precedent. This means that the challenge is unlikely to be successful. Microsoft has already addressed the FTC’s concern regarding potential exclusivity of Call of Duty. Investors who buy ATVI are likely to get $95 a share from Microsoft, the risk is that the trial would delay the closing date by a year at least, lowering the ARR. In a worst-case scenario where the deal doesn’t close, Activision will get a $3 billion break-up fee and will have a net cash position of $10 billion that it can use to appease investors. The stock also seems to be pricing-in the deal not closing, evident by the lack of volatility when news hit of FTC’s decision to challenge the merger.
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.