My Top 2023 Pick: A Levered Bet On The Microsoft/Activision Merger

Summary:

• In January 2022, Microsoft announced an acquisition of Activision Blizzard for $95 per share with an estimated closing date of June 2023.
• The major regulatory agencies in the US, UK, and Europe are reviewing the deal with some providing feedback already with some remedies likely required for it to go through.
• A levered trade can provide multiples of upside in the event of a successful deal closure while limiting the downside to an investor.

2022 has been a difficult year for stocks as a whole as the throes of a bear market finally took hold. I fear this is the case going forward which makes finding a best investment idea for 2023 very difficult. With a backdrop of a bear market continuing through much of 2023, my best investment pick for 2023 is Activision Blizzard (NASDAQ:ATVI).

For readers of Seeking Alpha, this will not be a new choice as there have been a lot of authors who have explored the name due to the acquisition offer that Microsoft (MSFT) put forward in January 2022 to purchase the company for $95 per share. Before the announcement of the deal, shares of ATVI traded at $65.39 but surged to over $90 after the deal was announced. Shares have since slid back now to the $75 to $76 range.

With any merger or acquisition, there are a lot of risks associated with it; this bear market setup also brings some additional risks in, including:

• Risk the acquiree does not approve the deal
• Risk of regulatory authorities
• Downside risk on a deal break

Risk of Acquiree Approval

This risk has been removed as the company voted overwhelmingly to accept the offer from MSFT in April 2022. With close to a $30 premium over the $65ish share price at the time, monetarily the offer was a good reward for shareholders. The company was also going through a lot of difficulty with a very toxic work environment so this acquisition would let the company “re-boot” its culture through integration with MSFT. There was not a lot of doubt that it would be approved, and it was.

Regulatory Risk

This is where the true risk of the deal closing sits. The US-based FTC has already sued Microsoft to stop the deal. Both companies are optimistic that they will win in court, and both had hoped to find a peaceful solution. From a high level, I struggle to see where the anti-competitive component comes in. Both Sony (SONY) and Nintendo (OTCPK:NTDOY) have more exclusive content than Microsoft does through its Xbox Platform, with Halo and Forza being the lead games for Microsoft. An acquisition of ATVI would bring Call of Duty but Microsoft has already offered its rights to Sony for its PlayStation Plus platform which would negate the exclusivity of that franchise. Of course, a deal needs to be worked out with Sony who could try to play hardball to scuttle the deal. Microsoft has an extensive lobbying arm, in Washington putting roughly $10m per year with close to 100 lobbyists to work to support the company’s goals which should help to find a negotiated solution prior to any trial.

The other major regulatory agencies requiring approval include the UK’s Competition and Markets Authority and the European Commission. Microsoft recently made a substantial investment with the London Stock Exchange Group which was likely a deal on its own merits but making its name felt in the markets isn’t necessarily a bad thing. The CMA has already come back with findings to Microsoft which will now go about the process of finding remedies. The European Commission will similarly require some concessions but could also lead to early approval.

The regulatory risk comes down to is there either a real risk of a Microsoft/Activision merger being anti-competitive in the videogame landscape or if there is a perceived risk of that occurring. Sony PlayStation will still be larger than the combined Microsoft/Activision entity just among the major consoles. The growth of mobile games in recent years, while obviously different in complexity and target audience, should also be considered in whether this type of acquisition would be anti-competitive.

Bear Market Risk

These two risks are the biggest risks to whether investors in ATVI see the $95 per share that Microsoft offers. There is an additional downside risk in this environment is how a trade in this would be structure. An investment in the equity gives you the full upside opportunity from the current price. This type of positioning also has a lot of risk in a bear market. There are a lot of estimates that ATVI could be worth even above the current share price as a stand-alone entity, but in this environment, there is a lot of room to the downside with a stock trading at a 25x P/E value. Even a re-rating to a 15x P/E would see a $45 share price or close to a $30 downside vs $19 upside if the deal closes; this is not a particularly attractive risk-reward.

A straight call option would give you pure leverage to the upside, but with a capped upside due to the offer price. With that in mind, I chose to use a Bull Call Option spread to try to leverage up a bit more due to the upside cap from the buyout offer. I chose to go out to June 2023; this is the month the deal is supposed to close but I would expect any regulatory issues would need to addressed in advance of the end of June. The $95 calls do not give enough juice at the current pricing, so I used $90s as the upper bound. For lower bound, I used $85. The net spread (utilizing the ask prices) is $1.90 vs. $5.00 on the spread. You could also use $80 which would give you a spread cost of $3.70 vs $10 but I liked the fact the net cost was 50% which let you do a bit bigger call option position.

If you choose to use this strategy, bear in mind your position sizing since if the deal breaks, your entire outlay will be worthless, and it is by no means a certainty that this deal will close.

The Takeaway

In the context of a continuing bear market, I like this speculation on the MSFT/ATVI acquisition since there is an upside pull on the share price in the form of the bid. The use of the bull call option spread, with appropriate position sizing, also limits your downside which an equity position would not. For this reason, it is my top pick for 2023 going into what will be another volatile market environment. A hat tip to twitter account @MarmotXI for the kernel of the idea for this trade.

Editor’s Note: This article was submitted as part of Seeking Alpha’s Top 2023 Pick competition, which runs through December 25. This competition is open to all users and contributors; click here to find out more and submit your article today!

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Disclosure: I/we have a beneficial long position in the shares of ATVI either through stock ownership, options, or other derivatives. 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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