Image Shown: Microsoft Corporation is buying Activision Blizzard Inc, the largest buyout for a US tech firm ever. Image Source: Microsoft Corporation – January 2022 IR Presentation covering its acquisition of Activision Blizzard Inc
By Callum Turcan
On January 18, Microsoft Corporation (MSFT) made history by making an all-cash offer to purchase Activision Blizzard Inc (ATVI) for $95 per share. The boards of both companies have already approved the deal. Inclusive of Activision’s net cash position, the deal is worth $68.7 billion which makes it the largest buyout ever for a US tech firm according to CNBC. This deal is expected to close in fiscal 2023 (Microsoft’s fiscal year ends in June). Once it closes, assuming the deal pasts antitrust muster, Microsoft views the acquisition as being accretive to its non-GAAP earnings per share. Our fair value estimate of Activision will be updated to reflect a modest discount to the buyout price to incorporate the small probability the deal won’t be completed due to antitrust concerns.
Deal Overview
Microsoft’s purchase of Activision will see major videogame franchises including Call of Duty, Warcraft, StarCraft, World of Warcraft, Overwatch, Candy Crush, and Diablo join its stable of properties. In March 2021, Microsoft closed its $7.5 billion all-cash acquisition of ZeniMax Media, the parent company of Bethesda Softworks, which is behind hit properties including Fallout and The Elder Scrolls. Additionally, Microsoft owns the game studios behind other popular franchises including Halo and Gears of War. Microsoft is now a video game giant on both the developer and publisher side of things.
When the Activision deal closes, Microsoft will have 30 internal game developer studios along with significant publishing and e-sports operations. Microsoft is also acquiring Activision’s Major League Gaming operations as part of this deal. Back in January 2016, Activision acquired Major League Gaming to enhance its ability to capitalize on the growing e-sports industry. Activision’s Call of Duty and Overwatch franchises already have sizable e-sports communities that are supported by Activision, and Microsoft has the resources to continue growing these e-sports operations.
At the end of September 2021, Microsoft had $130.6 billion in cash, cash equivalents and short-term investments on hand versus $3.2 billion in short-term debt and $50.0 billion in long-term debt on the books. With a net cash position of ~$77.3 billion, Microsoft has the financial capacity to fund its purchase of Activision without having to tap capital markets, an impressive feat. However, Microsoft may tap capital markets considering it is also in the process of acquiring Nuance Communications Inc (NUAN) through an all-cash deal worth $19.7 billion inclusive of Nuance’s net debt load, though that deal has run into antitrust hurdles in the UK.
That said, the company is a cash flow generating machine as Microsoft generated $56.1 billion in free cash flow in fiscal 2021 while spending $16.5 billion covering its dividend obligations and another $27.4 billion buying back its stock. Microsoft’s financial position is so strong that the firm does not even have to moderate the pace of its share buybacks to cover its acquisition of Activision. We expect its free-cash-flow strength to continue.
Microsoft intends to continue to push deeper into mobile gaming. Activision already has mobile versions of its popular games, including for Call of Duty, along with mobile-native games like Candy Crush. Making mobile versions of Halo, for example, could be used to further expand the reach of Microsoft’s gaming properties (particularly popular franchises designed for PCs and consoles that already have sizable followings). According to Microsoft, “mobile is the largest segment in gaming, with nearly 95% of all players globally enjoying games on mobile” which highlights the immense opportunity in this area.
Microsoft offers its Game Pass subscription service, which in short allows subscribers to play from a vast array of video games for a relatively low monthly fee. Additionally, its Xbox Live subscription is required to play various online versions of most video games on its Xbox console. Microsoft sells subscriptions that bundle its Game Pass and Xbox Live offerings.
Image Shown: Microsoft’s Game Pass service will get a huge boost from its pending Activision deal. Image Source: Microsoft – January 2022 IR Presentation covering its acquisition of Activision
Within the press release announcing the Activision deal, Microsoft noted that Game Pass had “over 25 million subscribers,” a milestone for the firm, and that Activision had “nearly 400 million monthly active players in 190 countries and three billion-dollar franchises.” By joining forces, Microsoft intends to add Activision’s vast slate of gaming titles to its Game Pass service to make that subscription more appealing, just as it did with previous acquisitions. It appears that the subscription base of Microsoft’s Game Pass service is steadily growing according to recent commentary from the firm.
Gaming Growth
The gaming industry is worth over $200 billion, according to Microsoft, and growing briskly. Across the world, three billion people play video games, and Microsoft forecasts that figure will grow to 4.5 billion by 2030. Longer term, there is ample room for upside as affordable Internet services become available in regions currently without such services. Greater access to electricity is part of this process. According to the World Bank, roughly 760 million people did not have access to electricity in 2019. While that represents a nice improvement versus the approximately 1.2 billion people who did not have access to electricity in 2010, there is ample room for improvement here. Microsoft notes there are roughly 4 billion Internet users in the world, approximately half the global population.
Image Shown: Microsoft views the growth outlook for the $200+ billion global gaming industry quite favorably. A greater percentage of households should eventually gain access to affordable internet services across the globe over the coming decades, which in turn would expand the number of potential gamers. Significant infrastructure investments will be required to make providing internet services at a reasonable price possible. Expanding access to electricity is part of this process. Image Source: Microsoft – January 2022 IR Presentation covering its acquisition of Activision
When the deal closes, Activision’s current CEO Bobby Kotick will step down. On a final note, Activision recently fired dozens of people as part of a company-wide push to clean up its corporate culture. From what we have read in the financial media, there is a great need for Activision to better its workplace environment and culture, and we appreciate its recent efforts on this front–though there is a lot of room for improvement. Microsoft should be able to keep this process going in the right direction (in terms of improving Activision’s corporate culture).
Concluding Thoughts
The potential for meaningful subscriber base growth at its Game Pass subscription service along with upside in the realm of mobile gaming and e-sports underpins why Microsoft pursued Activision. Building up the recurring revenue streams at its consumer-facing businesses represents a core part of Microsoft’s long-term strategy. Shifting its Office suite to a subscription service is an example of this strategy in action, and Microsoft has long been pushing its enterprise-facing businesses to focus on recurring revenues (Azure, Office, Dynamics 365, and other business segments all focus on selling subscription-oriented services to businesses).
As it concerns the purchase price for Activision, the high end of our fair value estimate range sits at $105 per share and our point fair value estimate sits at $84 per share of ATVI. Activision’s shares have launched to ~$82 at the time of this writing, up from a 52-week low of $56.40 hit just last month in December 2021. In our view, Microsoft is paying a reasonable per-share price for Activision (within the upper bound of our fair value estimate range). Though Activision will be a small part of Microsoft’s portfolio, antitrust concerns within the gaming market present a meaningful probability that the deal may not be completed, however. This is why shares of Activision have not yet fully converged to the $95 per share cash offer.
All in, Microsoft is simply a tremendous enterprise. Our fair value estimate for Microsoft sits at ~$340 per share of MSFT, and the high end of our fair value estimate range sits at $410 per share. The company’s capital appreciation upside potential is substantial, and its income growth trajectory is quite bright as well. Even in the wake of its pending deal for Activision, Microsoft still has room to aggressively grow its payout going forward given its stellar free cash flow generating abilities, bright growth outlook, and fortress-like balance sheet. We are enormous fans of Microsoft and include the company as an idea in both the Best Ideas Newsletter and Dividend Growth Newsletter portfolios. Shares of MSFT yield ~0.8% as of this writing.
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Callum Turcan does not own shares in any of the securities mentioned above. Apple Inc (AAPL), Cisco Systems Inc (CSCO) and Microsoft Corporation (MSFT) are all included in both Valuentum’s simulated Best Ideas Newsletter portfolio and simulated Dividend Growth Newsletter portfolio. Alphabet Inc (GOOG) Class C shares, Meta Platforms Inc (FB), Korn Ferry (KFY), PayPal Holdings Inc (PYPL) and Visa Inc (V) are all included in Valuentum’s simulated Best Ideas Newsletter portfolio. Oracle Corporation (ORCL) and Qualcomm Inc (QCOM) are both included in Valuentum’s simulated Dividend Growth Newsletter portfolio. Meta Platforms, Oracle Corporation, and Taiwan Semiconductor Manufacturing Company Limited (TSM) are all included in Valuentum’s simulated ESG Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.