Why Microsoft’s Activision Deal Is a Bad Idea

On Tuesday, Microsoft Corp. (

MSFT, Financial) made a big surprise announcement: it plans to acquire troubled game developer Activision Blizzard Inc. (ATVI, Financial) in an all-cash deal that values the company at $68.7 billion, representing a 35% premium to Monday’s closing market cap of $50.9 billion. If everything goes according to plan, the acquisition is expected to close near the end of fiscal 2023.

At first glance, this might seem like great news. After all, it will greatly boost Microsoft’s presence in the gaming market and it is expected to be immediately value-accretive. However, digging under the surface reveals there’s a lot for investors to be concerned about and, overall, the market seems to be betting against the deal.

The good

Microsoft’s gaming strategy has gotten more aggressive in recent years as its Xbox platform continues losing out to Sony’s (

SONY, Financial) PlayStation. Sure, Xbox has plenty of loyal fans, but sales numbers indicate the console gaming community generally prefers the newest generation of PlayStation.

To combat the lower popularity of its console, Microsoft has been acquiring game developers to increase the quality of games available on Xbox and, perhaps more importantly, to force the creation of more Xbox-exclusive titles.

In 2014, it bought Minecraft maker Mojang for $2.5 billion and, last year, it acquired Bethesda for $7.5 billion. It’s not a bad strategy; if Microsoft owns more game developers and has more Xbox-exclusive titles, then it could entice more players away from its main competitor.

Aside from console gaming, acquiring Activision would also help Microsoft in the mobile gaming and metaverse areas.

Mobile gaming is a fast-growing market because more people own smartphones compared to gaming consoles or even PCs. The initial cost of getting into console or PC gaming can be prohibitively high for some people, and others may feel the extra cost is not justified when they can just play games on phones that they are already paying for. Activision owns Candy Crush, one of the most lucrative games around.

Microsoft also sees great opportunity for popular gaming franchises to expand into the metaverse. Much like the internet, the metaverse will probably be a collection of loosely connected virtual realities rather than a single giant virtual reality, and the first movers in this space are games and social media.

The bad

Many gamers are lamenting the acquisition announcement because it could result in fewer games being released on PlayStation consoles going forward. The anti-competitive nature of this deal may seem inconsequential to many investors, but it is a well-acknowledged fact that monopolies harm innovation.

Consolidating too many developers under the Microsoft umbrella could easily result in a lower quality of games overall as the company feels less pressure from competitors, which could in turn make its overall brand portfolio less valuable and leave room for new competitors to appear.

Concerns that this latest acquisition deal is too anti-competitive could even potentially cause regulators to take action to block it. Even if it’s not blocked entirely, Microsoft could be required to divest some of its other gaming assets or sell off parts of Activision when the deal is closed.

The deal also leaves Activision CEO Bobby Kotick in place, at least throughout the transition. Kotick has faced calls to resign due to the toxic workplace culture he has allowed to develop, which is a large part of what made the company’s stock price decline throughout 2021. In fact, the company faces several active lawsuits over workplace misconduct allegations, and in the midst of Kotick’s lack of action to address these issues, 40 employees have left the company since last July.

Arbitrage analysis rarely lies

Perhaps the biggest red flag about the Microsoft-Activision deal is that the market seems to be betting against it.

Normally, if a deal has a high likelihood of going through and being value-accretive, the company being acquired will quickly be bid up to near or above the acquisition price. Typically, the potential arbitrage opportunity disappears long before most retail investors see news of it, as the big-time money managers will have already made their moves and closed the price gap.

If there is still a big gap between the stock price and the acquisition price even hours after the news has broken on major outlets, then there’s typically something wrong. No good arbitrage opportunity is still up for grabs this late in the game.

This seems to be the case here; Activision closed at only $82.31 per share on Tuesday, up 25% for the day. It would need to gain almost 10% more to reach the acquisition price.

That’s not to say that the deal is guaranteed to fail. However, from what I’ve observed with acquisition rumors over the years, the market only discounts them when there is a high chance of the deal not working out as planned.

Take PayPal’s (

PYPL, Financial) short-lived notion to acquire Pinterest (PINS), for example. Once whispers appeared on the Wall Street Journal, Pinterest shares rose, but they came nowhere near the rumored acquisition price. PayPal soon abandoned the idea because shareholders disliked it.

Conclusion

Microsoft’s bid to acquire Activision Blizzard may not be as great as it first appears. While it does have the potential to give the company a leg up in the gaming industry, it is highly anti-competitive and could thus be blocked or modified by regulators.

It also gives Microsoft a couple of big hits to its reputation. One of these comes from signaling that it believes it can only achieve gaming success by creating a monopoly, and the other comes from associating itself with Kotick (whose actions have already harmed his own company’s stock price).

Moreover, the market seems to be betting against the deal, as evidenced by the fact Activision’s shares are still nearly 10% below the rumored acquisition price. Microsoft’s stock is also down more than 2% for the day. Investors are heavily discounting the deal, and for good reasons.