Satya Nadella, chief executive officer of Microsoft Corp., gestures as he speaks during a Bloomberg event on the opening day of the World Economic Forum (WEF) in Davos, Switzerland, on Tuesday, Jan. 21, 2020.
Simon Dawson | Bloomberg | Getty Images
Microsoft‘s announcement on Tuesday to acquire video game maker Activision Blizzard for $68.7 billion came as a surprise to Peter Choi, a senior research analyst at Vontobel Asset Management, which held a $1.43 billion position in Microsoft stock at the end of the third quarter.
The world’s second-most highly valued public company plans to spend almost 53% of its cash pile on the deal, which is the largest in Microsoft’s 46-year history. And it’s may seem like a big chunk of change to investors interested in the software and hardware maker’s ability to keep expanding alongside other technology heavyweights, while also maintaining its financial health, including its quarterly dividend.
But the deal is not a big concern for Choi.
“$69 billion is about 3% of the size of the total company,” he said. “They have ample capacity to fund whatever else they would presumably want to, so I don’t necessarily see that as constraining other opportunities.”
Under CEO Satya Nadella’s leadership for almost eight years, Microsoft has reduced some of its focus on consumer-centric areas. The biggest star is now the Azure public cloud, which has grown share against market leader Amazon Web Services. Choi says the deal doesn’t necessarily change the company’s enterprise concentration.
“I think overall the company’s north star is still being more business- and enterprise- focused, and essentially helping people be more productive. That’s the ultimate mission of the company. I think when they think about areas outside of the core business, they do tend to be more opportunistic. So, obviously gaming, although that’s already a key franchise for them.”
The first Xbox console arrived in 2001. Microsoft has expanded gaming content production during Nadella’s tenure. The company bought Mojang, the developer behind video game Minecraft, for $2.5 billion in 2014. Microsoft’s $8.1 billion acquisition of ZeniMax Media closed last year, raising its number of studios from 15 to 23.
Still, Microsoft’s LinkedIn acquisition in 2016 was larger than those two, at $27 billion, and it happened under similar circumstances as the Activision deal. Microsoft moved in after LinkedIn stock went on discount, dipping 44% after the social network said revenue grew slower than expected.
Activision shares were likewise at a discount after 2021, which may have given Microsoft a reason to pounce.
Activision Blizzard shares fell 23% in 2021
Activision Blizzard stock fell 23% for the year as it faced new lawsuits and trouble getting games out the door on time.
In July of 2021, The California Department of Fair Employment and Housing filed a suit alleging Activision Blizzard and its subsidiaries fostered a sexist culture and paid women less than men. Over 100 employees reportedly pushed for CEO Bobby Kotick to step down in November following a Wall Street Journal article that said Kotick knew about the misconduct and failed to fully inform the board. An Activision spokesperson disputed the accuracy of the Journal’s reporting.
Then, in November, Activision Blizzard told analysts it was delaying the releases of Diablo IV and Overwatch 2. Worse, reviews of its new game Call of Duty: Vanguard, released the same month, weren’t stellar.
Microsoft had been considering other deals.
In 2020, it had looked at buying part of the social network TikTok when it had become a lynchpin in the trade war between the U.S. and China. But, ultimately TikTok owner ByteDance picked Oracle instead of Microsoft as a suitor.
“I think the initial reaction back then was, ‘What is going on?’ but they identified an opportunity,” Choi said. ‘They could have actually bought that for the rumored $25 billion or $30 billion. That would have been a steal.”
Activision Blizzard, whose Activision division was founded in 1979, is not growing as quickly as TikTok. Revenue rose less than 6% in the third quarter, compared with 22% growth for all of Microsoft and 16% for its gaming segment. Activision Blizzard’s operating margin is about 40% below Microsoft’s, at almost 45%.
Why Activision Blizzard is appealing to Microsoft
A scene from “Call of Duty Modern Warfare.”
Source: Call of Duty Modern Warfare
Still, Activision Blizzard has a community of 400 million monthly active players, Microsoft said Tuesday in its statement on the planned deal. In that sense, the deal lines up with Microsoft’s long-term interest in what Amy Hood, the company’s finance chief, has described as “networked assets,” or buying communities of people, as it did with GitHub and LinkedIn.
Choi sees potential for Microsoft to expand the number of people who subscribe to Microsoft’s Game Pass service. Game Pass lets Xbox, mobile and PC users play a library of games for $9.99 to $14.99 a month, depending on which systems you want to play on.
“You really need to believe that this makes sense as part of a greater whole if this can spur Game Pass — if you can accelerate the 25 million subscribers to 50 million, there’s a broader aspect of trying to grow the different parts of the Microsoft ecosystem.”
The recent developments presented Microsoft with a more affordable opportunity to access millions of people who are willing to pay for games, and who might also help Microsoft expand its Game Pass subscriber base, Choi explained.
“If you think about the importance of gaming content, there are really only so many large-scale companies out there, and for whatever reason, a lot of them aren’t going to be available,” he said. “The valuations aren’t going to make sense. A lot of things are going to have to come together for management to want to pull the trigger on this, I would assume. But when all the stars align and it fits within your strategy, it does make sense to go for it.”