Microsoft (MSFT) agreed to buy Activision Blizzard, Inc. (NASDAQ: ATVI) for $ 95 in cash per share with the closing of the transaction in 2023. The FTC is reviewing the deal. The ATVI transaction is a special two-digit merger arbitrage situation closes again. Investors can park their funds in ATVI to protect themselves from volatile markets and the recession.
Description / background
The opportunity for the arb merger materialized after a sexual harassment scandal at ATVI. Activist employees tried to fire Bobby Kotick as CEO for failing to provide a safe work environment and a cascade of delayed gaming ads affected the company’s reputation, dropping shares from $ 90 to $ 58. Microsoft sensed an opportunity to expand its gaming division, improving the content content of Xbox, and relied on its ability to enhance Activision’s workplace culture. He made a cash offer to buy the company for $ 95 per share. Microsoft will absorb ATVI with about a year of its free cash flows, ~ $ 56 million in ’21.
The FTC is evaluating the deal and its impact on the $ 200 billion gaming market. Activision generated $ 8 billion last year and Microsoft will increase its gaming market share from 6.5% in 2020 to 10.7% after the activation of the Activision deal. With promises to deliver games across all platforms, Microsoft should be able to clarify the scrutiny of the deal.
Microsoft President Brad Smith recently stated that the company’s proposed acquisition of Activision Blizzard is developing relatively quickly and the process is entering its mid-stage.
$ 95 in cash per share is the price with a commitment from Microsoft’s termination commission to Activision if the FTC does not allow the deal to continue. Termination rate scale: $ 2 million before January 2023, $ 2.5 million from January to April 2023, and $ 3 million from April to July 2023. The deal is expected to be close July 2023. The worst-case scenario for Activision shareholders is that the deal does not materialize. next July and the company alone generates more than $ 2 million in free cash flows, plus a $ 2-3 million termination fee from Microsoft.
If Activision decides to drop the deal because it found a better suitor, or for any other reason, the company will owe Microsoft just over $ 2 billion.
A binary outcome of the transaction makes this situation a simple risk arbitrage calculation. Do you think it will close or not. Putting 50/50 probability weights on the yes / no result, the table of expected values is presented below:
I don’t think Activision will fall below $ 76 per share with another year of positive cash flows, adding $ 2 billion to book value and another $ 3 billion in break-even fees if the FTC rules out the transaction. The safety margin is present regardless of the closing of the operation. Activision is in good financial condition, the balance is strong and the brand value of its games is important.
Definitely games like Call of Duty, Warcraft, Overwatch, Diablo, Candy Crush, HearthStoneetc., will generate an increasing revenue stream for years.
Holding Activision Long-Term is a reasonable backup plan, a 15x multiple EBIT in 2024 produces a market capitalization of $ 84 billion, 40% more than today.
Based in Wisconsin Call of Duty developer Raven Software’s quality assurance department voted in favor of syndication, which possibly caused a headache for Microsoft and other game makers. Production costs would increase and the flexibility of employee projects could suffer when unionized labor is introduced into the process of developing fast-paced games.
The FTC could collapse the deal due to antitrust concerns and a deep recession could hurt Activision’s profitability, and valuation multiples would shrink significantly.
The arbitration gap should close as we get closer to the date of the agreement.
Microsoft closing the deal at $ 95 per share will provide 25% IRR in 12 months.
ATVI presents a rare opportunity to allocate capital with a simple decision tree, or the transaction closes for $ 95 in cash per share for a 25% IRR in 12 months or not, leaving Activision to produce games in the next cycle game. In any case, the company should enjoy a profitable future with inflation-adjusted gaming prices. Investors should consider adding ATVI to the special situation basket.