Activision: Proving doubters wrong

Posted this a month ago as a reply to a fellow redditor asking about the ATVI deal.

But here are some points. You can easily find out more info online as it’s widely available data and info.

• upside case obviously is a 24ish % at current prices, and best part is you get it all back in cold hard cash, not MSFT shares. That is big upside considering the market environment and recessionary fears impacting sentiment this year
• downside case is a failure of the deal to go through, but then MSFT has to pay ATVI a breakup fee of 2-3bn in cash, which ATVI can use to buyback shares or conduct a special dividend.

Of course most people would be concerned w the question: how far will ATVI fall if the deal falls through?

• assuming that ATVI would return to trading at the multiples of its closest peers (Nintendo, Sony, EA, take two), a reasonable estimate would be ~$65-69 range EXCLUDING the impact of the break up fee, which is just about its price range before the acquisition announcement.
• if (AND A BIG IF) you include the cash breakup fee and assume that ATVI decides to return part of that to shareholders, one could see an additional $0.50 to $2 per share added on top of the range above.
• So actually the downside doesn’t seem all too bad, at around ~15% (assuming it really does fall to $65). This puts risk-reward ratio at 1.6 (24%/15%), which ain’t too bad at all. Morgan Stanley has also done it’s own downside analysis as well and predicted a price floor of $65 as well, and currently rates it a buy.
• to top it off it’s a fundamentally strong company as well, with game IPs and brands that are globally recognised and successful. It generates good cash flow and still has decent growth runway at least for the next 5 years, given that the gaming industry is still considered “mid to high growth”. Active user base continues to grow in the single digits and even the pandemic did not slow the business down as much as others.
• It’s latest call of duty release was it’s most successful ever as the company continues to be able to execute strongly on how to capture more gamers yet retain its existing one and monetise them well. It has a proven track record of developing, marketing and maintaining triple AAA titles. Balance sheet is healthy and there really aren’t much complaints with its fundamentals other than some controversies here and there.
• there are really only 3 regulators the deal needs to clear, FTC, EU and UK CMA. All 3 are seemingly on the side of not letting this pass. FTC has alr filed a lawsuit against ATVI, while both EU and UK CMA have raised concerns and papers of their own. Perhaps they are all playing the waiting game - if one regulator opposes it as the first mover, its much easier to “rationalize” opposing it as well, but the question is who would want to be that first mover? On the flip side, If one regulator approves it first, the chances of the deal going through would jump significantly as the others might just follow suit. Perhaps if you don’t like the uncertainty now, you could wait for some positive news (like a first major approval) and sacrifice some upside potential for more certainty. Prices could easily jump up to 83-86 by then.

Personally I hold q a significant amount of ATVI (~12% of my pf), because I hold conviction that MSFT has the right people in place to recognise how impt this deal is to them and to negotiate a concession agreement that makes everyone happy. MSFT has never failed an acquisition in its entire history and it lends some confidence that it has the right people, strategy and relationships in place to see this out. It’s unlikely the deal will settle so soon, a more realistic timeline would be Q3 or even early Q4 due to complexity and size of this deal and the amount of stakeholders involved.

Interestingly enough, as the price has been so flat since the announcement of the acquisition I had the extra benefit of this position buffering my portfolio from some of the market downside (reducing volatility) and actually I somehow (luckily) outperformed many indexes last year. The price action is lowly correlated to the market at this point but rather to developments on the deal.

People saying that “this deal is too big to fail” know nothing, don’t listen to them. Any deal, no matter the size, can fail still, so do still manage how risk adverse you are.

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Last week the UK regulator basically made a u turn on its provisional findings:

After reviewing what it called “new evidence”, the Competition and Markets Authority said on Friday that it no longer thought there would be a “substantial lessening of competition” in the console market if the Xbox maker takes over the publisher of the bestselling game franchise.

Price gapped up to ~$84 as of Friday close, and now the spread to deal price is about 12%. Although the risk reward may not seem as favorable as it once was when it was hovering around the 75-77 range the past 6-months, I still think there is opportunity present for those looking for a short term tactical trade idea (3-6 months)

• Just like in the EU regulator, the focus for UK is now exclusively on cloud gaming and anti competitive effects; which is a major win for the deal
• MSFT has boosted its efforts in soothing regulators nerves within cloud on top of consoles - most recently 2 10 year deals with boosteroid and ubitus (cloud gaming providers) on top of mega partnerships with Nvidia and nintendo
• As of now, 4 jurisdictions have cleared the deal (Saudi Arabia, Brazil, Serbia, Chile)
• The tone of the narrative in the markets surrounding this deal has clearly shifted - it has changed from criticism of the anti competitiveness of the deal towards a finding solution set that makes all parties happy
• The next 2 months will be especially closely watched - Decision dateline for CMA end april, decision dateline NZ end april, decision dateline for EU end may, FTC expert reports start may.
• Citi has upgraded its probability of the deal closing from 50% to 70% last Friday
• MSFT has won dismissal of a private consumer antitrust lawsuit (first sued in late december 22)
• It now looks likely that EU and UK will both clear the deal - Though uncertain, a continued push by the US FTC to challenge the deal becomes increasingly complex in the face of its 2 peers, a wise move would be to align itself with the EC and CMA in recognizing that there is no console related anti competitive effects. When that happens, we all know where the deal is finally heading towards.

As always, past performance is not indicative of future performance. This is not financial advice, do your own due diligence and risk-manage accordingly.