More than 17 months have elapsed since Microsoft offered to pay $68.7 billion in cash for Activision Blizzard, maker of the Call of Duty and World of Warcraft games.
This week, the Federal Trade Commission and Microsoft are facing off before U.S. District Judge Jacqueline Scott Corley in San Francisco. Scott Corley will decide whether Microsoft must hold off on consummating the deal to give the FTC more time to evaluate its antitrust merits, according to AP.
If the FTC has its way, Microsoft will face the choice of paying a $3 billion fee to terminate the deal, or renegotiate the deal beyond its current July 18 closing deadline to accommodate an FTC administrative trial scheduled to begin on August 2, noted AP.
Microsoft should pay the $3 billion fee and invest the rescued $65.7 billion in its cloud and generative AI businesses. With its market capitalization so close to the deal price, walking away would cause Activision Blizzard shareholders to take a big haircut.
Read on for an explanation of why Microsoft shareholders likely will be better off if the giant tech company spends the money in its cloud and generative AI businesses.
Why Microsoft Should Walk Away From Activision Blizzard
When Microsoft announced the Activision Blizzard deal back in January 2022, I thought it would be good for shareholders. It aimed at three potentially large markets; it would increase Microsoft’s gaming market share; the deal’s net present value would be positive; and Microsoft had a good chance of integrating Activision Blizzard effectively.
Since then, two big things have changed:
- The metaverse — which was then forecast to be worth trillions of dollars and could have contributed to the combined company’s gaming revenue — has fizzled; and
- Generative AI — where Microsoft has a strong market position — could be a game-changer on the order of the Internet in the 1990s.
San Francisco District Court Case Could Determine Whether Deal Goes Forward
To be sure, I would not advise Microsoft to pull the plug until the hearing in front of judge Scott Corley results in a decision.
If she decides in favor of the FTC, I think Microsoft should pay the $3 billion to cancel the deal because the FTC would likely delay it for years before ultimately blocking it.
How so? According to Hollywood Reporter, Microsoft’s lead attorney Beth Wilkinson said, “If we can’t close by July 18, and the court enjoins the transaction, nobody can withstand that and we certainly can’t.” Wilkinson envisions a “three year administrative nightmare” that would doom the deal, Hollywood Reporter noted.
Although I am not a lawyer, I think the odds are good that Scott Corley will enjoin the deal from closing on July 18. That’s because potential harm to consumers of letting the deal go forward exceeds the damage of letting the FTC’s administrative trial proceed.
The reason why is after acquiring another gaming company, Microsoft failed to honor its promise to make its games available on platforms other than Xbox, according to the FTC’s lead lawyer, James Weingarten.
Weingarten cited the example of Microsoft’s 2020 acquisition of Bethesda Softworks. Despite assuring European competition regulators that it wouldn’t limit games on rival consoles, Microsoft reneged — making one of Bethesda’s most popular titles, Starfield, exclusive to Xbox and Windows.
Wilkinson’s defense of not delaying the deal is consumers would be better off if Sony — whose PlayStation dominates the market and controls roughly twice Xbox’s market share, noted AP — faced competition.
She noted Microsoft aims to benefit gamers by making Activision Blizzard games available on more devices to more people. For example, Microsoft has already committed to making Call of Duty available on Nintendo’s Switch console and an Nvidia gaming subscription service, according to AP.
Wilkinson also argued Microsoft would have a financial incentive — in the form of higher revenues — by making Activision Blizzard games available on Sony’s PlayStation and other gaming platforms.
In June 28 testimony, Activision Blizzard CEO Bobby Kotick testified its Call of Duty would continue to be available on Sony’s PlayStation should Microsoft complete its acquisition of his company, according to the Wall Street Journal.
Since last December, when the FTC sued to block the deal, Microsoft concluded agreements to make Activision games available for a decade on Nintendo, Nvidia, and other platforms. Microsoft “says it has made a similar offer to Sony,” the Journal reported.
In June 28 testimony, Nadella testified he would like to eliminate exclusive arrangements between video games and popular gaming consoles. Regarding exclusive deals, Nadella said “I have no love for that world,” CNBC reported.
The executive testimony leaves open questions, such as: Will Kotick have the power to put his testimony into practice should Microsoft complete the deal? Will Microsoft abide by its agreements with rival game platforms?
While all the evidence has not yet gone before her, I could see Scott Corley deciding there is no harm to gamers in delaying the deal to give the FTC more time to consider its antitrust merits.
In the interim, gamers will be in the same position they are now. If the deal goes through next month and Microsoft makes Call of Duty and World of Warcraft exclusive to Xbox as it did with Starfield — she could argue consumers would be worse off.
Indeed, in May, Cowen analysts anticipated a mere 33% chance the deal would be approved. Cowen thought regulators might be concerned Microsoft would favor the release of Activision games on Xbox over rivals such as Sony’s PlayStation which could elicit a lawsuit to block the deal, MarketWatch reported.
Why Microsoft Should Invest The Cash In Cloud And Generative AI
Even if Scott Corley rules in favor of Microsoft, I see two reasons the software giant should cancel the Activision Blizzard deal:
- Gaming is secondary to Microsoft’s long-term vision.
- The $65.7 billion in freed up cash would yield a better return if invested in lines of business that are more significant to Microsoft’s growth.
Microsoft Sees More Potential In The Cloud Than Gaming
Microsoft seems to not consider gaming to be as essential to its future as Microsoft Cloud. How so? According to CNBC, a court filing released June 26 revealed CEO Satya Nadella’s ambitious goals for Microsoft and the strategies to achieve them.
Specifically, in a June 2022 “15-page memo with an accompanying 21-page document,” Nadella told his executives and board Microsoft aims to grow revenues at least 10% per year to reach $500 billion in 2030 revenue — more than twice its current level, CNBC noted.
Microsoft main growth driver is Microsoft Cloud — which includes the Azure public cloud (which competes with AWS and Google Cloud), parts of Microsoft 365 productivity software and portions of LinkedIn. “Our priority is to maintain growth above the market rate to extend our lead over GCP and close the gap with AWS,” Nadella wrote in the 21-page document, according to CNBC.
The $65.7 Billion In Freed Up Cash Would Yield More Growth If Invested in ChatGPT And Microsoft Cloud
I find it interesting that six months after announcing the deal to acquire Activision Blizzard, Nadella apparently did not consider Microsoft’s gaming unit to be a growth driver worth emphasizing.
Were Nadella to write such a memo today, I think he would have included ChatGPT as another significant growth driver and continued to place less emphasis on gaming.
In April 2023, I estimated that ChatGPT could add $40 billion to Microsoft’s revenues. To put that into perspective, in the year ending March 2023, Microsoft generated about $208 billion in revenue.
So, ChatGPT revenue could add 20% to Microsoft’s top line. By contrast, Activision Blizzard’s revenue for the period was $8.1 billion, some 2% below the year before level — representing about 4% of Microsoft’s revenue.
Were the Activision Blizzard deal to fall apart, it would free up $65.7 billion in cash that Microsoft could invest in ChatGPT-related new business lines and Microsoft Cloud.
That might help Microsoft achieve its $500 billion growth target ahead of schedule and boost its stock price considerably.
However, it would likely hurt shareholders of Activision Blizzard — whose June 28 market capitalization of 96% of Microsoft’s $68.7 billion deal price — embeds a high probability of the deal going through.
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