Growth Stocks: Activision Blizzard Inc.

The agreement to buy Activision Blizzard Inc. (ATVI.US) by Microsoft (MSFT.US) appears to go ahead with CMA ruling

The UK Competition and Markets Authority (CMA) has recently indicated that the deal is not likely to reduce competition in the console space. In addition, Microsoft revealed that part of its strategic logic is to promote subscription video games and create a universal application store. So Activision therefore continues to offer a buying opportunity; even if the deal falls through, it will do so because it has a monopoly position in the video game space.

The Competition and Markets Authority (CMA) initially (page 4) said it tentatively concluded that the proposed merger between Microsoft Inc. (MSFT.US) and Activision Blizzard Inc. (ATVI.US) is likely to lessen competition in gaming space and harm UK consumers.

The information that we will see about the agreement is taken from the official CMA page dedicated to the merger. In case you are interested in reading the full document, you can find the documents at the following link (English): Microsoft / Activision Blizzard merger inquiry - GOV.UK (www.gov.uk)

Mainly three (page 3) possible outcomes were discussed: 1) Block the merger. 2) Essentially divest from most of Activision Blizzard's business. 3) Implement some behavioral solutions (remedies). The case is even more interesting because the CMA said that the divestment option was feasible, which means that it is not considering behavioral solutions (option 3) to approve the deal. The CMA in its latest statement, announced that it was reducing its concerns regarding the settlement, acknowledging that Microsoft would certainly lose money if it restricted Call of Duty access to other platforms. As a result, the CMA updated its interim findings to say that "generally, the transaction will not result in a material lessening of competition in relation to console video games in the UK."

Why the CMA is (was) against the merger

At first, in the original interim findings, the CMA argued that Microsoft's acquisition of Activision could lead to less competition.

The CMA said that Call of Duty (CoD) accounts for a significant amount of time spent on PlayStation (page 174), so limiting access to the game could seriously damage the console's popularity. They also argued that it could limit the choice of consumers, who in some cases decide which console to buy based on the content available for the consoles (page 13). The CMA also noted that Microsoft's behavior following previous acquisitions in the space reflects a business strategy that favors gaming exclusivity. They also argued that although Microsoft would initially be hurt by limiting access to the game, CMA's models showed that the company would benefit financially in the long run by having the game exclusively for them (page 166).

CMA reservations applied to both game consoles and cloud gaming. Microsoft offered CoD deals to its console rivals, but there was no mention of how it would be incorporated should cloud gaming replace consoles as the predominant method of gaming.

The authority updated its interim findings to acknowledge that Microsoft's losses from the full exclusion of CoD make it less likely that the company would make the game exclusive to Xbox. However, the CMA emphasized that they still believe there are strategic benefits to exclusivity enforcement, but they place less importance on it than before (page 2).

What the CMA proposed as a solution (remedies)

The CMA prefers a ban on the merger or divestment of Activision's key assets to Microsoft's behavioral commitments. They said the only way they would consider the latter is if the sale is not feasible or if the losses incurred in the sale far outweigh the potential gains players could make from the merger. They added that their view is that a ban or divestment options are feasible, but acknowledged that they have not fully considered in detail how behavioral commitments might preserve relevant customer benefits. CMA prefers structural solutions (ban/divestment) because it is easier to monitor.

On why the CMA does not favor a behavioral solution, this particular paragraph stood out (page 9):

Circumstances in which the CMA might select a behavioral remedy as the primary source of corrective action are not present in this case. The two markets that the CMA has provisionally found in the Competitiveness Test (SLC) are multifaceted and continue to develop. This is particularly the case for cloud gaming, where customer offerings and market participants' business models are rapidly evolving. We are of the initial opinion that any behavioral solution in this case is likely to present material risks of effectiveness. We invite Parties to provide evidence on how these risks could be adequately managed to ensure that any behavioral remedies are effective.

Therefore, Microsoft needs to convince the authority that any development in the cloud gaming space will not affect the competition's access to Activision games. This is one of the areas that Microsoft failed to cover in its defense of the merger. Even in the updated interim findings, there was no update regarding competition in the cloud gaming space. So despite narrowing the scope of CMA concerns, it may still not approve of behavioral solutions.

What Sony said about the merger

Sony essentially agreed with the CMA's initial assessment, saying that Microsoft would have the incentive to withhold access to Activision's games. Sony said that Microsoft's strategy would hurt competition, gamers and developers. Sony cited Microsoft's behavior in acquiring previous games (ZeniMax, Obsidian, inXile, Ninja Theory to name a few) and noted that Microsoft did not deny that it plans to make some of the games exclusive (not Call of Duty though). The company wondered why Microsoft would spend almost $70 billion on Activision, if the latter's games were not vital to game consoles. Sony revealed that Microsoft only offered to keep the game available for PlayStation until 2027 (page 8). He also said that Microsoft's proposal did not include offering Activision games on PlayStation Plus. The company also warned that making Call of Duty exclusive to Game Pass would threaten competition in the space.

How Microsoft replied

Microsoft built its case on three main points:

The first is that denying access to a game cannot amount to an exclusivity enforcement strategy, noting that consoles like Nintendo managed to be very successful without access to the game. The company said that Activision's flagship game Call of Duty's usage was quite small for PlayStation (between 10% and 20%) and the game's status as a major entry was doubtful. Sony said Microsoft's numbers are inaccurate and provided its own internal numbers to the authority. However, those numbers were redacted, so it's unclear how big of a difference that is. Microsoft noted that Call of Duty was rarely chosen for Game of the Year, as another example of why the game is not crucial to the competition (page 3).

Call of Duty players are neither 'special' nor 'unique' in terms of spending or user engagement compared to players who prefer other popular franchises. Call of Duty does not drive spending on PlayStation and represents only % (redacted) of Sony's digital revenue worldwide. In 2022, Call of Duty players spent roughly the same amount of time on Xbox as FIFA, Fortnite, Grand Theft Auto, Minecraft, NBK 2K, and Rocket League players. Importantly, they also spent roughly the same proportion of time playing other franchises. This is inconsistent with Call of Duty having a greater ability to drive consumption of non-Call of Duty content on consoles than other popular franchises.

The second was that the Xbox was much smaller than the PlayStation. He said that Sony is a game publisher with its own powerful franchises like Uncharted and The Last of Us. He also said that PlayStation has more than double the monthly active users (MAU) that Xbox has.

Third, and perhaps most important, is that the Activision acquisition is a classic case of eliminating the double cost margin. Microsoft says its acquisition is easy to do as it will bring Call of Duty to its game subscription service (Game Pass), making it cheaper for gamers to enjoy Activision titles. Microsoft added that Activision could not do this as a standalone company, as it would not make financial sense. But as part of a larger Microsoft, the benefits the parent company would gain from growing its subscription service (and making the game available to Nintendo gamers) would far outweigh the financial hit Activision would receive from lost sales of the game. standalone game ( page 6 ):

A key benefit of Fusion for gamers lies in Xbox's plan to make Activision content available on Game Pass on the day the game is released (ie "day and date"). The difference between the two scenarios is marked. With the Fusion, Activision content will be available on at least one subscription service day and date, without the Fusion, on none. This is important from a consumer welfare perspective, because the more content consumers can access through subscription services, the lower the average prices of individual games will be. In the absence of Fusion, all consumers who want to play Call of Duty or another Activision title will need to purchase the game at full price.

Technical analysis

Faced with doubts about the CMA's decision in early consideration, Activision Blizzard's stock has maintained the below-the-radar price offered by Microsoft (MSFT.US) of $95.00 per share. If it is finally approved in favor of Microsoft, the shares will try to close the current gap that offers a potential 11.50% at yesterday's closing price.

ATVI.US, D1, Source: xStation

Final considerations

The battle between Microsoft and Sony over the Activision acquisition will come down to who can influence the CMA; Is the acquisition a viable example of eliminating the double cost margin as Microsoft says? Or is it trying to exclude competitors as Sony claims?

Microsoft argues that the CMA should keep in mind that the proposed solution should not affect business outside of its jurisdiction. We are not clear what that means for the authority's (CMA) ability to govern, given that the acquisition was approved by European regulators. The CMA now appears to tentatively agree with Microsoft that the deal may not lead to a significant decrease in competition. It's unclear what his final decision will be despite the latest release.

In our opinion, Microsoft would be a great opportunity if the merger is approved. The prospects of establishing a universal store that sells on Xbox, PlayStation, iOS and Android could go a long way to boost profits (page 12).

As Mr. Spencer explained due to (redacted) In particular, the concept of a next-generation game store operating on a variety of devices ("Universal Store") is risky... Driving consumers away from the Google PlayStore and The Apple App Store on mobile devices will require a major shift in consumer behavior. Microsoft hopes that by offering familiar and popular content, gamers will be more inclined to try something new. But this is far from guaranteed and also depends on proposed regulations and laws in the US and around the world, which would require Apple and Google to make their platforms and app stores more open to third-party stores and e-commerce platforms.

In addition Activision would also be an opportunity, regardless of what the CMA decides:

• If the merger is approved: Shareholders would earn an 11.5% profit on their investment (at Monday's closing price).
• Even if they don't: it's only because it's an extraordinary business with a sustainable competitive advantage according to all three parties involved in the battle. It will have about $14 billion in cash that it could use to buy back shares, plus the free cash flow it produces.

In any case, until the final decision of the CMA, which will be on April 26, we will not know what happens with this operation.

Dario Garcia, EFA
XTB Spain