Merger Arbitrage and Microsoft

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Microsoft announced on January 18th, 2022 that it would acquire video game company Activision Blizzard for 69 billion dollars, or $95 per share. It would be one of the largest tech acquisitions to date. Microsoft is demonstrating it’s continued endeavor to expand their influence over the video game market after a long string of acquisitions in the space, including ZeniMax Media, Smash.gg, Obsidian, and many others. Activision, on the opposite side of the deal, is demonstrating it’s need for new leadership after a host of internal problems. The deal is expected to go through by July of 2023.

With ticker ATVI now trading at 77.84 as of Friday at close, there is an alarmingly large gap between the proposed share price, and the current price driven by market sentiment. Alternative strategies to buy-and-hold are definitely nothing to scoff at in the current broad market environment, and if the deal goes through, the 22% upside is incredibly attractive.

If the deal goes through.

That’s the big issue in these situations. Whether it gets blocked by regulatory committees or doesn’t pass approval by the board, there are hurdles to take on before finalization. However, the board approved the sale of Activision Blizzard in late April, so what is the real risk of regulatory issues, and is this risk greater than the current 22% upside?

One way we can assess this differential is through looking at the comparative risk of other merger arbitrage plays.

Elon Musk’s bid on Twitter, for example, puts the stock at $54.20 per share, and the stock is trading at a discount of only 8%, as compared to Activision’s discount of 22%, displaying investor’s comparative confidence in the Twitter acquisition. So why are investors so much more confident in Musk’s flippant-yet-passionate Twitter bid as compared to Microsoft’s purchase of Activision?

One reason could be fear (and lack thereof) of monopolization, which is one of the largest characteristics of deals looked at by regulatory commissions. Microsoft’s buying spree of video game companies has led it to a large market share in a relatively short amount of time, and this even larger purchase has presented anti-trust concerns among investors. This fear is absent in Musk’s purchase attempt, and is reflected in the stock price.

FTC chair Lina Khan has been quoted as saying that they will only bring on cases “in which [enforcement] could really change the dynamic in the entire market,” implying that if a merger doesn’t have significant implications for how consumers and providers operate in the future, they are unlikely to take much action in the way of blocking it. However, Lina Khan has been very active in enforcing laws with big tech mergers — NVIDIA’s acquisition of Arm Ltd got blocked last year, and she’s reopened cases against larger tech companies such as Meta.

While I’m no M&A lawyer, I don’t believe the implied market share increase from 6.5% to 10.7% is enough to persuade the DOJ and FTC to block the deal. The $69 billion price tag brings up red flags, and warns of anti-trust action, but the price tag is not necessarily reflective of the actual effect this purchase will have on the market. The video gaming market in the US is not only influenced by domestic companies. The U.S. consumer market is still dominated by foreign companies such as Sony and Tencent, and an increase in the capabilities of Microsoft through this purchase could put the U.S. at a competitive advantage in the global marketplace.

It’s absolutely true that the deal would further solidify Microsoft’s gaming branch as a giant in the space, but they will remain in the third place spot behind both Sony and Tencent when comparing revenue. Another incredibly important aspect of the deal is that Activision Blizzard performs a completely different function to the rest of Microsoft’s gaming branch, a fact seemingly overlooked by market sentiment. Yes, they both operate in the same industry, but Activision often acts as a downstream supplier of games for Microsoft’s consoles, not as a direct competitor to Microsoft. If Microsoft were to buy a competitor such as Sony, the nature of the purchase would be completely different. Most of the value that Microsoft adds to the industry has nothing to do with creating games — their largest revenue driver is still in the hardware space. Nearly all of the value creation from Activision Blizzard is in the game development space, and an attempt at vertical integration has little legal grounds to be blocked.

But again, I’m definitely not an M&A lawyer.

People way more qualified than me feel the same way. 17 of 21 analysts looking at Activision have it’s price target set to $95, showing analytical confidence that the deal will go through. I don’t anticipate the acquisition to have a significant affect on the domestic market, and while the deal certainly could still get blocked, as you can never perfectly predict the actions of the FTC, I think the upside is far worth the slight risk.

Plus, Warren Buffet is betting on it too. Never inverse Warren Buffet.

This article is not intended to be financial advice.