Why is Microsoft Paying $68.7bn for Activision Blizzard?

Microsoft is set to buy games company Activision Blizzard for $68.7 billion in an all-cash deal.

Activision Blizzard owns some very popular franchises, including Call of Duty, World of Warcraft, and Candy Crush.

This $68.7 billion all-cash deal will take care of a sizeable chunk of Microsoft’s $130 billion cash reserves. The acquisition could face some regulatory pushback but all being well, it will be completed in 2023.

This is the biggest acquisition Microsoft has ever made, unsurprisingly. It is more than twice what it paid for that leadership meme factory, LinkedIn.

Microsoft has been a significant player in the gaming world since the launch of the Xbox in 2001. It also bought the ZeniMax games studio for over $8 billion in 2020, and its purchase of Mojang (creator of Minecraft) for $2.5 billion in 2014 has turned out pretty well so far.

Add in Microsoft’s Azure cloud services and the company has most of the components it needs to cement its position. 

But of course, this acquisition is about what comes next in gaming and Microsoft will believe Activision can plug some important capability gaps before they are widened further.

To understand the size of this particular acquisition, we need to broaden our view beyond just gaming. 

In fact, IGN reports:

“Microsoft’s Activision Blizzard deal is worth more than the 15 next most-expensive game studio acquisitions combined”.

Let’s place gaming within the wider “entertainment” industry’s biggest acquisitions:

And in the table below, I have highlighted the gaming acquisitions in green:

Five of these acquisitions (Activision, Zynga, Supercell, ZeniMax, King) targeted gaming companies, but there is a steep drop-off in price from number 3–4 in this list. Microsoft’s latest move puts gaming into the top tier, alongside content powerhouses like 21st Century Fox.

It is worth looking at a few of the other deals on this list to understand Microsoft’s motivations further.

Tencent took an 84.3% stake in Supercell in 2016, although it has since increased its investment. Supercell makes mobile games including the Clash of Clans series, and Tencent owns WeChat, which has over 1 billion users in China.

If we assess the global gaming market, it was worth $176 billion in 2021. The Asia Pacific region accounts for about 52% of global gaming revenues, followed by North America on 30%.

Year-on-year revenue figures are a little skewed for 2021, as 2020’s “stay-at-home” mandates inflated that year’s figures somewhat. But there are trends here that were in motion prior to 2020:

• Mobile gaming makes up over half of global revenues (52%), with smartphone gaming along taking 45% of the global total.
• Traditional PC and Console gaming may have reached their saturation point.

Given that the Take-Two games studio just bought mobile gaming specialist Zynga for $12.7 billion, Microsoft’s desire to make a move is a little clearer.

 Remember the Windows Phone? Yeah, Microsoft never really nailed mobile.

But why Activision Blizzard?

With so much cash at its disposal, an acquisition in the gaming space makes sense for Microsoft.

However, there are plenty of gaming studios out there and not all of them have the issues Activision Blizzard has.

The latter’s latest quarterly report states the top-line financials and swiftly moves onto a detailed section with the heading:

“Commitment to a Safe, Inclusive Working Environment”

There are numerous, very serious accusations of sexual misconduct at Activision.

The game maker’s shares have fallen 27% since California sued the company in July 2021 over the matter.

Corporations pay lip service to “company culture” when weighing up acquisitions, and it doesn’t seem to have been too much of a concern for Microsoft here. Perhaps, it saw an opportunity to swoop in while Activision was at a low ebb.

Its stock was trading at a Price-to-Earnings (P/E) ratio of 17.58 in December 2021. 

(This metric is used as a heuristic to understand if a stock is comparatively over-/under-valued. It is calculated by dividing the market value price per share by the company’s earnings per share. If it is low compared to its rivals, the stock might be under-valued.)

The S&P 500 ETF traded at a P/E of 24.56 in December:

That made the Activision stock a target for value investors. Microsoft will believe it can make the operation more efficient still, I’m sure.

Looking at their “fundamentals”, Activision is a profitable company and it has delivered quarterly growth consistently over the past 5 years. It had solid foundations before the scandals broke.

Here we can see their quarterly net income for the past 5 years:

Analysts had forecast 4% sales growth for Activision in 2022, which is obviously better than nothing but not enough to excite a company like Microsoft.

And Microsoft is set to pay 45% above market value to get this over the line, so it must see something more in Activision than just short-term earnings.

In the image below, I have taken the top 8 gaming companies by market capitalisation (November 2021). I’ve added in their key gaming franchises too, to give a sense of the content that drives those valuations.

Activision Blizzard comes in at number 3 and, while many of the others were busy making acquisitions of their own in 2021, it was dealing with a number of legal issues.

Electronic Arts bought Glu Mobile for $2.4 billion last year and Take-Two bought Zynga, as mentioned above.

Ubisoft has invested in Animoca Brands, a Hong Kong company that plans to “build the open metaverse”. It has also become the first big games developer to introduce “in-game NFTs”. It is not altogether clear that this is the direction Microsoft has in mind for its gaming division, so there may have been some strategic friction there.

Of course, Microsoft could have bought any of these companies with the cash it has available, but Activision has already integrated its own mobile gaming acquisition, King Games. In pure business terms, it is in a mature position.

Buying Activision Blizzard keeps them out of rival hands, too.

But there’s more!

Microsoft’s official announcement focused on the potential to strengthen its subscription service, Game Pass. Game Pass now has over 25 million monthly subscribers, up from 18 million last January. Subscribers can play games across multiple devices and they get a Netflix-style, “all-you-can-play” deal.

Looking at Microsoft’s last quarterly report, this little bullet point was tucked away in there:

Overall gaming revenues grew by a greater margin, but Microsoft also noted this was down to hardware sales. It mentions that third-party games sales fell below expectations, too.

Software sales are key for reliable, recurring revenues. Microsoft depends on third parties for this, which leaves them at the mercy of external production.

And if we look at the biggest gaming companies by quarterly revenues (Q3 2021), we see that Activision knows how to turn engagement into serious dough:

Put numbers 4 and 7 on that list together and you get a very serious rival to Sony. Sony’s share price fell 13% in response to the announcement of this acquisition. (That seems an overreaction and an opportunity to buy Sony shares, by the by.)

So, what games is Microsoft getting?

In short: it gets Call of Duty and World of Warcraft, plus Candy Crush on mobile. Activision has lots of other franchises and will no doubt create more as part of Microsoft, but these three are dominant today.

I wanted to look deeper to see if Activision creates games that are consistently “good”, and the extent to which these would bolster Microsoft’s offering.

To do so, I took all the reviews data off the MetaCritic site from 2015 to today. MetaCritic acts as an aggregator of reviews from across the global industry, so it should be a reasonable resource.

Then, I looked at the quantity of games released on each platform with a MetaCritic score of >80 out of 100, released between January 2015 and December 2021.

This will give us an initial idea of how well Microsoft’s Xbox consoles fare:

Microsoft lags behind Sony and Nintendo here, and games are a pretty important consideration when people weigh up consoles.

The industry is changing very rapidly, nonetheless.

Exclusive games are not quite as important as they were, in an age of cross-platform compatibility. As in, people on PlayStation and Xbox can play the same game together at the same time, using different consoles. But Sony is obviously still keeping a few exclusives of its own.

Personally, I would be very surprised if Microsoft now pulled existing Activision games from other consoles. It would be anachronistic and antagonistic to do so.

That said, Microsoft has hinted that it will retain some future exclusives from Activision for its monthly Game Pass subscription. Perhaps, it will keep some Call of Duty updates or special missions, for example.

Microsoft also now has a team of developers that can work on a new range of exclusives, from fresh franchises. It can pool talent across divisions to work on both consumer- and business-facing cloud challenges.

To cut a long story short, Xbox has fewer high quality exclusives than PlayStation. Microsoft sees bumper revenues when it sells a lot of hardware, and exclusive software is a way to make that happen.

But does Activision’s track record suggest they are the right solution?

Anything with a score of 90 or higher is categorised under ‘Universal Acclaim’ by MetaCritic.

There have been 105 of these games since January 2015, but the only two Activision entries on the list are Sekiro: Shadows Die Twice and a re-release of Tony Hawk’s Pro Skater, which both score 90/100.

For context, Stephen’s Sausage Roll (PC-only) got a score of 90/100. According to the game description, “The focus of Stephen’s Sausage Roll involves nudging sausages around to fully cook them.”

If Microsoft just wanted good games, it would have bought Take-Two. It has the Red Dead franchise (the latest iteration of which is the highest-ranked game on MetaCritic since 2017, 97/100), for instance. It also owns 50% of the NBA 2K esports league — and we’ll turn our gaze in that direction next. I might have a sausage roll for an energy boost.

Esports

Gaming is not just about playing, nowadays. Twitch, the Amazon-owned streaming platform, is wildly popular with people who want to watch their favourite streamers play games.

Microsoft closed its rival service, Mixer, in 2020 and migrated its customers to Facebook Gaming.

One of Activision’s biggest games franchises is Call of Duty and an astonishing number of people play/watch these games on Twitch.

Instead of releasing new blockbuster games every year, developers update already popular franchises. This might help explain Activision’s lack of brand-new additions to MetaCritic’s “Universal Acclaim” list. It doesn’t need new games when it can keep adding to the games people already love.

I downloaded a Twitch dataset and aggregated the viewing hours for all Call of Duty games from 2016 to 2021.

Even allowing for some inevitable pandemic uplift from 2020 onwards, this series is clearly drawing in impressive figures:

These are stacked bar charts that contain the various Call of Duty games and their viewing figures by month, by the way. (I used a fantastic Python package called Mito to explore the data, which I’ll write about soon.)

It is true that adding more games to the franchise should naturally grow the aggregate figures, but many of these games have been around since 2016. Black Ops and Modern Warfare still do the heavy lifting. 

Additionally, World of Warcraft has a median ranking position of 6 in Twitch’s monthly list of most popular games since 2015.

Updates to these games are similar to adding a new season to a popular TV shows. People love playing them but increasingly, they love watching them too. It seems all the more appropriate to compare this acquisition with Disney buying 21st Century Fox.

Microsoft has acquired 5G (AT&T Technology Network Cloud) and telecoms (Metaswitch) companies in the past two years, too. It has the cloud infrastructure to bring gaming entertainment to more contexts.

Activision’s latest report does not suggest that it expects Call of Duty to grow much further on consoles:

“On console and PC, Call of Duty MAUs and time spent exhibited very similar retention from Q2 to Q3 as our experiences in prior years.”

And this brings us back to our old friend, mobile.

See also, from Activision’s quarterly report:

“For Call of Duty Mobile, net bookings grew over 40% year-over-year in the third quarter, driven by double digit growth in the West and a continued contribution from the game in China.”

A-ha. 

The mobile version of the game is just starting to take off and, significantly, it is popular in China. It also offers more revenue generation opportunities, through in-game sales.

Looking at the number of streamers (i.e. the people who are livestreaming their own games), almost 200,000 people shared a Call of Duty Mobile live feed in 2021:

For context, there were 3.1 million streamers of the other Call of Duty games combined, so we are still dealing with a smaller portion of the whole here. But this is a growth area and that’s what Microsoft will want to see. 

Activision also notes in that same report, referring to its mobile-specific division:

• “King’s advertising business grew robustly, with quarterly revenue growing sequentially and year-over-year to a new high.”

So all in all, we can say that Microsoft is getting the following with this acquisition:

• Content: These new franchises will bulk up Microsoft’s Game Pass subscription, which already boasts 25 million paying customers. Microsoft can claim some new exclusives in future, too.
• Mobile gaming and advertising: Microsoft is weak in this area and Activision brings existing hits (Candy Crush) along with some growing audiences (Call of Duty Mobile).
• Esports: Microsoft has made moves into this arena but the failure of its streaming platform, Mixer, was a blow. It has the Azure cloud power to support large-scale esports already. This acquisition brings the games it needs to draw an audience.
• “Metaverse”: Details are thin on the ground in this regard, but Microsoft is now positioned to take advantage of whatever the metaverse ultimately entails.
• Transferrable capabilities: Microsoft said last year, “we take the tech that we build for a game and we help somebody have another great, real-world, entertainment experience.” The boundaries between gaming and other sectors are dissolving; Microsoft can take what it learns from games and apply this to other customer challenges.

Overall, this strengthens the company across the board in an important sector and adds capabilities that it simply didn’t have. Strategically, it places Microsoft on more solid ground at a time when the industry is consolidating.

It is a gamble too, of course. Microsoft is betting that gaming will unlock entirely new avenues for interaction and revenue generation, whether in the “metaverse” or otherwise.

Activision’s recent trajectory is steady, if unspectacular, and it has serious culture issues to address. 

But Microsoft is interested in what it could deliver next, with a set of new tools at its disposal.

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