Activision Blizzard: A Hold Whether The Deal Closes Or Not

Investment Thesis

Activision Blizzard (NASDAQ: ATVI) has garnered significant attention since the announcement of its merger with Microsoft (NASDAQ: MSFT). The proposed acquisition, valued at $69 billion, would mark Microsoft’s largest takeover to date. Since the announcement, ATVI’s stock price has experienced a notable increase, rising from $75 to $91 between January 12, 2022, and August 16, 2023.

While progress has been made on the deal, its completion hinges on obtaining approval from the UK’s Competition and Markets Authority (CMA). Microsoft has already gained support from the United States and the European Union, but the CMA has requested that the company sell its cloud gaming rights in the UK to prevent a potential monopoly. Microsoft has until August 29, 2023, to comply with the CMA’s requirements. Failure to meet these conditions would result in a break-up fee of $3.5 billion to $4.5 billion payable to Activision Blizzard.

Another setback for Microsoft is its recent loss to Sony (NYSE: SONY) in the battle for Call of Duty exclusivity. Microsoft had the opportunity to ban Sony from accessing Call of Duty before signing an agreement that allows the game to remain on PlayStation for the next 10 years. This development diminishes the potential profitability of the merger for Microsoft, as exclusivity rights could have bolstered Xbox’s competitiveness against PlayStation.

Despite these challenges, the acquisition of Activision Blizzard could still benefit Microsoft in various ways. By obtaining Activision Blizzard, Microsoft would enhance its presence in the gaming industry and strengthen its position in the metaverse, thereby increasing its competitiveness against Meta Platforms (NASDAQ: META). While the deal may not be as lucrative as initially anticipated, the substantial break-up fee and potential long-term gains make it a worthwhile endeavor for Microsoft.

Valuation

An analysis of Activision Blizzard’s valuation reveals that its EV-to-EBITDA ratio is significantly higher than that of Electronic Arts (NASDAQ: EA) and Nintendo (OTCPK: NTDOF). Starting in January 2022, ATVI’s EV-to-EBITDA ratio began to rise, while EA’s ratio declined. In comparison, Nintendo’s ratio remained relatively flat and significantly lower than its peers over the past two years.

Despite its higher valuation, Activision Blizzard’s relatively better debt-to-equity ratio compared to EA’s could partially offset concerns about its elevated EV-to-EBITDA ratio. A stronger leverage position enables ATVI to invest more in new games and enhance its competitiveness.

Why I might be wrong

While it is unlikely that Activision Blizzard’s stock price will experience a significant decline if the deal fails, the negative effects of the merger’s failure may be more pronounced than expected. The market has been heavily focused on the Microsoft-Activision Blizzard merger for nearly two years, and the absence of a successful deal could lead to increased uncertainty and potential investor disinterest. Consequently, ATVI’s stock price might not garner as much investor appeal as it did during the merger speculation phase.

Conclusion

Currently trading at $91 per share, Activision Blizzard’s stock presents a potential 4% profit opportunity if the Microsoft acquisition is successfully completed. However, this profit margin alone is not substantial enough to warrant a strong buy recommendation. Given the uncertainty surrounding the merger’s completion, ATVI is a hold at this time. In the event of a failed merger, Activision Blizzard would receive a break-up fee of $3.0 billion to $4.5 billion, which would significantly benefit the company. Furthermore, ATVI’s improved financial performance, overshadowed by merger news, could further support its stock price in the absence of a successful deal.

Disclaimer: The author of this article does not hold any positions in Activision Blizzard or Microsoft. This article is for informational purposes only and should not be considered investment advice. Investors should conduct their own research and consult with a financial advisor before making any investment decisions.