Microsoft (MSFT) Activision Blizzard, Inc. (NASDAQ: ATVI$ 95 cash per share with the transaction closing in 2023. The FTC is reviewing the agreement. The ATVI transaction is a two-digit special condition merger arbitrage Returns after closing. Investors can put their money on ATVI to protect against volatile markets and recessions.
Description / Background
The merger orb opportunity came into play after the sexual harassment scandal at ATVI. Activist employees tried to remove Bobby Kotik as CEO for failing to provide a safe work environment, and a cascade of delayed game announcements has hit the company’s reputation, dropping the stock to a high of $ 90s. Microsoft saw an opportunity to expand its gaming portfolio, improve the option on Xbox content, and be confident in Activision’s ability to improve the workplace culture. It made all the cash offer to buy the company for $ 95 per share. Microsoft absorbs ATVI with approximately one year of its free cash flow, $ 56b in ’21.
The FTC is evaluating the deal and its impact on the $ 200 billion gaming market. Activision made $ 8 billion last year, and Microsoft is closing its Activision deal by 6.5% to 10.7% in 2020. With the promise of delivering games to all platforms, Microsoft should be able to clear the deal.
Microsoft President Brad Smith recently stated that the company’s proposed acquisition of Activision Blizzard is proceeding relatively quickly and the process is entering its mid-point.
$ 95 cash per share, the price at which the FTC will pay the termination fee from Microsoft to Activision if the FTC does not allow the contract to continue. Closing fee ladder: $ 2b before January 2023, January-April 2023, $ 2.5b, and $ 3b April – July 2023. Deal is expected to expire in July 2023. The worst case scenario for Activision shareholders is that the deal will not materialize by next July and the company generates $ 2b + free cash flow on its own, plus a $ 2-3b termination fee from Microsoft.
If Activision decides to scrap the deal it has found a better suitor, or for whatever reason, the company owes Microsoft a little more than $ 2 billion.
The binary outcome of the transaction makes this situation a simple risk arbitrage calculation. You think it closes or not. Putting 50/50 probability weights on the yes / no result, the expected value table is presented below:
I don’t think Activision drops another $ 76 per share with another year of positive cash flow, adds $ 2 billion to the book value and another $ 3 billion in break fees if the FTC scrapes the transaction. There will be a margin of safety regardless of the expiration of the contract. Activision is in good financial condition, the balance sheet is strong and the brand value of its games is significant.
Arguably, games do Call of Duty, Warcraft, Overwatch, Diablo, Candy Crush, HearthstoneEtc., are going to generate a growing revenue stream for years.
Activision’s long-term hold is a reasonable backup plan, offering a 2024 15x EBIT multiple $ 84 billion market cap, a 40% increase from today.
Based in Wisconsin Call of Duty Developer Raven Software’s Quality Assurance Division voted to organize, possibly causing headaches for Microsoft and other game makers. Production costs increase and employee flexibility can be experienced when organized labor is introduced in the fast-paced game development process.
The FTC may fail the contract due to antitrust concerns, and a deep recession could hurt Activision’s profitability and significantly lower valuation coefficients.
We must close the arbitration gap as we get closer to the contract date.
Microsoft closes the deal at $ 95 per share, providing a 25% IRR in 12 months.
ATVI provides a rare opportunity to deploy capital with a simple decision tree, the transaction closes $ 95 per share for a 25% IRR in 12 months, or it does not, leaving Activision to produce games in the next gaming cycle. In either case, the company should enjoy a profitable future with the game price adjusted for inflation. Investors should consider adding ATVI to the special situation basket.