It’s been a wild ride in the markets to start the year. Gaming has been one of the few areas within tech that’s seen any optimism, mostly because of M&A. Take-Two first acquired Zynga before it was greatly overshadowed by Microsoft’s $69b bid for Activision-Blizzard. Modern Times Group also divested its esports business which rewarded shareholders nicely. Through it all, gaming companies have seen gains, or at a minimum slightly dampened losses, on speculation that they may be next. Microsoft has driven a large part of this by the aggressive approach they’ve taken to building their gaming business, one that its competitors may look to replicate.
There are a few underlying themes to the M&A activity we’ve seen in the year. First, companies are betting big on the opportunity in mobile, and second, content remains king. These themes work in tandem. Gaming companies want mobile exposure to increase their addressable users. Once they have that access, any IP, existing or acquired, becomes more valuable. I wrote previously about the Take-Two and Zynga deal. Ultimately, it’s a win for Take-Two as they’re able to pay a fair price for Zynga and should unlock Take-Two’s IP on mobile platforms.
Modern Times Group, a lesser-known mobile publisher based in Sweden, sold off its esports business this week. That business, ESL, historically hosted in-person esports tournaments. It’s being acquired and combined with FACEIT, an online esports platform, by Savvy Gaming Group. The combination of ESL + FACEIT makes plenty of sense strategically, and it creates a full competitive gaming platform that can now host both online and offline events. It’s a great outcome for Modern Times Group, but more importantly, it now sets the company up as a pure-play mobile publisher. At a market cap of ~1.4b, it’s a ripe acquisition target.
While Modern Times Group appears set to continue its strategy to acquire undervalued IP and continue to build out its portfolio, the market appears to like it as an acquisition target. Although it’s on the smaller side, it has both the mobile presence and valuable IP that’s desired. Other companies with appealing content that appear to be undervalued by the public markets include Ubisoft, Square Enix, and CD Projekt. These companies own incredible content portfolios but have largely disappointed gamers, and therefore investors.
Why are gaming companies subject to speculation they may be acquired? Who would acquire these companies? The answer lies primarily in the mega-cap tech companies Amazon, Google, and Meta. Netflix and Apple are other options, but less likely. For the acquisitive companies, gaming is an area of consumer in which they have ambitions, but not a great footprint. Amazon owns Twitch and is attempting to build its own publishing business, Google launched its game streaming platform Stadia, and Meta has been clear about its intentions as a Metaverse company, where gaming will undoubtedly make the biggest impact at launch. For these companies, owning valuable IP helps expand their efforts within gaming and ultimately helps them reach customers in a new way.
Acquisition speculation is heating up because of Microsoft’s aggressive efforts within gaming. Efforts that its competitors can no longer ignore.
Microsoft’s strategy in gaming has been shifting over the past few years. The company first launched the Xbox in 2001. For most of the 20 years since, the company has been measured by its ability to sell as many consoles as Sony and Nintendo. Microsoft even considered exiting the gaming business in 2014.
Now, Microsoft is playing a different game than its competitors. The company no longer wants its success to be measured by selling new generations of consoles. It’s made new Xbox games today available on previous and current generation hardware and allows cross-play with PC and PlayStation. Hardware has become less important, which has been a strong move in hindsight as consoles have been severely impacted by ongoing supply chain issues. Instead of a console refresh and new batch of games every 5-8 years, Microsoft is attempting to build the world’s largest game subscription service. It’s acquired ZeniMax Media for 7.5b, adding a plethora of content to its first-party slate, and made Halo: Infinite multiplayer free-to-play, knowingly giving up a higher number of sales of its most anticipated title in years. This is all done with the goal of converting gamers to its Xbox Game Pass subscription. This gives players Xbox Live Gold (the ability to play multiplayer games online) and access to its Game Pass title library. The library contains almost every first-party title, including its top-tier games, and even includes games through partnerships with other publishers like EA and Ubisoft. Microsoft has 25m Game Pass subscribers today. Therein lies the key to Microsoft’s long-term success in gaming. Build a massive gaming subscription business. Short-term monetization of content and its player base isn’t important. Today, it amounts to a rounding error in earnings.
Microsoft’s vision is to build the highest quality content portfolio, a massive network of gamers, and technology infrastructure that will make it as easy as possible to play games online. This strategy starts with content. The acquisition of Activision-Blizzard will bolster Microsoft’s existing gaming business and make its subscription offering more appealing. It also helps it expand into mobile, an area underserved by the company today. Microsoft can acquire an impressive content portfolio at about a 40% discount. While most of the attention is drawn to Call of Duty (rightfully so) the deeper portfolio of Blizzard may see the biggest boost from the acquisition. Microsoft is a great place for Activision-Blizzard to land, both for developers and players.
Developer Benefits
Activision-Blizzard’s developers undoubtedly win with this acquisition. By becoming part of Microsoft’s gaming business, they’ll get access to more resources which will result in better and more games. Microsoft has a much larger balance sheet, its Azure cloud system, and the entire Xbox platform.
Most importantly, developers will have a different goal than they did at Activision. It’s been rumored the development process at Activision has been tough. Management has wanted to see $1b franchises that can have frequent releases. It makes sense, investors have long loved Activision for its bookings growth and high free cash flows. Delayed or canceled titles would be a noticeably negative hit to any quarter. Under the Microsoft gaming umbrella, these issues become rounding errors. If a game needs another quarter or another year, it’s worth delaying it, as the company did with Halo: Infinite. Developers will be measured more on quality and less on frequency, something that hasn’t been possible at Activision-Blizzard historically. It’s even been rumored that Call of Duty may move away from an annual release sequence at some point in the future.
Finally, the Microsoft acquisition offers a way to improve the cultural problems at Activision-Blizzard. It’s unlikely Bobby Kotick leaves Activision-Blizzard without this deal. A change in leadership at the top is most needed for the company. Microsoft has the opportunity (and obligation) to address the cultural problems the company has faced.
Customer Benefits
How the transaction impacts customers will be of particular focus for antitrust regulators. The deal is a win for Xbox and PC gamers. They’ll get access to many high-quality titles which will likely be included in Xbox Game Pass. Players can expect the titles they love to be of higher quality in the future, because of the developers’ ability to prioritize quality over frequency. While the installments of some games may be more infrequent, it won’t matter as most of those gamers are now operated in a live services model.
Finally, gamers may see new titles from older IP, particularly on the Blizzard side. Franchises like Starcraft, Diablo, Tony Hawk, or even Guitar Hero stand to benefit from a new approach to game development.
Anit-Trust
Most of the attention on the deal post-announcement has been – will it ultimately get done?
On Wednesday 1/26, shares of ATVI closed at $78.78, about 17% below the announced deal price of $95. This spread is almost 2x that of ZNGA. The high spread represents two things: the high price of the deal and the threat that the acquisition is blocked by antitrust regulators.
I’m not a lawyer or an antitrust expert, but I’d bet that the deal gets done. Microsoft has largely avoided the antitrust issues in the last few years while its competitors have been under a microscope. The combined entity would be the third-largest gaming company by revenue behind Tencent and Sony, both companies outside of the US, which may be relevant. It’s also a vertical integration. The deal will make gamers (and developers) largely better off. Game publishers have long been active in M&A to build their first-party portfolios. The difference with Activision is that Microsoft could pull existing games off other platforms, most notably PlayStation. It’s been reported that Microsoft has committed to keeping the next three Call of Duty games on PlayStation, but stops short of saying they will be available permanently. I’d suspect that Microsoft agrees to continue to release Call of Duty and other existing franchises on PlayStation but will develop new and refresh old IP as PC and Xbox exclusives.
It’ll be some time before there is a ruling on the proposed acquisition. Microsoft is targeting a close in Fiscal 2023. Approval of the deal would be a win for Microsoft and would further incentivize the large tech companies to be aggressive with gaming M&A. The mega-cap tech companies are surely looking for ways to expand their gaming efforts to combat Microsoft.