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Activision Stock: Attractive Arbitrage Opportunity (NASDAQ:ATVI)


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On January 18, 2022, Microsoft (MSFT) introduced its acquisition of Activision (NASDAQ:ATVI) for $95 per share in an all-cash transaction. ATVI’s share value continues to hover round ~$80 as buyers stay skeptical about whether or not the regulators will approve the transaction and uncertainty concerning the upcoming shareholder vote.

Based on an anti-trust evaluation evaluation, I imagine the FTC will finally approve the transaction. Downside danger stays capped even when the FTC approval doesn’t pan out, making ATVI a sexy merger arbitrage alternative with an ~18% upside inside 14 months.

Vertical Or Horizontal Merger?

Given the scale of the transaction, the further request for data from FTC is inevitable. The FTC will then assess whether or not the acquisition is a vertical or horizontal merger. The former refers to an acquisition of an organization offering a distinct service (often a part of the provision chain) from the acquirer, whereas the latter refers to an acquisition of a direct competitor.

Vertical Merger

Vertical mergers had remained unchallenged for over twenty years until not too long ago. There have been three mergers challenged: Illumina-Grail, NVIDIA-ARM and Lockheed Martin-Aerojet Rocketdyne. The first was consummated and is at the moment present process court docket proceedings. While the latter two offers have been deserted. The purpose cited for disapproval of all three mergers was constant, being {that a} sole provider of essential downstream enter was being acquired.

There has been a consensus that the FTC will view the merger as a vertical merger. The causes are (i) MSFT’s key revenue-generating segments stay the Office and Windows companies and (ii) Xbox being a platform with gaming content material as a downstream enter.

Given that ATVI doesn’t present “critical” gaming content material inputs, FTC can have a tough time denying the merger if it views it as a vertical one. Further, there’s a multitude of profitable media content material consolidation priority in help of an MSFT-ATVI merger (suppose Disney-Fox, Discovery-WarnerMedia and Amazon-MGM).

Consumers could possibly be harmed and competitors stifled if MSFT was to transform fashionable titles like Call of Duty to Xbox exclusives. However, MSFT has confirmed that no less than Call of Duty will stay obtainable on the PlayStation platform. As such, there stays no purpose for FTC to disclaim this merger from a vertical merger standpoint.

Horizontal Merger

It is also argued that the merger is a horizontal one given MSFT’s presence within the sport publishing house with video games like Halo, Minecraft, Forza and Gears of War. This presence has since expanded with the acquisition of ZeniMax Media (owns The Elder Scrolls and Fallout IPs amongst others).

The FTC shall be following the Horizontal Merger Guidelines revealed in 2010. These tips give attention to the opposed aggressive impact on prospects be it pricing, high quality, selection, service or innovation. The proof of such opposed aggressive impact shall be (i) priority of opposed aggressive impact, (ii) lack of a considerable head-to-head competitor, (iii) elimination of a “maverick” and (iv) change in market focus.

Precedence of opposed aggressive impact

The FTC will evaluation the historic affect of latest mergers, entries, expansions or exits within the video gaming market or related markets to find out the aggressive affect of the merger. There is proscribed historic priority within the trade for acquisitions of ATVI’s measurement. The closest is Tencent buying a majority of Supercell for $8.6 billion. This acquisition didn’t immediate any value improve, as an alternative, the costs of digital items went down.

The same priority that the FTC may reference could be the Disney-Fox merger. Both mergers are related by way of the acquisition measurement and being within the leisure content material class. The Disney-Fox merger ended up as a plus for shoppers. They have been capable of benefit from the big library of Disney-Fox content material provided through Disney Plus at a cheaper price level than Netflix.

Given the above precedences had a constructive affect on shoppers, the FTC will discover it difficult to disclaim the merger on such grounds.

Loss of a considerable head-to-head competitor

MSFT and ATVI are opponents for certain, particularly within the first-person participant shooter (“FPS”) style. However, it will be difficult to argue that they’re substantial head-to-head opponents given the massive vary of fashionable options. These options, which can be found on each consoles and PC, are priced as little as free within the case of Fortnite, Apex Legends and Team Fortress 2.

Elimination of a “maverick”

A “maverick” is a agency that disrupts the trade be it by new know-how, enterprise mannequin or resisting value will increase. Elimination of such a agency will probably result in an opposed aggressive affect given its disruptive impact on the trade.

ATVI has not purchased something new to the desk in recent times. It has caught to its tried and examined franchises – Call of Duty, Candy Crush and World of Warcraft. There have been incremental gameplay enhancements, however innovation remained missing. The enterprise mannequin has remained the identical and it has been following the normal gaming pricing mannequin. It could be truthful to say that ATVI has not been a disruptive firm within the gaming trade for an extended whereas. As such, no “maverick” is being eradicated on this merger.

Change in market focus

If any, this is able to be the almost certainly cited purpose by the FTC to disclaim a merger. While attempting to find out the change in market focus, how the market is outlined issues. FTC has denied mergers on grounds of elevated focus in a narrowly outlined market. A distinguished instance is the 1997 Staples-Office Depot merger, the mixed firm would solely management 6-8 p.c of the general workplace merchandise market (barely vital share). However, the choose blocked the merger in acceptance of FTC’s “office supply superstores” market definition. The merger try was once more blocked in 2015 utilizing “B-to-B office supply” market definition.

Table 1: Market share of high 50 video games on PlayStation & Xbox revealed by Sony, MSFT & ATVI (measured in time performed in March 2022)

Market share of top 50 games on Playstation & Xbox

Author analysis

If one was to slender the market to video games on PlayStation and Xbox solely, the rise in market focus by the merger is 5.5%. The market share analysis in Table 1 highlights the fragmented nature of the market. Even a longtime large participant like ATVI holds solely about ~10% of the market. A mixed ATVI-MSFT market share of ~16% is nowhere near holding monopolistic energy.

Table 2: Market share of high FPS video games on PlayStation & Xbox revealed by Sony, MSFT & ATVI (measured in time performed in March 2022)

Market share of top FPS games on Playstation & Xbox

Author analysis

If one was to slender the market additional right down to the first-person shooter (“FPS”) style on PlayStation and Xbox solely, the rise in market focus is lower than 3% (Halo collection). As per Table 2, ATVI does have a domineering market share within the FPS style. On the opposite hand, MSFT has a restricted presence on this style because the Halo collection is just obtainable on Xbox and its recognition stays far behind that of Call of Duty.

Both market share evaluation highlights that there shall be a restricted improve in market focus. Thereby, a problem by FTC on such grounds shall be unlikely to cross muster.

Why The Huge Spread?

There are two key uncertainties behind the massive unfold: (i) the necessity for a majority shareholder vote and (ii) altering merger regulatory atmosphere.

Shareholder vote

Shareholders may vote to reject the merger. It is often led by activist buyers with vital stakes within the firm. Given there has not been any activist opposition so far and solely a easy majority is required, I imagine the vote will cross with no problem.

Changing regulatory requirement

The FTC has said that it is going to be reviewing supplies not lined within the tips akin to shopper information entry, affect on the sport developer labor market and affect on mistreated workers. Given the office harassment considerations at ATVI, FTC will probably focus its consideration on labor points.

Game publishing studios have traditionally been recognized to have poor working circumstances with compelled additional time, poisonous tradition and low pay. The trade has been capable of get away with it as labor provide far outstrips demand. I extremely doubt the MSFT-ATVI acquisition will change that trade labor dynamics.

I’d say that MSFT has among the higher office tradition within the trade. Learning from its errors of extreme involvement in Lionhead Studios (developer of the Fable collection), MSFT has since taken a hands-off method to acquired studios. This has labored nicely in lots of circumstances with few complaints heard. One of its acquired builders, Playground Studio, was even named probably the greatest locations to work.

Nonetheless, MSFT additionally has its share of office points in one in all its studios, Undead Labs. The office points appear to have come about because of the departure of its founder. But MSFT has since taken corrective actions in pushing out the concerned HR government and investing in range and inclusion.

MSFT’s emphasis on office tradition can also be evident in giving up on working with an acclaimed studio, Moon Studios (developer of the favored Ori collection), resulting from poisonous office tradition. One of its key executives, Bonnie Ross, Head of 343 Industries (developer of Halo Series post-MSFT’s break up with Bungie), has been instrumental in driving range within the gaming trade.

I imagine MSFT is well-positioned to right the poisonous office tradition at ATVI, which is probably going the explanation why it went forward with the acquisition. ATVI underneath MSFT will almost certainly be a a lot better working atmosphere for current sport builders. With that in thoughts, I discover little purpose why the FTC ought to cease this acquisition.

Downside Capped

Figure 1: ATVI DCF Valuation (put up failed acquisition)

ATVI DCF Valuation

Author analysis, Simply Wall St as of Apr 22, 2022

Based on analysts’ free money movement projections, a conservative discounted money movement valuation as per Figure 1 will yield a value goal of US$82. The valuation accounts for a $3 billion payout by MSFT ought to the acquisition fail resulting from antitrust points.

The share value will tumble put up the information of a failed acquisition probably as a lot as 13% to $69 (ATVI’s pre-acquisition value of $65 + $4 in money termination charge paid out per share). However, ATVI stays a enterprise with robust IPs that may proceed to generate robust money movement. Its share value will finally recuperate from the one-off failed acquisition shock and commerce at its intrinsic worth of US$82.

Nonetheless, if an investor is unwilling to attend for the corporate to commerce at its intrinsic worth, a low 13% draw back chance versus a excessive 18% upside chance stays a sexy risk-to-reward profile.

Timeline

Given the scale of the transaction, the events expect the conclusion of the merger by June 18, 2023 (closing extension deadline). MSFT shall be on the hook for US$2-3 billion ought to the merger be terminated resulting from antitrust points.

The particular shareholder assembly to resolve whether or not to proceed with the merger shall be held on April 28. A majority vote is required else the merger settlement shall be terminated.

In the meantime, MSFT/ATVI shall be compiling and submitting the knowledge as requested by the FTC. According to the steering, the FTC has 30 days to evaluation the submitted supplies. But the FTC has been recognized to take far longer, which is able to probably be the case for such a distinguished merger. My projection is the approval will are available Q1 2023.

Conclusion

It is plain that there’s danger concerned else a selection won’t exist. However, on this particular case, it appears the market has significantly overestimated the dangers resulting in a sexy arbitrage situation.



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