Activision’s Microsoft Deal Discount Offers a ‘Call of Duty’ to Investors

In January, Microsoft (MSFT) announced its deal to acquire Activision Blizzard (ATVI) in an all-cash offer of $95. Six months later, with a yawning discount in ATVI’s stock price to Microsoft’s offer, MoffettNathanson upgraded ATVI to an “Outperform” on Monday, hopeful the deal will be approved.

From a risk/reward perspective and a reasonable take on the FTC approval process, Moffett makes a convincing case that the shares are unduly discounted at 20% and worth a speculative buy.

The Biden Administration has recently been tough on mergers. The FTC voted to alter the formula for evaluating vertical mergers, cracking down on mergers billed as “pro-consumer.” Subsequently, the FTC sued to block Nvidia’s (NVDA) purchase of Arm Ltd. and Lockheed Martin’s (LMT) deal for Aerojet Rocketdyne (ARJT) .

Moffett believes the FTC’s Second Request for data in March suggests there’s a back and forth with a good-faith effort on Microsoft/Activision’s part to address concerns the commission has. They deem the duration of time that has passed with no objections from the FTC implies the FTC is likely entering the final stages with not much political heat from Washington with this proposed combination.

The U.K.’s antitrust agency has also opened a probe into the proposed merger to determine if the deal would reduce competition in Britain. Chinese antitrust authorities are also reviewing and will need to approve the merger. Microsoft contends the deal would benefit both video game players and the gaming industry.

From the start, it’s difficult to see how the transaction would alter the competitive landscape in the video game market. Moffett is doubtful Activision’s top console video game, Call of Duty, can help Microsoft steamroll competitors even if transformed into an Xbox exclusive. Nonetheless, a likely deal remedy could be to ensure access for Sony (SONY) and Nintendo (NTDOY) to Activision’s console games even though Microsoft would have little incentive to restrict games and they already committed to keep them available to the other console makers.

The wide deal spread would usually imply significant deal risk, but Moffett believes it’s more a function of the bear market and risk aversion than deal likelihood — hence the opportunity. The analyst argues that the stock has limited downside from current levels due to the reasonable P/E and the momentum at Blizzard with Overwatch 2 coming in the fall as a follow-up to the enormous success of the original Overwatch. Plus, releases are scheduled for Diablo Immortal and Dragonflight (the World of Warcraft expansion).

If the deal breaks due to antitrust action, Microsoft must pay a $3 billion breakup fee, about $4/share in ATVI. This infusion to Activision’s large cash hoard would cushion the market’s downside reaction to a negative FTC outcome. The hefty breakup fee would also possibly incentivize Microsoft to fight the FTC in court upon a challenge to the deal.

Since the deal was announced, Berkshire Hathaway (BRK.A) (BRK.B) added significantly to an original small stake in Activision to become the largest shareholder with a 8.25% stake (64.3 million shares). Berkshire is not known for arbitrage, so they must either see value in a stand-alone ATVI or also believe the market is discounting the likelihood of a deal far too much, posing a highly favorable risk/reward.

Most likely, Berkshire agrees with Moffett that there’s little rationale for why the FTC would block the deal, and, in the end, the deal will go through. The risk/reward opportunity in ATVI shares skews reasonably positive for a ~20% gain on a play of the deal closing versus ~15% loss if the deal gets blocked. Most investors are not merger-arb players, but MoffettNathan’s case and Berkshire’s involvement are enough to consider buying in.

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