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Activision acquisition would be good for Microsoft and the overall stock market


Microsoft ‘s (MSFT) nearly $69 billion cash offer to buy video game giant Activision Blizzard (ATVI) has been under tremendous scrutiny since it was first announced back in January. But at least one Wall Street research firm says it’s highly likely that the deal will be completed in the near future. We tend to agree. While Club holding Microsoft would shell out a big premium for ATVI shares based on current market prices, the tech giant was always prepared to pay up for what Activision Blizzard’s popular games such as “Call of Duty” and “World of Warcraft” could mean when paired up with its venerable “Halo” franchise and its Xbox consoles. Approval of a deal of this size would also be good for the overall stock market as it could send a message that the Biden administration is not closed off to all M & A. Wedbush this week added Activision Blizzard to its best ideas list, noting it believes that Microsoft’s takeover of Activision Blizzard is highly likely to be completed in the next six months. The timing is, of course, difficult due to the number of regulatory hurdles it would need to clear both in the U.S. and abroad. The analysts at Wedbush are betting that Microsoft will be willing to make concessions such as “making ‘Call of Duty’ available on PlayStation consoles for the next decade.” Generally, deals get blocked due to a view that allowing them to go through would create too much market concentration and therefore stifle competition. Regulators are also cognizant that fewer players in any one industry can lead to price increases and a lack of innovation to the detriment of consumers. Determining anticompetitive risk One way regulators look to determine potential anticompetitive risk is through what’s known as the Herfindahl-Hirschman Index (HHI). This measure attempts to quantify market concentration and can be used to calculate what that share will look like should a merger or acquisition go forward. It’s not the end-all, be-all — but still worth considering. The index is measured from near zero to 10,000. A low HHI indicates a highly competitive market, whereas a high one indicates control by fewer players. A true monopoly tops the scale at 10,000. According to the Justice Department’s website, “agencies generally consider markets in which the HHI is between 1,500 and 2,500 points to be moderately concentrated, and consider markets in which the HHI is in excess of 2,500 points to be highly concentrated.” Additionally, they note that transactions that “increase the HHI by more than 200 points in highly concentrated markets are presumed likely to enhance market power under the Horizontal Merger Guidelines issued by the Department of Justice and the Federal Trade Commission.” Calculating an HHI value for an industry is pretty straightforward forward: You simply square the market share of each company and add the values together. For example, in an industry consisting of four firms, each with an equal 25% share of the market, the HHI would be 2,500. The formula is 25 2 +25 2 +25 2 +25 2 for a total of 2,500. For an industry with three players, one controlling 40% and the other two controlling 30% each it would be 30 2 +30 2 +40 2 for a total of 3,400. Applying this methodology to the video game industry, it’s hard to see how regulators could justify blocking the deal based on historical precedence. According to a recent report from Newzoo , the 10 largest gaming companies by revenue represent about 65% of the market with $126 billion in total sales. Extrapolating that out, the total market is about $194 billion. The largest is China’s Tencent with about a 17% share, and the smallest in the top 10 is Sea Limited with about a 2% share. That implies that the other 35% of the market is made up of firms with equal to or less than about a 2% market share. For simplicity’s sake, let’s say an additional 17 firms have a 2% market share each to bring us to 100% of the market. (We know there could be hundreds or even thousands of small players making up that other 35%. The more players included the lower the HHI result. So our approach is being more conservative by dividing the market up into 17 additional players with a share nearly equal to that of Sea Limited.) That means the HHI, calculated by the market share number squared and then added together for all 27 companies, would be under 650. That’s far less than the 2,500 threshold for what the formula would consider a highly concentrated market. If the Microsoft-Activision Blizzard deal goes through, and you combine the market share concentration of the two companies, the HII would be just over 700. Clearly, based on the HHI, it’s hard to block the deal on the grounds that not doing so would provide Microsoft with monopolistic power in the gaming industry. Possible regulatory, legal hurdles However, more recently regulators have attempted to think about power in other ways, not just in terms of market share but also influence, which is more difficult to quantify. The current Federal Trade Commission under Chair Lina Kahn is suspicious of pretty much every combination and not keen on allowing deals to go through unless it for sure benefits the consumer. In fact, in The Yale Law Journal in 2017, focusing on how Amazon (AMZN) managed to get a foothold in so many industries while avoiding antitrust scrutiny, Kahn wrote, “The current framework in antitrust –specifically its pegging competition to ‘consumer welfare,’ defined as short-term price effects — is unequipped to capture the architecture of market power in the modern economy.” In her view, “Current doctrine underappreciates the risk of predatory pricing and how integration across distinct business lines may prove anticompetitive.” That integration across distinct business lines argument may be a point of focus in regards to the Microsoft offer as video gaming becomes more cloud-based and Microsoft is a cloud industry leader. Microsoft competitor Sony, which makes the Xbox competitor PlayStation, has challenged the deal, contending that Activision’s wildly popular “Call of Duty” game alone is a reason to block. Sony’s argument is rooted in what the loss of that game could mean for Sony’s PlayStation if Microsoft were to make it exclusive to Xbox. A federal judge recently blocked Penguin Random House from acquiring rival Simon & Schuster from Paramount Global (PARA) due to concerns that it could “lessen competition” for “top-selling books.” So Sony may have a leg to stand on by arguing that “Call of Duty,” a top-selling game, warrants special attention beyond that of other less popular games that most may not be familiar with but add to market competition in a broader sense. Politico recently reported that the FTC is likely to file an antitrust lawsuit on those grounds. Again, Wedbush cited in its note that to get the deal done Microsoft would probably need to keep the Activision games console agnostic for a period of time. That might not be the worst thing. While Microsoft might want to keep games Xbox only, it would likely limit sales of the games more than it would boost sales of Xbox. Video gamers are pretty entrenched when it comes to consoles and loath to switch. The other issue is how one measures the gaming market. Whereas we based our analysis on revenue generation, causing us to include names like Apple (AAPL) and Alphabet (GOOGL), which many may not consider gaming industry names because they don’t make consoles in the traditional sense and don’t develop or publish their own games. (Though you could argue that smartphones are handheld gaming devices). They instead monetize games developed by third parties via their app stores — and additionally, in Alphabet’s case YouTube streaming revenues. The FTC may opt to base it simply on the console and the video game title markets, or the impact on U.S. consumers and choose to leave out names such as Tencent, NetEase or Sea Limited. Put another way, the FTC may see the market breakdown differently and debate it from that perspective. Bottom line To be clear, we don’t believe this deal to be anticompetitive whatsoever, and we don’t think the FTC wants to bring forward a case that it’s not confident it can win. Everyone on Wall Street is watching this deal given the market price of Activision shares — around $76 — compared to the $95-per-share cash offer from Microsoft. That’s a big 25% premium. But remember, ATVI was trading around $65 the day before the deal was announced. Many observers struggle to see how it doesn’t go through. Even Warren Buffet’s Berkshire Hathaway (BKR.a), which very rarely invests in companies going through mergers, is an owner of Activision stock. Berkshire initiated the name in the fourth quarter of 2021 before the deal was announced in January. It added to ATVI in the first and second quarters of this year and then trimmed its position some in the third quarter. At Berkshire’s annual meeting in April, Buffett said , “If the deal goes through, we make some money, and if the deal doesn’t go through, who knows what happens.” Ultimately, whether you have a stake in this or not, you will want to watch this deal. That’s because how things shake out here could determine the future appetite for M & A (mergers and acquisitions) activity, which many companies depend on for growth. A robust or, at least, not an outright hostile environment for M & A could be supportive of a bottom in the overall stock market and help improve investor sentiment. The FTC is clearly looking to update the way it thinks about corporate power and this deal, along with a few others such as the proposed JetBlue (JBLU)- Spirit (SAVE) airline deal and the Kroger (KR)- Albertsons (ACI) supermarket merger, will provide valuable insight into how the agency is thinking about modifying its framework for approving or blocking deals in the future. Recall, DuPont (DD) terminated its Rogers (ROG) deal because it couldn’t get approval in China. So it will be interesting to see how the various regulatory bodies not only in the U.S. but around the world go about analyzing the competitive implications of the MSFT-ATVI deal. As it relates to Club holding Microsoft, we think it will be just fine either way. We think the ATVI acquisition would be a great move as it provides some of the greatest video gaming intellectual property in the world and furthers their initiative to build out a robust game streaming service. However, gaming is only one aspect of Microsoft’s incredibly successful business model, and we think Azure growth and the worldwide shift to cloud computing will continue to drive growth in the long term. (Jim Cramer’s Charitable Trust is long MSFT, AAPL, and GOOGL. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

A scene from “Call of Duty Modern Warfare.”
Source: Call of Duty Modern Warfare

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