Summary
Activision Blizzard stock has reached a new 52-week high following a federal court ruling that Microsoft can continue with its planned acquisition.
The court ruling dismissed the FTC's claim that the merger could lessen competition, suggesting instead that it could increase consumer access to Activision content.
While the Microsoft deal is likely to close, it is not guaranteed, and the remaining takeover spread is slim, suggesting that locking in gains could be a sensible move for investors.
Rich Polk
Article Thesis
Activision Blizzard, Inc. $Activision Blizzard(ATVI)$, which Microsoft Corporation $Microsoft(MSFT)$ seeks to acquire, has jumped to a new 52-week high in the low $90s following news that a federal court has decided that Microsoft can continue with its planned acquisition. At the current price, the remaining takeover spread is rather slim, which is why I believe that locking in gains could make sense.
What Happened?
In a deal that was announced around one and a half years ago, Microsoft Corporation plans to take over gaming company Activision Blizzard. There were many hurdles to this deal from the beginning, such as some politicians not liking takeovers by huge tech companies, while competitors to Microsoft and Activision Blizzard, such as Sony Group Corporation $Sony(SONY)$ also argued against this deal.
The United States and the United Kingdom were two of the biggest hurdles country-wise, but it looks like things are taking a turn in favor of Activision Blizzard and Microsoft in both countries.
Starting with the United States, we got news on Tuesday that a federal court has decided that the deal may proceed, as reported here on Seeking Alpha. The judge in this case, Jacqueline Scott Corley, argued [see link above, emphasis by author]:
The Court finds the FTC has not shown a likelihood it will prevail on its claim this particular vertical merger in this specific industry may substantially lessen competition. To the contrary, the record evidence points to more consumer access to Call of Duty and other Activision content. The motion for a preliminary injunction is therefore DENIED"
The court's argument that evidence suggests that more gamers/consumers will have access to the games developed and marketed by Activision Blizzard is highly important, as this essentially means that the main argument against this takeover -- consumers presumably being hurt -- is wrong. The FTC had tried to block this deal due to reasons such as a presumed impact on consumers, but with this court ruling, it does not look like this will actually hold up.
In the United Kingdom, there were some positive developments as well for Activision Blizzard and Microsoft. Regulators in the UK could be okay with Microsoft making some small divestments, and it does not look like the deal will get blocked in the country. A trial has been paused following an intervention by the Competition and Markets Authority. An unnamed source has suggested that Microsoft is okay with a divestment, although it has not yet been announced what asset Microsoft would divest -- presumably, it is not one of Activision Blizzard's core assets such as the CoD franchise or the Diablo franchise -- otherwise, Microsoft would not be willing to agree to such a divestment, I believe.
Why It Matters For Activision Blizzard And Microsoft
Following the release of these two news items, shares of both companies reacted. Activision Blizzard surged by a hefty 10% on Tuesday, soaring to the highest level in more than a year, at a little more than $90. The reaction has been less pronounced for Microsoft, which makes sense, as the deal is less impactful for the latter. Still, Microsoft saw its shares rise slightly as well.
For Activision Blizzard, things are pretty clear: When the United States and the United Kingdom are okay with the acquisition, then the likelihood of this deal closing is pretty high. This, in turn, means that current shareholders would eventually receive the promised cash payment for the deal, which is $95 per share. In other words, when the deal closes, Activision Blizzard's current shareholders will get a premium of around 4% versus where shares are trading today. That's nice, but not an especially hefty return, I would say. And since it is likely but not guaranteed that this deal will close, there is some remaining risk that the deal falls through -- in this case, Activision Blizzard's shares would likely drop meaningfully, as the current share price, and the recent share price increase, is driven by the deal being seen as likely to close. Fundamentals were not the deciding factor for ATVI's recent positive share price performance. For shareholders of Activision Blizzard, the positive news from both the UK and the US is thus important, as it means that they can now either exit their position at a pretty attractive price in the low $90s, or, alternatively, they can wait for the deal to close to capture the additional 4% of upside, although that comes with some risk as it is still not guaranteed that the deal will work out.
For Microsoft, the increased likelihood of this deal closing is positive as well, although not a game-changer. Microsoft is a huge and very profitable company that is active across many different end markets. This includes gaming, and management seemingly sees potential in this space, hence the decision to go for Activision Blizzard in the first place. But gaming is not the most important growth driver for Microsoft, and it most likely won't turn into that in the future -- with or without the acquisition of ATVI. Microsoft's performance in cloud computing and AI (via its stake in ChatGPT developer OpenAI) will be more important for its future business and earnings growth. Microsoft's exposure to the AI theme, which has been getting a lot of attention in recent months, is also the reason for Microsoft's strong share price performance so far this year. If the acquisition of ATVI goes through, this should have a positive impact on Microsoft's long-term growth, but the impact will be of an incremental nature, I believe. This will not have a huge or drastic impact on Microsoft, one way or the other. The positive deal news is thus way more important for the owners of Activision Blizzard, versus the less pronounced impact for the owners of Microsoft Corporation.
Should You Sell ATVI Stock Now?
In retrospect, Activision Blizzard was a great investment a couple of months ago, when shares were trading in the low $70s. Investors that bought at that price paid a reasonable multiple for Activision Blizzard on a standalone company basis, I believe, as Activision Blizzard was valued at around 17x profits back then. Also, those that bought in the low $70s had a lot of upside potential toward the deal price of $95 per share. Clearly, those that bought back then have seen pretty nice returns so far.
But buying today is very different -- if the deal were to fall through, ATVI's shares would likely head lower, as the valuation on a standalone company basis is pretty high, at around 23x net profits today. Also, the remaining upside toward the deal price is limited.
While some investors like merger plays and will find a good way to play the remaining upside of around 4% towards the agreed-upon deal price, I believe, that this is not a very attractive investment for most investors. Those that have been holding Activision Blizzard shares in the recent past might be better off selling their investment, thereby locking in their gains. The remaining upside is not overly appealing, and while the risk of the takeover falling through has declined meaningfully, the risk isn't zero. Exiting the position here in order to lock in one's gains and in order to avoid the downside risk -- which is now larger than it was a week ago, when shares were trading at a significantly lower price -- could make sense. Even if the deal goes through, we don't know when exactly that will happen. There thus is some opportunity cost for holding onto ATVI now, where the upside has a hard limit while putting one's money to work in a different investment could result in more generous returns over the remaining time until the takeover closes.
Takeaway
There was some positive news regarding the pending takeover of Activision Blizzard by Microsoft. It is now more likely that this deal will close compared to a week or a month ago, although it is still not guaranteed that this will happen. ATVI's shares have reacted very positively to this development, and are now trading pretty close to the deal price.
I believe that it could be a good idea to lock in the gains for ATVI shareholders, as the remaining upside is not very pronounced and since the potential downward risk in case the deal falls through is now a lot higher with ATVI trading at more than $90 compared to the past, when it was more reasonably valued on a standalone basis.
Source: Seeking Alpha
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