In Microsoft’s Activision deal, it’s not just stock prices but a future world at stake

There was some head-scratching across the big tech and gaming worlds in January when Microsoft announced an agreement to buy Activision Blizzard, a leading videogame publisher, for $68.7 billion. Microsoft CEO Satya Nadella framed its largest acquisition ever as a boost to the company’s growing metaverse strategy, even though Activision is best known for blockbuster games such as Call of Duty, World of Warcraft and Candy Crush, but not the mix of AR/VR and other technology underpinning the fledgling metaverse.

Upon closer inspection, however, Microsoft may now be better situated to become a leader in both the metaverse and gaming realms. “Microsoft is extremely well-positioned for the metaverse,” Bernstein analyst Mark Moerdler recently told CNBC. “But I don’t think this [acquisition] was purely a metaverse drive. They were also looking for bigger ways to gain depth and breadth in gaming.”

Moerdler anticipated that Microsoft might buy smaller game studios, but ultimately “decided it was better to make one big [purchase] versus lots of little ones,” he said.

The proposed deal still requires approvals from shareholders and U.S. and international regulators, which is expected to push the closing to June 2023.

Microsoft has played up the metaverse concept in its acquisition messaging, and between now and the deal’s anticipated close, Microsoft is speaking in terms of a dual-track model. “Gaming has been key to Microsoft since our earliest days as a company,” said Nadella in an email to its roughly 181,000 employees about the acquisition. “Today, it’s the largest and fastest-growing form of entertainment, and as the digital and physical worlds come together, it will play a critical role in the development of metaverse platforms.”

There’s no doubt that gaming is an attractive, lucrative sector. The global games market generated $180.3 billion in 2021, according to market research firm Newzoo, which predicts that gaming revenue will soar to $218.8 billion by 2024. eMarketer estimated that 2.96 billion people worldwide played digital games last year, whether via console, computer or mobile device, and that the figure will reach 3.09 billion in 2022 — or about a third of the planet’s population.

Microsoft first ventured into videogaming in 2001 with the release of the Xbox console, now in its fourth generation and enjoying a 14% jump in sales in the third quarter. Today, the Microsoft Gaming division, helmed by CEO Phil Spencer, comprises 23 game design and software studios and hundreds of games. The division’s Game Pass subscription service has more than 25 million customers, while nearly 10 million people have streamed games on the Xbox Cloud Gaming service.

While Activision isn’t considered a player in the metaverse — which remains a work in progress with various definitions — one of its videogames offers a good example of how it works. Blizzard released World of Warcraft in 2004, when it was the game studio that later merged with Activision in 2008.

“It’s a virtual world [your avatar] could walk around in with friends, build a tribe and go on raids together. That’s the metaverse,” said Mike Sepso, a former executive at the combined entity who is now the CEO of Vindex, an esports infrastructure platform.

Sepso points to several other games that incorporate metaverse elements, such as Roblox, Fortnite, Second Life and Microsoft’s Minecraft. On those platforms, players can teleport between millions of games, build virtual social spaces and even attend concerts — all while purchasing virtual stuff to heighten the experience. Most of these types of games require VR headsets and consoles, which favors Microsoft, with its HoloLens and Xbox hardware.

The virtual worlds in those games may not level up to the ones being prognosticated by metaverse proponents, where users are immersed via mixed reality in business meetings, doctor visits, vacations, and all types of ecommerce. That’s where Microsoft’s software, cloud computing, gaming and virtual technologies position the company well. And adding Activision’s gaming capabilities only enhances its outlook.

“I definitely see [the metaverse] as an extension of what gaming has been doing,” Spencer told The New York Times’ Kara Swisher in her Sway podcast about a week before the deal was announced. For instance, he said, Microsoft game developers are imagining virtual work spaces and some of the things they’ve learned in videogames about people coming together to cooperate to achieve tasks.

However — and whenever — the metaverse materializes, it will be predominately populated by Gen Z and subsequent generations, who will have exclusively grown up in the digital world, especially gaming. According to a recent study of Gen Z gamers by Razorfish and Vice Media Group, they spend twice as much time hanging out with friends in the metaverse than they do in real life. More than half said they would like to experience making money in the metaverse; 33% would like to experience building a career there; and 20% of their entertainment/leisure budgets will be earmarked for in-game purchases over the next five years.

While the tech sector is experiencing a correction, Microsoft remains one of its strongest players after its third-quarter earnings, and strong demand for its cloud services and software capabilities — both core components of the metaverse and gaming businesses — factor into its operating strength.

Activision reported lackluster first-quarter earnings, hurt by lower demand for its latest Call of Duty games, but its most notable new investor Warren Buffett of Berkshire Hathaway has been increasing his company’s stake, a merger arbitrage play, he told Berkshire Hathaway shareholders at the recent annual meeting, betting that Microsoft’s proposed acquisition of the video game company will close.

Berkshire now owns about 9.5% of Activision shares.

As tech has cratered, Activision’s stock price has fallen as much as 20% below Microsoft’s bid of $95 per share.

Clay Griffin, an analyst at MoffettNathanson, said the weaker-than-expected numbers on Call of Duty are bad for the fundamental story behind Activision. Should the deal collapse and Activision be forced to go it alone, the stock would probably be valued somewhere in the mid-$60s — but Griffin doesn’t expect that to happen.

“Occasionally I’ll see an arbitrage deal and do it,” Buffett said. “Occasionally it looks like the odds are in our favor, but absolutely we can lose money on that company, fairly large sums of money, depending on what happened if the deal blows up.”

“We don’t know what the Justice Department will do, we don’t know what the EU will do, we don’t know what 30 other jurisdictions will do. One thing we do know is that Microsoft has the money,” Buffett added.

Microsoft and Activision declined to comment.

In the interim, the fate of current Activision CEO Bobby Kotick is uncertain. He is part of two separate federal investigations launched last year, by the Securities and Exchange Commission and the Department of Justice, into how the company handled employees’ allegations of sexual misconduct and workplace discrimination. In November, The Wall Street Journal reported that Kotick had mishandled sexual-misconduct allegations.

The issue attracted Spencer’s attention before the deal was announced. Last November, as the headlines mounted, Bloomberg reported that he told employees he was “disturbed and deeply troubled by the horrific events and actions” at Activision Blizzard and that Microsoft was “evaluating all aspects of our relationship with Activision Blizzard and making ongoing proactive adjustments” as a result.

In fact, this was around the same time Spencer and top Microsoft officials began discussing a deal with Activision.

“When this [Activision] transaction closes, Microsoft Gaming will be the world’s number-three gaming company by revenue, behind Tencent and Sony,” Spencer said in the post-announcement webcast with analysts in January. “Until [then], Activision Blizzard and Microsoft Gaming will continue to operate independently,” he wrote in a blog post that day. “Once the deal is complete, the Activision Blizzard business will report to me.”

“In most acquisitions, senior management leaves,” Moerdler said. “In this instance, that’s more likely.”

Considering not only Activision’s vast cache of proprietary gaming intellectual property but also the nearly 400 million monthly active players, many of whom already are spending money in virtual worlds, and there’s not as much head-scratching over the acquisition, or the ambitions that Spencer will oversee.

“This deal solves a couple of issues for Microsoft,” Sepso said. “One, it adds a lot of great IP and player base to their Game Pass service in the short term. Longer term, that IP can be expanded into this primordial metaverse. It puts them in an enviable position as to who’s going to own the metaverse.”