Activision Blizzard Trades At A 13% Discount To Microsoft’s Purchase Offer (ATVI)

Activision Blizzard, Inc. (ATVI) rose 26% on Tuesday after Microsoft Corporation (MSFT) announced that it will be purchasing the company for $95.00 per share in an all-cash deal. That 26% rise resulted in an $82.31 close, 13% below the offer price and down from the initial $86.76 open. In this article, I briefly discuss why that’s the case, why I think there will be a quick bounce and how I am playing it.

First, there are some mild antitrust concerns with the deal, but Microsoft tried to calm those concerns by stating that it intends to continue to produce ATVI’s games for competitor platforms. Second, the deal is expected to close in MSFT’s fiscal 2023. Fiscal 2023 sounds like a year away, but MSFT’s year end is June 30 so the deal could close as soon as July 1. As the closing date is several months away, some investors are willing to sell at a discount in order to free up funds for other investments that they believe can earn them a higher return. Alternatively, there will be buyers who are attracted to the decent potential return in that time given low yields, stretched valuations and high volatility permeating throughout the market. Finally, the deal is subject to normal regulatory closures and ATVI shareholder approval. Given that the $95.00 offer is below the 52-week high, there could be some investors who balk at this deal.

While a combination of these issues should lead to some discount to the $95.00 takeover price, I believe that 13% is excessive and ATVI will see an immediate bounce, using two recent examples as proof.

ATVI trading similarly to two other recent takeover targets, ZNGA and ARNA

In my article on last week’s Take-Two Interactive Software, Inc. (TTWO) acquisition of Zynga Inc. (ZNGA), I laid out a bullish case for ZNGA. Last Monday it opened at $8.90 on initial reaction to the deal, but closed at $8.44, 14% below the value of the transaction. The bounce back to $9.00 was immediate and I exited with a profitable call option position last week. ZNGA now sits at $8.99, a little less than 8% discount to the $9.75 value of the deal based on TTWO’s close of $154.04.

Last month, Pfizer Inc. (PFE) purchased Arena Pharmaceuticals, Inc. (ARNA) for $100 per share in an all-cash deal. On December 13, ARNA initially opened at $93.09, a 7% discount to the purchase price. It sold off throughout the day to close at $90.08, a 10% discount to the purchase price. The next day it bounced back up to $92.00 and the day after to $92.85. ARNA currently sits at $91.98, again, an 8% discount to the purchase price. But it has traded as high as $94 last week.

The pattern is noticeable on both of these buyouts. On the day of the news, the stocks initially reacted strongly, then sold off throughout the day. The following few days resulted in a bounce in reaction to the overcorrection seen on day one of the news. I find this to be a normal process as the market takes a couple of days to assess the risks and upside associated with a deal and adjust the price accordingly.

Both the TTWO-ZNGA and PFE-ARNA deals are expected to close in the first half of this year. As they will close sooner than the MSFT-ATVI deal, finance theory suggests that they should have a lower discount than it. However, 13% seems like a bit much, just like how 14% was too much of a discount on ZNGA and 10% too much of a discount on ARNA after their first days of trading post-buyout. If ATVI reverts back to the initial gut reaction from the market of $86.76, this is a 9% discount to the offer. There are currently 10.8 million shares short on ATVI. These shorts will likely cover in the very near term as paying something less than $95 is better than paying exactly $95 in order to exit a position that no longer has any possibility of upside.

All three of these deals could be seen as favorable places to park one’s money. Particularly on ATVI and ARNA as both of those deals are pure cash, so the payout is not subject to any market volatility. But ATVI offers the best return of the three. The next section will explain how to further enhance that yield.

Use call options to increase returns

I went long short-dated call options on ZNGA to take advantage of what I felt was an immediate but modest increase in price to come and I did the same thing on ATVI, focusing on the $80 and $82.50 strike prices. While one can use call options to greatly increase the risk and return on this trade through leverage, more cautious investors can financially engineer the return beyond the 13% discount to the $95 offer by buying the stock and shorting call options. The January 2024 $95 strike calls last traded at $2.31. Shorting those calls at that price reduces the initial cash outlay from $82.31 to $80.00 and provides a 19% return to the $95.00 bid. In the unlikely event that ATVI trades above $95.00, these investors will be capped at a $95.00 price and be called out of their position.

Given the success I had on ZNGA and the consistent nature of the price action from it and ARNA in the days following their takeover bids, I feel confident in an immediate short term bounce on ATVI. I am looking for an $86.00 to $87.00 stock price by the end of the week but can still profit from a less pronounced increase.