Microsoft: This Is A Game Changer (NASDAQ:MSFT)

Microsoft Corporation’s (NASDAQ:MSFT) decision to acquire Activision Blizzard, Inc. (ATVI) for $68.7 billion earlier this year makes all sorts of sense for the company. As the gaming business starts to have a greater impact on the company’s financial performance, allocating more resources for its expansion appears to be a no-brainer at this stage. Even though the deal is not completed yet, as the antitrust watchdogs are currently reviewing it, there are good chances that Activision will become a part of Microsoft next year. As investors await for this to happen, this article aims at highlighting Microsoft’s current strategy in the gaming industry and explain how an expansion of its gaming business would be able to create additional shareholder value in the long run.

The Importance Of Gaming For Microsoft

It’s been almost a year since the deal to acquire Activision by Microsoft was announced, yet we’re still waiting for regulatory approval in order for the deal to go through. As antitrust watchdogs of the U.S., EU, UK, and China are reviewing the purchase, there are still a lot of misconceptions about the reasoning behind Microsoft’s decision to acquire Activision, considering that gaming is not its core business. Nevertheless, in the grand scheme of things, the gaming business has one of the biggest abilities to help Microsoft aggressively expand its reach and attract a large pool of new customers into its ecosystem, which is why acquiring Activision makes sense from a business point of view.

Back in 2015, I wrote an article about Microsoft’s gaming business here on Seeking Alpha. At that time, the gaming business was still playing a relatively minor part in Microsoft’s overall strategy. A few years before that article was published, the company’s management (with Steve Ballmer at the helm of Microsoft) made several crucial mistakes in the gaming business, such as the unsuccessful release of Kinect back in 2010 along with a failed launch of Xbox One in 2013. This made them a laughing stock within the gaming community.

Those mistakes also helped Sony (SONY) to take an undisputed lead in the gaming business and win the battle for the eighth generation of consoles thanks to the launch of PlayStation 4 in 2013, even though the company was on the brink of a financial ruin just a few years before that. The reason for Sony’s success during that time is mainly attributed to its then-CEO Kaz Hirai, whose One Sony strategy, which I also covered here on Seeking Alpha a few years ago, focused on utilizing the company’s competitive advantages and getting rid of divisions that are expensive to maintain and bring no value. This is the kind of approach that Microsoft’s management at that time didn’t take, which resulted in the stagnation of its gaming business after the momentum from the success of Xbox 360 in the mid-2000s disappeared.

However, things began to change when Satya Nadella became Microsoft’s CEO in February 2014. A month after taking a new role, he appointed an Xbox veteran Phil Spencer to lead Microsoft’s gaming department, and at the same time in September of that year approved the acquisition of Mojang, a gaming studio that created Minecraft, for $2.5 billion. It was at that time when it became obvious that the new management was interested in reviving Microsoft’s gaming business and making it a major part of its overall growth strategy. That’s why, in my 2015 article, I quoted Satya Nadella, who already at that time had announced the need for Microsoft to pursue its gaming ambitions. These would become a part of the company’s broader vision to improve the business’s overall customer appeal that, in the end, could lead to the improvement of its overall ecosystem of products and services.

With the new focus on gaming, Microsoft has made a number of major moves, which began to strengthen its overall positioning in the gaming industry and attract new users. With Phil Spencer at the helm of the gaming business, Microsoft began to focus on the gamers’ needs first, which resulted in the launch of Game Pass in 2017, the acquisition of a dozen of gaming developers in 2018, and the release of an initial version of a cloud gaming service xCloud in 2020. All of those things had one thing in mind, and that’s to make gaming as accessible as possible for everyone.

That strategy is working well for Microsoft to this day, since if we go through the company’s latest Q3 earnings report, we’ll see that out of $50.12 billion in total revenues the company generated during the period, $3.61 billion were generated by the gaming division. This accounted for ~7.2% of the overall revenues. As the gaming business has proven to be lucrative for Microsoft in recent years, it made all the sense to continue to explore various growth opportunities there.

The Bigger Picture

The acquisition of Activision is a continuation of Microsoft’s overall strategy in which gaming plays a crucial part, as was noted by Satya Nadella a year ago. At the same time, gaming is one of the most resilient growing businesses out there. Despite the forecasted Y/Y decline of the gaming market to $184.4 billion in 2022, the overall revenues generated by the gaming industry are still going to be higher in comparison to the pre-pandemic days. In addition, the long-term picture is bright, as the industry’s annual revenues in 2025 are expected to be $211.2 billion, which implies a CAGR of 3.4% from 2020 to 2025.

Another important thing to note is that an acquisition of Activision will allow Microsoft to break into the mobile gaming market in which it has no major presence whatsoever, as was noted recently by Phil Spencer. In recent years, the mobile gaming business has been aggressively gaining traction, and out of the $184.4 billion that the gaming industry is expected to generate this year, $92.2 billion of them are forecasted to be generated by mobile games alone. Considering those numbers, and the fact that out of $1.78 billion in net revenues that Activision made in Q3, $932 million were generated by its mobile business, it makes all the sense for Microsoft to gain exposure to such an attractive market.

In addition, if we were to assume that the deal has been completed and add those $1.78 billion of Activision’s revenues into Microsoft’s latest income statement in which it stated that it made $50.12 billion in sales, then we would see Microsoft generating a total of $51.9 billion. Under such a scenario, the gaming business alone would’ve generated $5.39 billion in revenues ($3.61 billion of actual gaming revenues in Q3 + $1.78 billion of Activision’s revenues in Q3), making it accountable for ~10.4% of overall new revenues, an increase from ~7.2% today. As a result, thanks to the purchase of Activision, Microsoft would be able to significantly double its gaming revenues in an instant and give the gaming division the ability to play a greater role in executing the company’s broader vision.

What’s also important to note is that, thanks to the Activision deal, not only is Microsoft getting access to the mobile gaming market along with a pool of new users that might be interested in exploring the company’s other offerings, but it also gets ownership rights for popular franchises such as Call of Duty and Candy Crush. It took decades for those franchises to become notable names in the gaming industry, and the good news is that Microsoft is getting them at $95 per Activision’s share, a price that is lower than Activision’s actual market price per share a year and a half ago.

All Eyes On Regulators

Since the boards of both companies have already approved the deal, the only ones who are stopping the deal from happening are the antitrust watchdogs from the U.S., EU, UK, and China. However, there are reasons to be optimistic that the deal will nevertheless go through and be completed by the end of June.

First of all, since Activision’s mobile business generates most of its revenues and Microsoft has no actual presence in the mobile gaming business, as was admitted by Phil Spencer, then the latter won’t be gaining much of the lead against others with this purchase. Therefore, there are no actual reasons for the regulators not to approve the deal.

At the same time, I have already mentioned that since 2014, when Satya Nadella and Phil Spencer started to run things, the strategy of Microsoft’s gaming department was to make games as accessible on as many devices as possible and that’s exactly what they were doing when they launched Game Pass in 2017. Therefore, by promising not to make Call of Duty an Xbox exclusive, Microsoft has a good shot of getting the regulators’ approval, since such a decision is aligning with its overall gaming strategy, which it has been pursuing for years.

However, even if for some reason the deal doesn’t go through, I would still be confident in Microsoft’s ability to expand its gaming offering for years to come, as its strategy pivot in 2014 under the new management has been successful so far. The only difference is that under such a scenario Microsoft would likely look for a smaller business with mobile gaming exposure only in order to guarantee the securing of such a deal.

The Bottom Line

In the grand scheme of things, the acquisition of Activision helps Microsoft to expand its presence in the growing video gaming market and reach a greater pool of new customers, who could be interested in exploring all the other products and services that the company offers at the same time. Therefore, if the Activision deal goes through, which is likely to happen at this stage, Activision has all the chances to help Microsoft accelerate the growth of its gaming business, which should lead to the creation of additional Microsoft shareholder value along the way.