Microsoft, Activision, And El Diablo

Microsoft Corporation (NASDAQ:MSFT) is committed to buying Activision Blizzard, Inc. (ATVI). The deal target is far more valuable than when the deal was first struck due to successes such as its new Diablo 4, pictured above. The companies have made progress towards closing their deal, securing approvals from the EU, China, Brazil, Chile, Japan, Saudi Arabia, Serbia, South Africa, South Korea, and Ukraine. ATVI holders also approved the transaction.

Only regulators in the U.S. and UK oppose it on novel grounds. In both cases, Sony Group (SONY) successfully lobbied to hobble a competitor. Microsoft has made every effort to appease these regulators with generous offers to fix any conceivable, legitimate antitrust issue. But in both jurisdictions, the regulators prefer the political spectacle to a legal settlement. Both want to fight.

In the UK, Microsoft has a high standard for their appeal. They need to show that the regulators acted "irrationally, illegally or with procedural impropriety." They were silly, but that isn’t enough to get overturned. The five to six day appeal begins Friday, July 28, 2023.

In the U.S., the case stands before Judge Jacqueline Corley. She dismissed the Demartini v. Microsoft Corp., 22-cv-08991-JSC (N.D. Cal. Mar. 20, 2023) consumer antitrust case against the deal, calling general allegations of potential anticompetitive effects insufficient, stating that:

These allegations do not plausibly support a reasonable probability of anticompetitive effects in a particular market that would harm Plaintiffs. While Plaintiffs allege Microsoft might obtain the ability to make Activision’s games exclusive, and they assert Microsoft would have an incentive to do so, they do not make any factual allegations that support the conclusory incentive assertion. Why would Microsoft make Call of Duty exclusive to its platforms thus resulting in fewer games sold? What is it about the console market or PC games market and Microsoft’s position in those markets that makes it plausible there is a reasonable probability Microsoft would take such steps. Plaintiffs fail to meet their pleading burden because the complaint does not allege facts that suggest answers to these questions.

The evidentiary hearing begins June 22, 2023. According to the merging parties,

As history shows, the Court’s ruling on the FTC’s request for a preliminary injunction will decide the fate of this transaction, particularly in light of the termination date of July 18, 2023. If Defendants prevail, the FTC’s longstanding and unbroken practice has been to walk away from its challenge. On the other hand, if the Court grants a preliminary injunction, it will effectively block the transaction because the FTC’s process is “glacial” and one “[n]o substantial business transaction could ever survive.”

They go on to categorically state that the preliminary injunction hearing will decide the fate of the transaction. Perhaps, as of this writing, there is a $13.79 net spread between the market price and deal price. I find this opportunity to be attractive despite the substantial deal hurdles because ATVI is far more valuable than it appeared when the deal was first announced. I had been using a $75 break price for most of the pendency of the deal, but it now appears that it would break to closer to $80 per share. Additionally, I take at face value the implication from the merging companies that they might take the bold step of closing the deal if the US court denies a preliminary injunction.

They could try to close before the Tuesday, July 18, 2023, walk date for a few reasons. First, they could determine that the UK opposition is immaterial to the overall deal. Secondly, Microsoft might prefer to close instead of renegotiating with Activision, which could reasonably ask for a substantial price bump in return for extending and litigating the deal. Were I Activision, I’d ask for $110 per share in a recut deal. It is worth at least that much to Microsoft.

Conclusion

The market has underpriced the possibility of a quick deal close or price bump.

TL; DR

I own ATVI as well as July 21, 2023, ATVI $92.50 calls. They price in less than a 20% chance of the deal closing or the price getting bumped by then. The true odds are probably twice that. These options are a bargain under $0.50 and are likely to trade to at least $1 if the June hearings go well. One reason why these are available is that people aren’t that afraid to simply own ATVI equity, so they haven’t bid up the options as a way to avoid a scary downside.

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