Is Berkshire Hathaway's Activision Blizzard Arbitrage Play In Trouble?
A penny for Warren Buffett's thoughts as European regulators turn the screws on Microsoft's planned purchase of the Call of Duty maker
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Even though Elon Musk and Twitter have succeeded in sucking up all of the oxygen in the M&A arena of late, I’ve nevertheless endeavored to keep a watchful eye on Microsoft’s proposed $68.7 billion move for Activision Blizzard.
Partly because I love the business side of video gaming and partly because Warren Buffett and co. are betting big that this deal will close, as planned, in the first half of 2023.
But, despite Microsoft offering $95 per share for the video game giant, ATVI 0.00%↑ continues to trade well below that number.
And, in recent weeks, Activision stock has even slid into the low $70s — its lowest levels since the acquisition was first announced back in January.
Mr. Market seems to be growing increasingly pessimistic about whether or not this deal will still happen at all…
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How Did We Get Here?
In Q4 2021, Berkshire Hathaway purchased 14.6 million shares of Activision Blizzard.
This relatively modest position was initiated by one of Warren Buffett’s investing lieutenants, Ted Weschler or Todd Combs, and would have likely remained an unremarkable footnote in Berkshire’s portfolio if not for slanted media innuendo about the “perfect timing” of this investment.
In response to these whispers of insider trading — and erroneous reports that Berkshire paid just $65 per share for its Activision stock — Buffett penned an open letter to defend his (unnamed) associate’s integrity.
Here are some of the highlights:
I then told [the Wall Street Journal] that the purchases were made by one of the two investment managers who operate independently of me at Berkshire and that he had acquired about 85% of his position in October, finishing his purchases in November. His average cost was about $77.
To sum up the facts, it was about three months after our manager’s first purchase that Microsoft announced its acquisition proposal of which Berkshire had no prior knowledge.
In any event, the investment manager’s $77 per share purchase could have been replicated after the Microsoft proposal was announced at a price of $78 or so. His purchase was no bonanza of any sort for him or Berkshire.
The story picks up again a few months later at Berkshire’s annual shareholder meeting.
There, we learned that what had started as a smallish long position in Activision had now grown into a sizable merger arbitrage play overseen by Buffett himself.
With ATVI 0.00%↑ languishing in the mid-to-high $70s at the time, Buffett jumped at the chance to scoop up shares in that lower price range — with the expectation of receiving $95 a piece as soon as next year.
As long as nothing scuttles the acquisition, it’s easy money for Berkshire.
In Q1 2022, Berkshire added 49.6 million more shares and then another 4 million in the following quarter. In all, Berkshire now owns 8.7% of Activision Blizzard — meaning that, if everything proceeds as planned, the company stands to turn a $1.2 billion profit when the deal closes.
Oddly enough, even with Buffett’s public “blessing” of the acquisition and its prospects for success, Activision’s stock price has sunk like a stone over the last few months.
At Activision’s current price of $72.66, any brave arbitrageurs would earn more than 30% on a deal that could be done and dusted in the next six to eight months. 👀
Nice work if you can get it.
Why All The Doubts?
Regulatory issues in Europe.
While Saudi Arabia and Brazil have already given the green light to this acquisition, it’s been an entirely different story across the pond.
Most of the worry stems from the Competition and Markets Authority (CMA) in the U.K., who recently ordered a full review of the Activision buy. In particular, the CMA seems quite concerned about how Microsoft potentially making the popular Call of Duty series exclusive to Xbox and Game Pass could harm Sony.
If I’m Microsoft, I feel rather hard done by the CMA for two big reasons:
(1) The British regulator paid little credence to Microsoft’s own history of keeping online-focused games on rival platforms.
Microsoft has acquired intellectual properties like Minecraft, Fallout 76, and The Elder Scrolls Online in recent years — and all of them remained available to play on other platforms afterwards.
If Microsoft hasn’t made Minecraft, perhaps the most popular video game in history, an Xbox exclusive, why the worry over Call of Duty?
(2) All of the focus on Sony ignores the big elephant in the room: Nintendo.
The CMA’s laser focus on how this move affects Sony oddly ignores the actual market leader in the video game space. The Nintendo Switch has done just fine without Call of Duty, routinely crushing both Sony and Microsoft in console and game sales over the past five years.
And Nintendo’s library of family-friendly games — unlike the more mature offerings on Xbox — doesn’t undermine Microsoft’s case. It strengthens it.
There are a million ways to succeed in the video game market and no single game, not even the great Call of Duty, can make or break a company’s competitive chances.
Nevertheless, the CMA still needs more convincing.
And so does the European Commission, which looks certain to follow the CMA’s lead and move its initial investigation into a second phase.
For its part, Microsoft is still striking a bullish tone. Phil Spencer, CEO of Microsoft Gaming, joined the “Same Brain” YouTube channel this week to discuss the latest twists and turns and reiterated his belief that the Activision deal will close before June 30, 2023.
I’m pretty confident in the deal closing. I think [regulators] are asking good, honest questions about a big deal. It’s definitely the biggest deal I’ve ever done.
Hopefully, he’s right.
But you’ll probably want to stay tuned nonetheless.
So Where Does This Leave Berkshire?
Remember: Berkshire was already on board the Activision Blizzard train before it ever became an arbitrage play. So, while Buffett is no doubt rooting for quick regulatory approval on this deal, it wouldn’t be the end of the world if it all fell apart.
Weschler or Combs felt confident enough in the game maker’s future to buy 14.6 million shares last year. There’s no reason to think that their opinion of the company has changed so much in the last twelve months that it’s now Microsoft deal or bust.
And if anyone out there is thinking about jumping in and playing this arbitrage opportunity out for themselves, then godspeed.
I get it: A 30% return in eight months is mighty tempting. Risky, but tempting.
Just be sure that you’re not doing it because of Warren Buffett. Coat-tailing anyone, even a legend like Buffett, rarely turns out well in the end.
I’m reminded of a story that Buffett told Becky Quick in 2015:
One time, when I was in college, I was at an annual meeting [for Marshall Wells] in Jersey City. There were only about four of us there at the meeting and a fellow named Lou Green, who was a very famous figure on Wall Street, said, “Why do you own this?”
I said, “I own it because Ben Graham owns it.”
And he said, “Strike one.”
(Laughs) That was not a good answer, even though Ben Graham was the dean [of security analysis]. You don’t own a stock because somebody else owns it. You own it because you do your own analysis and you decide where you think the future will be.
If you don’t know the answer to that, you don’t own it.
The last thing in the world any investor should do is to own a stock — or invest money in a (risky) arbitrage play — just because somebody else owns it.
Buffett learned not to coat-tail his idol — and we all need to do the same.
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Disclosure: This is not financial advice. I am not a financial advisor. Do your own research before making any investment decisions.