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It's the Subscriptions, Stupid: Microsoft Buys Activision
One of the more intriguing and attractive facets of tech titans like Microsoft, Apple, Amazon, and Alphabet is their newfound propensity to hoard cash. Between just the four of them, they’re sitting on north of $400 billion in cash and other short-term equivalents.
What inspired this yen for saving? It’s a fair question. Wall Street rarely rewards companies for cash-rich balance sheets, preferring to see that money used to chase growth. Sadly, financial security doesn’t set investors’ hearts racing in quite the same way. So you can cross price appreciation off the list.
The real answer is freedom. To do whatever you want to do, whenever you want. Maybe Apple prefers to reward investors by aggressively buying back shares. Or Alphabet likes keeping debt to an absolute minimum. Or Microsoft gets the urge to throw on a safari outfit and do a little big game hunting1.
And, last week, Microsoft did just that.
Microsoft announced plans to purchase gaming giant Activision Blizzard in an all-cash deal worth $68.7 billion. When the deal closes in 2023, $ATVI investors will receive $95 per share — a cool 46% premium over the previous day’s price — while Microsoft’s $130 billion cash pile gets cut in half. Big acquisitions are never easy, but it certainly helps when the buyer doesn’t have to scrounge around in the couch cushions to come up with the money.
Some see the purchase of Activision as a metaverse play, but the truth seems far simpler: it’s the subscriptions, stupid2.
When Satya Nadella took over as Microsoft CEO in 2014, he quickly pivoted some of the company’s top products into software-as-a-service. That’s business speak for software that’s licensed on a subscription basis and used through the cloud. Instead of asking customers to shell out big bucks for a new edition of Microsoft Office every few years, it’s now offered as a continuous, online service at a lower, annual price. Just enter your credit card deets and receive a lower upfront cost and the promise of more frequent updates and better security. Meanwhile, Microsoft gets recurring revenue pouring in each month. Everybody wins.
In the last five years, Microsoft’s revenues nearly doubled and net income rose from $25 billion to $61 billion. Even better, the company’s free cash flow clocked in at an impressive $56.1 billion in 2021. With numbers like those, it won’t take Nadella and co. long to replenish Microsoft’s cash pile after the Activision purchase closes.
So you can probably imagine how anxious Microsoft is to bring this new, subscription-based business model to its Xbox gaming division. The immediate payoff from Activision will be to Microsoft’s Xbox (and PC) Game Pass subscription service. Launched in 2017, Game Pass offers Xbox and PC users unlimited play of participating first- and third-party games through either download or streaming. That includes smash hits like Halo Infinite, Gears 5, and DOOM Eternal among others. All for $14.99 per month3.
Since most major gaming releases retail for around $60-70 a piece, the savings with Game Pass add up fast. So fast, in fact, that Game Pass users grew by 39% in 2021, to bring the current subscriber base up to 25 million. Gamers know a good deal when they see one.
But so does Microsoft. 25 million subscribers means hundreds of millions of dollars flowing into Redmond each month. And that’s before Activision titles get added to the service in 2023. Game Pass’s growth ain’t even close to slowing down.
Speaking of Activision titles, check out this murderer’s row of top sellers: Call of Duty, World of Warcraft, Diablo, Guitar Hero, Crash Bandicoot, and Overwatch. Add in ZeniMax/Bethesda4 blockbusters like The Elder Scrolls, Starfield, Fallout, DOOM, and Wolfenstein and suddenly Microsoft’s dream of building the “Netflix of gaming” doesn’t seem so farfetched any more.
Even the slightest possibility of Call of Duty becoming an Xbox/PC exclusive registers pretty high on gaming’s Richter scale. Call of Duty: Vanguard and Call of Duty: Black Ops Cold War were the two best-selling games in the United States in 2021. Now, they — and their many sequels to come — will be on Game Pass. Maybe exclusively. It doesn’t get much bigger than that.
In one fell swoop, Microsoft becomes the third-largest gaming company (by revenue) in the world behind Tencent and Sony. More importantly, though, the Activision purchase comes at the right time, at a decent price, and perfectly fits into the company’s overall strategy of monetizing software and services through subscriptions.
Something to consider5: $ATVI continues to trade well below the agreed-upon $95 purchase price, revealing some lingering concern from market participants that this deal might still fall apart for antitrust reasons. Big Tech is certainly in D.C.’s crosshairs these days, but Microsoft has mostly floated above the fray. Plus, we’re not exactly talking about a gaming monopoly here. Every analyst I’ve seen pays lip service to these antitrust concerns, but expects the deal to go through nonetheless.
When it does, Microsoft will be partying like it’s 1995.
Warren Buffett’s metaphor for making a huge acquisition. No animals were harmed in the writing of this story.
To paraphrase James Carville.
Game Pass also offers a lower tier at $9.99 per month that doesn’t include cloud play.
Microsoft purchased ZeniMax Media, one of gaming’s largest publishers, in 2020.
Obligatory disclaimer: This is not financial advice. I am not a financial advisor.