The largest tech deal on record experienced a breakthrough in regulatory hurdles on March 24, 2023, when the UK’s Competition and Markets Authority provisionally found that Microsoft’s proposed acquisition of Activision Blizzard “will not result in a substantial lessening of competition in relation to console gaming in the UK.”
On January 18, 2022, Microsoft announced it would acquire Activision Blizzard in an all-cash deal valuing the company at $68.9 billion, or $95.00 per share. The transaction, if approved by regulators, will make Microsoft the world’s third-largest gaming company (behind Tencent and Sony). In acquiring Activision Blizzard, Microsoft gains control over legendary gaming franchises like Call of Duty, Candy Crush, and Warcraft, as well as ATVI’s 400 million player base. Microsoft also unlocks significant opportunities in the mobile gaming market – the largest and fastest-growing gaming segment.
The deal has been going through multiple regulatory hurdles since it was announced. We wrote about this deal in detail in our January 2023 newsletter titled, InsideArbitrage Special Situations Newsletter: January 2023.
We wrote the following regarding the ‘Regulatory Overview’ of the deal:
On December 8th, the FTC voted 3-1 to file a lawsuit blocking Microsoft’s acquisition of Activision Blizzard. This marks the second major Big Tech suit from the Lina Khan-led agency and establishes a landmark trial over the future of antitrust behavior.
An FTC official stated,
“The lawsuit warns that the deal not only could give Microsoft an upper hand in consoles, but also an unfair advantage in more nascent gaming, such as subscription gaming and cloud gaming… The FTC argues that this deal could dampen innovation in these more nascent gaming markets.”
The biggest concern here is that Microsoft will prevent competitors from offering games like Call of Duty to their player base, which would limit equitable access to content.
There are several points to consider, the first being the gaming industry’s longstanding history of exclusive content. Since the Atari 2600 and the dawn of consoles, exclusives (and variations such as timed exclusives) have been ubiquitous in the industry. This excellent website provides a comprehensive list of exclusive games for different consoles and highlights how commonplace exclusive releases are in gaming.
Furthermore, Microsoft has been working hard to proactively sign agreements and telegraph its intentions not to limit access to Call of Duty. The company has already signed a 10-year commitment to bring Call of Duty to Nintendo platforms and offered the same commitment to Valve and Sony. Gabe Newell, the co-founder of Valve, responded positively to Microsoft’s offer by saying he doesn’t need an agreement as he knows Microsoft will release games on Steam. Only Sony has yet to respond to the proposal.
Microsoft’s president Brad Smith disclosed the Sony offer in a Wall Street Journal op-ed piece, noting that Sony was the “loudest objector” to the deal. Smith also said that the FTC didn’t allow Microsoft to sit with staff to discuss a “legally binding consent decree” to keep Call of Duty on gaming rivals, including Sony.
The FTC’s press release cited Microsoft’s record of acquiring publishers and limiting game access to rivals, specifically the recent Zenimax merger, after which Microsoft made several titles Microsoft exclusives despite assurances to the contrary. However, following the publication of this document, the European Commission corrected the FTC, stating that:
“the conclusion that there are no competition concerns did not rely on any statements made by Microsoft about the future distribution strategy concerning Zenimax’s games.“
The full complaint (which can be read here) further reinforces the growing trend of U.S. regulators bringing long-shot cases to court, even when there is a risk of failure. Antitrust issues are typically brought to court over consumer impacts arising from horizontal acquisitions. According to FTC guidelines: “The key question the agency asks is whether the proposed merger is likely to create or enhance market power or facilitate its exercise. The greatest antitrust concern arises with proposed mergers between direct competitors (horizontal mergers)”. Horizontal mergers represent the standard antitrust case, and the agency has gone so far as to create horizontal merger guidelines that provide the agencies’ analytical framework for determining anti-competitive behavior.
Critically, the litigation against Microsoft’s acquisition focuses primarily on the effects arising from vertical integration – a prosecution angle that is seldom used. In fact, the 2018 DoJ case against AT&T’s $85 billion merger with Time Warner (which the DoJ lost) was the first time an antitrust challenge to a vertical merger was litigated in over 40 years.
Anthony Micheal Sabino, a partner at Sabino & Sabino and a professor at St. John’s University School of Law, believes that prosecuting this case will be an uphill battle for the FTC.
“I think the government still has this knee-jerk reaction, that bigger means bad,” Sabino said. “Will tech mergers continue? Will there be consolidation in the industry? Sure. But I think, again, there’s going to be a higher level of scrutiny.”
On December 22nd, Microsoft released a document responding to the FTC’s complaint against the company. The introductory section arguments are structured around Microsoft’s underdog position in the console and mobile gaming markets, its promise to keep Call of Duty non-exclusive, and its game distribution channels.
On December 17th, the WSJ reported that a hearing would occur in the FTC’s administrative court in August unless a resolution is reached. The FTC’s aggressive response to the ATVI merger was largely expected, as the stock only dropped 1.5% in response to the news and has subsequently traded back up to where it was pre-announcement.
In addition to the pushback from the U.S. regulators, authorities in the UK and EU are also investigating the potential anti-competitive impacts that may arise from the merger. On September 15th, the UK’s Competition and Markets Authority (CMA) referred the acquisition for a phase 2 review and announced an in-depth investigation. Regulators had been meeting with rival Sony and spent weeks deliberating on the transaction. On October 14th, the CMA published its issues statement, which lays out the scope of the investigation.
In response to the CMA’s arguments, Microsoft submitted a lengthy 111-page document addressing each contention in detail. The concerns shared among US, UK, and EU regulators are largely similar, and reading Microsoft’s defense statement provides compelling evidence that the merger stands on firm ground. Among the previous points mentioned above, Microsoft is positioning itself as an underdog in the gaming industry, saying:
“Xbox is the smallest of the three console competitors with less than [20-30]% share worldwide and less than [30-40]% in the UK. The other party, in this case Activision, is only the fifth largest competitor of more than a dozen suppliers competing in the upstream market with less than a [20-30]% share worldwide and in the UK.”
“Activision’s limited share in console publishing (even when combined with Xbox’s own content) is less than [20-30]% worldwide and in the UK combined”
“PlayStation has more than double the MAUs (close to 60 million more) of Xbox.”
This is far from monopolistic, and even competitors such as Tencent’s CEO Strauss Zelnick claim to have no issues with the deal. Zelnick said in an interview with CNBC that: “Generally speaking, I don’t think people are particularly concerned because it remains a fragmented business… We don’t really think the competitive landscape is meaningfully affected in the event that that merger goes through,“
Notably, the CMA also released a summary of the responses gathered from the public relating to the CMA’s issues statement. According to the document, “Of the 2,100 emails that we reviewed, around three quarters were broadly in favor of the Merger and around a quarter were broadly against the Merger.” Seeing this level of public support, and the consensus rationale of those in favor of the merger, provides further evidence that regulators may face an uphill battle in proving the merger is anti-competitive.
The last agency to keep an eye on, the European Commission (EC), opened an in-depth investigation into the merger on November 8th. It has until March 23rd to make a decision, and recently released a ~90-page questionnaire to related parties asking about potential measures Microsoft may take to keep Activision Blizzard’s games exclusive to Xbox platforms.
If the merger closes in June as planned, investors will earn roughly $18.45 per share and realize a stellar 48% IRR (assuming a 6/30 close). The upside of a successful buyout is undoubtedly compelling, but what happens if the regulators block the deal? To answer this question, the following section reviews Activision Blizzard as a standalone company and provides a DCF valuation in addition to sell-side analyst estimates.
On March 24, 2023, the CMA stated that it has received a significant amount of new evidence in response to its original provisional findings. Having considered this new evidence carefully, together with the wide range of information gathered before those provisional findings were issued, the CMA inquiry group has updated its provisional findings and reached the provisional conclusion that, overall, the transaction will not result in a substantial lessening of competition in relation to console gaming in the UK.
The most significant new evidence provided to the CMA relates to Microsoft’s financial incentives to make Activision’s games, including Call of Duty (CoD), exclusive to its own consoles. While the CMA’s original analysis indicated that this strategy would be profitable under most scenarios, new data (which provides better insight into the actual purchasing behaviour of CoD gamers) indicates that this strategy would be significantly loss-making under any plausible scenario. On this basis, the updated analysis now shows that it would not be commercially beneficial to Microsoft to make CoD exclusive to Xbox following the deal, but that Microsoft will instead still have the incentive to continue to make the game available on PlayStation.
Martin Coleman, chair of the independent panel of experts conducting this investigation, said:
Provisional findings are a key aspect of the merger process and are explicitly designed to give the businesses involved, and any interested third parties, the chance to respond with new evidence before we make a final decision.
Having considered the additional evidence provided, we have now provisionally concluded that the merger will not result in a substantial lessening of competition in console gaming services because the cost to Microsoft of withholding Call of Duty from PlayStation would outweigh any gains from taking such action.
Our provisional view that this deal raises concerns in the cloud gaming market is not affected by today’s announcement. Our investigation remains on course for completion by the end of April.
The deal was trading at a large spread of 24.1% or over 48% annualized back in January 2023. After the UK regulators dropped their concerns regarding the deal, the spread has dropped to 12.57% or 47.8% annualized if the deal closes by mid-2023.
Another deal that has been facing regulatory hurdles is the acquisition of iRobot by Amazon. On March 20, 2023, a Politico Report stated that the Federal Trade Commission’s staff attorneys are leaning toward filing a lawsuit to block Amazon’s planned purchase of iRobot.
The Ring cameras and Alexa virtual assistants, have been under consideration based on alleged violations of the Children’s Online Privacy Protection Act. The triangulation of consumer data gathered from “smart homes” by Roomba devices, Ring and Alexa, have also been a matter of concern.
The iRobot deal is being investigated by the European Union for similar reasons. The deal is currently trading at a spread of 39.75% or 109.91% annualized if the deal closes by August 2023.
U.S. Xpress Enterprises (USX)
On March 21, 2023, Knight-Swift Transportation Holdings Inc. (KNX) and U.S. Xpress Enterprises (USX) entered into a definitive merger agreement, under which KNX will acquire USX for $808 million or $6.15 per share in cash, representing a premium of 310% USX’s closing stock price of $1.50 on Mar. 20, 2023.
According to the press release, based on 2022 results, U.S. Xpress is expected to add approximately $2.2 billion in total operating revenue (including $1.8 billion in truckload revenue), 7,200 tractors, and 14,400 trailers to Knight-Swift’s consolidated enterprise. After the transaction, Knight-Swift’s consolidated revenue run-rate is expected to approach $10 billion, while the truckload fleet will have approximately 25,000 tractors and 93,000 trailers.
The current spread on the deal is 3.19% or 9.16% annualized if the deal closes early in the third quarter of 2023.
Merger Arbitrage activity declined last week with two new deals announced, and four deals closing.
You can find all the active deals listed below in our Merger Arbitrage Tool (MAT) which automatically updates itself during market hours.
|Total Number of Deals Closed in 2023||43|
|Total Number of Deals Not Completed in 2023||2|
|Total Number of Pending Deals|
|Stock & Cash Deals||5|
|Total Number of Pending Deals||68|
|Total Deal Size||$583.47 billion|
New Merger Arbitrage Deals:
Shareholders Meeting Schedule:
Weekly Spread Changes:
The table below shows weekly spread changes between March 17, 2023, and March 24, 2023.
|GSMG||0.6921||Cheers Inc (N/A)||123.96%||105.19%||18.77%||All Cash|
|HVBC||28.95||Citizens Financial Services, Inc. (CZFS)||80.4||11.09%||-3.93%||15.02%||All Stock|
|GRIN||11.25||Taylor Maritime Investments Limited and Good Falkirk Limited (N/A)||86.67%||75.15%||11.52%||Special Conditions|
|TCFC||33.91||Shore Bancshares, Inc. (SHBI)||14.52||-0.29%||-5.16%||4.87%||All Stock|
|IRBT||43.65||Amazon (AMZN)||98.13||39.75%||35.71%||4.04%||All Cash|
|TCRR||1.5||Adaptimmune Therapeutics plc (ADAP)||1.1||10.86%||15.97%||-5.11%||All Stock|
|ATVI||84.39||Microsoft Corporation (MSFT)||280.57||12.57%||20.27%||-7.70%||All Cash|
|INFI||0.2||MEI Pharma, Inc. (MEIP)||0.24||25.39%||35.55%||-10.16%||All Stock|
|CEMI||0.39||Biosynex SA (N/A)||15.38%||28.57%||-13.19%||All Cash|
|FHN||16.76||The Toronto-Dominion Bank (TD)||56.55||49.16%||67.45%||-18.29%||Special Conditions|
Top 10 Merger Arbitrage Deals With The Largest Spreads:
Please do your own due diligence on deals with large spreads. Some of these large spreads might be related to regulatory issues or because of the way the deal is structured. We classify some of these deals as “special situation” deals in our merger arbitrage tool and provide additional details to help with the analysis. There may be unique situations related to special dividends, spinoffs, proration, etc. that need to be accounted for when looking at these spreads.
|GSMG||07/11/2022||Cheers Inc (N/A)||$1.55||$0.6921||04/11/2023||123.96%||2827.75%|
|GRIN||10/12/2022||Taylor Maritime Investments Limited and Good Falkirk Limited (N/A)||$21.00||$11.25||03/31/2023||86.67%||6326.67%|
|SAVE||07/28/2022||JetBlue Airways Corporation (JBLU)||$31.00||$16.78||06/30/2024||84.74%||66.95%|
|SIMO||05/05/2022||MaxLinear, Inc. (MXL)||$107.13||$65.12||06/30/2023||64.51%||245.27%|
|TGNA||02/22/2022||Standard General L.P. (N/A)||$24.00||$15.6||05/22/2023||53.85%||344.80%|
|FHN||02/28/2022||The Toronto-Dominion Bank (TD)||$25.00||$16.76||06/30/2023||49.16%||186.93%|
|BKI||05/04/2022||Intercontinental Exchange, Inc. (ICE)||$74.65||$54.58||05/04/2023||36.77%||344.13%|
|ACI||10/14/2022||The Kroger Co. (KR)||$27.25||$20.19||03/31/2024||34.97%||34.40%|
|TSEM||02/15/2022||Intel Corporation (INTC)||$53.00||$41.23||05/15/2023||28.55%||208.39%|
Two new potential Merger Arbitrage deals were added to the ‘Deals In The Works‘ section last week.
SPAC Business Combination
Disclaimer: I have long positions in Oak Street Health (OSH), Activision Blizzard (ATVI), Spirit Airlines (SAVE), First Horizon (FHN), Tower Semiconductor (TSEM), TEGNA (TGNA) and CVS Health (CVS). Please do your own due diligence before buying or selling any securities mentioned in this article. We do not warrant the completeness or accuracy of the content or data provided in this article.