More than one year after my original analysis about the proposed acquisition of Activision (NASDAQ:ATVI) by Microsoft (NASDAQ:MSFT) they have yet to close the landmark deal, which would be Microsoft’s largest to date. The delay is clearly not due to a lack of effort as Microsoft and Activision have been battling it out with regulatory authorities worldwide. This week Microsoft suffered a major setback as the UK’s Competition and Markets Authority blocked the sale which may result in Microsoft fully abandoning its efforts to acquire the gaming company.
As a Microsoft shareholder, I would still like to see the deal go through, but based on my analysis I may be one of the few authors on SA who believe the CMA is right to fear Microsoft’s consolidation of the cloud gaming market. More on this later.
First, let’s take a look at the charts
Following the CMA’s announcement Activision’s share quickly tanked, dropping more than 10% in just a few hours. In the days following the announcement, its shares stabilized at around $77-78 a share but that’s still a far cry from Microsoft’s proposed purchase price of $95 a share.
While Activision’s share price took a dive Microsoft experienced just the opposite, shooting up at a rapid clip due to its upside earnings surprise and renewed strength in mega-cap tech stocks in general.
While I am not an M&A expert, I can add some value by discussing the potential benefits Microsoft and Activision could gain from them finally closing on this deal and help shed some light on why the CMA may be so concerned.
Overview: The Growth of Real-Time Interactive Experiences
To understand why Microsoft was interested in Activision in the first place let’s start with a discussion about the video game industry, what makes it attractive, and what makes it such a challenging space to operate in.
First, on a positive note, the video game industry is massive and growing.
What started as a niche industry targeting children and tech enthusiasts exploded in popularity worldwide as consumers gravitated to new forms of entertainment powered by increasingly powerful technology. Long gone are the days when video games entailed playing Snake on your Nokia, now with just a headset our mobile phones can be used as virtual reality devices where we can interact in real-time with friends from all over the world.
Or maybe VR is not your speed, there are other games that are closer to interactive movies whereby the player can make decisions that have the potential to radically change the direction of the story. Detroit Become Human, has the player take the role of a detective where the choices they make determine if key characters live or die.
It’s my fundamental belief that we are moving to a world where entertainment becomes increasingly real-time generated, 3D, and interactive. These are all tailwinds benefiting the industry.
Such a massive shift in consumer preferences will create winners and losers. In my opinion, those that have the most to lose are the legacy providers of popular 2D content (movies + TV).
One of the largest of these companies, Netflix (NFLX), seems to be aware of this threat and is trying to adapt to remain relevant. In years past they launched interactive media experiences like Black Mirror Bandersnatch, a scripted live-action movie where watchers are asked to make real-time decisions about things like what cereal the character eats or what music they should listen to on the bus all the way up to some very big decisions… (which I will not spoil here!)
But beyond interactive movies, Netflix is making other moves in the interactive media space, notably their growing free games offering that is included in your Netflix subscription. But judging by the lack of news coverage, and what I’ve heard about the offering anecdotally I would venture to guess that Netflix’s games offering is off to a challenging start.
But Netflix does have one big head start, a huge customer base paying into a recurring revenue model.
The Power of IP
But a large subscriber base is not all that one needs to run a great media empire. Another challenge that Netflix has no doubt been feeling is the power of strong IP. As great as a huge subscriber base is Netflix simply lacks IP with the same clout as Disney’s Star Wars or Nintendo’s Mario.
The power of strong IP is clear, just look at the new Super Mario Bros movie which is already one of the all-time highest-grossing movies. Releases like Tiger King, Stranger Things, and Love is Blind, just can’t hold a candle to the strength of established IP.
It looks like Microsoft has learned the same lesson, IP is powerful. That’s likely a big part of the reason why they were attracted to Activision which has some of the highest-grossing IP in the industry vis-a-vis Call of Duty, Candy Crush, and many others.
Leveraging strong IP increases your chance of successful launch across all forms of content, from video games, to movies, to TV, to music.
IP is not a Silver Bullet
As essential as strong IP is, it’s not enough on its own to create a sustainable business that generates strong returns for shareholders, at least not usually.
You don’t have to look far for examples of this, even Activision itself has seen wildly fluctuating returns depending on the success of individual call-of-duty launches. Or alternatively, in the movie industry, massive commercial flops can torch hundreds of millions of dollars, even those based on strong IP like several of the latest Marvel movies.
When you are subject to the rapidly evolving tastes of consumers your financial success is dictated by whether you are able to hit that mark or not. And sometimes, despite best efforts, that mark is horribly missed.
The movie industry was slow to adapt, but Netflix forced them to. Now nearly all large movie studios own or have deals with a larger streaming service to get to lose lucrative recurring revenues.
But the video game industry has been even slower to adapt, in many ways it operates close to how it always has. Numerous individual studios invest huge resources into individual game launches and consumers buy the product one time. You can point to in-game purchases/DLC as positive steps in the right direction (at least positive for investors) but in the console market and PC market the industry is still overwhelmingly reliant on cranking out hit after hit.
As a caveat, the same cannot be said for mobile gaming which is largely built on a model of free-to-play games with recurring in-game purchases.
A Microsoft X Activision Combo could fundamentally reshape the industry
That’s where Microsoft and Activision come into the picture, I believe that the combination of these two could fundamentally reshape the industry, and that’s not me being hyperbolic, it’s my genuine belief. Here’s why:
Rolling in all of Activision’s IP into the Xbox Game Pass would combine all secret ingredients, powerful IP, a recurring model, and a massive audience could cement its position as the place to go for gaming.
Let’s take one hypothetical example to illustrate how this could drive value. Imagine a casual gamer, let’s call him ‘Kyle’, he only plays one game, the same game all his friends have, Call of Duty. The game, on its own, costs $70 a year. Let’s imagine Microsoft comes in with an aggressive offering, for $10 a month and you get access to all their games, new releases, and updates across your console, and mobile device. For each ‘Kyle’ that Microsoft can convert to its service, they earn more than 70% more than before ($120 a year vs $70). It becomes easier, and easier to convert more of these consumers as the portfolio of gaming properties on the service grows.
Given the strong profitability of its Azure cloud portfolio Microsoft can afford to invest heavily to make sure that the most important, most desirable games are on its platform. And if they wanted to, they have enough cash to continue the gaming shopping spree. If the deal is ultimately blocked, I think Microsoft will likely shift its sights to another studio.
Apart from Take Two’s Grand Theft Auto, and Nintendo, it’s hard to think of any other company with gaming IP anywhere near the quality possessed by Activision.
If they really wanted to, and I’m not suggesting they would do this, but if Call of Duty were made exclusive to Game Pass I believe they really could crush Sony, perhaps that is why the CMA is so fearful of the deal closing. Microsoft for its part, promises not to do that, but it’s easy to understand the threat that could pose should they go back on their word.
A brief word on the financials
Microsoft continues to execute on its cloud and office suite strategy, its Teams app continues to take share from Slack, showing off the power of the bundle. Azure, another growing category for Microsoft, is firing on all pistons, revenues have been stickier than many expected during the slowdown that started in 2022.
Revenues and EPS
After a slow decade of growth under prior CEO, Balmer, Satya Nadella has ushered in a new era of growth. Both revenues and EPS continue to grow despite macro challenges. Cloud helped Microsoft get to this point, but I believe that gaming could unlock that next leg higher if the Activision deal closes.
Return on Invested Capital
Unsurprisingly returns on capital have been strong, constantly generating doubt digits returns since the turn of the decade. As the cloud computing market matures I would expect these returns to moderate. Again, cloud gaming and its recurring revenues represent a potential catalyst to juice these levels over the coming decades.
Dividend and Buyback
As someone who is generally neutral regarding capital allocation, I don’t normally pay too much attention to dividends and buybacks as specific indicators in their own right. With that caveat, they can provide some indication to investors that management views the shareholders as owners that should be paid, not just third-party observers. They can also provide a sense of safety during times of increased market volatility and help nervous investors calm their nerves as they see the quarterly dividend check come in.
Microsoft and Activision are winning the competition, the combination of the two would make them the clear leader in the cloud video game subscription market. They could transform an industry reliant on mega-hits, to one based on recurring cashflows as subs become stickier over time.
Now all that’s left is for the transaction to be pushed over the finish line if regulators will get out of the way. Again, I am no legal expert, and this is purely speculation but I believe Microsoft will look to sue to push through the transaction. Given how fragmented the gaming market is it will be hard to prove this transaction is so anti-competitive to the extent that it should be banned. That said, I am not an arb-trader, but I will hold my Microsoft shares for the long term.
I rate Microsoft stock a Buy.
I hope you enjoyed reading my article, if you have any questions or have another viewpoint you wish to share feel free to let me know in the comments. Have an amazing day!
iOS 17 beta 1 offers an overhauled Apple Translate app that is more straightforward and easy to use. The redesign is available on iPadOS 17, too.
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WWDC is our favorite time of the year for many reasons. Not only do we get to try out the upcoming major updates to Apple’s operating systems, but we also sometimes get fresh hardware releases. This time around, we witnessed the debut of Apple’s Vision Pro, some new Mac models, iOS 17, iPadOS 17, macOS Sonoma, and watchOS 10. And while the Cupertino firm has provided the public with a comprehensive list of what’s new in these releases, many additions remain undocumented publicly. For example, we have just discovered that iOS 17 beta 1 redesigns the built-in Apple Translate app. The new user interface offers more intuitive controls, making the application more straightforward and easy to use.
As our screenshots above reveal, Apple Translate on iOS 17 beta 1 (right) is cleaner than that on iOS 16 and earlier versions (left). The new design simplifies the entire section, making it both more intuitive to operate and easy on the eyes. As someone who tries to rely on Google services as little as possible, I had always found Apple Translate unintuitive to use when compared to its Google counterpart. Through the iOS 17 update, users finally get to enjoy a more direct app.
For example, Apple Translate on iOS 16 continues to shift between the two selected languages, making it hard to tap on the right field straightaway. Furthermore, dismissing a translated phrase to type another one was also a pain. On iOS 17, pretty much all of my concerns have been addressed in the Apple Translate app.
While Google Translate remains superior in terms of translation accuracy and language availability, Apple Translate can handle my occasional translation needs just fine. And thanks to this overhaul, I feel even more motivated to depend on it and ditch Google’s solution completely. We can only hope that this design makes it to the final release in September, as Apple could change its mind at any given moment.
Launched during the company’s annual World Wide Developers Conference (WWDC) in Cupertino, Calif., the Apple Vision Pro is a wearable headset. The device will be capable of toggling between virtual reality (VR), and augmented reality (AR), which projects digital imagery while users still can see objects in the real world.
It can be used for immersive experiences in everything from work meetings and FaceTime, to photos, movies and apps.
“Today marks the beginning of a new era for computing,” said Apple CEO Tim Cook.
The headset, which Apple says will be available in 2024, won’t be cheap, starting at $3,499 US, or about $4,700 Cdn.
Apple unveiled its first new product since the Apple Watch in 2015. The Vision Pro VR headset lets users blend augmented reality with everyday life, but its $4,700 Cdn price tag may be a tough sell.
“VR kind of resurfaces every 10 years or so as the big thing,” Alla Sheffer, a professor of computer science at the University of British Columbia whose research areas include virtual and augmented reality, told CBC News. “And then it goes away.”
The question on many people’s minds: is this time different?
What’s the difference between VR and AR?
To grasp the technology’s implications, it helps to understand the technology itself. Traditional virtual reality is a computer-generated environment. Typically, a user wears a head-mounted display or headset like ski goggles, Sheffer explained. But instead of looking through those goggles, users see a display.
“You only see the virtual content. You don’t see the outside world,” Sheffer said.
VR also includes capture setups, and software that responds to them: think, for example, of a virtual reality golf game where you’re moving your hands, and that’s captured automatically and translated into a gesture using a virtual golf club.
There are two types of augmented reality, Sheffer said: head-mounted display, and cell phone. With head-mounted display AR, imagine you’re wearing the same ski goggles, but now they’re transparent. You can see what’s in front of you in the physical world, but you can also see what’s on the screen.
Cell phone AR, Sheffer explained, combines what you see on your phone’s camera with virtual elements. Imagine choosing a couch model on a retail website, and seeing it in your living room through your phone’s camera.
“You probably interact with AR a lot and don’t realize it,” said Bree McEwan, an associate professor at the Institute of Communication, Culture, Information and Technology at the University of Toronto, and the director of the McEwan Mediated Communication Lab.
Pokemon GO, Snapchat, TikTok filters and even Google Maps already utilize AR, McEwan said.
What already exists in this sphere?
The Vision Pro combines both VR and AR in one device, McEwan and Sheffer explained. But Apple is far from the first company to venture into the virtual and augmented worlds.
There are a number of VR headsets already on the market, including Meta’s Oculus Quest 2 and Pro. Its Quest 3 is set to launch later this year, starting at $499 US or about $667 Cdn. That device will feature colour mixed reality, which combines augmented and virtual reality elements, according to CEO Mark Zuckerberg.
Meta’s Quest 2 and Quest Pro devices comprised nearly 80 per cent of the 8.8 million virtual reality headsets sold in 2022, according to an estimate by market research firm IDC. Still, Meta has struggled to sell its vision of an immersive “metaverse” of interconnected virtual worlds and expand the market for its devices beyond the niche of the gaming community.
A pilot project at Reddam House School in Berkshire, England, has students using VR headsets in the classroom to learn traditional subjects in a new way. Petting woolly mammoths, holding planets in their hands, and examining the human heart are just a few of the experiences students have in this future-facing take on education.
It’s also used for interpersonal skills and public speaking training, McEwan said. Education is another major opportunity, she added. In one of the classes she teaches, McEwan gives students headsets and they do five weeks of classes virtually. It’s a model she started utilizing during COVID, instead of using Zoom.
Screen-based AR is already used in several industries, such as warehousing and manufacturing, Sheffer said, where you can point your camera at an object and a recognition software identifies it.
So, is the future virtual?
McEwan sees a potential future for headsets in the business sphere, and predicts more organizations may start providing them for meetings and training. And if people get comfortable using something in a business setting, that may bleed into the social environment, she said, noting that’s what happened with e-mail and intranet messaging systems.
But while there’s what she calls a “cultural imagination,” for popping a device on your head and appearing in the metaverse, she said we’re not there yet. “The average person is probably not quite ready to jump into VR all of the time.”
Whether or not headsets are going to finally take off is what Sheffer calls “the billion-dollar question.” VR had surges of popularity over the last several decades, but people didn’t want to wear the headsets, she said.
“I think if anyone can make it, it’s Apple,” she continued. “If they can make the headset convenient, and make people want to wear it, then all of the sudden this can go places.”