Microsoft’s Gaming Future
Microsoft’s recently sealed acquisition of Activision Blizzard, valued at $68.7 billion, is much more than a simple enlargement of its empire. The purchase, providing Microsoft with around 8.3% of the global gaming market share, underscores a sharp pivot towards vertical integration in the gaming sector, a move that could reap significant rewards in the coming years. This consolidation strengthens Microsoft’s gaming portfolio with top-tier franchises, bolstering its competitive standing in a market projected to swell to $665 billion by 2030.
The gaming industry’s growth is projected to climb a mere 2.5% in 2024, amid formidable competitors like Sony, signalling a fiercely competitive market landscape.
However, I remain optimistic about the underappreciated potential of Microsoft’s gaming division. I believe this segment is set to be a significant growth catalyst, potentially adding approximately $406 billion to the company’s market capitalization. As the gaming industry evolves, Microsoft’s adaptive strategies and innovative approaches will be crucial in harnessing the full potential of its gaming division in 2024 and beyond. I am bullish on the company and the stock and consider it a strong buy.
Microsoft’s Acquisition of Activision Blizzard
Microsoft’s acquisition of Activision Blizzard, announced in January 2022 and valued at $68.7 billion, is a transformative move for its gaming division, propelling the company into a commanding position in the video game software publishing industry. This deal, endowing Microsoft with an estimated additional 8.3% market share in the gaming industry, is a crucial step towards vertical integration in the gaming sector.
By acquiring Activision Blizzard, Microsoft has significantly broadened its gaming studio portfolio, encompassing a range of developers under Activision Blizzard, including Activision Publishing, Blizzard Entertainment, and King, the creator of the hit mobile game Candy Crush. The acquisition also includes rights to prominent franchises like Overwatch, Tony Hawk’s Pro Skater, Starcraft, Crash Bandicoot, and the immensely popular Call of Duty.
Furthermore, the acquisition could have broader implications, including its potential impact on Xbox Game Pass. Analysts anticipate that this move will bolster the Game Pass library with a substantial back catalog and future releases from Activision Blizzard, potentially increasing its attractiveness and subscriber base.
The deal faced regulatory (antitrust) challenges but finally concluded on October 13th last year. This delay impacted the integration of the two firms, but now the merger is back on track. Essentially, Microsoft is only now beginning to realize the benefits, as evidenced by recent developments at CES this month.
What’s New for 2024?
In 2024, Microsoft has intensified efforts to revamp the gaming landscape. The introduction of next-generation Windows 11 gaming PCs, unveiled at CES in collaboration with various PC partners, represents a significant leap forward in gaming technology. Microsoft’s partner PCs boast cutting-edge advancements, including the latest Nvidia GeForce RTX 40 Series GPUs with DLSS 3.5 technology and Nvidia Advanced Optimus, delivering a substantial performance boost and AI-powered graphic capabilities. Notably, this marks the first major gaming PC announcement since the Activision acquisition was finalized.
Similarly, Microsoft is gearing up for a significant refresh of its Xbox Series X console in 2024, codenamed Brooklin. This revamp is expected to feature an all-new design, double the console’s storage capacity to 2 TB, and improved wireless and Bluetooth capabilities. The enhanced console aims to provide a superior gaming experience, aligning with the latest design trends and promising a more sustainable gaming solution. Once again, this marks the first major console refresh since Activision joined the company, likely showcasing the first synergies with the console division.
Finally, Bobby Kotick, Activision’s former CEO, departed from the company on December 29th, signifying the start of the official integration with Microsoft and the anticipated synergies from this acquisition. With Mr. Kotick’s departure, most of the remaining leadership from Activision began reporting to Matt Booty, President of Microsoft Game Content and Studios. Booty was recently promoted to this position in October, following the deal’s closure.
Potential Upside Now That the Deal is Closed
The closure of Microsoft’s acquisition of Activision Blizzard, cemented in October, marks a seminal moment for Microsoft’s expansion in the gaming sector. This positions Microsoft as the third-largest gaming company globally, trailing only behind Sony and Tencent.
With the gaming market forecasted to exceed $655 billion by 2030, Microsoft’s augmented capabilities and resources position it strongly to capitalize on this growth.
The deal faced significant regulatory scrutiny due to its potential impact on the cloud gaming market. Consequently, Microsoft agreed to sell the streaming rights of Activision’s games to Ubisoft Entertainment, ensuring the availability of these titles on non-Windows operating systems for 15 years. This concession was crucial in assuaging antitrust regulators’ concerns and securing approval for the deal. While Microsoft may not solely utilize these games for hardware sales promotions, I anticipate exclusive features only available on the Microsoft hosted versions of Activision titles.
Microsoft’s Gaming Division: Playing with Big Dollars
Microsoft’s internal documents have indicated an ambitious target for its gaming revenue, aiming to reach $36 billion by 2030. However, the figure may seem conservative given the rapid expansion of the gaming industry and Microsoft’s strengthened position post-acquisition.
Valuation: Beyond the Numbers
In my opinion, there are a couple ways to value Microsoft’s gaming division, particularly in the wake of its Activision Blizzard acquisition. Microsoft’s gaming revenue for the fiscal year 2023 was $15.47 billion, a slight decrease from the previous year. However, the acquisition of Activision Blizzard, valued at $68.7 billion, significantly enhances Microsoft’s position in the gaming market, particularly in mobile gaming.
Taking this revenue and applying the company-wide price to sales (11.76) to it gives us a division (forward) market cap valuation of $181.92 billion. However, this does not consider the incremental revenue that Activision will provide. The gaming market is expected to grow from $249.55 billion in 2022 to $665.77 billion in 2030. Assuming that Microsoft maintains the same 8.3% market share Activision has, this implies $34.54 billion in new annual revenue.
Considering this, and applying the forward price-to-sales multiple of 11.76 to the projected gaming revenue, we can estimate a potential valuation bump to Microsoft of approximately $406.26 billion from Microsoft’s gaming division alone. This implies 14.2% upside to Microsoft’s market cap (assuming no share buybacks which they will likely have). Share buybacks will only increase the upside potential here in my opinion.
While this estimate is for 2030 revenue, I think this is a conservative estimate in that it does not include the revenue Activision brings in now, no new market share like I think will happen, and no new incremental hardware sales from Xbox because it has an even better suite of games on it because of the acquisition.
Risks to Thesis: Turning Challenges into Opportunities
Unfortunately, the broader gaming market is experiencing turbulence. Some analysts estimate that the market in 2024 will only book 2.5% growth. They’re attributing the modest growth to a weaker gaming title release slate compared to previous years and macroeconomic pressures.
In this case, I’m not particularly worried. Reports have come out that Microsoft could launch their new Xbox X console. This console will likely cause a hardware upgrade cycle boost and with its new game sales. There is even a scenario where Activision (under Microsoft) gains market share (from the 8.3%) as people use the new Xbox as a catalyst to buy more Activision games.
Takeaway: Looking Ahead
Microsoft’s strategic maneuvers in the gaming industry, through the acquisition of Activision Blizzard, represent a significant growth opportunity that I think will come into view in 2024.
While the gaming industry’s growth rate, predicted to be modest this year in comparison to previous years, gives me pause, I think Microsoft has a unique trick up their sleeve with respect to their new Xbox rollout.
With a potential marginal market valuation of approximately $406 billion from the gaming division alone, it stands as an underappreciated asset within Microsoft’s diverse portfolio. Leveraging its bleeding edge tech in other places, Microsoft is poised to dominate a new market: gaming. The stock is a strong buy.
