The Gaming Landscape and the Impact of the Acquisition
On October 13th, Microsoft officially acquired Activision Blizzard for $68.7 billion. This acquisition, the largest in the history of the global tech industry, is poised to reshape the entire gaming landscape. However, such a massive acquisition was no easy feat. Microsoft endured nearly two years of protracted antitrust battles in the United States, the European Union, and the United Kingdom, overcoming Sony's relentless opposition to reach this point.
Today, let's delve into this landmark acquisition within the context of the global gaming industry, exploring the fascinating and often cutthroat game of chess between Microsoft, Activision Blizzard, market players, and regulators worldwide.
This video will be divided into two parts:
- An overview of the gaming industry's landscape and the acquisition's role within it.
- A detailed examination of the acquisition itself. (You can skip to this part if you want to get straight to the juicy bits.)
While Activision Blizzard might not be a household name for those unfamiliar with gaming, many have likely heard of their games. Iconic titles such as World of Warcraft, Call of Duty, Candy Crush, Hearthstone, Overwatch, StarCraft, and Diablo all fall under the Activision Blizzard umbrella. They are undeniably a core player in the gaming industry.
Looking solely at financial data, Activision Blizzard's performance might not appear particularly impressive. Their 2021 revenue was $8.1 billion, placing them seventh globally among game companies. However, consider the top contenders: Tencent, Sony, Apple, Microsoft, and Google. These are all comprehensive tech giants that leverage their platform advantages to penetrate the gaming market. Activision Blizzard stands out as a company that has risen through the ranks organically, delivering hit after hit.
Once combined with Activision Blizzard, Microsoft's revenue surpasses Apple and Sony, propelling them to second place, trailing only Tencent.
The successful acquisition has significant implications for the entire gaming industry. The gaming industry can be broadly divided into two segments: developers (game creators) and publishers (platforms and distribution channels). Initially, these two segments operated independently. However, as the industry evolved, a power imbalance emerged, gradually tilting in favor of the platforms.
With countless games available, the developer side faces intense competition. Conversely, only a handful of major platforms exist. Moreover, game development costs have skyrocketed, with AAA titles like Cyberpunk 2077 and Call of Duty requiring billions of dollars and three to five years of development time. These escalating costs put developers at a disadvantage when negotiating with platforms.
Platforms, armed with vast user bases and capital, started to integrate vertically, controlling every link in the chain from development to distribution. This allows them to capture profits at every stage. Some companies even adopt an exclusive strategy, restricting their games to their own platforms. Nintendo exemplifies this approach, with 81% of its Switch platform revenue generated from its own games.
This brings us back to the top-grossing companies mentioned earlier—each one leverages its platform's user base. So why would Activision Blizzard, with its treasure trove of IP, willingly agree to be acquired?
The answer lies in their precarious position amidst these platform giants. With each platform prioritizing its own games, Activision Blizzard's profit margins were squeezed. Coupled with recent legal troubles, they recognized the industry's shift toward platform dominance. They concluded that aligning with a powerful player was a more favorable option, leading them to accept Microsoft's offer.
These platforms aren't engaged in a chaotic free-for-all. Each has its primary battleground. Tencent, Apple, Google, and NetEase predominantly focus on mobile gaming. Microsoft's true competitors are Sony and Nintendo, the "Big Three" of the console gaming world.
In terms of market share, Sony's PlayStation (PS) commands roughly half, while Microsoft's Xbox and Nintendo's Switch each hold about a quarter. Sony reigns supreme after two decades of competition. However, no single player has achieved complete victory. Nintendo, with its relatively closed ecosystem, enjoys a more independent user base. The real rivalry exists between Sony and Microsoft, with their respective consoles, the PS and Xbox, sharing a significant overlap in users and games.
Both companies have been locked in a head-to-head battle for over a decade. They are also the key players in the acquisition saga we're discussing. In recent years, both have been developing subscription services akin to a gaming-focused Netflix. For a monthly fee, members gain access to a library of games. In this model, the quantity and, more importantly, the quality of games available are paramount. This explains Microsoft's willingness to invest heavily in acquiring Activision Blizzard.
Sony's alarm at the announcement of the acquisition is understandable. It signifies more than just Microsoft's expansion. Activision Blizzard possesses a crucial asset, Call of Duty, which is not only their flagship IP but also a significant revenue generator for Sony.
Call of Duty is arguably one of the most commercially successful IPs in gaming history. Its importance to Sony cannot be overstated. Sony itself admitted that Call of Duty generated $1.5 billion in revenue for them in 2021 alone. Leveraging its dominance in the console market, Sony secured an exclusivity deal with Activision Blizzard, ensuring that the latest installment of Call of Duty would remain exclusive to the PS platform until the end of 2023.
Just as Activision Blizzard and Sony were seemingly enjoying a mutually beneficial relationship through Call of Duty, Microsoft entered the scene.
The acquisition's success would inevitably spell the end of Sony's exclusivity deal. Worse, should Microsoft make Call of Duty an exclusive title, Sony could witness a mass exodus of PS users, potentially jeopardizing their leading position. Understandably, Sony vehemently opposed Microsoft's acquisition of Activision Blizzard.
Under normal circumstances, if the market leader wanted to prevent a merger, they could simply outbid the competition. However, in this case, while Sony may wield greater influence in the gaming industry, they pale in comparison to Microsoft's financial muscle. Simply put, Sony couldn't afford to acquire Activision Blizzard. In fact, they weren't even close.
Sony's options were limited. Currently, only a handful of global tech companies—Microsoft, Google, potentially Samsung, and Alibaba—possess the necessary cash reserves. Even Apple and Tencent lack the financial capacity for such an acquisition, let alone Sony.
The Antitrust Tug-of-War
Microsoft's acquisition of Activision Blizzard wasn't a simple merger of two willing parties. Acquisitions of this magnitude typically undergo rigorous antitrust scrutiny. To understand this, we need to clarify the concept of antitrust law. What exactly does it oppose? It's not simply about a company's size. If that were the case, wouldn't Google's search engine, with its near-monopoly, be broken up?
Google treads carefully, ensuring they don't stifle competition. They maintain that their success stems from their superior product. While competitors exist, Google argues that their dominance is a result of consumer choice, not unfair practices. However, if they were caught manipulating their algorithms to suppress competitors' content or promote negative news about them, that would constitute clear evidence of anti-competitive behavior, inviting immediate legal action.
Antitrust law, therefore, doesn't target size itself but rather actions that hinder competition.
So, who scrutinizes these companies for potential antitrust violations? In this case, the primary actors were the antitrust divisions of the United States, where both companies are based, and other regions where they operate, such as the EU and China. If any of these entities determined that the merger violated their respective antitrust laws, the acquisition would be halted in those jurisdictions.
Naturally, Microsoft aimed for a smooth acquisition of Activision Blizzard. To achieve this, they needed to secure antitrust approval in all major regions where they operate. While most countries, including China, South Korea, Brazil, and even Japan, raised no objections, the primary points of contention emerged in the United States, the European Union, and the United Kingdom.
Microsoft faced the daunting task of convincing regulators in all three regions that their acquisition wouldn't harm market competition. Conversely, Sony's objective was to demonstrate to these regulators that Microsoft's intentions were far from noble, that they were, in essence, a wolf in sheep's clothing.
Assessing whether a company hinders competition, especially predicting future behavior, is inherently subjective. It's similar to judging a couple's future compatibility before marriage. How do you define "good" in this context?
Therefore, regulatory bodies rely on subjective assessments based on past actions and statements, scrutinizing emails and public pronouncements to determine whether the acquisition signals an intent to stifle competition.
Market sentiment often reflects this perception. When the acquisition was announced, Activision Blizzard's share price stood at approximately $65, while Microsoft's offer was $95. Ideally, if investors believed the acquisition would succeed, Activision Blizzard's share price should have immediately risen to $95. Conversely, if they deemed it unlikely, the price would have remained stagnant.
In reality, Activision Blizzard's share price jumped to $81 after the announcement and stabilized around $80. This suggests that the market initially estimated a 50/50 chance of success. Stock markets are incredibly efficient at reflecting market sentiment. After all, money is the most honest and swiftest indicator.
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Let's return to the initial market sentiment, which indicated a 50/50 chance of the acquisition's success. The stage was set for a fierce competition between Microsoft and Sony.
Anticipating a challenging path, Microsoft had strategically allotted an 18-month window for the acquisition, setting the merger date for July 2023. However, they underestimated the protracted nature of this battle.
As expected, following preliminary reviews, regulatory bodies in the US, EU, and UK initiated antitrust investigations. In June 2022, the UK's Competition and Markets Authority (CMA) announced an inquiry into the acquisition. The EU followed suit in September 2022, and in December 2022, the US Federal Trade Commission (FTC) filed a lawsuit to block the deal. Thus, Microsoft's antitrust battle commenced on three fronts.
The first blow came from the EU. On February 3, 2023, the European Commission expressed concerns that the acquisition would grant Microsoft an incentive to make Call of Duty exclusive to its platforms, harming competition. Activision Blizzard's share price dipped in response.
On February 21st, the EU held a closed hearing, summoning Microsoft, Activision Blizzard, and Sony. Leading up to this hearing, the companies had engaged in public exchanges, but the hearing itself reportedly witnessed a complete breakdown of decorum.
Jim Ryan, the head of Sony PlayStation, declared in court, "I don't want a new Call of Duty deal. I just want to block this acquisition." His statement revealed Sony's underlying concern: Microsoft's potential future actions regarding Call of Duty were secondary to the threat posed by the acquisition itself.
Sony's relentless opposition put Microsoft on the back foot. However, Microsoft had been quietly making moves behind the scenes. Over the preceding year, they had diligently secured game-sharing agreements with other gaming platforms, guaranteeing the availability of Activision Blizzard's Call of Duty on their platforms for the next decade.
Nintendo and Nvidia, the other two major gaming platforms, eagerly signed agreements, delighted at the prospect of effortlessly adding Call of Duty to their libraries. While Microsoft offered Sony the same deal, they steadfastly refused.
During the EU hearing, Microsoft confidently presented their agreements with Nintendo and Nvidia, demonstrating their commitment to fostering competition. This strategic move, coupled with their seemingly sincere attitude, significantly appeased the European Commission. They effectively addressed the concerns surrounding the acquisition.
This first round went to Microsoft, and Activision Blizzard's share price stabilized.
As a reminder, Microsoft's offer price for Activision Blizzard was $95 per share. Ignoring market fluctuations, the closer the share price was to $95, the higher the market's confidence in the acquisition's success.
Next, let's shift our attention to the UK front, specifically the CMA. In January 2023, shortly before the EU's hearing, the CMA hinted at potentially blocking the acquisition. However, following Microsoft's display of goodwill through its agreements and lobbying efforts, the CMA softened its stance. In March, they stated that their analysis suggested that making Call of Duty exclusive would be "loss-making" for Microsoft, implying that Microsoft had an incentive to share the game. This, they argued, indicated that the acquisition wouldn't stifle competition.
Activision's stock surged by 5% that day, and Microsoft celebrated, believing they had secured a crucial victory. However, Sony, known for its tenacity, wasn't finished. They publicly criticized the CMA's support for Microsoft, arguing that while the PlayStation was superior to the Xbox, the acquisition could prompt consumers to switch to the Xbox solely for Activision Blizzard games. This, they claimed, would distort market competition.
Sony also employed a rather petty tactic: their executives severed all contact with Activision Blizzard and Microsoft. Calls and emails went unanswered. It was a clear message: "We see through your charade, and we won't engage in any backroom dealings."
A month later, the CMA executed a stunning reversal. On April 26th, they ruled against the acquisition, deeming it anti-competitive. This decision sent shockwaves through the market. No one anticipated the CMA's about-face.
Ironically, their justification for the decision was even more perplexing. The crux of the debate between Microsoft and Sony revolved around the console market and the potential for stifled competition. However, the CMA dismissed concerns about the console market, stating they found no evidence of harm.
Instead, they shifted their focus to cloud gaming, alleging that Microsoft could leverage the acquisition to dominate that market. They argued that Microsoft's ownership of Xbox, Windows, and Azure, coupled with Xbox's cloud gaming subscription service, gave them a 60-70% market share in cloud gaming. The acquisition, they claimed, would incentivize Microsoft to monopolize Activision Blizzard's cloud gaming offerings, hindering innovation and competition.
While their argument held some merit, labeling the CMA's approach as disingenuous is appropriate. Cloud gaming, at that time, was a minuscule and immature segment, representing a mere 1% of the global gaming market.
Despite facing widespread criticism, including from UK Prime Minister Rishi Sunak, the CMA stood by its decision. This marked a significant setback for Microsoft, a "catastrophic defeat" in their own words. The UK's stance threatened to influence decisions in the EU and US.
Brad Smith, Microsoft's President, expressed his disappointment, stating, "This is probably the darkest day in our four decades of operating in Britain. The English Channel has never looked wider."
However, he also hinted at his next move, remarking, "If you want to bet on Europe, you bet on the European Union over the United Kingdom." He subtly praised the EU while criticizing the UK.
Despite the CMA's controversial decision, there was a silver lining for Microsoft. The EU remained optimistic about the deal. On May 15th, they approved the acquisition, albeit with conditions. Microsoft was required to ensure fair treatment and equal access to its cloud services, prohibiting any exclusivity deals. Essentially, they were instructed to keep their word.
The EU's approval was largely anticipated following the previous hearing, so the stock market remained relatively stable. However, Sunak's spokesperson took the opportunity to criticize the CMA, stating that while the UK had left the EU, they wouldn't deviate from their approach and remained a welcoming environment for tech companies. This was a thinly veiled jab at the CMA's decision.
While Microsoft planned to appeal the CMA's ruling, the matter wasn't settled yet. Let's now turn to the primary battleground—the United States.
The US antitrust authority, the FTC, differs from its EU and UK counterparts. Their role is to investigate potential violations and present evidence to a court. The final decision rests with the court, not the FTC.
However, the FTC is not to be underestimated. They actively seek out potential antitrust cases, targeting even the most prominent companies and acquisitions to prove their worth. For instance, they successfully blocked Nvidia's attempted acquisition of Arm, a leading chip designer. Undeterred, Arm swiftly shifted gears and opted for an IPO, becoming one of the largest public offerings of that year.
Given their track record, it was only a matter of time before the FTC set its sights on Microsoft's acquisition, a deal even larger than Nvidia's attempt.
After a year of gathering evidence, the FTC filed a lawsuit in federal court seeking to block the acquisition. On June 22, 2023, a five-day hearing commenced in San Francisco, marking a pivotal battle for both sides.
Recognizing the stakes, Microsoft assembled a formidable legal team. Instead of sending their gaming division head, they dispatched Satya Nadella, Microsoft's CEO, along with the head of Xbox and Activision Blizzard's CEO. The FTC countered by bringing in Jim Ryan, the head of Sony PlayStation, to participate remotely.
The central argument revolved around the console market and whether the acquisition would grant Microsoft the ability and incentive to stifle competition. While it was clear that Microsoft could theoretically engage in anti-competitive behavior, they had also demonstrated a willingness to cooperate. The court's task was to determine Microsoft's true intentions—to uncover evidence of their future plans.
To bolster its case, the FTC requested 3 million internal documents from Microsoft, encompassing emails, chat logs, meeting minutes, and more. Their objective was to find a smoking gun, a single piece of evidence suggesting that Microsoft intended to monopolize the market.
Microsoft, anticipating this move, had meticulously documented their internal communications, avoiding any indication of anti-competitive behavior. While we can't definitively know their true intentions, the FTC's efforts proved fruitless. They couldn't find a smoking gun.
Microsoft then turned the tables on Sony, demanding access to their internal communications. Sony, however, had been less cautious than Microsoft in their documentation. Jim Ryan's outburst during the EU hearing provided a glimpse into their less-than-tactful approach.
On the first day of the hearing, Microsoft dropped a bombshell. They presented an email from Jim Ryan, sent shortly after Microsoft announced the acquisition. In the email, Ryan acknowledged that Microsoft's acquisition wasn't driven by exclusivity but rather by a broader strategic vision. He expressed confidence in securing future Call of Duty releases for PlayStation, stating that he knew the CEOs of both companies well.
This revelation directly contradicted Sony's public stance, which centered around Microsoft's supposed intentions to make Call of Duty exclusive. Microsoft had effectively portrayed Sony's CEO as unreliable, casting doubt on their credibility.
In contrast, they presented themselves as transparent, inviting scrutiny of their internal documents, which revealed no evidence of anti-competitive behavior. This tactic significantly weakened the FTC and Sony's position before the judge.
Microsoft pressed their advantage, focusing on the issue of exclusivity. Nadella asserted that if it were up to him, he would eliminate exclusivity in the console market. However, he argued that this wasn't his decision to make; it was the industry leader who had established exclusivity as the norm.
This was a thinly veiled jab at Sony. Microsoft then presented data highlighting the stark difference in exclusive titles between the two platforms: Xbox had 56, while PlayStation boasted 296. They effectively argued that Sony was being hypocritical by accusing Microsoft of pursuing exclusivity.
Microsoft adopted a humble approach, acknowledging their defeat in the console market at the hands of Sony. They emphasized that even with the acquisition, they posed no threat to Sony's dominance and were committed to sharing. They even pointed out that Sony was the one refusing their offer of partnership.
Microsoft's strategy effectively exposed Sony's hypocrisy and lack of evidence, putting the FTC and Sony on the defensive.
Adding to the surreal nature of the proceedings, the judge and jury, composed of seasoned legal professionals, were largely unfamiliar with the intricacies of the gaming industry. Microsoft and the FTC spent a significant amount of time explaining basic concepts to these individuals. On the second day, they even brought in a PS5, Xbox, and Switch to demonstrate the differences between the consoles.
By the final day, the debate centered solely on Call of Duty. The judge, visibly perplexed, questioned whether the entire case hinged on this one game. The FTC, after a moment of reflection, conceded that it essentially did.
The judge and jury faced the unenviable task of comprehending complex industry dynamics and rendering a decision with potentially significant consequences for the market. Two weeks after the hearing concluded, on July 10th, the court ruled in favor of Microsoft, dismissing the FTC's case.
Activision Blizzard's share price surged from $22.7 to $91 upon the announcement, signaling the market's confidence in the acquisition's impending success. The FTC's defeat was comprehensive. The court systematically rejected each of their arguments, concluding that Microsoft had no incentive or intention to make Call of Duty exclusive.
This victory brought joy not just to Microsoft but also to companies like Google, Amazon, and Meta, which were facing their own antitrust scrutiny from the FTC. The ruling undermined the FTC's credibility. Despite subsequent appeals, the FTC ultimately withdrew its challenge to the acquisition on July 20th. Microsoft emerged victorious in the US.
Faced with defeats in both the US and EU, Sony recognized the futility of further resistance. They agreed to Microsoft's 10-year Call of Duty sharing agreement, effectively surrendering in the process.
By the end of July, all three major regulators had issued their verdicts. Only the UK's CMA stood in opposition. Facing mounting pressure from the US and EU, as well as criticism from the UK Prime Minister, the CMA found itself in an increasingly untenable position.
Following the FTC's ruling, the CMA softened its stance, signaling a willingness to renegotiate with Microsoft. Microsoft responded with a conciliatory gesture, offering to relinquish control of their cloud gaming business for a period of 15 years, transferring it to Ubisoft. This concession addressed the CMA's concerns and provided a face-saving way out.
The CMA seized the opportunity, announcing on September 22nd that they would likely reverse their previous decision. Activision Blizzard's share price soared to $94. On October 6th, they formally approved the acquisition.
After nearly two years, securing approval from over 40 countries, Microsoft emerged victorious on all fronts. The $68.7 billion acquisition, the largest in tech history, was finally completed on October 13th.