Why Microsoft’s $2T+ market cap makes its $68B Activision buy a cheap bet

'A flywheel of content and technology that gets more users on board'

Even though consumer gaming constitutes a small fraction of its overall business, Microsoft’s announcement yesterday of its all-cash $69 billion deal to buy Activision Blizzard proves that the technology corporation takes the sector plenty seriously.

It is easy to think that Microsoft should have invested the money into other, perhaps more lucrative businesses in its portfolio. But with a market cap just over $2 trillion (a number so large it’s hard to wrap your head around), Microsoft has vast resources to invest in the most logical parts of its business.

Even if this $70 billion bet doesn’t pay out, Microsoft will come out on the other side fairly unscathed. That kind of financial power gives a company myriad options, even if it involves making one of the largest acquisitions in tech history.

Let’s not forget that this deal comes on the heels of Microsoft’s acquisition of speech-to-text company Nuance last spring for $20 billion. That deal that is stuck in regulatory limbo in the U.K., which begs the question: Given it size and scope, could regulators end up taking a close look at the Activision Blizzard deal, what could be perceived as a gaming market land grab?

Even if this $70 billion bet doesn’t pay out, Microsoft will come out on the other side fairly unscathed.

With that in mind, we’re examining this deal’s financial viability to see whether Microsoft might have been better off putting those resources into the enterprise/business side of the house, or if its resources are simply so vast that the company doesn’t have to consider the sort of tradeoffs most companies must make when it comes to an M&A of this magnitude.

Digging into the portfolio

Although Microsoft is reporting earnings next week, we can still see the breakdown of how the company makes the majority of its money from its most recent report, disclosed October 26, 2021. In that earnings digest, the Redmond, Washington-based software giant reported over $45 billion in revenue, with its Intelligent Cloud division accounting for $17 billion of the total, and its Productivity and Business Processes group good for $15 billion more.

The consumer side of the house produced more than $13 billion in top line, but gaming was just a portion of that division’s results that includes certain Windows and Surface incomes, along with search and advertising.

In spite of the differential in scale between the company’s entertainment work and its enterprise income, Microsoft CEO Satya Nadella called out gaming in its earnings report call with analysts, praising its growth:

And in gaming, revenue increased 16% at 14% in constant currency, ahead of expectations. Better-than-expected console supply, and continued strong demand resulted in Xbox hardware revenue growth of 166% and 162% in constant currency. Xbox content and services revenue increased 2% and was relatively unchanged in constant currency against a strong prior-year comparable. Segment gross margin dollars increased 10% and 8% in constant currency. Gross margin percentage decreased roughly one point year over year, driven by sales mix shift to gaming hardware.

Clearly, the company sees gaming as an important growth driver. How does that fit into the recent deal announcement? Not merely in terms of the company stacking accretive gaming revenues, with Constellation Research analyst Holger Mueller viewing the transaction as a way to grow related incomes via Windows and Azure cloud services.

“This is all about getting load for Azure. [The company is currently on Google Cloud], but that [shift would] pay for $10-20 billion of the price [right there],” Mueller said. “Don’t forget Windows as a platform for these games; this is also a Windows protection play.”

But beyond the potential to boost Azure in its battle with AWS and Google’s competing public cloud offering, Microsoft is buying a huge chunk of business. Let’s put that into context, and then loop back to the strategic perspective to better examine the deal from Microsoft’s perspective.

Inside Activision Blizzard’s numbers

As with Microsoft, we don’t have numbers for the most recent quarter, which means we’re looking at Activision Blizzard through the lens of its Q3 2021 results.

In the third quarter of last year, Activision Blizzard generated $2.07 billion in total revenues, up from $1.95 billion in the year-ago period, and ahead of its anticipated $1.97 billion in total top line. Those figures represent an incredibly modest pace of growth, but a non-trivial sum of revenue, even for a company of Microsoft’s scale.

But the gaming giant makes up for its slower growth in profit, with its third-quarter revenues converting into $824 million of operating income and $639 million worth of net income. From this data set, we can do a few calculations:

  • Activision Blizzard implied run-rate, based on Q3 2021 results: $8.28 billion
  • Implied revenue multiple at Q3 annualized run rate: 8.3x
  • Annualized Q3 operating profit multiple: 20.8x
  • Annualized Q3 net income multiple: 26.9x

On one hand, paying just over 8.3x for any sort of software revenue feels cheap in today’s market. On the other, given Activision’s anemic Q3 2021 year-over-year growth rate, its profit multiples don’t feel particularly inexpensive.

This is where synergy comes into play. Corporations love to talk about how they are going to turn 1 and 1 into 3 by their combination. Microsoft, then, is likely assigning a price tag above Activision Blizzard’s real market value – set by its pre-deal stock price and resulting market cap – because it thinks that by bringing the gaming giant in-house, it can do a lot with it when it is fused to its extant gaming business.

Perhaps more than if it deployed that same $69 billion into another sort of deal, say, scooping up two or three key B2B SaaS companies, as Salesforce did when it paid almost $28 billion for Slack. In an odd twist, Microsoft would have had to pay more for such deals, given that enterprise software multiples are far higher than what we see in gaming, and it would have had to pay up for unprofitable revenue to boot. In contrast, Activision is accretive to the Microsoft bottom line from day one.

Of course, there is nothing to stop Microsoft from making those same B2B SaaS deals in addition to Activision. History has now shown that if they see a chance, they will probably take it, just as they did with the shift to the cloud a decade ago.

So the deal isn’t cheap, but it is also not insanely expensive. The question really becomes how the transaction will impact both Microsoft’s gaming aspirations and its other business units that may be called in to support Activision.

Building ‘a flywheel of content and technology’

If a company wants to make a big move into gaming, this acquisition checks a lot of boxes. In this case, it also provides a clear path for Microsoft to expand its sphere of market influence beyond Windows, Office, Azure and other cloud revenue without paying directly to do so.

Box CEO Aaron Levie told TechCrunch that the deal is a bold move to grab a piece of the burgeoning AR/VR gaming market. “If you believe VR and immersive computing is the future — whether for consumer or business use cases — Activision helps Microsoft build a flywheel of content and technology that gets more users on board to this future,” he said, adding “it’s a 10-year bet on greater convergence of entertainment and tech and a major asset that will play a role in making [the] ‘metaverse’ [concept] mainstream.”

Brent Leary, founder and principal analyst at CRM Essentials, said the deal shows that Microsoft is in a unique financial position. “You can’t help but marvel at the fact that a company can acquire one company [Nuance] for $20 billion and then follow that up with buying another company the next year for $70 billion,” he said.

He added that what is even more unusual is that one move involved the enterprise and the other consumer. “But the thing that really stands out is that these acquisitions are in totally separate areas — both of which have potentially huge growth opportunities. It just illustrates that Microsoft is operating at a level and scale that we’ve very seldom seen before.”

All of which could grab the attention of regulators in the U.S. and elsewhere. In an interesting coincidence, on the same day Microsoft announced this deal, the U.S. Federal Trade Commission (FTC) announced it would be taking a closer look at acquisitions involving big companies like Microsoft.

It’s also worth remembering that the $20 billion Microsoft-Nuance deal is tied up with regulators in the U.K in the Competition and Markets Authority (CMA), which is charged with looking at whether the deal will have an adverse impact on the competitive landscape.

One could argue similarly in the gaming market, although according to market share data from Statista, Microsoft sits in fourth place behind Tencent, Sony and Apple and can simply say that it’s making this move to compete with its more dominant competitors. In the end, it will be up to the regulators to decide if a deal of this scope could upend the playing field.


If the deal makes it past its upcoming regulatory gauntlet, Microsoft will have deployed a material portion of its cash position into a multi-part gaming company that plays across platforms, including mobile, thanks to the Activision-King deal of yesteryear. Precisely why Microsoft needs to push its way deeper in the gaming market might feel like a head-scratcher, but we’ve noticed for a long time now that platform companies tend to go incredibly broad over time.

The deal is therefore a fascinating financial transaction, showing how much mega-cap tech giants can dish out for what appear to be more ancillary parts of the overall business. And it shows us the power of platform companies more generally.

Whether governments will prove as sanguine about the deal as Microsoft and Activision remains to be seen. But if this purchase goes through, what sort of transaction is required to truly trip the wires? In a certain light, Microsoft’s Activision purchase provides us with something akin to a natural experiment in discerning today’s regulatory guardrails.

More when we have it.