2 Reasons Microsoft’s $7.5 Billion Bethesda Buy Will Boost Its Stock

will pay $7.5 billion to acquire ZeniMax Media and its game publisher Bethesda Softworks, according to Microsoft.

This is the best news for Microsoft shareholders since its bid to co-acquire TikTok was rejected last week.

How so? Microsoft’s Bethesda buy passes two key tests for successful acquisitions: it will give Microsoft a bigger piece of a large market and the combined companies will be better off. Whether the deal will pass the third test — earning a positive net present value on the $7.5 billion investment — remains to be seen.

The Microsoft/Bethesda Deal

Microsoft is paying $7.5 billion to acquire game maker ZeniMax Media, the parent company of gaming studios such as Bethesda. The deal — which gives Microsoft control of popular games such as The Elder Scrolls, Fallout, Doom, Quake and Wolfenstein — boosts Microsoft position against Sony by “deepening its game catalog seven weeks before both Microsoft and Sony release a new generation of gaming consoles,” according to the New York Times

The Gaming Industry

The U.S. videogame software industry is large, growing and highly profitable. According to IBISWorld, the industry generated $28 billion in 2019 revenue, $2 billion in profit and is expected to grow at a 5.7% annual rate in the next five years to almost $37 billion by 2025.

The global market is much larger. Worldwide gamers are expected to spend nearly $160 billion in 2020, according to the Times. While Microsoft envisions that by 2021, worldwide gaming is expected to reach $200 billion.

With 81% smartphone penetration by late 2019, access to and demand for mobile games has grown. Moreover, game consoles — such as those supplied by Microsoft, Sony, and Nintendo — are connected to the Internet thus giving them a marketing advantage in their efforts to boost direct game downloads, noted IBISWorld.

With the pandemic sending people indoors, Newzoo forecasts that about 2.7 billion people will play a game this year.

Why The Companies Will Be Better Off

This deal will give Microsoft access to a popular array of games and significantly add to its game development talent pool — thus boosting its market share.

Microsoft is already a big player in the videogame software industry with 9% market share — lagging Activision Blizzard
(13%), according to IBISWorld. It is also battling Sony in the gaming console industry.

Microsoft Studios — its in-house developer and publisher of video games — has gained market share through acquisitions of popular games— such as Banjo-Kazooie and its most popular game, Halo, which was developed by Bungie Studios for the original Xbox console. Microsoft’s gaming revenue is expected reach $2.5 billion in fiscal 2021 — growing at a 10.5% five year average annual growth rate, noted IBISWorld.

The pandemic has helped boost that growth rate considerably. In the June 2020-ending quarter Microsoft’s gaming revenue popped 64% to $1.3 billion from the year before.

The Bethesda acquisition will enable Microsoft to boost its portfolio of games available in its Xbox Game Pass and expand the number of creative studio teams from 15 to 23, according to the Times. Microsoft will add 2,300 employees from studios including “Bethesda Softworks, Bethesda Game Studios, id Software, ZeniMax Online Studios, Arkane, MachineGames, Tango Gameworks, Alpha Dog, and Roundhouse Studios.”

In short, the deal will boost Microsoft’s share of the gaming market and increase its ability to sustain those gains — with the help of Bethesda’s structure and leadership — which will remain in place after the deal closes.

Nevertheless, one analyst noted that the acquisition came at a time when Sony has a competitive edge. George Jijiashvili, an analyst at researcher Omdia, pointed out that Sony’s PlayStation 5 launch is stronger than Microsoft’s and is expected to “outsell the new Xbox devices, the Series X and Series S,” noted the Times.

In the long run, the acquired creative talent should boost Microsoft’s future gaming market share. As Jijiashvili argued, the delay of Microsoft’s Halo Infinite — a highly anticipated Xbox exclusive — “is a huge blow to Microsoft, but it is betting that the Game Pass Ultimate will sway more gamers in the long run, thanks to day-one launches, cloud gaming and a growing library of appealing titles.”

The Financial Impact on Microsoft

One big question mark of this deal is whether Microsoft will earn back the $7.5 billion purchase price through future incremental cash flows. Microsoft said that “the acquisition to close in the second half of fiscal year 2021 and to have minimal impact to non-GAAP operating income in fiscal years 2021 and 2022.”

This is a much better outcome for Microsoft shareholders than its failed bid for TikTok. As I wrote August 5, that deal would have burdened Microsoft with competitive, obsolescence, and political risk and could have cost the company $30 billion — considerably more than the $26.2 billion it paid for LinkedIn.

Unlike the short-video site, TikTok, gaming is in Microsoft’s wheelhouse. As CEO Satya Nadella told the Times, “Gaming has been there at the foundation of this company, next to (programming) languages perhaps and maybe operating systems, but the point is, going forward this interactive media has got much more reach.”

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