Why Activision Blizzard Had to Overpay for King Digital

Spending billions of dollars to acquire a company in an industry with few barriers to entry is always a questionable decision from a shareholder perspective.

But, in the case of video-game giant Activision Blizzard's  (ATVI) $5.9 billion deal for Candy Crush maker King Digital  (KING) , it's a transaction that had to happen. The talking points on the deal are compelling, as one would expect from a press release that was likely months in the making:

  • The combined company will have over half a billion combined monthly active users in 196 countries.
  • Mobile gaming revenue from the combined company is projected to grow cumulatively by more than 50% from 2015 to 2019.
  • Activision Blizzard is touting the opportunity to cross-promote content. So, at the very basic level, one could expect some form of Candy Crush ad/promotion in Guitar Hero. Or, if you download Candy Crush, you unlock a new map for Call of Duty or a song from the 1980s in Guitar Hero.

Keep in mind the background on King Digital, however, which collectively makes the acquisition quite risky for Activision Blizzard shareholders. By risky, I mean three things:

  1. The cash could have been better used, perhaps on share repurchases or along with debt, to acquire Grand Theft Automaker Take-Two Interactive  (TTWO) .
  2. As King Digital's popular Candy Crush ages and losses users perhaps quicker than execs at Activision Blizzard expect, it could lead to damaging asset write-downs.
  3. As key King Digital titles age, opportunities to cross promote content never live up to the potential pitched to investors at the time of the deal.

As for King Digital's history, there was the lukewarm response to the company's initial public offering in March 2014. The IPO priced at $22.50, it opened at $20.50, and then tumbled about 16% to around $19. As of Monday, King Digital's stock price was $15 and change -- it's telling on the attractiveness of the company's business model and financial performance since being public that Activision Blizzard only offered $18 a share, below the IPO pricing and not that much of a significant premium to Monday's close.

As for what the market has been assessing on King Digital, it's rather simple: the finite lifespan of mobile games. They come in to Apple's  (AAPL) app store with a bang, generate tons of downloads and in-game content downloads, but then lose users to new content developed by some 18-year-old programmer in San Francisco. Further, the games require constant updating to keep users enticed, but still fatigue could set in with the most popular games.


Here are several key metrics from King Digital's second-quarter results. Note that it's important to evaluate mobile gaming companies on a sequential basis because it better captures interest in popular franchises that are driving the bulk of total revenue (in the case of King Digital, Candy Crush):

  • Monthly active users (MAUs) were 501 million in second quarter 2015, down 49 million, or 9%, from first quarter 2015.
  • Monthly unique payers (MUPs) in the second quarter were 7.589 million, down 934,000, or 11%, from first quarter 2015.
  • Monthly gross average bookings per paying user (MGABPPU) decreased to $23.26 in the second quarter, down $0.38, or 2%, from first quarter of 2015.

In spite of the clear reservations Activision Blizzard shareholders should have, execs at the company had no choice but to overpay for King Digital. In fact, today's announcement suggests Activision Blizzard will be an aggressive acquirer of mobile assets as they appear in the future. I don't think it's a negative signal on the company's holiday season potential; it's scheduled to be in the market with some big titles, as always. Rather, the deal reflects a strategic positioning by the company amid several long-term shifts likely to reshape the gaming industry:

  1. The sizes of families in the U.S. continue to shrink, meaning fewer opportunities to sell traditional videogames meant for play on consoles. This is especially concerning for holiday periods, where a video-game company hopes to earn a good chunk of their annual business. Hence, Activision Blizzard has to pivot toward extracting revenue from games being played throughout the day by addicted moms and dads.
  2. Society is becoming attention-deficient and time-starved, which does not play well for traditional console gaming. Games such as Call of Duty take hours to really "get into" and those are hours many kids no longer have time to allocate. What kids do increasingly have time for is tapping and swiping on their mobile devices, which they are getting as gifts from parents at the age of 10 nowadays (and that includes tablets). There is a revenue opportunity for Activision Blizzard not being fully exploited today.
  3. Over time, it's likely Sony  (SNE) and Microsoft  (MSFT) will stop manufacturing consoles. Instead, gaming will just be direct download, which will place pressure on the return of investment on top gaming franchises such as Call of Duty (there is way more competition for downloads in the direct download universe, plus pricing is likely to be more competitive). Activision Blizzard needs a business that could help cushion its results as console gaming becomes obsolete.
  4. The next great tech device will likely be made for your finger, wrist, and head, or to be used while sitting in a car. The tie that will bind all of these devices: They are mobile-centric; in other words, they could be moved from location to location with ease. Again, that reduces the likelihood of a person sitting in a living room playing a videogame either on a console or downloaded from the Sony network. Activision Blizzard needs to be where the eyeballs are likely to be in the longer term.

Editor's Note: This article was originally published at 8:31 a.m. EST on Real Money on Nov. 3.

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