The U.K. Competition and Markets Authority (CMA) has announced that it is blocking the proposed Microsoft purchase of Activision Blizzard. Does this mean the deal is dead? The answer is complex.

Summary: AKA Just Give Me the Answer

DFC gets a ton of questions on this subject so we are providing a full summary of events here. However, for the quick summary: No the deal is not dead! However, Microsoft will likely need to make further compromises to appease regulators. The question is how far is Microsoft willing to compromise to get the deal approved? DFC now believes that the CMA may require Microsoft to offer more than it is willing to give. There is a growing danger that Microsoft will walk away from the purchase.

How Much is Microsoft Willing to Compromise?

DFC Intelligence believes the deal will go through provided Microsoft is willing to make some more concessions to appease regulators. But at what point does compromising eliminate the strategic objectives for making the acquisition in the first place?

This is a political issue where companies like Microsoft have ongoing relationships with regulators and look to frame deals to the political mindset. In the case of the Activision acquisition, Microsoft (with the help of Sony) carefully positioned the deal as an effort to help them bring more competition to the console market dominated by Sony and Nintendo.

The U.K. rejected Sony’s argument and found in favor of Microsoft on competition in the console game space. However, the larger issue the CMA had was around long-term competition in the emerging cloud gaming market.

Furthermore, the CMA rejected Microsoft’s proposed remedy because:

• It did not sufficiently cover different cloud gaming service business models, including multigame subscription services.
• It was not sufficiently open to providers who might wish to offer versions of games on PC operating systems other than Windows.
• It would standardise the terms and conditions on which games are available, as opposed to them being determined by the dynamism and creativity of competition in the market, as would be expected in the absence of the merger.

In other words, Microsoft needs to propose remedies that address those arguments. The strategy for acquiring Activision Blizzard is Microsoft can use games as a “Trojan Horse” to bring consumers into other Microsoft products and services, most notably on PC and mobile, not console.

A remedy acceptable to the CMA would probably limit Microsoft’s ability to use Game Pass as an entry to other services. There will be some point where Microsoft will walk away versus compromising.

Will the CMA Accept a Proposed Microsoft Remedy?

The big concern we saw in the CMA statement preventing the merger was the following language:

Accepting Microsoft’s remedy would inevitably require some degree of regulatory oversight by the CMA. By contrast, preventing the merger would effectively allow market forces to continue to operate and shape the development of cloud gaming without this regulatory intervention.

The CMA is saying that enforcing remedies that require ongoing regulatory oversight is not a hassle they want to deal with. It is easier to block the merger. This implies that somehow Microsoft needs to find a remedy that does not require ongoing oversight. This may be impossible.

When it comes to red flags in the proposed merger this was a big one. Requiring further compromise from Microsoft was expected. The concept that a deal that requires ongoing enforcement is unacceptable seems novel. It is hard to imagine Microsoft presenting a compromise that does not require regulatory oversight to assure continued compliance.

Can Microsoft Win on Appeal?

This is uncertain. The U.K. of course has its own appeal process that is different from the U.S. Microsoft must show that the CMA “acted irrationally, illegally or with procedural improprietary.” In practice, about one-third of CMA decisions are remitted on appeal.

Furthermore, the appeal process does not reverse decisions but instead remits them to the CMA for further consideration.

Even if Microsoft wins on appeal it will likely still need to compromise with the CMA. Once again, the CMA’s statement that they are not really interested in a remedy that requires ongoing oversight is a major cause for alarm.

Activision Blizzard Stock
ATVI stock was down on the news but not that much as the company reports record results

What Happens to Activision Blizzard if the Deal Does Not Go Through?

Activision Blizzard was struggling at the time of the acquisition and Microsoft agreed to pay a significant premium. Investors are rightly concerned that an independent Activision Blizzard will see a major decline in market valuation.

DFC is addressing this topic independently. However, we will note that after the CMA announcement, Activision quickly released its quarterly results and they were not only positive, it was one of the best quarters the company ever had. The company is setting records across many metrics.

The big loser if the acquisition does not go through is Microsoft. Without Activision Blizzard, Microsoft’s future strategy in the game business is in jeopardy.

What is the History of the CMA Investigation?

DFC Intelligence has been actively involved in looking at the proposed Activision Blizzard acquisition since the CMA ended Phase I of its investigation last September. For those really interested in understanding the arguments and politics behind the CMA investigation it is worth looking at how the investigation evolved. So we will present a summary of our past analysis.

First Indication CMA Was Going to Be A Potential Stumbling Block

Last fall there were multiple government agencies looking at the acquisition. Many of these investigations were finishing phase one and starting to enter a second phase of more detailed scrutiny.

The CMA released its phase one finding in September and Microsoft issued a reply in October. It was the Microsoft reply that first raised alarm bells.

As we said back in October:

The CMA announced two theories of harm it was investigating. Theory of Harm One is that Activision Blizzard’s game catalog will enable Xbox to foreclose its competitors in gaming markets. Of course, mainly that competitor is Sony and the PlayStation brand.

The bulk of Microsoft’s initial response to the CMA dealt with the first theory of harm. The focus was on Call of Duty and Sony’s market leadership position. Of course, Microsoft made note of the fact that Nintendo platforms do fine without Call of Duty.

CMA’s Theory of Harm 2 suggests Microsoft will have an advantage over rivals in cloud gaming by having a broad “multi-product ecosystem including a leading cloud platform and PC operating system.

Microsoft dismisses the second theory as a “novel theory of harm without any precedent.” Theory 2 is probably the larger issue, but Microsoft spends only a small portion of its response deflecting the concerns to the “nascent cloud gaming segment.”

CMA Provisional Findings

In February, the CMA issued a 275-page provisional finding where they suggested they were leaning towards blocking the merger. Full findings were expected on April 26, 2023.

The document concluded with two major issues:

  1. As a result of our assessment, we have provisionally concluded that the anticipated acquisition of Activision by Microsoft constitutes arrangements in progress or in contemplation which, if carried into effect, will result in the creation of an RMS.
  2. We have also provisionally concluded that the creation of that situation may be expected to result in an SLC in the supply of console gaming in the UK and in the supply of cloud gaming services in the UK, in each case due to vertical effects resulting from input foreclosure.

Once again, we expressed concern with Theory of Harm 2 but were confident the deal would be approved.

At the time DFC stated:

Microsoft responded to the CMA issues last fall and focused primarily on the Theory of Harm One (what we call the damage to Sony theory). Back in October DFC argued that Microsoft’s response to the CMA Theory of Harm 2 was rather glib and that could come back to bite the company.

Indeed nearly 80 pages of the document dealt with the Theory of Harm 2. Unlike the FTC, which seems to be doing a superficial dig into the issues, the CMA appears to be taking the matter seriously. The CMA looked into details around cloud delivery including offerings from competitors Amazon, Google, and Nvidia.

Overall DFC still believes the arguments against the merger to be weak. The merger is still expected to be approved. However, the issues raised by the CMA, especially in Theory of Harm 2, appear to be the most serious.

The CMA Rejects Sony’s Arguments

On March 24, the CMA updated its February provisional findings to note they were dropping the Theory of Harm One and only pursuing the Theory of Harm Two.

DFC’s conclusion at the time:

Overall this is good news for those betting on the merger going through. However, it is not that surprising. Theory of Harm 1 was a rather ridiculous concern focused on potential harm to one company, market leader Sony. Theory of Harm 2 is a more serious issue around the control of cloud distribution that could have a significant impact on consumer options.

The CMA Blocks the Deal

As promised, on April 26, the CMA announced its verdict. They were blocking the deal. This was not surprising but what did catch us off-guard was the language that “accepting Microsoft’s remedy would inevitably require some degree of regulatory oversight by the CMA.”

This is now a political battle and appears the post-Brexit U.K. is not afraid of flexing its muscle. Is the government even in the mood to negotiate? DFC’s past confidence that the deal would go through has definitely weakened.

The situation is a major political one that is likely to be a drawn-out battle. We do not expect an approval decision until 2024. However, if Microsoft decides to drop the acquisition that could happen sooner.