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Regulatory And Legal Headwinds
I am downgrading Microsoft (NASDAQ:MSFT) from buy to a hold. I support the video gamers’ US lawsuit against Microsoft’s proposed $69 billion takeover of Activision Blizzard (ATVI). This is a strong follow-up to the US The Federal Trade Commission’s decision to block Microsoft’s $68.7 billion takeover of Activision The FTC is skeptical of Microsoft’s assurances that it will make Activision video games available on rival platforms.
This deal could hurt Sony’s (SONY) PlayStation and Nintendo (OTCPK:NTDOY) console and online players. The FTC complaint stated that Microsoft has a record of making exclusive games after buying ZeniMax Media, parent company of Bethesda. Microsoft is no stranger to losing an antitrust case. The FTC initiated an antitrust action in the 1990s. The US Department of Justice won that antitrust case against Microsoft.
A court decision that forbids the proposed takeover will not improve Microsoft’s estimated forward revenue CAGR of 12.93%. It could limit the total addressable market of Microsoft’s new patent application for ads on online/streaming video games. Microsoft will not be able to increase its advertising revenue through Activision Blizzard’s list of successful PC, console, and mobile games.
Seeking Alpha has published eighty-six of my buy recommendations for MSFT. This is the first time I cannot rate Microsoft as a buy. The gamers complaint seeks a court order to forbid Microsoft’s proposed purchase of Activision. The core argument is that this acquisition could be violating Section 7 of the Clayton Antitrust Act. The FTC move to block this deal is paramount. It sets a precedence that the European Union and China antitrust authorities will probably emulate going forward.
The most probable future scenario is that Microsoft will repeat Nvidia’s (NVDA) termination of its $40 billion bid for ARM Limited. Microsoft was one of those companies who protested against this Nvidia effort to control the IP of ARM. Microsoft is now trying to buy and control the IP of Activision.
Why The Change Of Heart?
I cannot endorse MSFT as a buy because it is no longer a high-growth stock. My usual growth stock requirement is a company needs to have a steady 18-20% revenue CAGR. My basic high-growth stock valuation is usually 20x forward GAAP. I could raise it to 22x if a company is a strong profit generator. Yes, Microsoft is highly profitable. Microsoft’s gross margin is 68.26% and net margin is 34.37%.
Unfortunately, MSFT’s forward GAAP P/E is 25.33x. I usually respect my own stock evaluation rules. MSFT is a great company, but it is no longer a GARP investment that you should buy now. The highest June 2024 EPS is $12.48. My forward P/E for MSFT is 22x. My best forward scenario valuation for Microsoft is only $274.56. If we take the average $11.16, my lowest forward valuation would be $245.52, just a bit higher than MSFT’s recent closing price of $244.53.
MSFT’s YTD performance -28.10%. This big dip has not eliminated the relatively high 8.45x forward Price/Sales ratio of MSFT. This is significantly higher than the average price/sales ratio for the Information Technology sector, which is 2.42x. My refusal to not give MSFT a buy is also due to its short-term bearish Stochastic Oversold Buried trade signal. It means the fast stochastic of MSFT is currently below 20 and has been so for the past five trading days. The short-term EMA averages are also bearish on MSFT. The last trade of $244.53 is lower than MSFT’s 5-day EMA of 244.76, and 13-day EMA of $246.56.
FTC Could Win Its Legal Fight Against Microsoft
I am not a lawyer, but my opinion is that this proposed buyout of Activision by Microsoft is not just a vertical merger. Mrs. Khan, Chairman of the FTC, and her subordinates could convince skeptical US courts that Microsoft’s proposed takeover is a horizontal merger which could suppress competition.
The Clayton Antitrust Act applies to Microsoft’s takeover of Activision Blizzard. Microsoft is already the no. 2 video games company with a 2021 gaming revenue of $16.3 billion. Activision is no. 5 with a 2021 gaming revenue of $8.8 billion. Microsoft is not only a vendor of Xbox console hardware and operator of a cloud gaming service. It also owns several video development and publishing companies.
It is us, gamers, who are getting monetized in the $196.8 billion/year video games industry. Investors should take notice when the video game players are also sucking. The upper vertical power and aggregate horizontal influence are obvious. Microsoft could dictate where Activision Blizzard could publish its current and future video games. Those loyal gamers are protesting Microsoft’s ambition to own Activision Blizzard could sue in Europe in China. Sony is not going to be submissive. Sony has $4.55 billion in total cash. It can hire enough lawyers in different countries. These lawyers could assist in government-initiated and private suits against Microsoft’s effort to own Activision’s IP.
Losing The Fight To Buy Activision Decelerates Microsoft
I understood Microsoft wants to own Activision Blizzard to get new growth driver. It wants that $8.8 billion gaming revenue so that it could unseat Sony as the no. 1 video games company in this planet. Microsoft also wants its upcoming patent on advertising in online and streaming games to reach more eyeballs. Activision has 97 million monthly active players. Blizzard has 31 million monthly active gamers. King Entertainment, a wholly owned subsidiary of Activision Blizzard, has 240 million monthly active players. That is 368 million advertising eyeballs that Microsoft will not have.
Guesstimating the future lost ad revenue on those 368 million active gamers is not an exact science. The average gamer spends 8 hours and 27 minutes per week. Health issues have not prevented me from spending at least 2 hours on Mobile Legends and Fritz 18/Chessking 2022 every day. On Saturdays, I spend at least 5 hours playing PC games like Grim Dawn and They Are Billions. Let us just guess that Activision Blizzard players spend at least one hour per day playing games.
Microsoft could probably deliver three 5-to-10 second ads at an average of $4 CPM (Cost Per Mille) ad impression rate. Multiply $12 by 360 million and divide by this by 1,000 (CPM). You get $4.32 million per day of potential online/streaming ad revenue to gamers. You can get a higher daily ad figure if you think gamers play more than one hour each day. There’s more than 900k average daily players of Overwatch 2. Those core daily players aren’t playing for just one hour per day.
What To Do After The Defeat
Should the FTC’s denial suit win in court, Microsoft could still use that $68.7 billion to buy other smaller companies that cannot threaten the long-term viability of Sony and Nintendo. Ubisoft (OTCPK:UBSFY) is cheap at just $3.35 billion market valuation. Capcom (OTCPK:CCOEY) is also small and affordable at just $6.64 billion. I think American and Chinese authorities would be happy if Microsoft takes a controlling stake of NetEase (NTES). NetEase does not develop or publish console games. Sony and Nintendo probably won’t mind Microsoft controlling it.
I won’t mind it at all if Microsoft buys Roblox (RBLX) or Sea Limited (SE). I think that it was a divisive move for Microsoft to attempt to buy Activision Blizzard and its IP. Microsoft is a greedy bull rushing towards a China porcelain shop. The FTC and gamers suits are guardians with big hammers.
My takeaway is that Microsoft should just use most of that $68.7 billion to invest or own green/renewable energy companies. The ownership and operation of solar and wind farms could reduce the electricity costs associated with the Azure,.Net, Windows 365, Microsoft 365, and Dynamics 365 platforms. Azure alone has dozens of global data centers. The share of solar and wind energy in global electricity production is only 10.7%. My fearless bet is that Microsoft’s network of data centers around the world still mostly uses coal and gas-powered electric power plants.
Microsoft’s 2020 announcement that it will be carbon negative by 2030 should remind CEO Nadella what the priorities are. I think buying Activision should not be a top priority. I will rate MSFT as a buy if it tries to acquire solar-centric firms like JinkoSolar (JKS) or Canadian Solar (CSIQ). Microsoft has more than $107 billion in cash. It could buy five of the ten top grossing publicly-traded solar energy companies.
The 15.7% CAGR of the $160.3 billion (2021 estimate) global solar energy industry is higher than Microsoft’s 5-year average revenue CAGR of 15.41%. The video games industry’s estimated CAGR is only 9.1%.
To date Microsoft’s most impressive renewable energy act is its 2020-era 500 MW solar PPA partnership with Sol Systems. Instead of partnering with renewable electricity suppliers, Microsoft can build or buy companies that operate solar and wind plants. Spending more on cost-efficient electricity sources could help dispel that rumored Google (GOOG) document alleging Azure has had a recent operating loss of $3 billion.
I won’t mind if Microsoft invests more billions in OpenAI so it could create a cheap low-code tool help me learn C# faster. I want a no-code Microsoft software that will let me create WASM apps using Blazor and ASP.net.
Final Thoughts
You can hold on to your MSFT shares. Microsoft is a dominant, high-profit company. A 12% forward revenue CAGR is still good in my book. My no. 1 factor when evaluating stock is not antitrust-related court room fights. It is Piotroski F-score. Microsoft touts a current F-score of 6. This is 2 points lower than its F-score of 8 in September 2021. An F-score of 6 is still acceptable because the highest F-score is 9.
Microsoft does not need to own and control Activision Blizzard. The FTC can win its antitrust legal fight against Microsoft. The better thing to do is for Microsoft is to make a graceful exit. Nvidia did this on its failed attempt to control ARM Holdings Limited. Like I mentioned previously, Microsoft can find new growth drivers by buying other smaller video games companies or solar energy firms.
If you are confused that I could mix an antitrust video games-centric essay with solar energy topics, please forgive me. I am one of those out-of-the-box, nonconformist writers/thinkers/activists produced by the University of the Philippines – Diliman. The point is that Microsoft needs cheaper renewable energy to make sure its Azure platform becomes more efficient.
A more efficient Azure segment could help Microsoft improve its outstanding dividend scorecard.
