End of Consolidation?

After almost 11 months of investigation, the United States Federal Trade Commission (FTC) announced it is seeking to block Microsoft’s $68.7b acquisition of Activision Blizzard (ATVI). As a result, the deal that sparked conversations about an era of consolidation in gaming might actually be signaling a major hurdle for future acquisitions.

Scrutiny of this acquisition is still ongoing internationally. The FTC initially announced a review of this record-breaking deal back in February, but remained relatively silent until just last week. Across the pond, the European Commission is continuing to review the acquisition, although there has been no definitive action to-date. Over in China, regulators have also not made a firm decision, although their State Administration for Market Regulation (SAMR) did reject to review the transaction under an accelerated “simplified procedure.”

Framing the FTC’s Perspective

The FTC’s decision to intervene in the Microsoft / ATVI acquisition is not entirely unexpected given both the magnitude of this transaction ($68.7b) and its implications on the nearly $200b in annual revenue that the global gaming industry generates. The FTC claims that the acquisition would give Microsoft the option to suppress competition in the distribution of gaming content given the company’s existing Xbox, xCloud, and Game Pass offerings.

Anticompetitive mergers & acquisitions have been a major area of focus for the FTC under Lina Khan, the current Chairwoman. While attending law school at Yale, Khan gained a following after publishing her thoughts on anticompetitive corporate behavior in an article titled “Amazon’s Antitrust Paradox,” which was featured in the Yale Law Journal. In that piece, she stated that antitrust arguments focused on consumer welfare and low prices (an argument that has almost always protected vertical mergers since the 1970s) fail to paint a complete picture of anticompetitive behavior in the age of internet platforms with wide-reaching data capabilities (New York Times). In the case of Microsoft and ATVI, this means that the merger’s goal of providing a “superior” value to Game Pass subscribers should not overshadow potential harm to competitors.

Perhaps most relevant to the current case at hand with Microsoft and ATVI, Khan’s paper essentially rejected the 1984 merger guidelines released by the FTC and Department of Justice (DOJ) which effectively provided vertical mergers a regulatory pass. Vertical mergers are defined as when “two or more successive stages of production and/or distribution of a product are combined under the same control” (Yale Law Journal). Given these types of transactions do not typically combine head-to-head competitors, the arguments to determine if behavior is anticompetitive are quite nuanced. The combination of ATVI’s gaming content and Microsoft’s distribution channels falls into this category.

Regardless of personal opinions around the validity of these transactions, one thing is objectively true: current standards around vertical mergers are relatively unclear. After almost four decades of operating under the 1984 guidelines that Khan opposed, the FTC updated their standards in 2020. However, the FTC promptly withdrew the 2020 guideline updates just one year later due to “unsound economic theories that are unsupported by the law or market realities.” Considering no new guidelines have been proposed, the Microsoft and ATVI decision will likely help shape the course of antitrust regulations.

While the FTC, led by Khan’s aversion to verticalization, may be pursuing a noteworthy win against “Big Tech” consolidation, we do not believe that blocking Microsoft’s acquisition of ATVI is the right decision or has sufficient grounds to be blocked.

The Case Against Microsoft Acquiring ATVI

Despite our firm’s position in favor of this acquisition being approved, we do believe that FTC has a few valid concerns worth reviewing.

The primary risk that the gaming industry now faces is the potential for ATVI titles to be excluded from distribution platforms outside of Microsoft’s ecosystem (i.e., Playstation, Switch - which are both consoles that are direct competitors to Xbox). If this happened, it could impact a significant portion of the more than 360 million monthly active users that currently play ATVI titles. It could also limit a sizable revenue stream for other platforms that have historically distributed titles like Call of Duty and Overwatch. Selling 3rd party games generates platform fees (another ongoing anticompetitive debate) for game distribution ecosystems.

ATVI has attempted to be proactive in addressing this concern. The company has continuously released press announcements with a clear intention to signal an amenable attitude towards other platforms. A few examples of this include bringing Call of Duty to Nintendo Switch for the first time, pledging a 10-year Call of Duty contract with PlayStation that allegedly includes access on PS+ (Sony’s subscription service), and continued collaboration with Steam.

That said, Microsoft does not have a perfect track record of upholding their commitments to make content widely available. The FTC specifically called out Microsoft for making several Bethesda titles (including Starfield and Redfall) exclusives after promising European antitrust regulators that it had no incentive to limit access across other platforms. This is clearly casting serious doubt over Microsoft’s current guarantees for a platform-agnostic distribution strategy. Promises designed to appease regulators’ concerns are both easy to make and easy to break for any number of reasons (i.e., contractual disputes, changes to terms).

It is also worth noting that this is not Microsoft’s first run-in with the FTC, and it is unlikely to be the last. Dating back to the late 1990s, Microsoft sparred with the FTC when the company tried to push Netscape out of the browser market. Microsoft did this by bundling Internet Explorer and other applications (for example, pushing Microsoft Word over WordPerfect in 2008) with its Windows operating system. This lawsuit spawned the creation and success of other browsers like Google’s Chrome which overtook Internet Explorer in market share in 2012. Without these decisions, there is a legitimate argument that innovation would be stifled due to new entrants being held out of the market.

Today, Microsoft is pursuing a different kind of bundling strategy by expanding the value proposition of its Game Pass subscription through ATVI’s legendary content portfolio. Although Microsoft claims that it can optimize the acquisition by keeping ATVI’s content on all platforms, there is a good case for exclusively housing it within their own ecosystem.

Our View: Why the Merger Should Be Approved

Even in light of these concerns, our team at Konvoy believes that blocking Microsoft’s acquisition of ATVI would be a mistake and the FTC’s case is weak. Opinions may vary, but we believe that this acquisition is well aligned with recent precedent.

One of the most pertinent cases to review is the Department of Justice’s (DOJ) antitrust suit when AT&T sought to acquire Time Warner for $85b in 2016. Note that both the FTC and DOJ are responsible for enforcing the federal antitrust laws in the United States. While both parties generally cover different sectors, they are effectively held to the same rules and standards. In this case, the concern was that one of the largest internet and telephone providers (AT&T) had already acquired the largest satellite entertainment company in the US (DirecTV), and now sought a portfolio of programming that would have unparalleled access to consumers (Time Warner - owner of HBO, Warner Bros, and Turner Broadcasting). Much like the combination of Microsoft and ATVI, the joint entity would be able to supplement their deep distribution capabilities with a portfolio of market-leading content.

It is worth noting that AT&T’s case marked the first time in 40 years that the government fully litigated a vertical merger that combined two companies that were not head-to-head competitors. Despite the DOJ’s best efforts to argue that the transaction would inhibit competition, the judge ultimately disagreed.

In another relevant case, Amazon acquired MGM for $8.5b earlier this year (within the purview of the current leadership at FTC). This gave Amazon’s Prime Video streaming service access to over 4,000 movies and 17,000 television shows. The FTC declined to challenge this transaction, yet is choosing to challenge a similar vertical acquisition with Microsoft and ATVI.

We have clear examples from both the FTC and DOJ that a platform owner acquiring content does not necessarily qualify for antitrust intervention. Beyond precedent, there are three other practical reasons we believe the acquisition should be allowed:

• Platform Agnostic Pledge: If Microsoft does in fact continue to allow ATVI’s content to be distributed outside of their own channels, the status quo is effectively maintained for other platform owners (i.e., Sony, Nintendo). As previously mentioned, there is no guarantee that Microsoft will follow through with their promise, but the FTC is capable of retroactively blocking anticompetitive behavior. The FTC exercised this last year, when it prohibited Broadcom from entering into certain exclusivity or loyalty agreements with its customers.
• Mobile Ambitions: Microsoft has highlighted that a big driver of this acquisition is access to the mobile category. The company currently lacks a presence in this channel, but aims to build a marketplace that actually increases competition for a medium that is essentially owned by Apple and Google. This is particularly timely, as Apple is potentially preparing to allow third-party app stores on its hardware.
• Market Share: If the ATVI acquisition is completed, Microsoft will become the second largest games revenue producer globally. In 2021 the combined entity would have earned $21.0b in gaming revenue. Microsoft would only be behind Tencent ($32.2b) and jump past Sony ($18.2b) and Apple ($15.3b) while also significantly extending their lead on Google ($11.0b) and NetEase ($9.6b). This would suggest that post-acquisition Microsoft would have generated ~11.6% of all gaming spend ($180.3b) last year. However, since this acquisition is particularly focused on content, it is important to look at the relative market position across game sales. Taking a closer look at Game Pass, which has become Microsoft’s clear focus within gaming (particularly in conjunction with its cloud gaming service), we can estimate a run-rate of roughly $4.5b in annual revenue across 25m reported subscribers paying an average of $15 per month. Considering the United States alone spent $51.7b on game content in 2021, the combined global entity (pre-synergies) would have only accounted for $12.6b, or ~24%, of American content sales.

Takeaway: We believe that Microsoft’s acquisition of ATVI will result in a positive outcome for multiple stakeholders and the broader gaming industry. Consumers will have access to a superior subscription offering (Xbox Game Pass) that provides unprecedented value, and game developers will have a more valuable channel to potentially monetize their content. From a competitive perspective, platform owners will need to find ways to provide more value to their audience. This acquisition does not prevent them from doing so. As a result, while the FTC may be looking to make an example out of Microsoft as the agency pursues an increasingly aggressive antitrust strategy, we believe that this acquisition should not be blocked.