How Will Gamers and Investors Respond to Microsoft’s Acquisition of Activision Blizzard?

BRIAN KENNY: In March of 1962, two aircraft engaged in a dog fight while circling a planet in the far reaches of outer space. Fortunately, no lives were lost in the incident, which took place in a lab at MIT as part of the first known computer game called Space War. Powered by a computer the size of an SUV with primitive graphics and controls, Space War was hugely influential in the launch of the first generation of video games. 60 years later, the gaming industry generates over 200 billion dollars in revenue around the world. Gen Alpha, those born after 2009, spend more time gaming than they do streaming content or social networking. With numbers like that, it’s no wonder that the sector is crowded with over 22,000 gaming companies in the US alone. 70% of those firms will fail within the first few years, but for those that take off, the sky is the limit. Today on Cold Call, we’ve invited Professor Joseph Pacelli to discuss the case entitled, Call of Fiduciary Duty: Microsoft Acquires Activision Blizzard. I’m your host, Brian Kenny, and you’re listening to Cold Call on the HBR Podcast Network.  Joseph Pacelli’s research covers topics related to capital market gamekeepers, culture and diversity, and new technology. You are a first timer on Cold Call, thanks for joining me today, Joseph.

JOSEPH PACELLI: Thanks for having me here today.

BRIAN KENNY: Great to have you to talk. Are you a gamer? I should ask that.

JOSEPH PACELLI: A little bit. I do a little bit on the side.

BRIAN KENNY: Yeah. I totally missed that. I’m way too old for that, and I totally get the appeal, but I can’t play any Madden games. I don’t have the dexterity or the smarts. I don’t know what it is.

JOSEPH PACELLI: You know what’s pretty amazing about games these days? They have so many accessibility options, you can literally turn it on to story mode and just click your way through.

BRIAN KENNY: So, you’re saying that even somebody like me could figure out …

JOSEPH PACELLI: If I can do it, anyone can.

BRIAN KENNY: So, this is a great case, and obviously very timely, and this is a huge industry. I think a lot of people who are listening are gamers and will enjoy hearing about it. So, thanks for coming on to talk about it.

JOSEPH PACELLI: Yeah, thanks for having me.

BRIAN KENNY: Let’s just dig right in then. If you could start by telling us what the central issue is in the case and how you would start this in the classroom with your cold call.

JOSEPH PACELLI: Yeah, so essentially, we’re exploring this recent acquisition where Microsoft decided to buy Activision. And it was right in the midst of this very large scandal, which Activision was involved in some gender pay and sexual harassment and discrimination suits. And so, the case essentially explores some different issues thinking about, does this acquisition make sense? Primarily from Microsoft’s side, but also thinking about Activision’s side. So, Microsoft… they’re thinking about, over the past decade or two, they’ve been thinking about how to continue to grow and strengthen their gaming business. And there’s a lot of competition here, particularly from Sony and Nintendo, and so Microsoft comes in and announces their intention to buy Activision right as the stock price is declining. Right in the heat of all this misconduct being announced. And so, the key issue we explore is, given these allegations, should Microsoft buy Activision? And then, at what price? Given that they’re potentially buying a firm with a pretty bad culture, at least a lot of baggage.

BRIAN KENNY: Yeah. We always like to know what prompts a faculty member to write a business case, so I’m just curious, what made you decide to write about it? There was a huge headline, this was obviously a big news story, but what led you to write the case?

JOSEPH PACELLI: Yeah, absolutely. So, most of my research focuses on misconduct and culture. So, for example, I have done recent research trying to understand how much job seekers actually value culture. So, we’ve done some of this in a field experiment showing that individuals are more willing to click on jobs that advertise diversity. More recently, we’re actually looking at job postings and we show that companies that promote culture actually can get more applicants. So, it really fits into my whole research area looking at the value of corporate culture, and it’s really difficult to examine, to think about what is the price of a good culture firm? Or how to make a business case for it. And the acquisition setting is kind of nice because you could actually see how much a company, like Microsoft, is willing to pay for a company like that. Activision has all these potentially cultural problems being revealed in the news.

BRIAN KENNY: Yeah. And I could imagine there’s all kinds of pushback on that too. There’s public perception things that go along with Microsoft and why they want to do this. Probably raises a ton of really interesting questions. I teased a little bit in the intro about the gaming sector, it’s enormous, but maybe you can talk a little bit more about who the major players are in that landscape and where Activision fits in.

JOSEPH PACELLI: This is an industry that, in 2020, was more than 160 billion dollars in revenues. A large portion of the market nowadays is mobile gaming, about nearly half of it. It’s an industry with a ton of growth, growth expected over the next 10 years, at about 12 or 13% per year. A lot of it’s being driven from this potential for the Metaverse. What surprised me is actually the video game sector is actually larger than the movie and music industries combined, so it’s a huge industry. The major players, really if you think about it in terms of console and software: Sony, Microsoft and Nintendo. The Xbox, PlayStation, Nintendo Switch, those are probably the major players, but you also have Tencent, Electric Arts, and some other software companies out there as well.

BRIAN KENNY: Yeah. And then a whole bunch of little indie ones too that, like I said, most of them don’t even survive.

JOSEPH PACELLI: And Microsoft does a good job of trying to give a platform for indies to sell their content on their service, so Microsoft’s pretty good with that.

BRIAN KENNY: I would imagine that the pandemic probably got a lot of people into gaming that might not have been into it before. I’m just wondering if there’s been any sort of documented effect of COVID on the gaming space.

JOSEPH PACELLI: Yeah, the pandemic was huge for gaming. The industry grew considerably. I mean, the effects were somewhat obvious that people were forced to stay inside.

BRIAN KENNY Yeah, what are you going to do?

JOSEPH PACELLI: What do you do, right? Netflix did amazing during the pandemic. Gaming did amazing. Some companies actually took this as an opportunity to start to provide content for free, to try to attract more gamers. So, I think if you look at the financials, a lot of companies really saw a huge boost during the pandemic. And it’s actually interesting when we think about the case, one of the challenges for the students, as we’re thinking about how to value Activision, is trying to think about where their growth is going to go in the next few years. Because the pandemic makes it look like everything is trending in a great direction, but it’s hard to unwind the effects of the pandemic and say, “Well, what did Activision look like in the past three years absent a major worldwide pandemic?”

BRIAN KENNY: Yeah, like would all those people who picked it up during the pandemic continue to play or are they going to go back to whatever they used to do?

JOSEPH PACELLI: Right, right. And that’s a big debate here is whether or not this is a major shift in gaming trends or if this is a transitory bump that will revert and we’ll see less growth in the future.

BRIAN KENNY: I was really surprised when I read in the case about how old Activision is. I mean, it’s been around for a long time.

JOSEPH PACELLI: Yeah, nearly 50 years. So, it was founded in 1979 and then it went public in ’83 originally, and then in the 80s there was a video game market crash. Essentially what happened was there was a lot of cheap content flooding the market and Activision really couldn’t compete because everything was being sold very… People basically buying out cheap content and reselling it at a low price. Activision couldn’t compete so they wound up reorganizing themselves in the late 80s, early 90s, and really focusing on, as the industry starts to heal itself, think about how do we produce really great content? And they were known for a lot of popular games like Tony Hawk Pro Skater and Guitar Hero. And so, they grew throughout the 90s as Nintendo came in and made the industry a little bit more sound when they introduced quality control standards with Nintendo and the Super Nintendo.

BRIAN KENNY: And this is all console-based gaming. So, none of this is streaming, this is all way before …

JOSEPH PACELLI: This is all way before streaming. This is all console based. You plug into your TV.

BRIAN KENNY: Yeah, you got to buy hardware, and then your parents have to put it together. I was on that side of it.

JOSEPH PACELLI: That’s right, that’s right.

BRIAN KENNY: Oh, my goodness.

JOSEPH PACELLI: You remember the cables, right? The red…

BRIAN KENNY: Yeah, I still got some of those cables kicking around. What do we use that for? So, let’s talk about Bobby Kotick and his background a little bit. I’m curious about how he came to be in charge at Activision.

JOSEPH PACELLI: Yeah, so he came into the company, he bought it at a low point in the early 1990s. And, like I was saying, he’s the one responsible for completely restructuring the company to focus on video games and high quality games. He’s an interesting character. So, gamers are very passionate, right?

BRIAN KENNY: Yeah.

JOSEPH PACELLI: And what’s interesting when you think about publicly traded gaming companies is that gamers and investors don’t always see eye to eye. So, I would describe Kotick’s leadership style as one that probably drew both criticism and praise. So, the gamers like to criticize Bobby because they say, “Well, he doesn’t really understand gaming, he’s just in it for … he just knows what sells well.” But obviously investors like that, so he’s one of these controversial figures.

BRIAN KENNY: So, we know, for instance, that in the tech sector there’s been a lot of cases brought against tech companies. A lot of accusations of kind of a frat boy atmosphere at some of these firms. And there were some accusations that were leveled at Activision as well, so we’ll talk about that a little bit further in the conversation, but before we go there, I wanted to understand a little bit more about how the acquisition of Blizzard came to pass. How did Activision end up with that opportunity?

JOSEPH PACELLI: Yeah, so this was in 2007, and so I think Blizzard was known for popular content like Warcraft and Diablo. They had really good content and this was a pretty big merger. I think it was one of the largest at the time. So, the idea was that Blizzard could benefit from having access to Activision’s large marketing budget, which they’ve been building over the years. And Activision could benefit from bringing in this really awesome content, like Warcraft, and also leveraging the online presence that Blizzard had. So, I think the combined entity created assets of nearly 19 billion dollars with a ton of goodwill.

BRIAN KENNY: And did it also shine a light on the firm in a way that maybe revealed some of the issues that they were having?

JOSEPH PACELLI: So, there’s no evidence that issues are being revealed at that time. I do think, as the allegations started to come out more recently, there was a sense that this has been there for a while, but no one’s reported it.

BRIAN KENNY: What were some of the allegations?

JOSEPH PACELLI: So, it was pretty bad stuff. So, it was sexual harassment and there was talk of, they called them Cube Crawls, where I think management would walk from cubicle to cubicle and make unwanted advances on women in the workplace. A general lack of women in leadership. Unequal pay. I think there was one story where, I think I read, actually, a couple joined at the same time and they were comparing salaries. And I think the man said that he’s actually making … realized he was making a lot more than his girlfriend at the same role.

BRIAN KENNY: Crazy. Yeah. So, like I said, we’ve heard that about the tech industry, we’ve heard it about other industries as well, how did Kotick and the leadership in the company respond to the allegations?

JOSEPH PACELLI: Initially, not very well, to be honest. So, the company, their knee jerk reaction was to respond by issuing a statement saying that the lawsuit was distorted and false. And then the Chief Compliance Officer came in—Townsend—and she sent a message to the staff basically reiterating the same idea. So, I think it was only, you mentioned Blizzard a moment ago, it was only Morhaime, the former Blizzard executive, who came in and showed initial support. He wrote a blog post saying he believed the allegations and publicly apologizing. And then eventually the firm would change its response, but the initial reaction was not great.

BRIAN KENNY: So, very interesting that the person from the outside was able to see this and acknowledge it, but within the firm itself, they were saying, “nothing to see here.”

JOSEPH PACELLI: Yeah. So, Morhaime, I think he was in the entity, because I think he was from Blizzard. So, when they acquired Blizzard, I think he was still part of the company. But Kotick didn’t say anything initially and I think Townsend made it worse, the compliance officer, by really reiterating that message that this is all distorted.

BRIAN KENNY: So, I’m wondering how the employees reacted to Kotick’s response.

JOSEPH PACELLI: Yeah, also not very favorably. I mean, it was just a series of bad press for Activision. So the employees signed an open letter condemning Townsend’s statement and they planned a walkout to protest the company’s response to the lawsuit. So, Kotick finally stepped in and he responded with a public letter calling the initial response tone deaf and said the company was taking action. And then the fallout proceeds from there, of course.

BRIAN KENNY: Yeah. And it was in the press. I mean, I remember reading about it. So, there was a lot of fallout that came from this. So, I guess the question that probably comes up in the classroom a lot, and certainly that the case raised is, why would Microsoft go near this, given how hot it was at the time?

JOSEPH PACELLI: Yeah, so it’s an interesting question. So, we saw the stock price start to decline, and as the fallout was becoming more and more prevalent in the press, Microsoft comes in and starts to make an offer. And so we don’t really know what Microsoft’s true intentions are, but one could conjecture that Microsoft is trying to acquire Activision at a time that’s optimal, when the price is at a low point. It’s interesting, they still pay way above market price, but it’s unclear how much that premium would’ve been in normal times, because Microsoft really jumped on this opportunity.

BRIAN KENNY: Yeah. What was Microsoft’s place in the gaming ecosystem? I mean, they have Xbox, that’s a huge product line for them. So, they already had a lot of great assets and the lead position.

JOSEPH PACELLI: Yeah, so Microsoft’s been in the gaming space since about, I’d say it’s probably 2001 when they became really serious about this, that’s when they introduced the first Xbox. And so, the three major players are Microsoft, Sony, and Nintendo, at least in the console gaming space. So, Microsoft and Sony are really, if you’re one of the more serious gamers, Microsoft and Sony are usually competing pretty intensely. And so, what Microsoft did that was pretty innovative in the past, I think it’s been since about the mid-2010s, they introduced this Game Pass, which is like Netflix for gaming. And a lot of it happened after Satya Nadella took over the company. We saw Microsoft really start to push more towards services. I think they originally purchased Minecraft and then it led to thinking about, how can we expand our services. And so, Game Pass was a pretty great value for gamers in that, for 10 or $15 a month, get access to hundreds of games. And this really changed the mindset around gaming. And so they introduced that in the mid-2010s, and then with their most recent console, the Xbox Series X, they actually started creating opportunities where they’re trying to bundle Game Pass with the console. Really, they’re trying to push this service, kind of like Netflix for gaming.

BRIAN KENNY: Okay. The case title specifically mentions fiduciary and so, I want to talk about that for a second, because I’m wondering, if we just step away from this particular acquisition, what are the fiduciary responsibilities of a firm like Microsoft as they’re thinking about this kind of acquisition? What do they owe to their shareholders?

JOSEPH PACELLI: I mean, at the end of the day, I think it’s like any other company, they owe their shareholders value and you want to see stock price grow. And the questions surrounding this acquisition are whether or not this is good for shareholders or not, and so that’s essentially what the students will debate is whether or not Microsoft … I think they’re spending a large portion of their … It’s an all cash deal. So, I think it’s, what, $70 billion, right?

BRIAN KENNY: Yeah, yeah.

JOSEPH PACELLI: They’re spending a large portion of their cash reserves on this acquisition, whether this is a good thing for shareholders or a bad thing. So, I think really time will tell, but students may argue that this is going to eventually unwind itself into problems for Microsoft. We might start to see decline in sales from this acquisition, it could be reputational damage, there could be a lot of employee turnover. You’ll note that they’re actually keeping Kotick around for a year despite some of the-

BRIAN KENNY: I wondered about that. Why would they want to keep him around? And I guess optics don’t necessarily factor into this decision as much as I thought they might.

JOSEPH PACELLI: Yeah. And the initial response was kind of a little bit odd. I think there was initially some uncertainty about whether Kotick would stay around and then I think later they announced that he would stay around for a year. My guess is they’re keeping him around because he probably offered some stability. Yeah, like I said earlier, he does seem to be liked by many shareholders. Analysts seem to be somewhat favorable of his leadership style, despite the allegations. So, I’m guessing that Microsoft finds some value in keeping him around. And I think that a lot of this is trying to, how do we have that value and also manage our image here too, in that he’s clearly in a lot of negative press space.

BRIAN KENNY: Did Activision have the option to say no to this acquisition?

JOSEPH PACELLI: So, actually Activision, I think, countered the original offer. So, I think Microsoft, I think they offered around, was it $80 a share was their initial offer price? And Activision actually was able to counter and push that up to about $95 per share. So, I believe they claim that they went out and were looking at other offers, and so they definitely didn’t accept the first offers. They definitely could have said no and walked away. Now this is an awesome opportunity for them because it provides a lot of cover from the investor pressure related to these scandals. So, one might question whether they would actually walk away from this.

BRIAN KENNY: Yeah, it was a deal they couldn’t afford not to take.

JOSEPH PACELLI: Right, right.

BRIAN KENNY: If we look at the industry more broadly, it seems like there’s a lot of consolidation going on.

JOSEPH PACELLI: Right, right.

BRIAN KENNY: Yeah, yeah. So, this case is indicative of a larger trend, I guess, within the gaming industry, which is consolidation. There’s a lot of consolidation going on and I wonder if, in your opinion, that kind of consolidation can sap the industry of innovation?

JOSEPH PACELLI: It’s an interesting debate. So, I think, coming back to our earlier discussion about gamers versus investors, I think there’s been a lot of claims over the past 10 to 20 years from gamers that consolidation is potentially hurting the quality of games. Especially as a lot of these opportunities to pay for additional content, micro transactions, it becomes something that gamers hate. On the other hand, investors seem to be doing well from this. The industry is super profitable. The interesting question to me is whether or not Microsoft will pull this deal off. I think there’s potentially concerns about antitrust issues, especially with IP like Call of Duty, whether they’re going to be able to completely keep Sony out of the solution here is unclear. And I think that’s something analysts are talking about.

BRIAN KENNY: Yeah, yeah. So, time will tell, I guess.

JOSEPH PACELLI: Time will tell, for sure.

BRIAN KENNY: Joe, it’s a great case. I wonder if you could just tell us one last thing before we end here, which would be, if you want people to remember one thing about the case, what would that be?

JOSEPH PACELLI: I think at the end of the day the idea is that culture matters, in thinking about M & A deals and pricing. The culture that Activision is dealing with, these allegations, will ultimately affect the value of the deal in some way. I think it’s not yet clear what’s going to happen. It’s possible that Microsoft was able to purchase Activision at a discount, that would explain why they rushed into this deal in December. It’s also possible that this will bring in future problems. We may see brand dilution, we may see employee turnover, so I think only time will tell.

BRIAN KENNY: Yeah. We certainly do know that people care about the firms that they buy products from and often time they will vote with their feet.

JOSEPH PACELLI: That’s right.

BRIAN KENNY: Yeah. Joseph Pacelli, thank you so much for coming on to talk about it.

JOSEPH PACELLI: Thank you so much for having me.

BRIAN KENNY: If you enjoy Cold Call you might also like our other podcasts: After Hours, Climate Rising, Skydeck, and Managing the Future of Work. Find them on Apple Podcasts or wherever you listen. Be sure to rate and review us on any podcast platform where you listen. If you have any suggestions or just want to say hello, we want to hear from you. Email us at coldcall@hbs.edu.Thanks again for joining us. I’m your host, Brian Kenny, and you’ve been listening to Cold Call, an official podcast of Harvard Business School, brought to you by the HBR Presents network.