Spurred on by the latest news, we wanted to show in this monthly flash info edition how and why video games, which is one of the usual sectors of ODDO BHF Artificial Intelligence, experienced an unprecedented series of mergers and takeovers in the first few weeks of 2022.

Two major takeovers in the sector already in early 2022

The video game sector was snubbed by investors in 2021 (-6% by the VanEck Vectors Video Gaming and eSports UCITS ETF, vs. +27% by the S&P 500) under the combined impact of: 1) fears of a sudden return to normal of player engagement after lockdown-driven boosts; 2) numerous postponed launches of new games, due to the remote- working challenges facing the industry; 3) serious issues in the areas of corporate culture and working conditions at several companies (Activision-Blizzard and Ubisoft in particular); and 4) the consequences of the change in IDFA (ID for Advertisers) at Apple for mobile video games.

In reaction to these concerns, a wide swath of the market no longer considered video games as “investable”. But then Take-Two and Microsoft reminded us suddenly of the value available in the sector. First when, on 10 January 2022, Take-Two bought Zynga (which we hold in our fund) for almost USD 13bn (paid for about two thirds in shares and one third in cash), or a 64% premium to Zynga’s latest closing price. And then, on 17 January 2022, when Microsoft announced it had reached an agreement to buy Activision for USD 95bn (all in cash), or a 45% premium to the latest closing price. On top of the opportunism of these deals (buying good assets at attractive prices after their underperformance of 2021), there are some fundamental reasons for this rush to acquire the sector’s main strategic assets, which we felt would be worth detailing in the paragraph below.

What’s behind this acceleration in video game history?

There are several reasons for the pick-up in major strategic deals in the sector: 1) to lock down quality content (franchises and live-service games), given that industry players stand out in their content and not their platforms. Content exclusivity will be crucial for video game streaming platforms, such as Microsoft ’s Xcloud, Alphabet ’s Stadia and Amazon ’s Luna); 2) to generate cost synergies but mainly income synergies. Microsoft could enhance the attractiveness of its Xbox Game Pass greatly by adding Activision-Blizzard games. It could also benefit from Activision-Blizzard’s know-how to develop mobile games using its own franchises (Halo, Forza Horizon, Elder Scrolls, etc.).

Take-Two could draw on Zynga’s mobile/free-to-play expertise to market its key franchises on mobile devices, while Zynga will use Take-Two’s know-how to accelerate its cross-platform initiatives; 3) to access an established base of gamers. Activision-Blizzard has an active base of 390m MAUs (as of September 2021), or more than the number of Netflix subscribers or active users of Twitter or Twitch; 4) to secure quality human resources, given the growing shortage in the industry caused by the many opportunities at large tech companies and blockchain gaming companies; and 5) to prepare the ramping-up of the Metaverse concept (of which game publishers are ultimately the pioneers) and to counter the head starts taken by Meta (ex- Facebook ) and Roblox in in this field.

A strategically attractive sector for investors seeking M&A targets

The video game sector currently features an asymmetry between:

• a high number of potential buyers who have the means to pursue their ambitions and reasons for moving quickly;
• a scarcity of available targets having key franchises that can make a difference.

Among the sector’s main potential buyers are the following:

1. Sony, whose share price fell 12% on the news of the Microsoft /Activision deal, reflecting the risk of lost market share by PS5 vs. its challenger ( Microsoft ’s Xbox), unless Sony reacts by acquiring AAA game content for its console, given that Microsoft has, through Activision, acquired about 10% of the games offered on Sony’s PS5. Activision’s flagship games (e.g., the Call of Duty franchise) will nonetheless remain available on PS5 in the short and medium terms, by virtue of contracts that are still in effect. And the regulator will no doubt demand that Activision remain available on the PlayStation platform.
2. GAFAMs and in particular Amazon (for the Cloud Luna game platform), Alphabet (for its Stadia platform) and Meta/ Facebook to consolidate its first-mover advantage in the Metaverse must rush to buy up the last video- game franchises available on the market. Alphabet and Amazon have tried to develop games in-house in recent years, but without much success for the moment. One year after acquiring its first studio, Alphabet closed its video-game development division. Amazon has invested hundreds of millions of euros over the past 10 years in its own studios but has managed to bring out just one real game (New World), which got off to a good start but has been unable to maintain that momentum.
3. Netflix unveiled its ambitions in video games in 2021 with many new hires and an initial small acquisition (Night School Studio). This is worth doing for Netflix in helping it stand out from its competitors (HBO, Disney, Hulu), to justify price hikes and ride the growing links between video games and audio-visual content.
4. Disney may also want to bring video-game development back in-house, after closing down its studios in 2016 and outsourcing development based on its franchises. It could make this move in reaction to the industry’s boom in recent years.

Given this long list of strategic and powerful buyers, which find themselves, de facto, in a race to make acquisitions, there are now only a few Western targets available:

1. Take-Two, which is the best remaining franchise in AAA games, with outstanding top management (Strauss Zelnick, CEO and chairman) and which looks even better after its plan to take over Zynga;
2. Electronic Arts (EA), but a deal is less feasible there, as some of its games are closely intertwined with licences (its FIFA games, for example);
3. Ubisoft, which holds many well-regarded franchises (such as Assassin’s Creed, Rainbow 6, and Far Cry) and possesses expertise in open-world games and a large mass of developers (about 20K).