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In a deal announced last week, two giants of the gaming world said they would combine. Activision Blizzard (NASDAQ: ATVI) is paying $5.9 billion to acquire King Digital Entertainment (NYSE: KING), the European leader in mobile gaming.
The deal is immediately interesting because it joins a leader in console video games with a powerhouse in mobile gaming. Hit games including Activision’s “Call of Duty” and “World of Warcraft” will now be under the same roof as “Candy Crush Saga.”
The deal is expected to boost Activision’s adjusted earnings next year by 30%. It also gives the new company more than 500 million monthly users spanning 200 countries.
CEO Re-Think?
The deal was somewhat surprising because of Activision CEO Bobby Kotick’s previous aversion to the entire mobile free-to-play business model. He thought that games such as “Angry Birds” were nothing more than one-hit wonders and that social gaming was a fad not worth pursuing.
So instead of going down the path of a Zynga (NASDAQ: ZNGA), Kotick opted to launch Skylanders. More than 250 million of these interactive toys were sold, becoming a $3 billion franchise for the company. It also started a whole new industry as companies such as The Walt Disney Co. (NYSE: DIS) jumped into the marketplace.
But then apparently Kotick noticed that last year King Digital had revenues of $2.2 billion. The trigger on the deal was pulled.
Deal Blemishes
Does the deal make sense?
In a way, Kotick had to make the deal. His company is facing the same pressures as others in the entertainment content business. That pressure is coming with the shift from the “big screen” to the small and often mobile screen.
Activision has not been successful in its meager efforts in mobile so far. So in effect, it is buying the expertise of the management team at King Digital.
King Digital is profitable. It generated $119 million in profit on only $490 million in revenue in the second quarter. And “Candy Crush Saga” is still the No. 3 top-grossing game on Apple’s (NASDAQ: AAPL) App Store more than three years after its initial release.
But there are blemishes. With its games being free, nearly all of that revenue is generated by a tiny fraction of its users – 7.6 million of its 340 million monthly users, to be precise. That’s only 2.2%.
King’s user numbers are edging down too. In the latest quarter, the number of users dropped by 5%. And in the second quarter, spending on King’s titles fell by 13% year-over-year.
Deal Logic
But there is King Digital’s extensive global user base to consider. Keep in mind that 60% of that base is female, which is not a traditional segment for video game makers. That had to attract Kotick. Sales not tied to “Candy Crush” are on the rise too.
Activision does have 35 years worth of intellectual property as well. It has to be hoping that the team at King can work some magic with that in the mobile gaming world. King has worked some magic so far without spending a lot on research and development either. King’s R&D spending is just 10% of sales, versus 50% at Zynga.
To me, the deal makes sense.
Combining Activision’s history of long-lasting hits like “Call of Duty” with King Digital’s model of getting little drips of revenue over long periods should work.
And with Activision only paying about seven times cash flow for King Digital, I see why Bobby Kotick made the deal.
He could have another counterintuitive winner here as he did with Skylanders.
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