Activision Blizzard: A Buy Ahead Of Likely Microsoft Deal Regulatory Approval

• Microsoft's acquisition of Activision Blizzard has shareholder approval
• $95 per share offer depends on regulatory approval
• Consensus view is that the deal will close
• Market-implied outlook favors deal-closing, but substantial probability of failure and a subsequent decline in share price
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Shares of Activision Blizzard (NASDAQ:ATVI) fell 28% in 2021 and continued to fall in the early days of 2022. The entire picture changed on Jan. 18 when Microsoft (NASDAQ:MSFT) announced a consensus outlook is calculated using price targets and ratings from 27 analysts. The consensus rating is bullish and the consensus average 12-month price target is $94.91, about 21.4% above the current share price.



Source: Investing.com

The prevailing view is that a share of ATVI is worth what MSFT has proposed to pay for it. There is, of course, some possibility that the deal will not happen or that it will be delayed for some extended period of time.

Market-Implied Outlook for ATVI

I have calculated the market-implied outlook for ATVI for the 7.7-month period from now until Jan. 20, 2023, using the prices of call and put options that expire on this date. I chose this specific expiration date to provide a view through the end of 2022 and because the options expiring in January are heavily traded. I considered also running an outlook using options that expire in June of 2023, which would provide an outlook closer to when the acquisition is expected to close, but the options trading at this later date was very thin.

The standard presentation of the market-implied outlook is a probability distribution of price return, with probability on the vertical axis and return on the horizontal.



Source: Author’s calculations using options quotes from E-Trade

The market-implied outlook for ATVI is unlike any that I have calculated previously because there are two substantial distinct peaks in probability. The first, and higher probability, cluster has a maximum in probability corresponding to a price return of 15%. The second range of outcomes has a peak corresponding to a price return of -7.5%. For contrast, compare this to the previous market-implied outlook with a single peak and which is consistent with typical results.

What this outlook is showing is that the market anticipates two distinct possible outcomes—one in which the acquisition is on track to close and the share price rises, and one in which the acquisition has failed or been substantially delayed and the share price declines. The peak-probability outcome associated with the deal being on track has the share price at $90 rather than the $95 offered by Microsoft because the deal will not be completed by the time the options expire.

Having two distinct peaks in the market-implied outlook is very intuitive, given the binary outcomes--one with the acquisition being on track and one in which this is not the case. The expected volatility of this distribution is 24% (annualized), which is low. The market-implied outlook is indicating that the most probable outcome is for ATVI’s acquisition to go forward, in which case investors can expect a gain of around 15% between now and early 2023, with the remaining spread persisting as a discount that reflects the remaining potential for the deal to fail.

Theory indicates that the market-implied outlooks are expected to be negatively biased because investors, in aggregate, tend to be risk-averse and thus should be willing to pay more than fair value for downside protection. There is no way to measure that this effect is present, but such a bias would mean that the market-implied outlook should be interpreted as even more tilted to favor the deal closing than it appears.

Summary

While ATVI shareholders approved Microsoft’s offer, there are significant regulatory hurdles. In this situation, the attractiveness of owning ATVI shares mainly depends on the estimated probability that the acquisition will close.

To examine this question, I have looked at two forms of consensus outlooks. The first, the Wall Street analyst consensus, indicates that the deal will close and that, as a result, the shares will be worth $95. The market-implied outlook, which reflects the consensus view among buyers and sellers of options, is that there is a substantial probability that the deal will not be completed, although the probability of a successful completion is greater.

The bi-modal market-implied outlook is very intuitive in showing these outcomes. Given that both the Wall Street consensus and the options market consensus favor the success of the deal, my rating on the stock is buy / bullish.

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Written By: Geoff Considine, Ph.D