Monday, December 10, 2007

Vivendi Acquires Activision

Last week, Vivendi announced the acquisition of a majority share in Activision. If all goes according to plan, Vivendi's online gaming and entertainment business (most notably Blizzard Entertainment) will be merged with Activision's business. Vivendi will end up with a majority stake in the combined company, which will continue to trade under the name Activision.

The press release spells out a strategic rationale for the transaction (emphasis added):

Said Robert Kotick, Activision's Chairman and Chief Executive Officer: “This is an outstanding transaction for Activision and our stockholders, as well as a pivotal event in the continuing transformation of the interactive entertainment industry. By combining leaders in mass-market entertainment and subscription-based online games, Activision Blizzard will be the only publisher with leading market positions across all categories of the rapidly growing interactive entertainment software industry and reach the broadest possible audiences. By joining forces with Vivendi Games, we will become the immediate leader in the highly profitable online games business and gain a large footprint in the rapidly growing Asian markets, including China and Korea, while maintaining our leading operating performance across North America and Europe. Activision stockholders will benefit from significantly increased earnings power and the recurring nature and predictability of subscription based revenues, while also having the opportunity, if they choose, to receive $27.50 per share for a portion of their shares in the post-closing tender offer.”



How compelling is this rationale?

Activision asserts that the merger will give the combined company "leading market positions across all categories of the rapidly growing interactive entertainment software industry." This rationale implicitly assumes that leadership in each category is a desirable position for the company. This assumption sounds plausible, given the high fixed cost and low variable cost structure of the industry, but would be worth verifying.

Assuming that category leadership is a desirable outcome, the economic value the merger creates, as well as the level of effort required for post-merger integration, will depend in part upon whether the leading market positions would arise from economies of scale or economies of scope. The merger could generate economies of scale if Activision and Vivendi had overlapping customer bases, redundant cost structures, or underutilized assets that could be rationalized as a result of the combination (a typical rationale for, say, merging two banks with overlapping branch networks). On the other hand, the merger could generate economies of scope if Activision and Vivendi had complementary businesses that could add value to each other (a typical rationale, for, say, merging a bank with an insurance company).

Scale-based mergers generally require far more effort than scope-based mergers, but have a much greater likelihood of creating value. For example, in the retail banking industry, scale-based mergers have gradually but painstakingly created value during the past decade of consolidation, whereas scope-based mergers in financial services have proven far less durable.

In the Vivendi-Activision deal, I'd suspect most of the anticipated synergies are due to economies of scope, as the press release already implies that each company is already a leader in its respective categories.

The press release only mentions one specific economy of scope, the Asian market access that Vivendi would provide to Activision. How much value does this synergy provide? If this were the only synergy, would a transaction with Vivendi be the cheapest and best way to get better access to China and Korea? Have Activision and Vivendi already developed a plan to capture the value of this opportunity?

Do the companies have any other synergies in mind? Does Vivendi intend to extend the Activision game franchises to more fully take advantage of the subscription-based business model? Does Activision have unique product development skills or distribution channels that could otherwise increase the value of Vivendi's Blizzard Entertainment franchises? Are there other cross-sales opportunities?

I'll be curious to see whether this merger was motivated by strategic considerations, and if so, to what extent the synergies are realized, and to what extent they cover the premium that Vivendi is paying for Activision. Or whether this merger is motivated more by financial considerations (such as finding a more optimal capital structure for Vivendi's game business).

Hat tip: WoW Insider

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