The Long and Short
Microsoft all-cash acquisition sets a pandemic mark
Meredith Contente | January 21, 2022
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Microsoft Corp (MSFT) recently announced that it would be acquiring Activision Blizzard (ATVI), in an all-cash transaction valued at $68.7 billion. The combination will create the third largest gaming company in the world. This marks MSFT’s largest acquisition in its history and the largest all-cash transaction since the start of the pandemic. ATVI bonds tightened about 30 bp on the news, though they continue to trade 15-30 bp behind MSFT depending on maturity. While MSFT has yet to state its intentions with the existing ATVI debt, there is a strong likelihood that one of the agencies equalizes ATVI’s debt rating with that of MSFT, leaving plenty of upside left for ATVI bondholders. Among the options MSFT could take with respect to ATVI’s debt: assume and guarantee, exchange for new MSFT bonds, tender or make-whole. Make whole calls of the existing debt would provide the most upside, while conducting a debt exchange would mean that the exchanged bonds would likely trade on top of existing MSFT bonds. In either case, the most upside is in the ATVI 1.35% 2030 bonds.
Exhibit 1. MSFT Curve vs. ATVI Curve
MSFT will pay $95/share in cash for each share of ATVI, representing a 45% premium to where ATVI’s stock closed on 1/14/22. MSFT has yet to breakdown the percentage of debt financing they plan to utilize in financing the deal. We note that when MSFT acquired LinkedIn for $26.2 billion back in 2016, MSFT tapped the debt market for $19.75 billion ahead of the closing. That translates to roughly 75% of the purchase price funded with debt, despite having $137 billion of cash on hand at the time. MSFT ended the most recent quarter with $130.6 billion of cash on the balance sheet. With a purchase price of $68.7 billion for ATVI and assuming 75% debt financing (similar to the LinkedIn transaction), we could see MSFT look to tap the market for just over $50 billion. MSFT is estimated to generate $65 billion of free cash flow this fiscal year (ended 6/30/22). While the dividend consumes roughly $17 billion and assuming $15 billion in share repurchases, MSFT would be in a position to repay the debt financing associated with the transaction within two years. Should MSFT pause share repurchases post the closing of the acquisition, MSFT would be able to repay the debt in roughly 12 months. The deal already received shareholder approval from both companies and is expected to close in the first half of calendar 2023.
Agencies Affirm MSFT –ATVI on Review for an Upgrade
Moody’s affirmed MSFT’s ratings with a stable outlook noting that the acquisition makes sense strategically for MSFT while having both a strong cash position and free cash flow generation that provides it with financial flexibility to execute the transaction. Furthermore, Moody’s believes MSFT’s long track record of steady financial performance support the acquisition as the agency estimates that MSFT will produce EBITDA margins above 50%. We note that on an LTM basis, MSFT’s EBITDA margin was 50.4%. Moody’s placed ATVI’s Baa1 rating on review for an upgrade with the review focusing on the regulatory hurdles for completion and the treatment of ATVI debt. Should MSFT assume and guarantee ATVI’s debt or conduct a debt exchange, the agency plans to equalize ATVI’s ratings with those of MSFT. However, should the company not support the debt, Moody’s will likely notch ATVI’s ratings or could potentially withdraw the rating.
S&P also affirmed MSFT’s AAA rating while placing ATVI’s A- rating on CreditWatch positive. S&P will likely view ATVI as a core subsidiary of MSFT when the deal closes and will equalize the ratings, even if the debt is not guaranteed. S&P believes MSFT will leverage ATVI’s video game portfolio to propel its gaming strategy. As such, MSFT will report ATVI’s financials as part of the company’s Gaming segment. S&P plans to withdraw the ATVI rating if all ATVI debt is repaid at the close. The CreditWatch is expected to be resolved after the transaction closes.
Fitch expects MSFT to have sufficient capacity to continue to retire debt at maturity while maintaining its dividend and share repurchases and keeping gross leverage consistent with its triple-A rating. Fitch noted that MSFT’s cloud products will continue to be a growth driver given the high rate of cloud adoption. MSFT has largely been retiring debt maturities and given its EBITDA growth, total leverage is expected to remain within the 0.5x-1.0x range. ATVI bonds are not currently rated by Fitch, but if bonds are exchanged into MSFT bonds, they would gain the AAA rating by Fitch.