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Why Microsoft Paid $7.5 Billion for Gaming Wizard ZeniMax

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Microsoft (MSFT - Free Report) may have lost the battle to own a stake in TikTok, but they are winning on multiple fronts in the gaming wars as they capitalize on pandemic trends and the surge in GaaS, or gaming as a subscription service.

And this week's announced acquisition of privately-held ZeniMax -- owner of studios that create the post-apocalyptic Fallout games and the fantasy series The Elder Scrolls -- further expands their empire just ahead of the November launch of the next-gen Xbox video game consoles.

In the video that accompanies this article, I go over many of the details of the $7.5 billion deal including great analysis from the writers and editors at CNET like Jeff Bakalar who produced a couple of excellent videos I reference.

In his piece What Microsoft's $7.5B purchase of Bethesda parent ZeniMax means for Xbox Series X, CNET editor-at-large Ian Sherr observed this on Tuesday...

"The move grows the number of in-house Xbox game development studios to 23, up from 15 earlier, giving it control of some of the game industry's most popular franchises. Microsoft also plans to run Bethesda as its own division, with leadership and structure intact."

What is Microsoft's Game Strategy?

One of the first big gamer-industry acquisitions by CEO Satya Nadella was Minecraft maker Mojang in 2014 for $2.5 billion. That was followed in 2018 by a flurry of smaller deals before this week's record gaming investment, which carried a familiar price tag nonetheless.

Also in 2018, Microsoft announced it would "acquire GitHub, the world’s leading software development platform where more than 28 million developers learn, share and collaborate to create the future. Together, the two companies will empower developers to achieve more at every stage of the development lifecycle, accelerate enterprise use of GitHub, and bring Microsoft’s developer tools and services to new audiences."

While the price of $7.5 billion was the same, the GitHub deal was done purely with Microsoft stock, while this week's bid for ZeniMax is all cash. My point in bringing up this purchase is that it seemed to fit well with Microsoft's mission as a software company, while gaming seemed like a side project where Xbox console sales were less than $2 billion in 2019.

But then I brushed up on the homework -- I had done this podcast and article in 2018: The $100 Billion Cult: Video Gaming & Global Youth Culture -- and was awakened to find that projections for the size of the gaming market in 2021 are now $200 billion.

And I also took a closer look at their year-end fiscal 2020 report (Q4 ended in June). Getting the numbers right about how big gaming revenues are -- from content, services, hardware, and PC -- isn't easy since the company doesn't break it all down clearly.

But the end results are pretty clear: these gaming revenue sources are the fastest growing across all Microsoft segments. I go over the details in my video.

Nadella and Spencer: A Bigger Vision for the Netflix of Gaming

In interviews and press statements this week, CEO Nadella and Xbox head Phil Spencer explained the logic of a $7.5B deal for a game developer and its deep library.

"As a proven game developer and publisher, Bethesda has seen success across every category of games, and together, we will further our ambition to empower the more than three billion gamers worldwide," Nadella said in a statement.

That "three billion gamers" number is another key figure on Nadella's mind besides the TAM (total addressable market) projection of $200 billion. I guess all of this should be no surprise as mobile devices could turn anyone into a "gamer" and Nintendo (NTDOY - Free Report) Switch sales topped 55.7 million units last year as the company grew annual revenues 9% to $12.31 billion.

And the "Netflix (NFLX - Free Report) of Gaming" reference comes from Piper Sandler software analyst Brent Bracelin who coined the moniker specifically for Microsoft's Xbox Game Pass subscription service. The genius of this move, as detailed by Jeff Bakalar, is that Microsoft will offer special deals and financing on new Xbox consoles with the purchase of extended-term GaaS subscriptions.

In an interview with the CEO and Spencer, Ian Sherr explained that "What's driven [Nadella] is a belief that interactive entertainment will be a key technology in the next 10 years and that gamers who use Microsoft products expect the company to make titles like those made by the studios he's bought."

And Nadella clarified it this way: "You can't wake up one day and say, 'Let me build a game studio.' The idea of having content is so we can reach larger communities."

"Content is just the incredible ingredient to our platform that we continue to invest in," Xbox head Phil Spencer said in that same interview. "This doubles the size of our creative organization."

I've always seen the tech giants like Apple, Alphabet, and Amazon as careful with their cash hoards because they can better spend a few billion internally to develop their own projects, versus going out to pay top-dollar for an established large-cap enterprise that had already developed a successful business around what they wanted to do.

But on this deal for ZeniMax, I agree with the top brass that this was a sweet deal for Microsoft to pick up all this content, the creative studios that made it, and all their faithful fans. They could never have replicated it at twice the price, much less even years from now before the competition did something similar, or better.

How Gaming Drives Serious Innovation Via Competition

The obvious big competitor that some gaming industry experts believe Microsoft has bested in the digital playground wars is Sony (SNE - Free Report) and their Playstation platform, who also has a new next-gen console coming this season.

Like Satya Nadella, I am not a gamer. But my understanding is that by offering PC capability for most games and services, Microsoft has freed itself from the console wars, and consumers from needing to purchase one. And yet they are still free to innovate with Xbox and find willing audiences for it, as we shall soon seen with November's launch of the $500 Xbox Series X and $300 Xbox Series S.

The other important player here, who can be both console and desktop-neutral, is of course NVIDIA (NVDA - Free Report) . Jensen Huang and his teams of rock-star engineers, who create massively parallel architectures for high-speed computing on GPU technology platforms, just introduced the gaming world to their latest high-powered card, the GeForce RTX 3080.

Built on the Ampere GPU architecture, which debuted in May and already stormed through supercomputing and hyperscale data centers, NVIDIA said on September 1 when it revealed the RTX 30 Series GPUs that "no one knew for sure what the new architecture would be capable of when unleashed on gaming."

Now they do, as these reviews posted on the company news page reveal...

"Nvidia brought it this generation,” PCWorld’s Brad Chacos wrote. “Ampere is indeed Nvidia’s greatest generational leap in recent memory.”
"The RTX 3080 is just stupidly, ridiculously, insanely fast. Period.” – declared Eber Anthony, at Hardware Canucks.
"The bottom line is that the RTX 3080 is the new high-end gaming champion, delivering truly next-gen performance without a massive increase in price.” – wrote Jarred Walton, for Tom’s Hardware.
"We can now confirm that this really is the biggest generational leap in PC graphics we’ve seen in years – perhaps ever,” – noted Bill Thomas, at Tech Radar.

It seems like it was only yesterday that NVIDIA unveiled the first Turing RTX card. Here was my breathless coverage in the summer of 2018...

Who Cares NVIDIA Makes Great Gaming Graphics?

NVIDIA CEO Jensen Huang gave computer gamers and developers more than they could ask for this week in Cologne, Germany at the Gamescom conference.

It's fair to say he stunned the crowd with amazing views, stats and demos on NVIDIA's record-breaking new "deep learning" architecture called Turing, featuring RTX image and light reconstruction/simulation powers that enable computers to teach themselves to do in real-time what it takes a Hollywood CGI studio months to do.

The world beyond gaming and CGI got to learn new phrases like "ray tracing" and "rasterization."

But if you are not a gamer or NVDA investor, you might find it hard to care. While I am not a gamer, I am an NVDA investor, and I'm here to give you two big reasons to care...

1) NVIDIA gaming graphics R&D is giving them deep knowledge about the next frontier of human evolution: AI

2) AI is going to dramatically change the world as you know it

I first addressed the stunning implications of NVIDIA's R&D reveal in my article from August 21, 2018...

NVIDIA Gaming Drives the Deep Learning-AI Revolution

Be sure to watch today's video to get the details on how Microsoft plans to more deeply penetrate the $200 billion gaming market.

Disclosure: I own NVDA shares for the Zacks TAZR Trader portfolio.

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