Money Talks is a column that explores what happens when business, the economy, and culture collide.
What’s $7.5 billion between friends? That’s been the general reaction of the gaming and business press to the news last week that Microsoft will be spending that sum to acquire ZeniMax Media, the parent company of, among others, powerhouse video-game studio Bethesda Game Studios, maker of Fallout 4, Doom, and Skyrim. Coverage of the deal has focused on how Bethesda will help Microsoft’s overall gaming strategy, by driving users to its Netflix-style GamePass service (which offers users access to an array of games for $15 a month), and whether Microsoft will now make Bethesda’s games exclusive, keeping them from owners of Sony’s PlayStation 4 and the forthcoming PlayStation 5.
In other words, the discussion has been all about whether it makes sense for Microsoft to ally itself with Bethesda. But in the process, a bigger, and in some ways more interesting, question has been skipped over: Even if allying with Bethesda makes sense (which it does), why would Microsoft buy ZeniMax to do it?
That may seem like a foolish question, given that buying other companies is something that most big companies do as a matter of course: From 2014 to 2019, M&A activity averaged close to two trillion dollars a year in the U.S. alone. But all that activity hasn’t changed a basic truth, which is that most deals are great for the company being acquired, and not so great for the company doing the acquiring. As Aswath Damodaran, a finance professor at N.Y.U., puts it, “More value is destroyed by acquisitions than by any other single action taken by companies.” Microsoft itself is a case in point. In 2013, it spent $7.2 billion to acquire Nokia’s smartphone business, and within two years was forced to write off the entire value of the acquisition as worthless.
Microsoft is giving up $7.5 billion in cash. That’s a ton of money — it’s nearly as much as what Disney spent in total to buy Star Wars and Marvel, two of the most valuable cultural franchises in history.
The Nokia deal is an extreme example. What’s more common is that deals go wrong because the buyer just overpays. And that’s a serious risk in ZeniMax’s case. It’s true that the purchase means Microsoft will get all the company’s intellectual property and its future profits. But in exchange, Microsoft is giving up $7.5 billion in cash. That’s a ton of money — it’s nearly as much as what Disney spent in total to buy Star Wars and Marvel, two of the most valuable cultural franchises in history. And on top of that, Microsoft is going to be bearing all of ZeniMax’s game development costs and the cost of its 2,300 employees. As a result, for Microsoft to get a barely reasonable return on its investment, ZeniMax will have to generate at least $500 million in profits every year. Considering that that’s around the company’s estimated annual revenue in most years, that’s a big ask.
It’s possible, as many gaming journalists have suggested, that Microsoft is mainly buying ZeniMax so it can make Bethesda’s games exclusive to its new Xbox Series X console. Microsoft’s major competitor, Sony, has lots of high-profile exclusive games for its new PlayStation 5 console. The assumption is that Bethesda could help provide something similar for Microsoft, so that gamers desperate to play Elders Scrolls VI whenever it finally appears, or the next Fallout game, will shell out hundreds of dollars for a Series X.
The only problem with this strategy is that Bethesda’s profits right now come from selling games across all platforms, including Sony’s. If Bethesda were to stop making games for the PlayStation, that would wipe out a huge chunk of its annual profits — the very profits that are supposed to justify the acquisition cost. Paradoxically, if Bethesda is making games exclusively for Microsoft, it’s probably less valuable, not more.
Much of the analysis of the deal succumbs to the fallacy of ownership: the idea that you need to own a company in order to derive value from it. You don’t. If Microsoft wanted new Bethesda games to be available on GamePass on its first day of release, it could make a deal to set that up. If it really wanted Bethesda to release certain games exclusively only on the Xbox Series X, it could cut a deal for that, pricey though it would be. In fact, Bethesda has two games right now that will be coming out exclusively on the PlayStation 5, and Sony, obviously, didn’t need to buy the company to make that happen.
This deal, ultimately, isn’t about the bottom line. It’s about peace of mind. It isn’t about taking risks so much as trying to hedge against them.
That doesn’t mean buying, as opposed to partnering, is always a bad idea. After all, in 2000, a year before it launched the Xbox, its first ever game console, Microsoft spent $40 million to buy game developer Bungie, whose game Halo became the Xbox’s killer app, and would eventually generate billions in revenue for the company. That’s one of the great acquisitions of all time.
But the more you spend, the higher the returns need to be. And in ZeniMax’s case, Microsoft said, in the press release announcing the deal, that its impact on operating profit will be “minimal” in 2021 and 2022. Since games are a cyclical business, that’ll change in years when Bethesda has a huge hit. But if the deal’s not going to generate much profit in the year after it’s completed, Microsoft’s not earning back its $7.5 billion anytime soon.
So from an economic point of view it’s hard to see how this deal makes sense. But Microsoft doesn’t seem too worried about that, perhaps because this deal, ultimately, isn’t about the bottom line. It’s about peace of mind. It isn’t about taking risks so much as trying to hedge against them.
After all, buying ZeniMax guarantees one thing that a partnership can’t: that no one else can buy ZeniMax. It also guarantees that Bethesda games will always be on GamePass from day one, and helps ensure that GamePass will have content users want. And $7.5 billion still seems like a steep price to pay. But Microsoft has $130 billion in the bank, and its market cap is $1.5 trillion. When you’re that rich, you might be willing to spend seven and a half billion dollars in order to sleep a little better at night.