Microsoft is hunting acquisitions to build out its gaming business, which Morgan Stanley estimates to be worth $40 billion to $45 billion.
But don’t expect it to buy Electronic Arts or Activision.
The economics of buying a big gaming company don’t make much sense for Microsoft, which makes a “large content acquisition less likely than investors believe,” Morgan Stanley analyst Keith Weiss said in a note published Monday
That means Microsoft will probably focus on smaller gaming publishers in its quest to turn Xbox into the Netflix of video games and beat out its biggest competitor, Sony.
“Bottom-line — the economics of driving a strong return from such an acquisition appear challenging,” Weiss wrote. “Microsoft would have to pay for revenue streams which couldn’t be replicated post acquisition.”
Morgan Stanley drew this conclusion after creating a model for what it would take to acquire a hypothetical publisher valued at $39 billion — a midway point between EA’s $31 billion market cap and Activation’s’ $53 billion market cap.
The model showed that Microsoft would have to get 100 million subscribers to its gaming platform in four years in order to justify the expense of a large acquisition. Microsoft would likely struggle to attract such a large userbase, according to the note, since it represents 1/3 of the estimated total console gaming population.
And while adding games like Madden and Call of Duty to its subscription service would likely attract new customers, it probably wouldn’t be enough to offset the cost.
This is in part because an acquisition of that size would require Microsoft to pay a premium of around 25%, according to the note. And whatever company it acquired would likely lose some of its revenue streams once its licensing rights are restricted to Microsoft.
So if Microsoft wants to keeping building out its proprietary gaming content, it will likely keep targeting smaller studios.
The company has already made a play for smaller publishers. In June, it announced a new internal studio called “The Initiative,” as well as the acquisition of four smaller content studios: Ninja Theory, Playground Games, Undead Labs, and Compulsion Games.
And Microsoft is rumored to be in talks to acquire Obsidian Entertainment, according to Kotaku.