Microsoft (NASDAQ:MSFT) offered on Jan. 18 to pay $95 per share in cash for all of Activision Blizzard‘s (NASDAQ:ATVI) shares. This will likely turn out to be a good deal for MSFT stock, even though it has not moved much higher as of Jan. 19.
Moreover, it’s a good use of the cash on Microsoft’s balance sheet. According to the press release, Microsoft said the Activision acquisition will cost $68.7 billion, including the cash on Activision’s balance sheet. This will be the largest cash acquisition ever (in fact, the largest in Microsoft’s history).
A Cash Deal Microsoft Can Easily Afford
The cash expense won’t cause Microsoft to sweat at all. As of Sep. 30, Microsoft had $131.6 billion in cash and short-term investments on its balance sheet, according to its 10-Q.
So, even including the $3 billion in a potential breakup fee and lawyer’s costs, Microsoft will have no trouble paying for the deal. In fact, it will have over $62 billion in cash left over on its balance sheet.
Moreover, Microsoft produces a ton of cash flow each year. According to Seeking Alpha, in the last 12 months (LTM), the company produced $81.945 billion in cash flow from operations. After deducting $21.525 billion in capital expenditure spending, its LTM free cash flow is $60.42 billion.
That implies that the company could easily afford to do another acquisition over the next 18 months as its existing cash continues to build up. That shows how incredibly profitable Microsoft presently is with its existing businesses.
What Analysts Think
According to Barron’s magazine, Activision, the gaming software company, makes popular games such as Call of Duty, Candy Crush, and World of Warcraft. But more importantly, Barron’s quotes an analyst, Brent Bracelin from Piper Jaffray, who wrote that “the deal implies a value for Activision of 6.6 times forward sales.”
According to a survey by Seeking Alpha of 27 analysts, Activision Blizzard is forecast to produce $9.06 billion in sales by the end of 2022. That would put it on a forward price-to-sales (P/S) multiple of 7.63 times. However, the same survey also showed a forecast of $10.53 billion for 2023.
That lowers the forward P/S multiple to 6.53 times. So this must be what Bracelin was referring to — 2023 sales. That makes sense as the deal is likely to take 18 months to close.
More importantly, according to analysts, the deal will be synergistic for both companies. According to the online magazine, “its franchises will make Microsoft’s gaming platforms such as Xbox more popular and better positioned for the future.”
Where This Leaves MSFT Stock
Since MSFT stock closed on Nov. 19 at $343.11 per share, it has dropped to $310.27. This represents a decline of 9.57% off of its peak. Nevertheless, it still has a huge market value of $2.329 trillion, right below that of Apple (NASDAQ:AAPL) at $2.769 trillion.
Assuming that the deal could be synergistic for Microsoft by the end of 2023, It’s possible that by 2023, its earnings per share could well exceed $4.82. That is the estimate that analysts surveyed by Seeking Alpha project for MSFT even without the ATVI cash deal for 2023.
That implies that net income contributed to Microsoft after the deal could be greater than $3.754 billion. This will contribute around 5% more to Microsoft’s forecast of $78.45 billion in net income by 2023. That implies that it is paying around 20 times its forecast earnings (i.e., 1/0.05 = 20x).
So, on the one hand, Microsoft can clearly afford the deal. But on the other hand, it does not seem to be overpaying for the acquisition. This is seen from both a P/S metric standpoint and also from a price-to-earnings (P/E) metric. And that is even before any synergy benefits are added to the deal.
Therefore, all in all, this looks like a pretty good deal for Microsoft, its shareholders and for MSFT stock in the long term.
On the date of publication, Mark R. Hake did not hold any position (either directly or indirectly) in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.