Redacted: Acquisitions (Premium)

With Microsoft’s blockbuster acquisition of Activision Blizzard still hanging in the balance, it’s interesting to know that the software giant has had its eye on other video gaming industry giants. And that things might have gone quite differently for Xbox.

This post is the third in an open-ended series of articles plumbing the depths of the recent and unprecedented Xbox leak. I had hoped to wrap this up quickly, but the other incredible news from last week—including Panos Panay’s departure from Microsoft and then Microsoft’s AI special event—proved especially distracting. But let’s get back on track with some insider information that reveals how the software giant’s strategy to revive Xbox led to a series of key acquisitions as well as a few near misses.

As it turns out, Microsoft has a long history of video game studio acquisitions, dating back to the Bungie acquisition that brought the original Halo in-house for the original Xbox console launch in 2001. This was followed by Rare (Kameo, Perfect Dark Zero, Viva Piñata, others) in 2002 and then its shocking $2.5 billion purchases of Minecraft maker Mojang and the Gears of War franchise in 2014. But with Xbox losing three console generations in a row, the previous one badly, the software giant decided that the only way to beat Sony was to play the same game. And so it stepped up the studio acquisitions in a bid to create a massive catalog of Xbox exclusive and cross-platform content. The biggest so far is ZeniMax Media, which owned the Bethesda, id Software, Arkane, and other studios and set Microsoft back $7.5 billion in 2020.

Today, Microsoft owns 23 game studios and several core franchises, including Halo, Gears, Minecraft, Flight Simulator, Fallout, DOOM, Forza, The Elder Scrolls, and more. And should the Activision Blizzard acquisition go through—and it looks like it will now—it will add Call of Duty, Candy Crush, Diablo, Overwatch, World of Warcraft, Starcraft, Crash Bandicoot, and others to that list.

But things could have gone differently. In mid-to-late 2020, at the height of the COVID pandemic, the U.S. government was considered banning the popular TikTok video creator platform because of its ties to China, and Microsoft, inexplicably, tried to intervene by partially acquiring the service. And then by fully acquiring the service for $20 billion. Things got messy, Oracle got involved, and then the Chinese government stepped in, changing its export control rules to prevent either firm from taking full control of the company. And so Microsoft gave up on TikTok and Oracle partnered with the company on its U.S. operations. And in a post mortem, I analyzed its public statements about walking away for clues to why it would have even wanted TikTok in the first place. Obviously, I wrote, Microsoft could have benefitted from moving this popular service to Azure.

But Microsoft had other motives, as it turns out. According to internal documents that were part of the Xbox leak, it was TikTok’s popularity with consumers that drove Microsoft to consider acquiring it in the first place. And you won’t be surprised to learn that many within the software giant were not happy with Microsoft’s pursuit of the controversial service. And that some dissension led to discussions about what other targets might make more sense.

“I get that this whole Tic Tok (sp) discussion is happening outside the regular core biz discussions, but it really makes me wonder why we would not find targets like Nintendo more attractive, if we want to find a way to increase our consumer exposure and relevance,” Microsoft corporate vice president Takeshi Numoto wrote in an email to Xbox head Phil Spencer and Microsoft CMO Chris Capossela in early August 2020. “Tic Tok or any other social network seem to have little in the way of hard-hitting (not conceptual) adjacencies that would help us accelerate its growth (reason of us being a better owner since it will be banned otherwise, does not feel like a sound logic).”

“With gaming, while we have been a consistent #2, we have strong franchises, and a secular shift to the cloud (and perhaps immersive [Mixed/Augmented Reality] over time) that can really help us shift our position (both vis a vis Sony but also Steam). And in this context, it feels like Nintendo has such a rich set of franchises that can help us shore up our content franchises that we can then have accrued to the shift we will likely have to the cloud and to [MR/AR] over time. (And then perhaps even back to social networks given the volume of game viewing as content/community — what if thought about AltSpace as our new social network for next-gen immersive games?)”

[Microsoft acquired the AltSpace social VR platform in 2017 and did nothing with it. It was shut down this past March.]

This conversation is interesting because while Takeshi was on Microsoft’s Senior Leadership Team (SLT) with Capossela and Spencer, he was also part of Microsoft’s commercial marketing efforts and had nothing to do with Xbox, gaming, or consumer. But in his view, TikTok was not an ideal choice. And he communicated that to two top executives at the company who were both more involved on the consumer side.

“Great thoughts,” Chris Capossela responded. “TikTok has really fallen into our lap rather than being something we actively sought out for our consumer business. If you said what is the next best consumer asset that we should spend $10B to $30B on, I don’t think we’d say it’s TikTok. But the stars have aligned to give us a chance so we should look hard at pursuing it.”

Capossela then launched into a general discussion about how and why Microsoft might make major acquisitions in the consumer space, and why TikTok was a one-off exception.

“As you know, for each of the solution areas, we have a set of companies we’d love to acquire if the timing and terms were right. They of course have to be willing to sell, and they have to see us as a top company to sell to (like Mojang did). TikTok has not been on any of these lists, so I think it’s important to realize the current discussions are ones that developed due to geo-political dynamics and the good fortune we have with a strong, trusted brand that makes TikTok look to us as a way to avoid being shut out of the U.S. market by the current administration. You can argue if it wasn’t on any of our lists why are we entertaining the idea, but I think we never envisioned that this could be really possible and these big acquisition opportunities come along so rarely, that we can’t afford to not pursue the idea. I completely agree with you that it’s not as adjacent as a variety of other prosumer/consumer assets that we might like to buy.”

In other words, TikTok was not a good fit, but it was such a big opportunity that the company—presumably the SLT and board of directors—felt compelled to at least try. And Capossela hinted that the were other big fish out there that Microsoft was considering.

“I won’t ‘out’ Phil on the list of possible gaming acquisitions that we’ve shared with the board but I will say they are focused on great content companies that would help us improve the Game Pass catalog, deepen our PC and mobile content, and help us in regions of the world where Xbox has had less success to date. There have been lots of rumors recently of Microsoft being in talks with a variety of major content players like Warner Brothers, EA, etc.”

It’s impossible to not think of Activision Blizzard when you read “great content companies that would help us improve the Game Pass catalog, deepen our PC and mobile content, and help us in regions of the world where Xbox has had less success,” as this is almost the exact rationale that Microsoft has used publicly to describe its desire for that acquisition. But his mentions of Warner Bros. Interactive and EA are interesting, and I bet Microsoft would have pursued either or both had Activision Blizzard fallen apart. EA is well known, of course, especially for its successful sports franchises, but Warner Bros. Interactive owns the studios behind Batman: Arkham, Mortal Kombat, Suicide Squad, Hitman, and other popular franchises and games.

And Spencer was over the top in his reaction to a possible Nintendo acquisition.

“Takeshi, I totally agree that Nintendo is THE prime asset for us in Gaming, and today Gaming is our most likely path to consumer relevance,” he responded. “I’ve had numerous conversations with the LT [leadership team] of Nintendo about tighter collaboration and feel like if any US company would have a chance with Nintendo we are probably in the best position. The unfortunate (or fortunate for Nintendo) situation is that Nintendo is sitting on a big pile of cash, they have a BoD [board of directors] that until recently has not pushed for further increases in market growth or stock appreciation. I say ‘until recently’ as our former MS BoD member ValueAct [an activist investment firm] has been heavily acquiring shares of Nintendo and I’ve kept in touch with [Valueact CEO] Mason Morfit as he’s been acquiring. It’s likely he will be pushing for more from Nintendo stock which could create opportunities for us. Without that catalyst, I don’t see an angle to a near-term mutually agreeable merger of Nintendo and Microsoft and I don’t think a hostile action would be a good move so we are playing the long game. But our BoD has seen the full writeup on Nintendo (and Valve) and they are fully supportive on either if opportunity arises, as am I.”

So Valve, which owns Steam and the Half-Life, Counter-Strike, Portal, Left 4 Dead, and Dota games, has also been at the top of the acquisition list. Very interesting.

And there was more:

“Confidentially we have two fairly active M&A [merger and acquisition] discussions in Gaming right now, Warner Brothers Interactive and ZeniMax,” Spencer continued. “I took ZeniMax to the BoD last week and prior to the BoD discussion I asked [Microsoft CFO] Amy [Hood] and [CEO] Satya [Nadella] if they wanted me to slow either or both of these given the TikTok discussions, and they both emphatically told me ‘no’. They are fine doing all 3 of these if the deals make sense. I won’t say WB or Zeni is Nintendo, but both are for sale and gettable by us if things align. [The] biggest obstacle in WB is IP [intellectual property] ownership, we wouldn’t own any of the IP which hurts long-term flexibility, and the only obstacle on Zeni is the valuation expectations of the founders. But I think it’s likely one or both of these will happen, which will help us continue to double down on our Gaming relevance.”

I love this aggressiveness—Nadella and Hood were willing to acquire TikTok, Warner Bros., and ZeniMax, all at the same time—and how it previews how much Microsoft was willing to later spend on Activision Blizzard, and the lengths to which they would go to consummate the deal despite major regulatory headwinds. And Microsoft did, of course, snag ZeniMax, just a month after this conversation for $7.5 billion.

“To give a sense of scale, ZeniMax is about the size of our current first-party studios organization, so that would be doubling our content asset,” Spencer continued. “[The] downside is it’s more core, less broad, not mobile, more North American/European, etc.”

That last bit points to the interest in Activision Blizzard, of course, which has a strong presence worldwide and on mobile.

“I love this discussion and value you looking at the opportunities here,” he concluded. “At some point, getting Nintendo would be a career moment and I honestly believe a good move for both companies. It’s just taking a long time for Nintendo to see that their future exists off of their own hardware. A long time… . :-)”

Fascinating.

Phil Spencer’s raw desire for Nintendo has been publicized broadly in the wake of the leak, of course, but this conversation makes it appear more possible than I would have otherwise believed. As I write this, Nintendo is of course testing its next-generation game console, which will succeed the Switch. And so it appears that this future that Spencer imagines for the company is still a long time off. But I very much agree with him about Nintendo missing the boat on cross-platform games. I’ve long argued that Nintendo could grow dramatically by releasing its catalog NES, SNES, N64, and other games on mobile, especially, and on other consoles too. This is a place where Microsoft could help, for sure. After all, Spencer is all about cross-platform, and he has adapted Nadella’s “meet your customers where they are” mantra to gaming.

It’s an incredible future to contemplate.