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DONE DEALS - Cash of the Titans

To strike a deal with Vivendi Games, Activision cedes ownership control but keeps a tight grip on management.

In games, two players are SOMETIMES better than one. But figuring out how to overcome rivalries and work together as a team can be a challenge.

Consider the case of Vivendi and Activision. Vivendi’s games division had a huge hit on its hands with the online role-playing game World of Warcraft, part of its Web-based Blizzard Entertainment unit. But its Sierra Entertainment arm, which makes games for consoles like Sony Corp.’s PlayStation and Microsoft Corp.’s XBox, was losing money, and the French media conglomerate didn’t have the right management team to fix the problem. In addition, Vivendi felt that investors were failing to recognize the value of “World” because it got lost on the company’s enormous balance sheet.

On the other hand, Activision has a track record of wringing profits out of the console market. It has built the No. 2 franchise, by sales, in the games industry with such popular titles as Guitar Hero. The company’s hard-driving chief executive, Robert Kotick, saw World of Warcraft providing the revenue boost he needed to catch Electronic Arts, the world’s largest video games maker. But Vivendi’s insistence on retaining a majority stake was a tough concession for Kotick, who led an investor group that bought a controlling stake in Activision for $500,000 in 1991. According to a January 31 SEC filing, Kotick owned nearly 4.5 million shares and had options to buy 8.7 million more by mid-March, which would give him a 4.2 percent stake.

To reconcile their interests, the two sides agreed on an unusual reverse takeover of sorts that gives Vivendi a controlling 52 percent stake but keeps Kotick and his highly regarded management team in charge. Under the deal, Vivendi will contribute its games business and $1.7 billion in cash to the new enterprise, which will be called Activision Blizzard and be valued at $18.9 billion.

Vivendi agreed to buy back up to $4 billion worth of stock in the merged company five days after the deal closes at $27.50, giving Activision shareholders a chance to exit at a 31 percent premium. The transaction is due to close in the first half of this year once it obtains U.S. and European regulatory approvals. The deal has already had a big impact, prompting Electronic Arts to launch a $2 billion bid last month for Take-Two Interactive Software, maker of the Grand Theft Auto game series.

The Vivendi deal includes protections for Activision management, according to Brian McCarthy, a partner at Skadden, Arps, Meagher & Flom, Activision’s legal counsel on the deal. Kotick cannot be fired without a majority vote of both the three independent directors on the 11-member board and the board itself — to which Vivendi will appoint six members and Activision two.

“We wanted to make sure the independent board members would have a voice and that the rights of the Activision shareholders would be protected,” Kotick tells Institutional Investor.

The deal allows Vivendi to unlock the value of its games division by assessing the unit’s worth at $8.1 billion — $1 billion more than what had been implied by Vivendi’s stock price. “It’s a brilliant deal because each company valued the other more highly than the market was valuing it,” says Michael Pachter, an analyst at Wedbush Morgan Securities. “They created something out of nothing.”

So far the proposed deal has propped up Activision’s share price at about $27 in the face of a sharp drop in consumer-related stocks. Between the December 2 announcement and late February, Electronic Arts’ stock fell by 15.7 percent.

The key to the deal was solving a fundamental need for both companies, says Nancy Peretsman, the investment banker at Allen & Co. who advised Kotick. “Call it situation analysis: How do you create the right answers in light of the underlying facts, as opposed to saying, ‘Here’s a balance sheet we have or transactions to sell. Let’s find someone who wants to go do what we’re selling.’”