Microsoft is acquiring Minecraft maker Mojang for $2.5 billion. I’ve got mixed feelings about the transaction.
The strategic benefits are questionable and financially, Minecraft is worth maybe $1.8 billion — a valuation which assumes a sequel is as commercially successful as the original, and which assumes the intellectual property rights founder Markus Persson took out of Mojang is part of the transaction.
A $1.8 billion valuation leaves $700 million that new revenue streams like additional merchandising, a successful movie, etc. are unlikely to cover.
The best possible explanation might be that Microsoft is using its foreign cash reserves to pay for the acquisition — money that would be difficult for Microsoft to use domestically for tax reasons.
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The press is speculating that Microsoft is acquiring Minecraft so it can “tap into a cultural phenomenon” and entice players to Microsoft’s platforms.
I don’t buy either explanation. Xbox is already a cultural phenomenon, as is Halo and Skype. Microsoft doesn’t need another property to create brand awareness. Moreover, Minecraft is like Angry Birds and Candy Crush Saga — still popular, still recognizable, but past the point of explosive growth. Microsoft would be buying an asset on the downward slope of the hype cycle.
The only way such a high purchase price makes sense is a sequel. The graphics in the first Minecraft are quite basic, so as long as Microsoft can retain the charm and gameplay of the first, I can see existing users upgrading for a better visual experience.
Microsoft claims 90% of all paid customers have played Minecraft in the past year — that’s an impressive statistic.
But even with a successful sequel, the math only gets us partly there. $1.8 billion to be exact.
OK, not exact. We’re missing too much information for a valuation to be anything but a high level estimate; but let’s utilize public data and what I remember from my days in banking, consulting and an MBA to see what we can come up with.
We make the following assumptions:
Mojang will sell 13 million units in 2014. This figure is based on PC sales over the last 24 hours as representative for the year (upside: holiday sales; downside: accelerated saturation) and a similar mix of PC to total sales in 2013. This represents a 23% decline versus the 17 million units sold in 2013.
We forecast sales will decline another 23% in 2015 to 10 million units.
Minecraft 2 launches in 2016 and does as well as the original: 54 million copies to date plus 23 million over the next two years for a total 77 million units.
Now that we have sales, we need price. According to the Wall Street Journal, 41% of Minecraft’s revenue is from PC at a $27 price; 32% from console at $20; and 27% from mobile at $7. The resulting weighted price is $19. We assume this stays constant (upside: up-selling and cross-selling; downside: higher mobile share).
| Share | Price | Weighted | |
| PC | 41% | 27 | 11 |
| Console | 32% | 20 | 6 |
| Mobile | 27% | 7 | 2 |
| Total | 100% | 19 |
We also assume a 10% discount rate, 50% revenue to equity cash flow and growth equal to inflation in the terminal value. 50% sounds like a lot, but reasonable given Minecraft’s mammoth 79% profit margin.
Every investment bank puts in at least 5% synergy in their M&A models, so we follow suit here. Revenue can benefit from Microsoft’s more expansive distribution channels and redundant costs can be eliminated.
Given these, we calculate a net present value of $1.8 billion. $1 billion over the projected period and $800 million for the terminal value.
That seems about right to me.
To double check, we turn to market multiples.
Technically, Mojang only produced $128 million of profit but it also paid $129 million to Persson’s company to license the intellectual property rights he carved out of Mojang. This is a technique to ensure the founder gets paid before shareholders do, but it’s also not usually a real operational cost. If Microsoft gets these rights in the acquisition — and thus no further pay outs — Mojang’s true profit is closer to $257 million. Probably a good assumption given Mojang’s founders are all leaving.
A convenient comparable to Mojang is KING, the public company behind Candy Crush Saga. KING has a market value of $4.1 billion and earnings of $568 million for a P/E of 7.3. Multiply that with Mojang’s earnings to get a $1.9 billion valuation.
Another comparable is Supercell, the company behind Clash of Clans. Softbank recently acquired Supercell for $3.0 billion. Given earnings of $464 million, applying Supercell’s P/E of 6.5 to Mojang’s earnings results in a $1.7 billion valuation.
| Revenue ($ m) |
Profit ($ m) |
Margin | Market Value ($ m) |
P/E | Mojang Value ($ m) |
|
| King | 1,884 | 568 | 30% | 4,140 | 7.3 | 1,873 |
| Supercell | 892 | 464 | 52% | 3,000 | 6.5 | 1,662 |
| Mojang | 325 | 257 | 79% | 2,500 | 9.7 | 2,500 |
Projecting equity cash flows gets us a valuation of $1.8 billion. Using P/E multiples from Supercell and KING gets us $1.7 to $1.9 billion. Not bad, the two methods match!
Without seeing a balance sheet, it’s hard to feel too confident but $1.8 billion seems directionally correct.
So how does Microsoft expect to make up the $700 million difference? Do they believe they can sell that many more copies under the Microsoft banner? According to our financial model, Mojang will need to sell 160 million copies of Minecraft 2 at a weighted price of $19 from 2016 to 2018 to justify a $2.5 billion valuation. That’s more than double what the original will sell in its lifetime. Unlikely.
Perhaps Microsoft intends to leverage Minecraft’s young user base to cross-sell Microsoft products? Get them early kind of thing? Even then, it’s a stretch.
Microsoft simply paid too much.
THE CORNERPLAY 
First, nice analysis. Question for you, though, and it potentially affects your analysis above. What do you make of MS saying it will only be breakeven in year 1 under GAAP?
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It probably refers to the idea that Microsoft expects to make even money using its cash for the acquisition than it would otherwise, i.e. leaving it in the bank earning interest. This doesn’t meaningfully affect the above analysis because it’s 1) based on one year of reporting and 2) cash has a much lower discount rate than non-public equity.
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That’s my understanding as well. But some sites are reporting that as just $25 million, which I guess is plausible if its invested very conservatively. I haven’t translated your assumptions in a year one profit projection, but I expect it would be well north of that. So MS’s guidance for just breakeven seems odd
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Agree, it confused me as well. We might have to wait for more info to dissect that number. It could be lots of things, like another big payout to the founders as “licensing” or “consulting” fees to make the deal happen.
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The current markert is going towards and developing more and more Smart devices. From what I know Microsoft already own Motorola, could it be possible that Microsoft plans to merge the two of them to tap into this new growing market that has yet realise it’s full potential? Using it to tap into some of the Asian countries are opening up to the world.
And Windows-based Smart phone might be the testing platform for them to test market response?
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There are many other ways to make that 700 M gap you are talking about. I think MS buying out Mojang is actually the smartest move from MS so far. Because MS desperately needs contents especially for kids and Minecraft being owned by MS will boost their other platforms as well.
MS will most likely make more money from the f2p model online bases off that game, plus Minecraft movie, animation, merchandise, and licensing out to other companies and so on.
If MS wanted to make money off from “Gaming” business, MS would’ve probably bought out Supercell, Kings, or any other game developers that make tons of money. But why Minecraft? MS did not buy Minecraft, MS bought heart of generation of gamers. (this is quoted from somewhere else) This will lead MS to be more successful in their sequel and other digital business area.
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We tend to overestimate the value of those merchandising opportunities. The $1.8 billion valuation actually already includes $50 million of additional revenue above and beyond what Mojang already earns outside of Minecraft (~$15 million)…which would imply a relatively successful movie. I don’t know much about the movie industry, but let’s say the Minecraft movie earns $1 billion. Which I’m sure you agree is a massive success. What’s Mojang’s cut? No more than 5%, or $50 million.
Still $700 million of valuation short.
I do agree that Minecraft has great cachet among kids…but so does the Xbox brand.
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My personal opinion here but MS will most likely to recoup most of the money from F2P model based online game.
You’d agree that Minecraft has millions of players playing everyday either offline or private servers. Considering any other successful F2P online games such as League of Legends, CrossFire, Dungeon & Fighter and etc, their revenue is 500 M up to 1 Billion USD a year.
Minecraft hasn’t even set up the official server but with MS’s funding, Minecraft can turn into “Minecraft Online” free to play version w/ in-game purchase feature like other F2P online games.
Can Minecraft make up to 1 Billion USD a year like other successful online game? I don’t know, but it certainly has potential with so many fans around the world.
I doubt that MS will recoup their money by 2015 like they say, but I wouldn’t be surprised if they actually do so.
On top of that, MS can make Minecraft exclusive on their platforms only, which will boost their platform sales up (Windows phone, Xbox exclusivity) but I highly doubt they will do that to avoid criticism from the players. But who knows? MS may increase license fee ridiculously so that Sony, Nintendo may turn down the deal so that Minecraft may not get on PS or other console devices. (eventually making it exclusive for MS platform only)
Just my thoughts though,
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The break-even on a GAAP basis thing doesn’t mean Microsoft expects to make back their $2.5 billion — see comments between Brent and me above.
I have mixed feelings about F2P. I thought about modeling it, but didn’t because the core audience for Minecraft are kids and F2P fits better with young adults and the “housewife” segment. F2P could easily ruin the purity of Minecraft.
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While it is sensible to think that F2P model fits for young adults, it is not entirely true especially in Asia.
Maple story for example, its players are around 6~12 years old and this F2P game makes approximately 500 million USD a year. Dungeon & Fighter? it’s mostly element school kids up to high school kids and that game makes around 600 M USD, Cross Fire which is another game that makes 1 billion USD a year ALONE in China.
Minecraft may be popular in US and Europe, but the game was never really introduced in Asia because the game is a package “Buy 2 play” game. (Although yes it does have small group of community) But if Minecraft Online F2P comes out with local language in Asia, it will definitely be a game changer for Mojang & Microsoft.
You said the young kids wouldn’t pay for F2P minecraft… but have you seen those big private Minecraft server such as Mineplex, Hypixel, Shotbow and etc…. any idea how much they make w/ F2P model? You would be surprised.
In fact, according to the article, the reason why EULA has changed back in June was that Mojang received too many mails from the parents of players saying the kids are spending too much money while the game was already purchased which is violating previous EULA. But Mojang never took action of it and now they are enforcing it so that these servers can’t implement “pay 2 win” but it’s ok to charge them subscription fee now. So the revenue may have decreased.. but still… In Asia, Pay 2 win is generally accepted and just imagine all of Chinese kids playing MC and all the money that will bring in.. (Only that MS decides to launch Minecraft Online version that is)
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Forgot to mention one more,
There are several developers that are investing millions of dollars making Minecraft-like F2P online games already, targeting of course young kids. Don’t underestimate F2P model.
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