The 2-Part Deal that Could Benefit Video Game Investors

In July, Activision Blizzard (ATVI) reached an agreement with Vivendi (VIVHY) to buy 601 million shares of Activision's stock for roughly $8.2 billion. Since then, the agreement has been put on hold due to a lawsuit by two shareholders who claim that the Activision board will improperly benefit from the deal. But what does the deal mean for you as an investor?

The two part deal
Vivendi will sell its shares of Activision in two segments. First, Activision will acquire 429 million shares from the French company at a discount for $13.60 per share, for a total of roughly $5.8 billion. Activision will use a combination of its cash and new debt to pay for these shares.

This is good for shareholders because Activision will retire a majority of the 429 million shares upon purchase, which will reduce the total number of shares outstanding. In turn, this will raise the company's earnings per share, just like any other stock buyback.

The company will add $4.6 billion of debt to help pay for the agreement. This will allow the company to keep $3 billion in cash on the balance sheet to maintain financial stability. Adding that much debt may make investors nervous, but CFO Dennis Durkin is confident that the company's free cash flow generation will be enough to cover the debt and continued investment in the business.

Activision Blizzard has had consistent free cash flow that tops competitors like EA (EA) and Take Two (TTWO) .

ATVI Free Cash Flow data by YCharts

While all three companies experience the same seasonal trends in free cash flow, Activision has remained above its competitors in this category. By generating more cash, Activision will be able to handle more debt than EA or Take Two, which have total debt of $564 million and $536.69 million, respectively. In addition, the interest expense from the added debt is tax deductible and will act as a tax shield for Activision (the silver lining of having debt).

Part 2
Second, a separate investor group will purchase another 172 million shares for $2.3 billion. Among the investors are CEO Robert Kotick and co-chairman Brian Kelly, who have invested a combined $100 million in the agreement.

When a company's management owns a significant portion of the company they're running they have extra incentive to improve its performance. If management doesn't have a stake in the company then they could make decisions that show positive short term performance but are detrimental to the company's long term growth. By investing in their own company, Kotick and Kelly's actions will affect their net worth as well as other investors. This makes them more reliable which is a good sign for investors.

What next?
The deal that Activision Blizzard has made with Vivendi will take Vivendi's stake in the company from 61% to 12%, and will give Activision control of its operations. The company's new capital structure will improve its return on equity, its leaders will have a larger investment in the company, and there will be fewer shares outstanding. All of these things are good for investors. Activision is currently appealing a lower-court injunction that halted the deal, but if that fails then the company could seek a shareholder vote to approve the Vivendi buyout. If it comes to that, I think it would be in shareholders' best interest to vote in favor of the deal.

For more information on the lawsuit check out this great Foolish article .