EA Goes Private for $55B in Biggest LBO Ever, U.S. TikTok Valued at $14B & GDP Revised Upward

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1:59Welcome to Prof G Markets. I'm Ed Elson. It is September 30th. Let's check in on yesterday's market vitals. The major indices all rose to start the week. Meanwhile, Treasury yields fell in anticipation of the jobs report due Friday. The price of gold breached$3 ,800 for the first time ever on the pending threat of a government shutdown. And finally, Etsy stock popped 16 % after OpenAI announced instant checkout, a feature for shopping within ChatGPT. OpenAI is piloting the feature with Etsy, but more than 1 million Shopify merchants will soon be available. OpenAI will collect a transaction fee from every purchase made within ChatGPT.

2:44Okay, what else is happening? Video game maker Electronic Arts is set to go private in the largest leverage buyout ever, valued at$55 billion. The investor group includes Saudi Arabia's sovereign wealth fund, Jared Kushner's investment firm, and also private equity firm Silver Lake. The deal still requires approval from the Committee on Foreign Investment in the US, which evaluates foreign transactions for national security risk. The stock soared 15 % to a record high last week, and shares climbed another 5 % yesterday after it was confirmed. So EA, Electronic Arts, is being taken private for$55 billion, the largest leveraged buyout ever.

3:26This is the company behind all of your favorite video games, Madden, The Sims, FIFA, which is my favorite game of all time. To be clear, this isn't the largest acquisition ever. We have seen larger, but it is the largest LBO ever. So a quick reminder, what is an LBO? What is the difference between that and just a regular acquisition. Well, the difference lies in how the deal is financed. With leveraged buyouts, the financing is mostly provided by leverage, i.e. debt. So that's what's happening here. JP Morgan is providing the debt to the investor group, and the investor group will then use that debt financing to take the company private.

4:03So the other question is, why are they doing this? What do these investors see in EA? I mean, yes, it is a great business. They're doing around$7 billion in revenue. On the other hand, though, it is also a business that isn't really growing. In fact, revenue was flat this year. And that's been a theme not just for EA, but also for the video game industry at large. I mean, ever since COVID, you had this explosion in the video game industry, and then revenue started to fall back down, started to flatline. And since 2021, video game spending has fallen 12%. Video game stocks have been underperforming, And that also includes EA, Electronic Arts.

4:44So to help us understand this take private deal, why did they pay$55 billion for EA? Our producer, Claire Miller, spoke with Michael Pachter. He is the managing director of equity research at Wedbush Securities. The Saudis have been pretty vocal that they want to be in the game space for a long time. And while they've made some meaningful deals, they haven't really gotten into anything other than mobile so far. So they made a tiny e-sports acquisition and two big mobile acquisitions that have worked really well. But their stated goal from the beginning was that they wanted to create jobs in Saudi Arabia.

5:23And I think that's generational. I don't think they're looking to fire several thousand people and move them to Saudi Arabia. But they're hoping in the next 20 years that as these companies grow, they can replace workers and build out an economy in Saudi Arabia. And that's noble. They should be doing that for their people. It is the public investment fund. So, you know, nominally that money belongs to the people of Saudi Arabia. And I think that this is a good step to making that happen. So the deal from their perspective makes sense because if you're going to get involved, get involved in a big way.

5:55You know, pick off the biggest remaining guy that's available. I mean,$0.10 bigger but not available. I think EA, from their perspective, it makes a lot of sense to sell while they can. Andrew Wilson got there and the stock was in the teens. You know, it was up to the 170s before this deal, now over 200. Shareholders are getting rewarded. He's getting rewarded. And, you know, to be fair, EA had kind of stopped innovating. They had stopped really growing their core business. The Saudis, I think, can fix the business quickly by exploiting mobile, which they're great at with Scopely and Niantic and by taking some of the core EA properties and making them free to play globally like EA Sports Football Club Ultimate Team.

6:43If they do those two things, they pay for the deal. And those are two things EA wasn't going to execute properly. So I think the Saudis actually add value here. Why are the Saudis interested in the gaming space specifically? Why is that part of their long-term investment strategy? I wish I could give you insight into their minds. I mean, I think that the prince is a gamer. You know, he's the right generation. And I think that, you know, they have a very young population and shockingly, Middle East and North Africa are the biggest, it's the biggest growth area for games. So I think it's something that resonates with the public.

7:18They haven't yet institutionalized that where they have a lot of people in degree programs making games, but I think they see that as an emerging, you know, economy and emerging opportunity, everybody on the planet likes entertainment, you know, and it's, you know, you're seeing like Arizona with opportunity zones for film. You're seeing everybody trying to get a piece of entertainment. Games is kind of the last bastion, last untouched area that, you know, people make games essentially at home. I mean, they don't, you don't have to have a core, you know, group of people in a particular location.

7:54So I think that the Saudis look at this as a growth opportunity. The aging population is going to buy more and more games in the next 100 years. And I think they just see it as a growth opportunity they can participate in. They're paying a 25 % premium to the closing price from before the deal. What do you make of that premium? Is it warranted? It's enough to hold off anybody else. So the answer is nobody else is going to bid. warranted. You know, EA probably generates around$2 billion of free cash flow. So they're paying 26 times free cash flow. The simple math for your listeners is, you know, divide one by 26.

8:35You know, it's a 4 % free cash flow yield. You'd be better off investing in treasury bonds, you know. So clearly this is not a financial transaction. But if the Saudis can monetize by expanding EA into mobile because EA sucks at mobile. So if they're able to take these properties like soccer and football and Star Wars and Battlefield and The Sims and make mobile games that work, they'll double that cash flow. If they take Ultimate Team, which is the free-to-play part of the sports, and take it from behind a paywall to free, I think you double that. So I could see these guys getting the$6-7 billion in free cash flow by running the business more aggressively than EA has been running it, and that would pay for the deal.

9:19I'd like to get your thoughts on the video game space more generally. The industry is bigger than the music and movie industries combined, and Gen Z spends more time playing video games than they do on social media. So you would think that video game stocks would be ripping, but over the past five years, they've actually lagged the S &P 500. So before the deal was announced, EA's stock was up 27 % in that time frame. you compare that to the S &P at nearly 100%. Why do you think gaming has lagged the market? Because the public companies aren't really pure play for participating in game growth. The game opportunity, simply stated, the$200 billion global games market that's bigger than movies and music, that's about$150 billion mobile.

10:08And then the remaining$50 billion is about$30 billion of free-to-play on PC and console and$20 billion of game sales. The EAs of the world, most of their revenue comes from game sales. You know, they're probably 60 % from game sales and 40 % from other. So you really weren't participating in that mobile business at all, and that's really where the growth is, or in that free-to-play market, just a little bit, and that's where the growth has been. Console and PC buying games, that's yesterday's business. Your kids aren't going to ever buy a game. Your kids are going to play free-to-play all the way.

10:42And they're not going to ever own a console. They're going to play on a connected TV. So the opportunity in gaming isn't EA. The opportunity in gaming is Microsoft and Amazon and Google with cloud and NVIDIA with cloud chips and anybody else who creates the cloud infrastructure to make that happen. So AI and tools, Roblox. Roblox is the one that actually will participate in that because they're essentially the YouTube of game creation. So they'll participate, but it's hard to buy the rest of these guys. So look at Roblox stock. That's outpaced the S &P by a lot because the market gets that. EA is lagged because they weren't participating in the areas that are growing.

11:27I found it interesting that the candidate for the largest LBO in history was a gaming company. Was that surprising to you at all? And if not, do you think this will be kind of a starting gun for VCs to reenter the gaming space? I don't think that being the largest makes any difference at all. Like, I can't remember the name of the book, but I read a book and they made a movie out of the RJR LBO, which I think... Barbarians at the Gate. Yeah, there you go. It was like$20 billion or something. And, you know, that's back when we all valued consumer packaged goods. So now all this is really telling you is that people are looking for IP as a play.

12:11But, you know, ultimately, no, there'll be a bigger deal. You know, there are plenty of companies that are worth a lot more. I mean, Microsoft is worth a lot more. Amazon is worth a lot more. Not that anybody's going to buy them, but Tesla's battery business is worth more, You know, so Tesla's self-driving car business is worth more. So, no, I'm surprised it took this long to buy a game company. EA was for sale back in 2000 and again in like 7 and again in 15 and again in 19. You know, they've constantly been for sale. The problem is that they didn't have a buyer. It was always, oh, the big media companies.

12:49Comcast has its own problems. They're not buying anybody. You know, Warner Brothers has its own problems. I mean, look what's going on with Paramount and with Warner Brothers now. It's like Larry Ellison, the knight on the white horse is coming in to save traditional media. So I think it really is just that it takes somebody weird and thinking different like the Saudis. By weird, I mean their motive is not to make money. Their motive is to drive business to Saudi Arabia, and that's different. They can afford to pull this off. they will in fact make money because I think they will do things EA was really afraid to do like make FIFA ultimate team EA Sports Football Club ultimate team free to play.

13:34So yeah, I guess I was surprised but it's not surprising. Got it. It's very interesting. Thank you, Michael. I appreciate you joining us. It's my pleasure. Say hi to Professor G, my idol. I will. Thank you. Take care. That was Michael Pachter, Managing Director of Equity Research at Wedbush Securities. Ultimately, what this really comes down to is attention. I mean, the truth about the video game industry is that it is one of the most powerful attention arbiters in the world. Young people spend a quarter of their entertainment time playing video games. Gamers play an average of 15 hours per week, which is roughly the same amount that Americans spend eating, caring for their children, and socializing combined.

14:19So, these are total attention merchants. They are absolutely crushing it in terms of locking in our attention. What these companies lack, however, is an ability to monetize that attention, or at least an ability to monetize it as effectively as companies like Meta and Google and ByteDance. In fact, despite the amount of attention they receive, video games account for only 3 % of global advertising spend. You compare that to television, which commands roughly 23 % of global ad spend. In addition, there was this other study that found that brands spend less than 5 % of their marketing budgets on video games.

15:00So what you have here is a surplus of attention that is not really being monetized all that well. I mean, if attention is the new oil, then this is basically an oil field that has been identified, it's been surveyed, it's been tapped, it's been drilled. The only thing left to do now is to sell that oil. That's what they need to do now. And perhaps that is what makes EA such a great target for an LBO, for a leveraged buyout. And that is, the hard part here has already been done. But these tech companies, these video game companies, they have gotten the attention. They've already done that part.

15:39And now it's time for the private equity guys to step in and do what they do best. And that is monetizing, taking the asset and figuring out how to squeeze as much cash as possible out of that asset. And by the way, private equity is incredible at this. They did it with healthcare. They did it with industrials and retail. And so now, now it's perhaps time to do it with video games. This is the perfect opportunity in a lot of ways, because ultimately there's a lot still left to be squeezed out of the video game industry. Now, does that mean that EA games are going to get better? Probably not. This probably isn't great news for gamers.

16:19And as Michael said, EA will move towards the mobile and free-to-play markets. In other words, more banner ads are on the way. But it does mean that EA games are about to get a lot more profitable. And that is the opportunity here. That's why they paid$55 billion, a 25 % premium, the largest LBO in history. But in our view, that was worth every penny.

16:47The White House revealed that the TikTok deal will value the US version of the company at$14 billion. That announcement came after President Trump signed an executive order approving the proposal, which will keep TikTok operating in the US. ByteDance, however, has not confirmed any agreement. So a couple of weeks ago, we asked this question, what will the pricing of the TikTok deal look like? And what will that pricing tell us about the nature of this deal? Well, we now have our answer. It is$14 billion. That values the new entity at roughly one-time sales. that's about the same multiple as General Mills.

17:25And for comparison, Meta trades at roughly 11 times sales. So 11 times sales versus one-time sales. And this is for a company that is actually growing faster than Meta. It's the fastest growing social media platform in the world. It's the platform from which 40 % of young Americans get their news. Supposedly, that company is worth$14 billion. Supposedly, it is actually less valuable than Domino's Pizza. So right off the bat, the deal looks rigged. And if this were a company that were trading on the open market, if this were a free auction, if this were going public, for example, you'd probably be looking at a valuation above$50 billion, maybe closer to $100 billion.

18:12And even that, depending on your perspective, even that might be cheap. This is $14 billion. Now, there are some caveats. Supposedly, ByteDance is going to charge a licensing fee, and apparently that will translate to roughly 20 % of the company's revenue. So, that partially explains how cheap the pricing is here, but it certainly does not explain all of it. How did they land on$14 billion for the US version of TikTok? I don't know, but something certainly seems off here. Let's bring in Scott Galloway. Let's see what he makes of this new detail.

18:52Scott, good to see you. Good to be seeing my brother Eduardo. Edumante. Edwino. This is good. Yeah, this is good. Nice new nicknames. Yeah. We want to get your reaction to the TikTok news. TikTok, we finally have a valuation. We have a price on the deal. $14 billion for TikTok US. Your thoughts on the valuation? Well, depending on who you talk to, whether it's that guy Ashwan, who's the tech analyst, or other analysts who try to put a fair value on it, or just looking at multiples on other companies, it's going for somewhere between 70 % and 90 % off of retail, off of what it would get if this was a true deal and people were allowed to bid on it.

19:36As a matter of fact, I think earlier in the year, earlier in the year. I forget his name, the guy who owned the Dodgers at one point, put together an investor group and offered, I think, 50 % more. And my understanding is that the deal includes sort of a tail or a claim on up to 40 or 50 % of the profits back to ByteDance. But even if you double the valuation to$28 billion, it's still basically a massive discount to its free market value. Well, I was interested to hear some of those valuation numbers there. I saw reports that or estimates that this company, this U.S. company should be worth around $50 billion, which I also thought that was low.

20:18I mean, TikTok U.S. compared to, let's look at Reddit, for example, around$45 billion or Twitter, which was in the same ballpark,$40 to$45 billion. And this is 14. So if we're going to play the valuation game, I think is they'll do somewhere around 15 billion this year, somewhere between 20 and 15 billion just in the US. If it got the same valuation as Meta, and I don't see why it wouldn't, 10 times revenue is you're looking at 150 billion. If these guys, if this deal actually goes through, and I'm still suspect the deal is going to close, you're looking at an IPO, the value is the thing probably at 150 billion to a quarter of a trillion dollars, which will be a 10x markup for basically either investing in one of Trump's shit coins or investing in his campaign.

21:02So So if you're an ally of the president's, you get an investment that will likely be marked up 10x on billions of dollars of deployed capital within the next 24 months. That's a straight oligarchy, socialism deciding who gets, you know, deciding picking winners and losers amongst your friends. It's a cross between corruption, socialism, and oligarchy. And my disappointment is that there aren't more Democrats kind of raising their hand and saying, yo, Ellison and Susquehanna, this is an illegal deal. You are engaging in illegal business activity. And as soon as there's a real attorney general in office and the next three and a quarter years will go fast, we're going to unwind this fucking Frankenstein of a deal.

21:48It's just, I find it very frustrating that the rule of law and the basics, you know, I met somebody who's participating in this deal. And all of these guys are just, they are such, quote unquote, free marketer warriors. They talk about the markets and competition. And then when they get a chance to participate in what is corrupt oligarchy, they're all for it. You know, Sequoia, General Atlantic, all of these guys know this is total bullshit. you know, something tells me the Soros funds weren't invited to bid on this deal, right? Something tells me even a guy like Ken Griffin, who's a moderate, unless you've already given to the Trump campaign and you're hardcore on his side, no matter what he does, you do not get to participate in what has traditionally been a free market around this.

22:38So your friend who got in on the deal. Do you know how he or she got the call? Yeah, he's giving a shit ton of money to Trump. And by the way, it's not my friend. Okay, your acquaintance. It's somebody I know, and is going to get to participate in the deal. Got it. Which seems to be a very key detail. I mean, the thing that we're describing here, the thing that you're describing is illegal, is the nature by which this deal was finalized. I mean, the idea that only a select set of people are getting access to this deal that prices the company at what I believe and what it sounds like you believe is a ridiculously cheap valuation.

23:23This is a question that we asked several weeks ago. It was, we'll know if this deal stinks because we'll look at the price of the company. And if it's a joke of a price, which in my view,$14 billion is, then we know this was a setup and the people who got in on the setup were friends of the president and you have firsthand evidence right here name a democrat in this deal i mean here here's okay so first off it's probably a violation of all sorts of intro you know international trade agreements we're not supposed to do this having said this china pulls this kind of shit all the time so let's let's walk past it back let's give the president some credit and say this thing is a threat to the U.S., and I have figured out a way to capture some economic value while reducing the risk of the defense threat of a propaganda machine affecting our youth.

24:13Okay. And he wants Americans to, because they've created the value by spending so much money on this thing, they want Americans to capture it. All right. That violates all sorts of international trade treaties, but okay, fine. Then the way you would do this is you would say, okay, here's the company. It will be owned by something called TikTok US Co. Now it's an auction. Who's going to pay the most for it? And then those people pay a market price. And by the way, the existing investors either get cashed out or they can roll their stake or they can bid on new TikTok US Co. But to price it at an incredibly low price and then hand it out like a birthday cake to your donors is flat out corruption.

24:56So, okay, I'll tell you what, Ed and Scott will bid$14 billion and$1. I'm not exaggerating, Ed. We could raise it in a second. If they said yes, we'd go out and raise it. Easy. If all of a sudden we had a tangible chance of getting TikTok, the rights to U.S. TikTok, you and I could raise that money in about 72 hours. You know, I think we should try to do it i think that's what we need to do well here's the thing if there's a case i mean if you really and i'm i'm down for this kind of stuff put together an llc bid 15 billion and then when you don't get it which you won't you you basically have a suit in my opinion you have a very tangible legal case against the government for if for not you know for for not going to the highest bidder.

25:51That is what you are supposed to do. If they're closing DMVs or they're closing Veterans Affairs buildings, right? They take that real estate. There are emoluments clauses, or I don't know what the term is, where when you sell that real estate, you're not allowed Westwood Park or in Westwood, the VA has some of the most prime real estate, Veterans Affairs building. I don't know if they're closing that building or not, but that real estate is probably worth$300 million or$400 million. There are all sorts of laws saying you have to sell it to the highest bidder because U.S. citizens own that land.

26:27And if you just carve it up and give it to the most right-wing L.A. real estate developer who happens to support Trump at a below market price, you are cheating U.S. taxpayers out of money. And that's the same thing as here. They are taking somewhere between 30 and 60 billion dollars of gains from U.S. citizens and investors that should have the opportunity to buy this thing and bid it up. Well, you recently predicted that this wouldn't go through. The update we have right now is that this is still a framework. We still don't have any signed terms. We don't have any, I mean, we don't really have anything.

27:11The White House has said that Xi Jinping has signed off, but the Chinese government has not approved of the deal, or at least they haven't said anything publicly. So it appears maybe this is going through, still not totally clear, but let's just get an update on your prediction. Do you think a deal is going to go through? Last time we spoke, you said, no, it's not going to happen. Do you think it might? Look, there's no doubt about it. The likelihood it's going to close has gone up. Yeah. And I don't, you're going to find this hard to believe, Ed, but occasionally I'm wrong. I know it doesn't seem that way.