Death Watch 2024, Continued -- Embracer Group will cease to exist, and XBox (!) is starting to spiral

About five months ago, Dan Olson AKA @foldablehuman AKA Folding Ideas, posted a two-and-a-half hour video about the meme stock movement with the catchy title, "This Is Financial Advice." I won't try to recap the entire thing (although you should definitely watch it if you haven't), but I do want to draw attention to the portion about Bed Bath and Beyond's desperate last-ditch attempt to stay afloat: a financing arrangement known as "death spiral financing."

Very quickly, the arrangement involves a company with more debt than they can repay, not enough revenue to meet operating expenses, and no fat remaining to trim from their operation. This company, BBBY, accepted a financing deal from a private equity firm, with the understanding that they would release shares to the market in order to raise the funds needed to repay them.

The simple fact of such a deal is enough to drive down share prices on its own, and a flood of new shares will also depress the share value, which means that the number of shares needed to repay their PE financiers keeps increasing, in an ever-increasing spiral of share dilution and devaluation that ultimately failed to repay all of their debts, let alone raise enough money to continue operating.

BBBY was forced to file for bankruptcy, was de-listed from NYSE and NASDAQ, and no longer exists. And this was the model that immediately came to mind when I learned of Embracer Group's latest galaxy-brained plan to save themselves from a very similar situation, using a very similar-sounding financing scheme.

From Video Games Chronicle:

Swedish game and media holding company Embracer Group has announced its plans to split into three separate entities.

[...]

As part of the separation process, Embracer has entered into a new financing agreement, through Asmodee, which is worth €900 million. Embracer says the proceeds from this will “repay existing debt and reduce leverage in the remaining Embracer Group”.

The three separate entities are:

• Asmodee, the former Embracer Group's board games division, which will now do business as a separate entity, with an issuance of shares to follow, which will enable them to raise the money required to pay their share of Embracer's €900M debt. 
• Coffee Stain and Friends, the former Embracer Group's AA/indie games division, which will now DBA as a separate entity, with an issuance of shares to follow, which will enable them to raise the money required to pay their share of Embracer's €900M debt.
• The main body of the former Embracer Group which will now do business as Middle-earth Enterprises & Friends, keeping "the Lord of the Rings and Tomb Raider IPs, along with the likes of Dead Island, Metro and Kingdom Come Deliverance," along with the remaining third of Embracer's €900M debt.

Essentially, it's death spiral financing, with Embracer taking out a debt consolidation loan to pay back other creditors, and issuing new shares to raise the money to pay back the new loan. It does buy them some time: they don't have to make any payments against the new loan for 18 months, although I'll bet that they're still accruing and compounding interest the whole time, with a no-doubt-huge balloon payment coming due at the 18 month mark. 

The truly genius part, though, it the three-card monte that they're playing by splitting the company in three, allowing them to issue those shares without having to release all of them as Embracer. This helps mitigate the share dilution which doomed Bed, Bath & Beyond, and their share price actually ticked upwards on the news.

Long story short, though, Embracer Group will cease to exist, and the three new entities that replace it still owe the money that Embracer owed, while still having no real prospect of increasing revenue the way they'd need to in order to cover both financing costs and operating costs. Embracer Group have not saved themselves with their new financing deal. They just weren't forced to cut as bad a deal as BBBY did.

And Embracer are the only AAA-level player in the video game business that are spiralling. Now joining them on Death Watch is, astonishingly, Microsoft Gaming.

From Kotaku:

On May 7, Xbox announced that it was closing three studios—Tango Gameworks (Hi-Fi Rush), Arkane Austin (Redfall), and Alpha Dog Games (Mighty Doom)—with a fourth support studio, Roundhouse Studios, being absorbed by the team behind Elder Scrolls Online. According to a new report, on May 8, in the aftermath of these surprising shutdowns, Xbox President Matt Booty and Zenimax head Jill Braff held a large meeting with staff and laid out the reasoning behind the cuts.

As reported by Bloomberg, during the meeting Booty praised Hi-Fi Rush, but wouldn’t go into specific details on why the studio behind the colorful action game had been shut down.

Speaking more broadly about the closings, Booty reportedly explained that Xbox and Bethesda’s studios had become spread too thin, like “peanut butter on bread,” and that team leaders felt understaffed. The idea being that by closing studios, Xbox would free up resources elsewhere within the company. Booty also told staff at the meeting that Akrane Austin’s closing had nothing to do with Redfall flopping with fans and critics.

Reportedly both Tango and Arkane Austin had pitched games to work on next, including a Hi-Fi Rush sequel and possibly a new Dishonored or similar single-player immersive sim-like game. Those likely won’t happen.

To be clear, Microsoft Gaming is back-stopped by Microsoft Corporation, a three trillion dollar corporate entity that absolutely could cover their XBox losses from petty cash.

 

Apparently that won't be happening, though. Microsoft Gaming CEO Phil Spencer has been hinting for months that Microsoft would be reconsidering their gaming strategy if XBox and Game Pass didn't show revenue growth and profitability by the end of 2023, which clearly hasn't happened. And with $69 billion dollars' worth of Activision Blizzard now ballooning their costs, but not their revenues, and Game Pass subscribers starting to churn, it would seem that Satya Nadella has lost patience with the Game Pass experiment.

To be be clear, none of this was inevitable, and it does not have to continue to be the way they do business. This was a choice; Microsoft is choosing to double down on a strategy that passed its point of diminishing returns years ago, but the line must go up, so the layoffs and studio closures are happening anyway. And I think Phil Spencer and Sarah Bond know this; Spencer has been keeping a very low profile ever since the news broke, and Bond's ill-considered interview with Bloomberg was most notable for the thousand-yard stare she showed to the world while struggling to string together word salad which would sound like an explanation of why they shut down Tango Gameworks, a studio which was making exactly the type of game that Matt Booty said they needed more of... after the closure. 

So, yes, it now looks like Microsoft is going to cut their gaming division loose so that it can follow exactly the same death spiral into irrelevance that Embracer Group has recently completed. At this rate, Microsoft will be shuttering their own gaming division before the start of the next console generation, in spite of being a three trillion dollar company that absolutely could cover XBox's losses without breaking sweat. It's infuriating, and the resulting treatment of the people that they're callously discarding would seem unbelievably cruel if it wasn't so obviously the inevitable outcome of their own executives' decisions, and therefore entirely believable. 

Microsoft Gaming's Zenimax arm was an obvious target for restructuring, having been poorly managed even before being acquired by Microsoft, who proceeded to take a hands off approach with Bethesda in spite of them clearly needing more hands on the helm. If I were to guess, I'd say that Blizzard will be next, with the World of Warcraft and Hearthstone teams remaining mostly intact (WoW still makes money, and Hearthstone has a successful mobile version) and the Overwatch and Diablo teams being shut down (both are currently struggling with player retention and need lots of expensive development to come back).

Let's set the clocks, though: 

• We'll check back in 18 months to see which of Asmodee, Coffee Stain & Friends, and/or Middle-earth Enterprises & Friends are declaring bankruptcy after failing to raise enough money to pay back their share of Embracer's €900M debt.
• We'll check back in 60 months to see if Microsoft still have a gaming division at all, or if they've done a Google and shut it like a Stadia rather than continuing to throw good money after bad.

Because really, if Microsoft's Game Pass strategy can only yield this sort of futility and failure, what's even the point of them?

[W]ith the Xbox portfolio seemingly growing bigger with acquisitions only for Microsoft to then lay off the developers doing the most interesting work, it raises questions about the actual value of the company’s Game Pass subscription service. After all, that service seemed great, in no small part, precisely because it gave subscribers access to the games made by the very developers that have now been shuttered.

Reactions have been coming in thick and quick, but my favourite take so far comes from SkillUp.

Incidentally, if you're still subscribed to Game Pass, this is just another good reason to cancel that subscription. Assuming that Game Pass being a bad deal for almost everybody wasn't already a good enough reason, that is.