Microsoft's (MSFT 2.17%) stock has rallied more than 730% since Satya Nadella took over as the tech giant's third CEO on Feb. 4, 2014. That massive rally, which boosted Microsoft's market cap from about $300 billion to nearly $2.3 trillion, was largely driven by Nadella's intense focus on expanding the company's cloud-oriented businesses.
Microsoft has also remained resilient over the past few months as rising inflation and higher interest rates rattled the broader tech sector. As a result, it remains a popular safe-haven stock for many investors.
I believe Microsoft is still a solid long-term investment with a reasonable path toward hitting a $3 trillion valuation in the near future. But before investors scoop up more shares of Microsoft, they should recognize these three red flags, which could disrupt the company's near-term growth.
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1. Its plans to acquire Activision Blizzard
On Jan. 18, Microsoft announced that it would buy Activision Blizzard (ATVI +0.00%) for $68.7 billion in an all-cash deal, which values the video game publisher at nearly eight times next year's sales.
This purchase would make Microsoft the third-largest game publisher in the world after Tencent and Sony and add iconic gaming franchises like Call of Duty, World of Warcraft, Overwatch, Diablo, and Candy Crush to its lineup of first-party games. It would also strengthen its all-you-can-download Game Pass platform, which has over 25 million subscribers, while widening its moat against Sony in the console race.
This deal makes strategic sense, but Microsoft would also be inheriting Activision's deeply troubled business -- which is struggling with a sexual harassment and discrimination lawsuit, aging franchises, major game delays, and difficult year-over-year comparisons in a post-lockdown market. It could also attract the scrutiny of antitrust regulators, which might force Microsoft to abandon the deal altogether and pay Activision up to $3 billion in breakup fees.
This massive deal might work if Microsoft quickly resolves Activision's problems, but it could also be a bright red flag for its Xbox business.
2. Its lack of progress in the metaverse
Microsoft claims its purchase of Activision will expand its reach across the metaverse -- which will presumably blur the lines between the physical and digital worlds with multiplayer games and mixed-reality devices.
After all, Call of Duty, World of Warcraft, Hearthstone, and Overwatch are all fairly popular multiplayer online games. However, it's unclear if Microsoft will actually create new versions of those games for its main hardware bet on the metaverse -- the HoloLens -- as it famously did with Minecraft.
Microsoft also still hasn't launched a consumer-facing version of the HoloLens, which it initially released to developers nearly six years ago. Instead, it dabbled with Windows Mixed Reality headsets by working with a few third-party hardware makers, but those devices were largely overshadowed by Meta Platforms' stand-alone Quest VR headsets.
To make matters worse, The Wall Street Journal recently reported that Microsoft's HoloLens team had lost about 100 of its 1,500 employees to Meta -- which reportedly poached them with much higher salaries.
That lack of progress in the hardware market raises a red flag, especially as other big competitors like Apple gradually expand into the mixed-reality and metaverse market. It also makes Microsoft's description of the Activision deal as a "metaverse" move seem like a desperate cry for attention as its industry peers also hype up their metaverse plans.
3. Its planned takeover of Nuance is in limbo
Lastly, investors might have forgotten that Microsoft also agreed to buy the transcription technology company Nuance Communications (NUAN +0.00%) for about $19 billion last April. Microsoft had expected the deal, which would strengthen its cloud-based healthcare services, to close by the end of 2021.
The deal has already been approved in the U.S. and Europe, but the U.K.'s Competition and Markets Authority (CMA) recently launched a new probe into the merger. In early March, the CMA will decide if it will expand the investigation or finally approve the deal. If the deal is ultimately blocked, Nuance will need to pay Microsoft a $515 million breakup fee.
On its own, the delayed Nuance deal isn't a red flag for Microsoft. I believe the CMA will likely drag its feet for a while longer but ultimately clear the deal.
However, that scrutiny could spell trouble for Microsoft's planned purchase of Activision Blizzard. If it's taking antitrust regulators this long to approve the Nuance deal, it will likely take an even longer time to clear the Activision deal.
The regulators could also force Microsoft to modify the terms of the deal or even bar it from making Activision's future games exclusive to Xbox consoles and Windows PCs. If that happens, Microsoft might simply abandon the deal and accept the breakup fee.
Is Microsoft's stock still worth buying?
I'm still bullish on Microsoft's long-term prospects, which are more tightly tethered to its cloud business than its gaming and hardware segments. Nonetheless, I think investors should still recognize the soft spots across its sprawling ecosystem and examine its messier business decisions.
That said, I think Microsoft's stock is still worth buying today -- even if it fumbles the Activision deal, falls behind in the metaverse race, and faces tougher regulatory probes for its future investments.
