(Bloomberg) -- The UK competition regulator told Microsoft Corp. on Wednesday that it has serious reservations about the company’s pending acquisition of video game publisher Activision Blizzard, but that one way to assuage those concerns would be to divest blockbuster franchise Call of Duty.

While Microsoft has said it’s determined to get the $69 billion deal done, hiving off Call of Duty, one of the most lucrative game franchises in the world, would likely call into question the economics of the transaction.

A new game in the 20-year old series comes out every year. Across the lifetime of the franchise, Call of Duty  sold more than 425 million units and brought in more than $30 billion in revenue, before the most recent installment came out last fall, according to the Washington Post.  That steady source of revenue and the game’s enduring popularity are part of what endeared Activision Blizzard to Microsoft, whose gaming unit operates dozens of studios, the Game Pass subscription service and the Xbox game console.

The series’ latest installment, Modern Warfare II, released in October and topped $1 billion in sales within 10 days. It became the best-selling game of 2022, according to industry researcher NPD Group. While video-game sales slowed across the industry in 2022, Modern Warfare II buoyed Activision’s fourth-quarter results, contributing to the company’s 43% jump in bookings— the biggest increase in nine quarters. 

“Microsoft has been very clear that they want all of Activision and I don’t think they’re interested in a deal without Call of Duty,” said Joost Rietveld, an associate professor in the department of Strategy and  Entrepreneurship at the UCL School of Management. “The synergies that Microsoft receives from Activision Blizzard definitely include Call of Duty, as a package of the IP and the developmental power its studios bring.”

In its report, the UK Competition & Markets Authority found concerns around the deal’s potential to harm competition in the gaming console market between Xbox and Sony Group Corp.’s PlayStation–particularly because Call of Duty is “important to the competitive offering of each.” If Call of Duty were to become exclusive to the Xbox ecosystem, which includes the Xbox app on computers, it would significantly erode PlayStation’s appeal to consumers.

In the CMA’s own survey of PlayStation Call of Duty players, 24% said they would switch consoles if the game were to become an Xbox exclusive. “Reducing this competition between Microsoft and Sony could result in all gamers seeing higher prices, reduced range, lower quality, and worse service in gaming consoles over time,” the CMA wrote in a statement.

The agency proposed several “structural” remedies that could help get the deal through, but none of them are likely to be palatable to Microsoft.

The list of remedies included Activision Blizzard divesting its businesses associated with Call of Duty. Activision Blizzard operates three core studios working on the blockbuster franchise as well as a handful of subsidiaries offering support on the series, including quality-assurance testing.

Other potential structural remedies include separating Activision, a unit of Activision Blizzard Inc. that accounts for about a third of the company’s operating revenue, and Blizzard, another unit that’s the creator behind World of Warcraft and Diablo.  Activision merged with Blizzard in 2008 in a deal with Blizzard’s then-owner, Vivendi SA.

An Activision Blizzard spokesperson said the CMA’s proposal isn’t the end of the conversation, adding that “Microsoft now has the opportunity to make their case on the path forward. We already know they want to keep COD available on all platforms.” 

CMA also said some “behavioral remedies” could be possible, which could include promises on licensing agreements.

Microsoft has repeatedly said it has no plans to make Call of Duty exclusive. The software giant has offered to keep Call of Duty on PlayStation for several years and a similar deal to Nintendo Co. for its Switch console. Microsoft Gaming Chief Executive Officer Phil Spencer maintains that the company’s plan is to seed its content across as many screens and systems as possible. 

“We are committed to offering effective and easily enforceable solutions that address the CMA’s concerns,” Rima Alaily, Microsoft’s corporate vice president and deputy general counsel, said. “Our commitment to grant long term 100% equal access to Call of Duty to Sony, Nintendo, Steam and others preserves the deal’s benefits to gamers and developers and increases competition in the market.”

Wall Street is becoming increasingly skeptical of the likelihood the merger is approved. Activision shares slumped as much as 4.2% to $72.45 on Wednesday after the CMA’s announcement, putting them nearly 24% below Microsoft’s cash offer of $95 a share. At this point, the market sees a 10% to 30% probability of the transaction being completed, said Aaron Glick, a merger arbitrage specialist at Cowen & Co.

“The provisional findings, taken together with recent media reports, indicates that there is a very low, perhaps negligible, likelihood of the CMA reversing course and approving the transaction with only behavioral remedies,” Glick said.

Microsoft has a history of making games developed by companies it acquires exclusive, which has not gone unnoticed by regulators. After its $7.5 billion acquisition of ZeniMax Media Inc., owner of game publisher Bethesda Softworks, Microsoft announced its decision to make future ZeniMax titles Starfield and Redfall exclusive to Xbox consoles, Windows PCs and Xbox Game Pass subscribers. 

The CMA is the first major global regulator to conclude that the deal could harm gamers by weakening the rivalry between Xbox and Playstation. The regulator found that the deal could result in higher prices, fewer choices, or less innovation for UK gamers in both the console and cloud gaming services arenas.

Microsoft could appeal a decision by the CMA, which is scheduled to issue a final ruling in April, but that could drag on for months or even years. In the meantime, the deal is also facing scrutiny in the EU and US, where the Federal Trade Commission has sued to block it. The FTC’s court decision or any potential EU decision could then also hamper any UK behavioral remedy that’s put in place.

The deal is scheduled to close by the end of Microsoft’s fiscal year, which concludes in June, but all regulatory clearances may not be resolved by then. Microsoft will have to pay as much as $3 billion in breakup fees if the transaction falls apart.  

--With assistance from Yiqin Shen.

©2023 Bloomberg L.P.