Microsoft is divesting Undead Labs under newly appointed Xbox CEO Asha Sharma. Sharma’s July 6 memo consolidates Xbox around its largest franchises, with Mojang and King now reporting directly to her, and four studios are divesting from Xbox. This indicates Microsoft has shifted away from Game Pass towards an internal bar for what a first-party studio must contribute. At the same time she dropped “We have also learned that we are not the best home for every type of studio; in a typical year, we lost 64 cents for every dollar we invested.” A new buyer is underwriting Undead Labs with a different cost structure and a different definition of success. How can Undead Labs show that an asset can be impaired under one owner and investable under another without either party being irrational?
What is Undead Labs’ acquirer actually buying?
Let’s start with what we know:
State of Decay is an established franchise with more than 10 million players
State of Decay 3 is targeted for 2027 and is currently in alpha
Microsoft has announced terms for Undead Labs to move to an undisclosed new owner, the transaction has not yet finalized
What can we reasonably infer?
More development capital is required to absorb a combination of development completion, publishing, marketing, and post-launch support
The buyer’s return is heavily concentrated in State of Decay 3 and its commercial tail
What do we not know?
Buyer’s purchase price and required return
Remaining budget to ship State of Decay 3
IP and publishing rights
Microsoft’s retained franchise economics
Studio burn rate and headcount
Let’s reverse-underwrite the acquisition to understand the buyer
We aren’t going to assign a value to Undead Labs. Instead, we are going to solve for the maximum entry price under an explicitly constructed case. How does an acquirer determine what the maximum price tag Undead Labs an acquirer should pay? Stay with me, this may seem dense but it’s an overview of how studios are priced when they are shopped around.
Here is the formula we are going to use:
Pmax = PV(future free cash flow + terminal value) - completion capital - separation costs
Where:
Pmax is the maximum upfront equity consideration.
PV() is present value, a formula that calculates what a future amount of money is worth right now.
Completion capital includes remaining development, launch marketing, and working capital required to complete and ship the game.
Future free cash flow includes launch receipts, catalog tail, DLC or expansions, and post-launch operating costs.
Terminal value is the estimated worth of an asset after a specific forecast period, a single value to represent all future value post-free cash flow.
Separation costs are the costs related to losing and replacing central Xbox functions that are missing post-acquisition such as finance, HR, IT, legal, etc.
Let’s run through each one and give a rough estimation.
Completion capital: headcount × fully-loaded cost × months to ship
Headcount: 120 estimated headcount
Fully-loaded cost: $16.6k fully loaded costs (monthly)
Months to ship: 12 months to ship
Internal completion payroll is at ~$24M. I use this as the known core of completion capital. External development, QA, localization, certification, launch marketing, working capital and contingency will increase the actual number.
Separation and standalone run-rate: the functions Microsoft previously supplied must now be funded by the acquirer
Finance: $450K
HR and people operations: $400K
IT and security: $650K
Legal and compliance : $350K
Facilities, procurement and administration: $400K
Payroll, HRIS, ERP and corporate software: $450K
Audit, tax, insurance and board costs: $500K
Misc.
Estimated separation G&A is $4M. One-time separation costs for leaving Microsoft and migrating systems, legal entities, contracts, and corporate functions to the new corporation.
Free cash flow (FCF): cash receipts - costs required to operate the studio and support the game
Cash receipts: premium sales, subscription payments, DLC, catalog sales from older games, licensing
Costs required: development payroll, contractors and outsourcing, post-launch content, marketing, finance, HR, IT, legal, taxes, and working-capital needs
Free Cash Flow = (Units * Net Receipts per Unit) + (Subscription / Platform Receipts) + DLC and Catalog Receipts - Operating and Support Costs - Marketing Costs
Forecasted FCF
Year Free cash flow
2027 $20M
2028 $35M
2029 $25M
2030 $15M
Total $95M
The FCF is not worth $95M today because cash received later is worth less than cash received today. I discount future cash flows at a 25% target equity return to reflect completion, retention, carve-out, and single-product concentration risk. We calculate the Present Value using:
PVt = FCFt / (1 + r)^t
So $95 million of nominal future cash flow is worth only approximately $57.3M today at 25% target equity return. These figures represent an illustrative scenario rather than forecasts derived from disclosed Undead Labs financials.
Under this forecast, State of Decay 3 is expected to sell ~6.2M units. At a $60 retail price and $42 net taking into account the platform fees, we can apply the same discount across all 4 years to reach a blended $29 per unit. Taking the topline receipts of $179M ÷ $29 = ~6.2M units. State of Decay 2 hasn’t disclosed units sold but has surpassed 10M players across units and Game Pass.
Terminal value: the representation of the remaining value of the catalog IP, future sequels, the development team, licensing opportunities, and other value the studio would have for its current owner or if sold to another buyer.
I assign an illustrative $40 million residual value to the franchise, catalog and operating studio after 2030.
After 2030 the terminal value is an estimated $40M. Now we need to discount the $40M to today using the present value formula. This gives us a Terminal Value of ~$16.4M at a 25% target equity return.
Pmax = PV(future free cash flow + terminal value) - completion capital - separation costs
Pmax = 57.3 + 16.4 - 24 - 4
Pmax = 45.7
The preliminary model leaves approximately $46M of purchase-price capacity excluding external completion (contractors) and working-capital requirements. The useful output is not that Undead Labs is worth $46M, it’s that $46M is the maximum remaining headroom before several significant capital requirements are even added.
What does the new owner need to do differently
The first step is to define a new, narrow success reality across both the studio and State of Decay 3’s release. Calculate the acceptable launch sales for State of Decay 3 and the steps the acquirer needs to take to get there.
The buyer’s job is to ensure the launch is successful. For the first 100 days, the buyer needs to:
Rebaseline the game
There needs to be an established completion-cost ceiling on what the game is shipping down to the feature-level. This gives the finance forecast a hard upper range to work against.Rebuild standalone costs
Forecast the remaining 12 months of development and 12 months post-launch to determine the minimum liquidity required to support the studio to ship the game. This gives a financial ceiling to work against.Review staffing
This is the unfortunate, negative press generating side of acquiring a divested game studio. The buyer needs to identify a launch-critical role map and contractor conversion plan for roles not critical to shipping. This is to remove the nonessential burn without damaging delivery.Lock the commercial GTM playbook
The platform, publishing, subscription (Game Pass), and IP-rights schedule for the launch of the game. This is to determine the buyer’s net receipts and where they are coming from.Define launch governance
Monthly reviews, milestones, gates, and marketing thresholds that determine how funds are released and when marketing capital is spent. This is to give a structure for both the buyer and the studio to work and plan against.Establish downside protection
The terms for when a cancellation, delay, or additional capital is required. This is to establish when the buyer stops funding or changes the GTM plan.
The buyer is likely underwriting a commercial tail beyond launch through expansions, recurring content, and co-op retention. Without that tail, the $95M FCF case becomes much harder to support.
What must the buyer believe
Undead Labs’ buyer wants 3 things to occur:
State of Decay 3 must ship within a bounded completion budget.
The buyer must control enough of the franchise and publishing economics to capture the launch and commercial tail.
The studio must generate enough cash after launch to support continued operations without another uncapped capital injection.
Under my illustrative case, future cash flow and residual value support approximately $74 million of value today at a 25% target equity return. But the final purchase-price ceiling depends on a number of properties not captured here to describe the full completion and separation requirement.
The buyer does not need to believe Microsoft was wrong. It needs to believe that under a lower carrying cost, tighter capital controls, and a longer commercial tail, Undead Labs can generate an acceptable return on the capital still required to finish and operate it.