Video game industry in consolidation phase
Posted by talleyrand on Monday, August 26 2002

By Carrie Kirby, San Francisco Chronicle

Like Pacman chomping ghosts, cash-rich video game companies are starting to gobble up smaller outfits.

In recent months, Electronic Arts, Sony Computer Entertainment America Inc.,

THQ Inc. and Activision have all bought video game studios, and industry watchers say that's just the beginning of a wave of consolidation that is likely to engulf more small and medium-size firms.

Analysts say the buying binge comes as console companies and software publishers try to ensure they'll have a broad range of exclusive game titles, a major competitive factor. And with some game budgets entering the stratosphere of movie budgets, it's becoming harder for small game developers to remain independent.

After buying Black Box Games, the Vancouver developer of the Need for Speed series of racing games, Redwood City's Electronic Arts, is ready to keep buying.

"(Electronic Arts) has more than $1 billion on hand in cash and reserves, so it stands to reason that we're considering strategic investments," EA spokesman Jeff Brown said. EA, which is the largest game publisher, with hits like the Sims and the Madden Football series, has blown through sales expectations this year.

But EA's billion looks like chump change compared to the war chest of another game maker: Microsoft Corp. With $38.7 billion in cash and short-term securities, the maker of the Xbox console could buy the entire $9 billion video game industry four times and still have enough left over for extra controllers.

An Xbox spokeswoman said Microsoft doesn't discuss its acquisition strategy,

but observers say if the Redmond, Wash., firm isn't looking to buy, it should be, because it lacks hit games. In May 2002, the most recent month for which data is available, four of the top 10 games were for PS2, four were for Nintendo's GameCube or handheld GameBoy Advance, and only two were for Xbox.

"Microsoft has tried to grow the Xbox business organically, but it is being left behind by Sony," said Dean Takahashi, author of "Opening the Xbox: Inside Microsoft's Plan to Unleash an Entertainment Revolution." He added that Microsoft has already unsuccessfully tried to buy Japanese studio Square Co. and has even talked with Sega Corp.

Far from seeing itself as an acquisition target, Sega, with headquarters in San Francisco and Tokyo, says it is in talks to make some purchases of its own.

The company is looking for studios that could fill holes in its lineup as it pumps itself up to compete with the biggest publisher, Electronic Arts, said Charles Bellfield, Sega of America's vice president of strategic planning and corporate affairs.

Bellfield would not name targets. But analyst Edward Williams said it's safe to assume that Sega has been a suitor of any of the studios sold recently,

such as Phoenix's Rainbow Studios, bought by THQ of Calabasas Hills (Los Angeles County) in January, or Hayward's Z-Axis, bought by Santa Monica's Activision in May.

Analysts say these acquisitions are probably the first of many as the game industry matures.

"Publishers are discovering that scale is important, and breadth of product offering is important," said Edward Williams, an analyst with Gerard Klauer Mattison. Williams owns shares in THQ; his employer has no banking business with game companies.

This acquisitive mood comes at a time when small studios are finding it tough to compete.

"Fifteen years ago, two kids in their garage could create a game that would sell a million units," EA's Brown said. But EA now spends $5 million to $10 million to develop its top titles. In the 1990s, in the days of the PlayStation 1 and Nintendo 64, EA was spending $3 million to $5 million per title.

As the holiday season approaches and the three console manufacturers jockey for position, it becomes imperative for them to lock in games that will be exclusively available on one system.

The surest way to do that is to buy the game's developer, IDC analyst Schelley Olhava said.

Sony's purchase of Incog Inc. Entertainment this month allowed Sony to assure that future Twisted Metal games, a big seller, will be exclusive to Playstation 2, she said.

Because of that, the most likely acquisition targets "have a killer game in a given vertical" or "a stable of franchises that can be leveraged," said P.J. McNealy, an analyst with the research firm Gartner. Microsoft purchased Chicago's Bungie Studios to get the game Halo, which has proven to be the most popular Xbox title.

Price is a factor, too. Despite the boom in the industry, many small companies are losing money or not earning much, and their share prices have fallen. Redwood City's 3DO, France's Infogrames Entertainment and Chicago's Midway Home Entertainment Inc. are all the subject of buying speculation because of their low market capitalizations.

After losing $48 million in fiscal 2002, shares of 3DO closed at $1.75 Friday after effecting a 1-for-8 stock split. Thursday, before the split, it closed at 22 cents.

But 3DO chief executive Trip Hawkins said the company is better off mounting a comeback as an independent than becoming part of a large firm.

"Under these conditions, it would be like giving the company away," Hawkins said. Besides, bigger is not necessarily better in the game industry, he said.

3DO's low stock price is the result not just of its poor performance, Hawkins said, but also of negative perceptions surrounding events like the Nasdaq threatening to delist it and a June disclosure that the company faces "substantial doubt" about its ability to continue as a going concern.

Midway has a market cap of $294 million. Representatives were not available for comment.

Infogrames closed at $2.85 on Friday, with a market cap of $199 million. But its liabilities, including $110 million in long-term debt, far exceed its assets of $168.5 million.

Infogrames executives said in a conference call earlier this month that the firm is trying to remain independent. A spokeswoman contacted this week offered no further comment.

Another likely acquisition target is Vivendi Universal's games unit, which includes Los Angeles' Universal Interactive Inc. and Irvine's Blizzard Entertainment. Vivendi executives have said they're likely to sell off more small businesses as the conglomerate casts around for cash, and many expect the game companies to be part of that sell-off.

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