Analyze This: What To Make of the Industry's Urge to Merge?

They are the professional analysts who research, keep track of, advise their clients on, and opine to the news media about the video game business. In Analyze This, we present a timely question pertaining to the business side of the industry, and then simply let a trio of analysts offer their thoughts directly to you. Each person's opinion is his own.

Ed Barton of Screen Digest, Jesse Divnich of Electronic Entertainment Design and Research, and Michael Pachter of Wedbush Morgan Securities considered these questions:

Generally, what are your thoughts about mergers (such as the recent one between Activision and Blizzard) and all the talk, rumors and speculation about other possible mergers/acquisitions in the industry (including EA's attempt to buy Take-Two)? Why has there been, apparently, such a strong "urge to merge"?

Which developers or publishers do you see are ripe for being acquired?

Ultimately, how do you think this will affect various people in the industry -- like the developers and the consumer?

Ed Barton, Screen Digest

General thoughts on mergers in the industry:

One of the biggest drivers has been the increase in development costs for all platforms, but, in particular, for graphics-intensive platforms. Sharply increasing development costs have increased the financial risk of games development.

Another factor driving consolidation is the eagerness of diversified media companies looking to expand their involvement with the video games industry.

As the current hardware cycle matures and the next generation of consoles approach, we might see something on a larger scale as a media group looks to acquire an entire publisher. The likelihood of this will increase during the hardware transition phase, which is traditionally when a publisher's financial performance suffers.

More recent transactions have been driven by the desire to expand both product and geographical reach. The marriage of Activision's proven Western hemisphere console publishing capabilities with Blizzard's global PC and PC online gaming capabilities is a compelling combination.

With EA and Take-Two, the story is more about domination of the U.S. market and combining some of the most exciting gaming IP around today. There is another significant quick win in the overlap between their sports games publishing operations with immediate savings to be realized, as well as market share gains, by eliminating duplication.

Other companies ripe for acquisition:

SCi Entertainment has attracted a lot of scrutiny recently, and any firm which must undertake dramatic changes in leadership and strategy will come under the microscope as acquirers look for cheap assets.

SCI/Funcom's Age of Conan: Hyborian Adventures

Major publishers are looking to build online gaming capabilities, both in the casual and core gamer spheres. I think some of the more successful developers and operators specializing in online games and MMOG's will present attractive targets to publishers looking to enter these markets.

Effects on developers and gamers:

If the publishing industry were to consolidate further, one might argue that a lack of competition could lead to a monoculture in which fewer risks are taken and innovation suffers.

However, recent developments in gaming (digital distribution opening up markets to smaller players, a renewed emphasis on casual games, and moving away from the two-year development cycles of graphic-intensive games) suggest that even the largest operators realize the value of diversity and its key role in the ongoing healthy of the industry.

I hope there exists the potential for smaller, smart operators with compelling products to grow and establish themselves.

Jesse Divnich, Electronic Entertainment Design and Research

General thoughts on mergers in the industry:

During periods of rapid growth, organizational expansion through acquisitions and mergers is a healthy sign of a maturing industry.

Because of this, it is far too easy to fall prey to industry outsiders looking to get a piece of the pie. We have seen recent examples of this with companies like MTV solidifying their industry presence in the gaming sector with the acquisition of Harmonix.

To prevent this, video game publishers must increase their company's value to make a possible acquisition far too expensive. Aside from increasing an organization's value, mergers and acquisitions increases the barriers of entry for outside competitors.

MTV makes for another good example: While MTV had the capital to purchase Harmonix, they did not have the resources or expertise to launch a product successfully in the retail channel. This ultimately led to the MTV/EA partnership on Rock Band.

Other companies ripe for acquisition:

THQ is about the only big one left. Potential acquirers are still deciding whether THQ is worth the premium price it would go for in today's market. It is safe to say that THQ is under a lot of pressure right now to prove that they are worth that premium.

There are also Majesco and Midway, both of which are struggling to achieve profitability. I would not be surprised to see both of their assets acquired within the next five years, especially Midway, since they do have a more robust selection of intellectual properties and wholly owned studios.

Midway's Mortal Kombat vs. DC Universe

In terms of developers, anyone who is not already owned by a publisher is ripe for the picking. We have already seen major acquisitions of developers such as DICE, BioWare and Pandemic. It is only a matter of time before others are picked up by publishers in an attempt to secure more intellectual properties and talent in the industry.

Effects on developers and gamers:

As the industry becomes more centralized, powers begin to shift from the largely scattered development community to the well-established publishing community. Less talented, smaller or un-established development teams will be forced to be acquired, or will lose crucial development opportunities.

For the already established, respected or acquired development teams, they will see many benefits. First, they will see bigger budgets. Second, as publishers continue to expand into new markets, their titles will have a larger geographical reach.

There is, however, an opinion that as our industry grows, creativity takes a back seat to proven design practices and established intellectual properties. This assumption stems from the idea that creativity is risky; therefore, publishers avoid creativity. I believe [this] is an illogical and erroneous assumption. In fact, publishers are constantly on the lookout for new development practices that will reduce cost as well as new gameplay elements that will increase appeal among gamers.

Michael Pachter, Wedbush Morgan Securities

General thoughts on mergers in the industry:

I don't see an urge to merge.

I think that Vivendi had legitimate concerns about its own ability to manage the tremendous profits generated by Blizzard, and recognized that Activision was in a better position to re-deploy these profits productively.

Thus, the Activision/Vivendi deal came about in order to maximize profitability of the Vivendi assets - not much more to it than that.

As far as EA/Take-Two are concerned, Take-Two has progressively weakened over the last seven years, in spite of the phenomenal success of the Grand Theft Auto franchise. The company has had six CEOs in seven years, and the frequent change at the top has cost it a lot of continuity.

It made several bad decisions (several failed licenses: 24, The Da Vinci Code) made a disastrous foray into sports, and has continued to chase cool new franchises (BioShock, Borderlands, LA Noire) while letting older franchises (Max Payne, Red Dead Revolver) fade into oblivion.

The company also made really poor choices on sequels (Manhunt and Bully), instead of focusing resources on properties that had worked in the past. So EA sees a company in trouble, and is seizing the opportunity to capture GTA.

Other companies ripe for acquisition:

I don't see anyone particularly well positioned to be acquired, except perhaps Codemasters or Atari/Infogrames. The others are too costly, and a chunk of revenues could go away in an acquisition - THQ has a lot of licenses that likely terminate upon change of control.

Codemasters/InXile's Hei$t

It's possible that someone will value Ubisoft, but that would cost a ton. And if it's not a friendly deal, Ubisoft management could start a competing company across the street and likely would attract much of the key talent.

If a company wants to buy the ability to develop games, they can buy a lot of talent for $1 billion. Most quality studios cost [under] $200 million (e.g., Traveler's Tales, Bizarre Creations).

Even Pandemic Studios and BioWare were far cheaper [than it would be to buy] THQ or Ubisoft. There are still great developers out there (Insomniac Games, Bungie, Media Molecule, Epic Games, id Software) that would make a company immediately competitive in games.

Effects on developers and gamers:

Ultimately, I think that the cost of developers will rise, as it should. These guys are the real "stars" of the industry. Although the publishers add a lot of value, their business model is similar to the movie studio model of the 1940s, where the studio had the stars under contract, and the studios kept all of the "upside-from-film" profits.

That model migrated to a model whereby the stars are paid a percentage of both the gross and profits from-film, and the studios keep only a modest percentage of the profits.

While I don't see this happening in the video game industry for several years, maybe decades, I do see the developers getting a bigger slice of the pie in the future. That should serve to attract even more talent to the development community, and make games even better in the future.

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