Strategy Process Section 090 Blog

Proposed EA, Take-Two Merger Will Spark More Consolidation
Tuesday, Feb. 26 2008
Fox Business: Ken Sweet

News that Electronic Arts wants to buy game developer Take-Two Interactive should be the beginning of even more mergers and acquisitions in the video game publishing business.

With the production cost of a major video game soaring, and competition increasing between video game consoles and the computer gaming market, industry analysts said consolidation in the video game publishing industry is sorely needed.

Electronic Arts (ERTS: 47.94, +0.01, +0.02%), publisher of the Madden NFL series and The Sims, made an unsolicited $2 billion bid on Monday for Grand Theft Auto publisher Take-Two Interactive (TTWO: 26.54, -0.31, -1.15%). The bid valued shares of Take-Two at a 62% premium from the company’s closing price on Feb. 15--sending the company's stock soaring through the roof.

The proposed merger of EA and Take-Two is the second merger announced within the video game industry in the past three months. In December, video game publisher Activision (ATVI: 27.17, -0.08, -0.29%) said it would merge with software developer Blizzard, a subsidiary of Vivendi (VIV: 6.73, +0.08, +1.20%).

Take-Two's Board of Directors said in a statement Monday they rejected EA's bid, saying the offer undervalued the company.

Like the airline industry, the $9.6 billion video game industry has been ripe for consolidation for some time, analysts and experts said. The costs of producing a major title for a console like Nintendo's Wii, Sony's Playstation, or Microsoft's Xbox, are now so high that if a title does poorly, it can take out the entire game publisher.

“For the small-time publishing houses, it’s a huge financial gamble to put all your cards in one title,� said Edward Williams, a video game industry analyst with BMO Capital Markets.

There are two sides to the video game software business: development and publishing. Development houses create the games, while publishing houses get the game ready for consoles and computers. Think of developers as authors and publishers as book publishers.

EA is one of the largest third-party video game publishers and developers. The company makes games and distributes them. While Take-Two is also a developer and publisher, it's primary business is to develop titles. Take-Two makes nearly all their money from the company's hit series Grand Theft Auto. While it does have some other major titles, the company's entire financial future is staked on GTA.

EA can afford to take Take-Two under its wing because it has multiple franchises working under the company's umbrella. Plus, EA needs Take-Two, analysts said.

“Take-Two has one of the best development teams in the industry,� said Doug Creutz, a video game analyst with Cowen and Co. "It should bring some fresh ideas to EA, which for most people has become pretty stagnant when it comes to ideas.�

A key issue in the video game industry is scale, analysts said. Video game publishers need the infrastructure and talent to produce blockbuster titles across multiple platforms like PlayStation, Wii and Xbox--on top of producing titles for computers. If a company is a single-title video game developer, the business can go months, even years, without making a profit.

That's a huge financial gamble. According to industry experts, a big-name franchise can cost a publishing house upward of $20 million to $40 million per title for development and publishing.

The costs are mainly related to the scale and vastness that games now require. Game publishing companies are not making titles like PacMan or Pong anymore. Instead games often have multiple levels and intricate graphics that require millions of lines of code and teams of 50-100 game developers.

As the barriers to entry grows, the industry may start looking more like its media cousins in a few years, where conglomerates will control the bulk of the creative content being produced, analysts said.

"It's turning into the movie business," said Cruetz. "You'll have smaller players like Lions Gate Films who are the exception to the rule, but the bulk of the content is in the hands of companies like Sony Pictures of Warner Bros."

While most analysts believe consolidation will continue in the industry, they disagree on where it will come from.

There are very few major U.S.-based video game publishing houses that haven't been acquired or made into giants themselves. One of the last ones is game publisher THQ (THQI: 19.04, +0.01, +0.05%), whose shares soared more than 10% in trading Monday on takeover speculation. There are also smaller game development houses like id Software or Epic Software, both privately held and both seen as potentially lucrative takeover targets.

Williams said he believes consolidation will come from overseas: most likely in Japan and Europe. Japan is the world's largest market for video games, and has some notable video game publishing houses that could merge with an American counterpart like Square-Enix (SQNXF), maker of the Final Fantasy series, or Capcom (CCOEF). There is also Ubisoft (UBI) in Europe.

Cruetz, meanwhile, said he does not believe there will be a joint Japan-U.S. game publishing merger because of the cultural differences. "Japanese video game publishers are not as popular in the U.S. as they are at home and visa versa," he said.

Instead, Cruetz said he sees consolidation coming from big publishing houses buying up start ups.