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Creating Value in a Game Company February 28, 2005 In the new report Market Leaders in the Video Game and Interactive Entertainment Industry, DFC Intelligence provides a detailed analysis of the leading publishers in the interactive entertainment industry. One of the obvious questions that a report like this looks at is what do investors value in a game company? Of course, this begs the question of which company is the most valuable. The chart below shows the market valuation of leading publishers based on the stock price of February 8th. This chart is sorted not by raw market value, but instead by the ratio of market value to revenue. Market Value of Interactive Entertainment Companies
*This is estimated fiscal
revenue in millions for the current fiscal year ending 3/31 (2005) except for
Microsoft (6/30), Eidos (6/30), Take-Two Interactive (10/31), Midway (12/31) and
Vivendi (12/31) for which the figures are actual fiscal revenue for fiscal 2004. As the above chart shows, Electronic Arts is clearly the top publisher when it comes to market valuation (Microsoft, Sony and Vivendi Universal are of course diversified far beyond games). However, EA is the leader in almost every category and comparison with a company that is in a league of its own can be a little unfair. What we thought was more interesting was the high position of Japanese publisher Square Enix. Square Enix is clearly a mid-sized publisher, but their market value of 4.48 times estimated fiscal 2005 revenue is far above other publishers of similar size (Midway is a special case because Sumner Redstone has been almost single handedly driving up its stock price). This month we thought we would speculate on some of the things Square Enix might be doing right in the eyes of the investment community. Square Enix is a fairly new entity created from the 2003 merger of Square, founded in 1983, and Enix, founded in 1975. Prior to the merger, each company had been known for their role-playing game (RPG) franchises. Square was the company best known for the Final Fantasy franchise, while Enix published the Dragon Quest games (Dragon Warrior in North America). Final Fantasy games have sold 56 million units since their first release in 1987, while Dragon Quest games have sold over 35 million units since 1986. Since 1997, Final Fantasy games have sold better in North America and Europe then Japan, while almost all the Dragon Quest games have sold in Japan. The two companies had combined revenue of 66.8 billion yen in 1996, which was more then 2004 combined revenue of 63.3 billion yen. This of course, begs the question, why are investors so bullish on this newly combined entity? There are several notable things about Square Enix that we thought we would highlight. These are some of the universal features that we think appeal to the general investment community when it comes to evaluating game companies. 1) The Games: Top Franchises and AAA games Of course, it is all about games. That is why we spend so much time looking at the franchises each company owns, both how they have performed in the past and their future potential (obviously that is the key concern to an investor). In this respect, Square Enix’s two key franchises come out very strong. We have picked both Final Fantasy and Dragon Quest as two of the top 10 game franchises (see the chart below). Both Final Fantasy and Dragon Quest are RPGs that not only have a long history, they also have a great deal of future potential. The RPG category in general is very strong because these games tend to have international appeal, do well on emerging platforms including online and mobile and are story-based so that they easily translate to other media. Final Fantasy does well in Japan, North America and Europe, has already been made into a movie, has had older content repurposed for portable platforms and has a successful online version. When Square combined Final Fantasy with Disney characters they created a whole new franchise in Kingdom Hearts. Compare this with our number 5 franchise, Grand Theft Auto. The GTA games may out sell Final Fantasy on a per game basis, but the franchise just doesn’t seem to translate as well to portable platforms, online games, merchandising and spinoffs with Disney characters. Dragon Quest has been more traditional and specific to the Japanese market. However, this franchise should have potential to spread on a multi-platform, international basis, like what occurred with Final Fantasy starting in 1997 with the release of Final Fantasy VII. Our number 10 franchise, Sony’s Gran Turismo has sold a similar number of units to Dragon Quest in a shorter amount of time and with fewer releases. However, the thinking behind ranking Dragon Quest higher was that Sony has done a good job of maximizing Gran Turismo’s potential. Much of Dragon Quest’s potential remains untapped. DFC Intelligence’s Pick for the Top Game Franchises
2) Platform and Business Model Diversity Square Enix’s philosophy is that the “Network is the Game” and “Everything Plays Games.” The idea is that games can be played by people anytime, anyplace, anywhere. To emphasize this idea of diversity, the company reports its revenue and operating income in several divisions: Offline Games, Online Games, Mobile Phone, Publications and Other (which includes licensing). In fiscal 2004, 61% of revenue and 68% of operating income came from offline games. However, all divisions reported positive operating income and online games alone accounted for a significant 14% of revenue. Clearly the investment community likes to see companies that are leaders in emerging areas like online games and mobile phone content. The simple fact that Square Enix can separate its results into such categories is clearly a big plus in the eyes of the investment community. The company’s message is that the future involves consumers having easy access to networked, multi-platform games and Square Enix is leading that charge. 3) Cool Buzz Words In some ways it is ironic that Square Enix’s philosophy is the “Network is the Game” and “Everything Plays Games. This clearly refers to future plans and not past behavior. Square Enix has been one of the most platform dependent publishers in the market. Platform diversity has not been one of Square Enix’s strength and the key products have generally been exclusive to a specific Nintendo or Sony platform. In several cases Square Enix relied on Sony or Nintendo to handle the publishing and marketing of its products. However, that was the past and Square Enix is now clearly talking about the future in language that the investment community wants to hear. Square Enix is not a game company, they are a “Digital Content Company” that “Deploys Polymorphic Content.” This is heady stuff, but if you take a closer look it is not that much different what competing publishers are doing, making most of their money from “offline games” while exploring opportunities in online and mobile games. The difference is Square Enix has clearly articulated its vision and backed it up with some cool terminology. The trend seems to be catching on. Electronic Arts now breaks down revenue for “Mobile Platforms.” Basically this combines revenue that used to be reported separately in more mundane categories like “Game Boy Advance” and “Game Boy Color.” The new categorization is not as informative, but it clearly drives the message home that EA is thinking about the future. 4) International Appeal The game business has exploded on an international basis and investors are looking for companies that have an international business. Square Enix has been very Japanese centric, but they clearly fit the bill, especially when it comes to expansion possibilities. Slightly more then half of Final Fantasy units sold have been in Japan. However, since the worldwide push for Final Fantasy VII in 1997, more units have been sold in North America and Europe. Now there is the potential to go outside of these core markets into emerging markets in the rest of Asia. Then there is Dragon Quest which has yet to have a significant impact outside of Japan, but should eventually be able to penetrate other markets. International appeal is one reason that we rank the Final Fantasy franchise above Electronic Arts’ NFL football games. The NFL franchise provides a steady source of revenue on a predictable annual basis (more then Final Fantasy). However, the NFL games appeal almost exclusively to the U.S. market. As part of our ongoing research efforts DFC Intelligence is delivering free monthly briefs on hot topics in the interactive entertainment and video game industry. You (or a colleague of yours) have signed up to receive these briefs.
DFC Intelligence’s research services provide detailed strategic analysis of the interactive entertainment industry. A sample of reports on the video game and PC game market include: Worldwide Market Forecasts for the Video Game and Interactive Entertainment Industry Complete five-year forecasts for all individual console and portable game platforms by region (Asia, Europe, North America, rest of world)) through 2009. Also included are PC game forecasts and historical sales figures. The report has several scenarios for future market growth including an analysis and forecasts for new systems from Sony, Microsoft and Nintendo, as well as new portable game systems. The Business of Computer and Video Games This report includes an historical analysis, overview of individual hardware system, top-selling games, game genres, consumer demographics, business models, retailer profiles, marketing elements and case studies, industry trends. Market Leaders in the Video Game and Interactive Entertainment Industry This 750+ page report profiles major companies in the interactive entertainment industry. Each individual company report is about 25-50 pages and has an historical background, financial overview, product analysis and a frank assessment of the outlook for that company. The Online Game Market This 660 page report contains a comprehensive analysis of the online gaming market. Includes current sales trends, market forecast, and in-depth company profiles.
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