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Separating the Winners from the Losers in 2004 January 18, 2005 The final numbers may not be that impressive, but, all-in-all, 2004 was a pretty good year for the interactive entertainment industry. Of course, saying it was a good year is a relative statement. There has been a wide disparity in performance among individual companies in the game industry and 2004 went a long ways towards highlighting the difference between the haves and the have nots. Nevertheless, there were some positive signs that pave the way for long-term industry growth. This month we highlight some of the key trends of 2004 and look at how the stock prices of individual companies have performed over the past three years. The Big Name Sequels The big games in 2004 had familiar names with numbers after them: Halo 2, Doom 3, Half-Life 2, The Sims 2, Metroid Prime 2: Echoes, Metal Gear Solid 3: Snake Eater, Everquest II, Star Wars Knights of the Republic II, and so on. A handful of products got more original in naming the sequel (Grand Theft Auto: San Andreas, Ratchet & Clank: Up Your Arsenal, Prince of Persia: Warrior Within), but truly new properties were few and far between. However, this is not a bad thing. For one, all of the above mentioned titles were great games that should only extend their respective franchises. Secondly, all these big games were original intellectual property. This was not a year dominated by Hollywood licensed products. For consumers the games of 2004 were better then ever. Portable Market The portable market is finally getting some competition! The Nintendo DS was arguably the biggest surprise of 2004 and showed us a newly aggressive Nintendo. Not only did Nintendo announce and launch the DS in the same year, the product was launched in North America before Japan, a significant first for Nintendo. Because the PSP does not have a North American launch until 2005 (March??), the real battle will have to wait until next fall. However, the DS launch helped show that there is substantial pent-up demand for these cutting-edge new portable systems. Both the Nintendo DS and Sony PSP are excellent systems and software is likely to be a major factor in the consumer purchasing decision. The main question is when will there be room for third-party publishers to make serious money in this market. This issue is of crucial importance because so many publishers will be relying on the portable systems to ease the platform transition. PC Games The poor PC game market has gotten the short end of the stick the past few years as publishers focus the bulk of their efforts on the console systems. However, 2004 may have helped change that. The PC game market not only saw some major blockbusters like Doom 3, Half-Life 2 and The Sims 2, but they saw the release of some significant top-notch products like Rome: Total War, Sid Meier’s Pirates, Far Cry and others. The PC is also still the leading platform for another major trend, online games. Online Games The online game market continues to grow on a worldwide basis. The Xbox Live service passed the one million subscriber mark in 2004, but the PC online game numbers are even more impressive. In 2004, three of the most important massively multiplayer online games (MMOG) of all time were released for PC: NCsoft’s City of Heroes, Sony Online Entertainment’s Everquest II and Vivendi Universal Games/Blizzard’s World of Warcraft. The comic-book themed City of Heroes showed MMOGs could expand in both content and audience, Everquest II showed a major product could transition its audience and World of Warcraft showed how top-notch developers can redefine an entire genre. The MMOG games get all the attention, but online game are clearly much more then the hard-core subscription products. The casual game sites attract tens of millions of users, many adult females. Online site NeoPets got their characters into McDonald’s Happy Meals. Games can increasingly be downloaded online, not only on PC systems, but on the console systems. Microsoft launched the Xbox Live Arcade download service in November. Perhaps the biggest thing to note about the online game market is that it brings interactive entertainment into parts of the world that have not been able to afford the expensive hardware and software needed to play games. This brings us to our next major trend, China. China China is the largest market in the world, but game companies have not been able to tap into it. Games are not unknown in China, it is just that piracy runs rampant and outside providers have not been able to find a way to make money. This may be slowly changing. Online gaming has been exploding in China as providers (many from South Korea) find a way to charge consumers pennies per hour and make money on volume. Now companies are actively starting to do formal product launches in China. Nintendo launched its iQue product in China late 2003 and followed it up in 2004 with a Game Boy Advance release. Now Electronic Arts, Sony Online Entertainment and other U.S. publishers are actively setting up ventures to reach the Chinese market. Price Cuts and Product Shortages Finally all major game systems reached a price point of $150 or less. The PlayStation 2 and Xbox both saw a significant increase in sales with their 2004 price drops. These sales increases would probably have been substantially more if these systems had actually been available over the holiday season. Sony went to a sleek new slim design for the PS2, but consumers were lucky to find one on the shelf in late 2004. By the week before Christmas not only the PlayStation 2, but the Xbox and Nintendo DS were all but impossible to find at retail. Theoretically this paved the way for the widely available, low priced GameCube. Unfortunately for Nintendo it just doesn’t seem to be their generation in the console market. EA Dominance Electronic Arts is clearly in a league of its own when it comes to interactive entertainment software publishers. The company has dominated the 128-bit generation. As the chart below shows, EA’s stock has increased 123% in the past three years. The average for the industry as a whole was an 8% decrease over that period. The question other publishers are now asking is how can they possibly compete with EA. Towards the end of 2004, EA showed that it would aggressively defend any challenge to its throne by using its substantial cash reserves. By the end of fiscal 2004 EA had over $2 billion in cash. In the second half of calendar 2004, Electronic Arts started to spend its money in some major deals including buying game developer/development tools provider Criterion Software, making a bid for Digital Illusions, signing an exclusive deal with the NFL and making a hostile investment in French publisher Ubisoft. The NFL and Ubisoft deals came in December and Wall Street responded enthusiastically. By the end of November 2004 EA stock was basically at the same price as at the start of 2004. In December 2004 EA stock increased 26%. Our view of EA’s maneuvers are a little more skeptical. In some respects the EA deals can be seen as a sign of a company desperate to find ways to support a market valuation that seems to be heading from $15 billion towards $20 billion. All of the deals mentioned above seem to be done out of fear of the competition. Electronic Arts has never been a pioneer in game development and in much of 2004 the competition seemed to be getting the edge. Arguably EA’s two best games of 2004, Burnout 3 and The Sims 2, were developed basically by outside developers (although EA owns both development companies Criterion and Maxis). One of EA’s strongest PC game franchises of recent years, Battlefield 1942, was created by Digital Illusions. Most of the highest quality games of 2004 came from other publishers. Goldeneye: Rogue Agent was one of fall 2004’s most disappointing games. The company’s strongest in-house franchises remain sports titles and Need for Speed games. Ubisoft is probably particularly galling to EA because, among developers, Ubisoft now has a stronger reputation as a place of creative innovation. When we talk to young developers we often hear that Electronic Arts is a great place for developers to start out and learn the ropes, but once a developer gains experience a company like Ubisoft provides more freedom of expression. This type of talk does not affect the short term business, but is always a worrisome long-term sign for a company trying to support an $18 billion market valuation. Of course, Electronic Arts has the luxury of being able to buy itself out of trouble. Sega and Take-Two’s ESPN games were clearly making a dent in EA’s seemingly impenetrable sports game business. While they were competing mainly on a budget pricing strategy, the ESPN games were just as good as the EA Sports products. Clearly quality alone is no longer enough to support the EA Sports games. This means EA is forced to go to expensive deals to lock in an exclusive license. None of our statements are meant to apply that anyone is close to challenging Electronic Arts’ dominance. The challenge Electronic Arts faces is how they can continue to match their own incredibly successful track record. In our view it is always a worrisome sign when a company looks to use its checkbook to make potential problems go away. Increasingly this is something EA has been forced to do. Right now EA is one of the few companies with the luxury of deep pockets. Sony and Microsoft have pretty much given Electronic Arts a pass on competing in software during the 128-bit generation. However, this is likely to change in the near future. Media conglomerates like Viacom and News Corp are once again eyeing the video game business with interest. One thing these large companies can do is write big checks. Yes, EA has been dominating in recent years. No, that dominance is anything but assured going forward. Stock Performance Did we mention that Electronic Arts has done well the past couple of years? Unfortunately the same is not true for the rest of the major companies involved in the interactive entertainment industry. Overall the average company saw a stock price decline of 8% between January 2002 and January 2005. At first glance the performance in 2004 seems a little better as the average stock price increased 6% (between January 14, 2004 and January 13, 2005). However, these numbers are somewhat misleading. Electronic Arts wasn’t the only company with a December stock run. EA target Ubisoft’s stock had been down 25% for the year until December 20 and the EA investment. Then there is the special Midway case. Midway was in bad shape at the start of 2004 and then Viacom chairmen Sumner Redstone started buying the bulk of company shares and as a result drove up the stock price. If Electronic Arts, Ubisoft and Midway are eliminated the average interactive entertainment company stock price was down 4% in 2004. 3-Year Stock Performance
*Results for companies on the Tokyo Stock Exchange are presented monthly. **Sega performance is only to September 2004 when the company merged with Sammy. Since the October merger the stock of the Sega Sammy holding company has been up 22%. ***Without Sony and Microsoft the three-year average loss would be 6% instead of 8%. 1-Year Stock Performance
*Results for companies on the Tokyo Stock Exchange are presented monthly **Sega performance is only to September 2004 when the company merged with Sammy. Since the October merger the stock of the Sega Sammy holding company has been up 22% Our upcoming report Market Leaders in the Video Game and Interactive Entertainment Industry will have a detailed individual look at the recent performance of the major game companies. This month we thought we would take a brief look at some of the stronger performing companies and compare them with some of the disappointments. Among the stronger performers we have chosen Activision, Namco and of course Electronic Arts. In the disappointment category we have spotlighted THQ, Capcom and Atari/Infogrames. THQ and Activision Both THQ and Activision have often been touted in recent years as having the potential to be the next Electronic Arts. In the past three years, Activision has taken long strides towards diversification. Absent the occasional Red Faction, Full Spectrum Warrior or Warhammer 40,000, THQ is still very much the company built on licensed properties, namely wrestling and kids movies and TV shows. Activision has had all kinds of clunkers over the years but now has a nicely diversified product line. No longer just the company Tony Hawk built, Activision has value PC games, publishes high-end PC games like Doom 3, Call of Duty, and Rome: Total War, Marvel licensed properties, Dreamworks licensed properties and some original IP with long-term potential like True Crimes. It is no wonder that Activision is often mentioned as leading candidate to be acquired by a media conglomerate. On the other hand THQ has grown but they have not necessarily expanded. The company had a nice end of 2004 run with some strong quality product in Full Spectrum Warrior and Warhammer 40,000: Dawn of War. However, the key growth driver was the renewal of the Nickelodeon license. THQ’s growth has come almost entirely from the Nickeloden and Pixar licensed games. It is not a bad business by any means, but it definitely makes THQ still a bit of a one-trick pony. Capcom and Namco Both Capcom and Namco are two long-established names in the interactive entertainment industry. Both companies are Japan-based arcade companies that built a significant home video game business in the 1980s with the 8-bit Nintendo system. Namco and Capcom have had some major hits outside Japan but they have failed to translate that success into a consistent, stable international business. In recent years, the larger Namco has clearly outperformed Capcom, not only on an overall basis, but in the home video game business. Namco only gets about one-quarter of its revenue from home video games, but that is clearly becoming an increasing focus for the company. In recent years, Namco has had some major high profile hits in North America and Europe with games like Tekken 4, Dead to Rights, Tekken Tag Tournament, Pac-Man World 2, Namco Museum, Xenosaga and Ace Combat titles. With Namco it has clearly been a case of quality over quantity. Home video games are a more important business for Capcom, accounting for as much as two-thirds of revenue. Unfortunately, Capcom’s home video game business has declined in recent years. In fiscal 2004 (ending March 31, 2004) Namco’s home video game revenues actually passed Capcom’s home video game revenue. Calendar year 2003 was a disaster for Capcom. The company more then doubled the number of product releases but saw overall revenue decline. Capcom still has some strong franchises, but their business is a fraction of what it was back in the heydays of Street Fighter II in the 16-bit era. Atari/Infogrames and Electronic Arts In many ways comparing these two companies is unfair. Electronic Arts has been far and away the best performing company while Atari/Infogrames has been the worst. However, both companies are similar in that much of their growth occurred through acquisition. Furthermore, on a market share and revenue basis, Atari has clearly been one of the biggest growth stories of the past several years. The difference is that 1) Electronic Arts started with a solid base of sports games and 2) Electronic Arts was able to successfully consolidate the acquired companies and brands. Electronic Arts has a well-trimmed product line. Atari’s product line is all over the map. Atari has some strong brand names but, with the exception of Dragonball, they have not done much with them. For Infogrames Entertainment, parent company of the Atari Group, the brand confusion starts right at the top with trying to figure out something as basic as what to call the company. Electronic Arts is trying to figure out ways to spend its excess cash. After years of losses, Infogrames is trying to figure out how to turn a profit. 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 600+ page report profiles major companies in the interactive entertainment industry. Each individual company report is about 15-40 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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