In this season's blockbuster videogame "Halo 2," players scramble to acquire carbine rifles, needle-spewing guns and other alien weapons for blowing away rivals.
Now, some of the game industry's big guns -- medium-size and large game publishers -- are being stalked themselves, as possible takeover targets.
The prowling for deals comes as production and marketing costs for videogames escalate. The trend is expected to become more pronounced as the $24 billion global industry shifts to a new generation of game consoles in the next year or two. Industry executives and analysts predict spiraling game costs will cause further consolidation.
The world's biggest game publisher, Electronic Arts Inc., stoked such predictions last week when it announced a deal to acquire nearly 20% of the shares in one of Europe's biggest game publishers, Ubisoft Entertainment SA, in a transaction with an estimated value of $85 million to $100 million. Ubisoft's shares jumped 25% the day the purchase was announced.
Executives of Electronic Arts, which has a market value of about $19 billion, were cagey about their intentions in purchasing the shares; the Redwood City, Calif., company is acquiring the stock from a Dutch media-investment firm. But they said the stake could be useful if Ubisoft decides it wants to give up its independence. Ubisoft executives say they consider the move by Electronic Arts hostile, though they won't say whether the company is considering selling itself.
Electronic Arts, responsible for the popular "Madden NFL" and "Lord of the Rings" games, has left little doubt about its broader acquisition plans. "I think you will see consolidation in this business, and we will be a consolidator," rather than be acquired, Electronic Arts Chief Executive Larry Probst recently told an investor conference in New York.
Tobias Crabtree, a portfolio manager at money-management firm Leeb Capital Management Inc. in New York, says the strength of Electronic Arts' balance sheet, with about $2.5 billion in cash and cash equivalents, could easily allow it to make a "sizable acquisition or two." "I anticipate EA trying to make similar deals," says Mr. Crabtree, whose firm has $110 million under management and has been adding modestly to its position in Electronic Arts over the past quarter.
The upshot is that in the videogame industry, bigger is increasingly becoming better, both in terms of long-term competitiveness and perhaps share-price growth. The largest game publishers, Electronic Arts, Activision Inc. and THQ Inc., have the resources to maintain a broad pallet of games allowing them to weather industry ups and downs better than game makers that depend on the success of just a few titles. Smaller game makers that don't have a deep bench are ripe for being acquired.
Big media and Internet companies also are likely consolidators. Barry Diller's IAC/InterActiveCorp several months ago held talks about a possible acquisition of Activision -- whose portfolio includes "Spider-Man" and the skateboard game "Tony Hawk Underground" -- though the talks between the companies are no longer believed to be active, according to people familiar with the matter. New York-based IAC/InterActiveCorp and Activision, of Santa Monica, Calif., declined to comment. Activision's stock has steadily climbed since October, rising 21 cents to $19.82 as of 4 p.m. yesterday in Nasdaq Stock Market composite trading, not far below its 52-week high of $20.50, reached this month.
Viacom Inc.'s board of directors set up a committee earlier this year to review possible acquisitions of videogame companies, including "Mortal Kombat" publisher Midway Games Inc., an independent Chicago company in which New York-based Viacom's CEO, Sumner Redstone, owns a controlling 74% stake. Midway's share price steadily rose earlier this year but was down four cents to $10.74 as of 4 p.m. in New York Stock Exchange composite trading, about the same level as July.
Walt Disney Co., of Burbank, Calif., says it also is hunting for videogame acquisitions, though it looked at Activision and other large publishers and decided they were too expensive.
Meanwhile, British game publisher Eidos PLC, responsible for the "Tomb Raider" series starring Lara Croft, said this year that it was talking to other parties about "possible business combinations." Since its 52-week high in May of $3.40, Eidos shares have plummeted. They were up 3.4% yesterday to $1.52 as of 4 p.m. on the Nasdaq. In Japan, videogame makers such as Namco Ltd. and Capcom Co. are looking more seriously at possible tie-ups and mergers to counter a shrinking local market and long-term financial woes, say Japanese videogame-industry executives.
To date, consolidation in the videogame industry has centered on the largest players buying small game developers that couldn't keep up with rising development costs. Industry executives say those deals will continue apace and mostly will involve established players such as Electronic Arts and THQ, of Calabasas Hills, Calif., picking up closely held game developers in deals worth less than $100 million.
Even large players are feeling the pressure, though, especially with an expected surge in game costs when Japan's Sony Corp. and Microsoft Corp. introduce successors to their PlayStation 2 and Xbox consoles within the next couple years. Development budgets for console games currently can range from $5 million to $10 million, with additional marketing costs, in some cases, close to those amounts. The additional power of the new generation of consoles will require even bigger investments in art and engineering, as much as doubling game costs, some analysts estimate.
Adding to the pressure, games for the new consoles aren't likely to yield much revenue in their first years on the market, since the installed base of machines they can play on will be small in comparison with the current generation of consoles. The upshot: lots of deal discussions throughout the industry. "Even those guys with critical mass are talking to each other" about possible deals, says John G. Taylor, an analyst at Arcadia Investments Inc., a Portland, Ore., investment-research firm that doesn't hold any shares in game companies or offer stock recommendations. Mr. Taylor, who personally owns shares in Electronic Arts and New York-based Take-Two Interactive Software Inc., still thinks there are obstacles to big game deals, such as inconsistent quality in the portfolios of many publishers.
Traditional entertainment companies, such as DreamWorks SKG and Time Warner Inc., have invested heavily in game development in the past, with mostly poor results, according to analysts and industry executives. Many of them, though, attempted to build game studios largely on their own.
Game-industry executives say strong forces are pressuring them to get back into the business, including strong growth for the industry, expected to expand globally at a compound annual rate of 20% for the next four years, according to a study by PricewaterhouseCoopers LLP. Researchers and executives expect the growth in gaming to come at the expense of other traditional forms of entertainment. "You've seen declines in young male viewership of television," says David Zucker, CEO of Midway Games. "They're going somewhere. We know where they're going."
Meanwhile, Microsoft looms with a huge checkbook and an aggressive agenda in games. Since the Redmond, Wash., software giant, which has a market value of about $292 billion, entered the console-videogame market in 2001, its sales have been stifled by a lack of top-tier games for its Xbox game machine. Microsoft got the Xbox titles that have sold well -- both installments of the "Halo" franchise -- through an acquisition of Bungie, a small game-development studio.
Microsoft will come under increasing pressure to fill in the dearth of games as it prepares its next-generation Xbox for sale late next year. One possible target would be Take-Two, the maker of the blockbuster "Grand Theft Auto" series, whose newest versions appear first on Sony's PlayStation 2 game console before they are made available on other machines. The Securities and Exchange Commission a year ago launched an investigation into alleged accounting violations at Take-Two. The company said this month that it made an offer to settle the inquiry. With a market capitalization of $1.54 billion, Take-Two is valued more highly than many investors think Microsoft would be willing to pay for a game maker. But with "Grand Theft Auto" under its own roof, Microsoft could have one of best-selling games of all time for its Xbox and pull the rug from beneath its chief rival, Sony, which has a market capitalization of about $35 billion.
Microsoft also could try buying its way into Japan, one of the largest videogame markets in the world but one where Xbox sales remain anemic. The sheer size of EA makes it an unlikely acquisition candidate for all but the likes of Microsoft -- a hookup that Mr. Crabtree of Leeb Capital Management says he could envision.
