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The Players

Video game CFOs reach the next level.
Tim Burke, CFO Europe Magazine
September 3, 2008

Even a successful strategy can benefit from a fresh twist. For five years, US video game publisher Activision entertained gamers with its Call of Duty series, pitting good against evil during the second world war. Last year it took an unexpected step and gave the latest game a contemporary feel, replacing Nazis and B-17 bombers with terrorists and stolen nuclear weapons. The new game sold more than 10m copies, beating all its predecessors, and helped Activision achieve record revenue and an industry-leading profit margin.

In July the company gave its business a similar shake-up. After satisfying shareholders with 16 years of revenue growth, it merged with the games subsidiary of French media group Vivendi. The newly named Activision Blizzard — Blizzard Entertainment was Vivendi Games' celebrated development studio — has pro forma revenue of $3.8 billion (€2.4 billion) and is giving industry leader Electronic Arts (EA) a run for its money. According to CFO Thomas Tippl, it will be the most profitable games publisher in the world.

The bigger, bolder Activision Blizzard speaks volumes about the games industry's growing significance in the media world. The industry will be worth $48 billion this year and nearly $70 billion by 2012, predicts PricewaterhouseCoopers. Compare that with the music industry's sluggish performance, or the record $158m taken by The Dark Knight — the latest Batman film — on its opening weekend with the $310m pulled in by the Grand Theft Auto IV game on one day in April.

But don't think the CFOs of games companies have it easy. Even as the spotlight shines favourably on the industry, the cost and complexity of developing new game after new game are rising. So while their creative counterparts are trying to keep gamers glued to the screen, the finance chiefs of games publishers worry about many of the same issues as CFOs in other industries — getting stronger balance sheets, greater scale and improved operational efficiency, all of which help them develop more titles, push more products and make more money.

The growth of leading games companies — Activision Blizzard, EA of the US and French rival Ubisoft — show finance chiefs in other sectors just how quickly they can respond to rapid-fire industry changes. The way the finance chiefs themselves tell it, the key is a combination of solid risk management and savvy research and development. But not all have succeeded (see "You Got Flagshipped!" at the end of this article), and even big names have stumbled. Can their CFOs now help see the companies through the economic downturn in their key markets?

Just Grow Up
Steering a company's finance strategy can be tough, especially when the very consumer base around which its business model is built morphs so rapidly. But while a recent study in the US found that the average age of a gamer is now 35, far from the stereotypical teenager on whose pocket money the industry once relied, the new demographic is in fact a blessing — older players have more money to buy more games. "It's no longer a very young demographic without much purchasing power," says Phil Stokes, a London-based partner in the entertainment and media division of PwC. "That demographic is grown up and used to buying games, and as they get more money in their wallets they go out and invest in new games — it's what they've always done."

But connecting with these gamers consistently — through the current wave of games consoles such as Sony's Playstation 3 (PS3), Microsoft's Xbox 360 and Nintendo's Wii, or through online and mobile gaming — now requires companies to operate on a very different scale.

The importance of scale wasn't lost on dealmakers at Activision and Vivendi. It certainly made sense to investors — ahead of a late August stock split, Activision Blizzard's share price was about $37 in mid-July, compared with Activision's standalone price of $22 when the deal was announced last December.

Activision was no slouch on its own though. Founded in 1979, it was the first independent games developer. Following an ill-judged move into business-application software in the 1980s that saw the company file for Chapter 11, it refocused on games in the early 1990s. Acquisitions have helped the company expand and successful long-running titles encouraged steady sales. During the last fiscal year to April 2008, the company nearly doubled its revenue to $3 billion and achieved an operating margin of 16.5%.

For Tippl, Activision's CFO since 2005, it's by design, not accident, that the company is reaping the rewards of its current strategy. "There's this concept that this is a hit-driven business where you throw a lot of things on the wall and hopefully something sticks," says the 41-year-old Austrian, a 14-year veteran of Procter & Gamble. "That's not how we run the business. Our job and our strategy have always been to make sure we have a plan in place that grows our existing franchises every year."

Easier said than done these days. It was once fairly straightforward to hit growth targets with frequent product updates to tried-and-tested franchises, such as Call of Duty and a series involving celebrity skateboarder Tony Hawk. But just as the gamer profile has changed, so have the types of games that become hits. Traditional console titles helped make Activision an industry leader, but now newer markets are showing the biggest growth prospects. This requires lightning-fast strategy shifts.


Why Casual Is Smart
One of the new markets involves subscription-based online offerings. The beauty of these games for CFOs is that they help to smooth the industry's notorious sales peaks and troughs around the lifecycles of traditional consoles. "This has been a super-cyclical industry, and the thing CFOs want the most is predictability," says Jason Mauricio, an analyst at Arete Research in London. "They don't want surprises, they want smooth earnings. Some of the newer developments coming up in the video game industry are allowing that to be more of a reality." For its part, Activision Blizzard generates more than $1 billion in revenue and more than $500m in profit from subscription businesses, thanks largely to its ownership of the Blizzard-developed World of Warcraft, an online game with some 9m monthly subscribers. EA, meanwhile, also sees this as a growth area, and expects online revenue to rise by some 50%, to more than $285m, in the year to April 2009.

Another new focus is what gaming execs call the "casual" market. It's a loose term covering simple games that anyone can pick up and play, such as sports simulations played with the Wii console's motion-sensitive controller. The market has introduced new consumers to the industry. Casual gamers might be put off by the array of buttons on a normal console controller but, as Tippl says, "everybody knows how to swing a tennis racket." Activision's hit here is Guitar Hero, a franchise it acquired when it bought publisher RedOctane in 2006. Players press buttons on a plastic guitar (sold with the game) in time with on-screen prompts. The franchise has brought in more than $1 billion of revenue, and this year the company released a new title in partnership with rock group Aerosmith, as well as a version designed for Nintendo's handheld DS console.

Casual gaming has also been a hit at Ubisoft, a 22-year-old, €928m French publisher and developer. According to Alain Martinez, Ubisoft's CFO for the past eight years, a big attraction is the cost of making such games: a casual game made for the DS, for example, has far lower development costs than a game for the PS3 or Xbox 360, allowing Ubisoft to experiment in ways it couldn't afford to do on other consoles. "If a game costs €500,000 [to make] instead of €15m, you can make 30 games for the price of one and try different things," Martinez says. Last year, revenue from Ubisoft's casual business, Games for Everyone, increased to €230m from €70m, and Martinez says the division boasts an average contribution margin of more than 30%.

That kind of growth has made Ubisoft a sturdy performer. When Martinez joined the company, annual revenue was less than €200m. It's now the third-biggest independent publisher after Activision Blizzard and EA by market cap, and expects to pass the €1 billion revenue mark this year. Edward Williams, an equity analyst in the New York office of BMO Capital Markets, says the board has done "a phenomenal job of growing their business" and calls the company "a core holding for the cycle."

Studio System
Like Activision Blizzard, Ubisoft's focus is on size, which in turn allows it to make more titles. In 2000 the company owned only one brand, while today it has 14 multi-million selling franchises, with more on the drawing board. "The cost of development and the ambition of these projects are getting higher all the time," says Martinez. "Therefore fewer companies are capable of taking risks on several projects like we do."

Ubisoft has 3,500 developers working in 19 studios in 15 countries, many in regions where the company benefits from lower investment costs, such as Romania, Morocco and China. In June it announced plans to open a 20th studio in Sao Paulo. As for development and production costs, Martinez says the company can spend €300m each year. But despite its ambitious plans, last year the company managed to cut R&D spend to 28% of sales from 34%, thanks to such strong sales figures.

Another key factor for games companies is to own most, if not all, of the intellectual property (IP) in a company's portfolio, the CFO says. While Ubisoft has made games based on the TV show Lost and the film King Kong, it normally focuses on in-house brands from which it takes all revenues rather than paying royalties. Owning the licence for a game based on the next popular Pixar movie is good, Martinez admits, "but if you're capable of creating your own IP that can [be equally as popular as a movie], that's even better."

To this end, Ubisoft struck a deal earlier this year with American author Tom Clancy to buy the rights to all IP using his name, having previously developed action games over the past ten years such as Tom Clancy's Rainbow Six and Tom Clancy's Splinter Cell. The deal gives the group a chance to develop the franchise in new ways. Initially it went from books to films to games, but Martinez sees no reason why the newer games can't be made into books and movies under Ubisoft's ownership.

This kind of multimedia thinking led to Ubisoft's acquisition in July of Hybride Technologies, a Montreal-based special-effects studio known for its work on films such as 300 and Sin City. Martinez believes the move should bring Ubisoft several benefits: along with new technology the games group can use, Hybride has contacts in Hollywood that he hopes will allow Ubisoft to obtain new licences, as well as turn its own IP into movies.


Back on more familiar ground, Ubisoft's challenge is to repeat the success of last year, when the company had a runaway hit with Assassin's Creed, a game which allows users to pretend they're assassins in 12th-century Jerusalem. Martinez isn't worried about the pressure. Assassin's Creed was hugely successful, but it was the only new Ubisoft franchise launch last year. This year the company expects to launch five, giving it reason to raise its full-year revenue forecast from €1 billion to €1.02 billion. "We don't think last year was exceptional," the CFO adds. "On the contrary, even though this year we won't launch another Assassin's Creed, we're still capable of growing, and hopefully growing as fast as the industry — if not faster."

Clean Slate
Publishers need to sell about one million copies of a game on the PS3 or Xbox 360 just to break even. But as in the film industry, ploughing money and time into a new title is no guarantee that it will receive good reviews or attract consumers. So if Ubisoft's slate of five new franchises looks ambitious, what does that say for the 14 new brands scheduled at its $3.7 billion American rival, EA?

One of the best-known names in the games industry, EA hasn't had it easy. "We were essentially flat in our performance [in fiscal 2007] in an industry that was growing nicely with the console cycle," says its California-based CFO, Eric Brown. "The net result was that we lost some share. That's not something EA is accustomed to."

To address the problem, the board focused on corporate and creative measures, initiating "a big push in terms of efficiency, better 'owned' IP, creation and delivery, more of a focus on operations," says Brown. Last summer the company restructured its business around four divisions: EA Games, EA Sports, EA Casual and a separate division for its popular Sims franchise. It gives the group a fresh framework, says Brown, and introduces new priorities for him as CFO. "To the extent that we can enable and enforce autonomy and agility while maintaining all the advantages of scale, common systems [and] common reporting, we'll get the maximum operating leverage," he says. It could be a long journey. In the fiscal year to April 2008, revenue rose but the company reported a $454m loss. The board expects to report a profit for next year, although its losses continued into the first quarter.

Mauricio at Arete Research says launching 14 brands in one year is risky given marketing costs. Conversely, Brown claims EA's line-up is "the best I think we've ever had." The CFO says that the company balances its portfolio to ensure it has an offering for almost every type of player: gamers who like the idea of Littlest Pet Shop are a different demographic from those eager to buy a game called Face Breaker.

The company is also using M&A to buy brands. At the time Brown spoke with CFO Europe, EA was in the middle of a $2 billion takeover bid for Take Two Interactive Software, the company behind the wildly popular Grand Theft Auto series. EA's hostile tender offer expired in mid-August after being extended several times since February, but the companies have since entered confidential talks that could lead to a deal.

In all, it's an exciting time for Brown to return to the EA fold. He left a COO post at one of its California studios in 2000, then was CFO of two software firms before returning to EA as finance chief earlier this year. The company's focus on quality is the same, he says, but opportunities in the casual and online markets have changed the game for finance chiefs. When a new title takes off today, "there are multiple ways to expand that and monetise it," he says. One such new revenue stream is in-game advertising, which the company has been working on for almost two years. In the latest instalment of racing franchise Burnout, for example, players speed past billboards advertising clothing brand Diesel and vehicles emblazoned with the Gillette logo.

Another new revenue model has been developed with an online football game that EA launched in collaboration with FIFA in South Korea. It's free for gamers to play, but they must pay for extras such as new kits for their virtual footballers. Brown won't confirm whether the company makes more from these micro-transactions than it would from selling the game as a packaged product, but claims that FIFA Online generates about $1m a month of revenue, split between several parties including the football association. In its latest results, EA's overall digital revenue — downloads, micro-transactions, in-game advertising and the like — rose by more than 25% to $342m.

Catch Them if You Can
At Activision Blizzard, Tippl reckons that with games such as World of Warcraft the company has lessons to offer the digital industry about how to develop dependable revenue streams from an online community. "These are things that Facebook and MySpace and so on still have to figure out how to do, and it's a big step from offering a product for free to charging for one," he says. "We are already there. We are already monetising that user base, and as a result I think we have a big advantage over many of the media companies."


Media companies are keen to catch up. Disney has been investing more in its inhouse games development studio, while Warner Brothers has invested in UK publisher SCi Entertainment. "Gaming companies are attractive targets for media players," says Williams at BMO Capital Markets. "As the consumer today is looking for more dynamic and interactive forms of entertainment — and these games really represent that — I think other companies not currently in the games category will get more aggressive to find a way into it."

Tippl is not concerned. "It's one thing to identify a fast-growing segment that is very profitable. It's another thing to actually figure out how to get your piece of the pie," the CFO says. "Video games have many unique features and require different skill sets from the music business or the movie business. We are quite comfortable with our position."

Economic woes do not seem to be keeping games industry chiefs awake at night, no doubt to the envy of those in other industries. CFOs and industry experts agree that the games sector has proved reasonably recession-proof in the past — consumers who enjoy video games consider them good value for the hours of entertainment they get. Tippl sees no reason for that to change, credit crunch or not. He reasons that consumers have little else to take up their leisure time. "They can't afford to drive anywhere because the gas prices are so high. They can't afford to dine out, so they're going to spend more time at home," he says. "What else are they going to do? They've got to be entertained somehow."

Tim Burke is senior staff writer at CFO Europe.


You Got Flagshipped!

As any keen video game player knows, there are plenty of pitfalls along the path to being a winner. That goes for the publishers and developers of the games too. And it seems that the smaller the publisher or developer, the more pitfalls it faces, especially if it is too reliant on only a few games which may quickly fall out of favour with gamers. "Small guys can win [in this industry,]" says Phil Stokes, an entertainment specialist of PricewaterhouseCoopers. "The question is, can the small guys win consistently?"

It's a question that SCi Entertainment, a UK-listed publisher that owns the Tomb Raider franchise, has struggled to answer. Its shares have fallen as takeover speculation failed to produce a bidder, and the board given a shake-up, with former CFO Phil Rogers taking over as CEO in January this year to head a turnaround. Analysts claim the company has been too reliant on too few brands. The company now expects its results for the year to July to show a loss of up to £100m (€127m), on revenue of £134m.

Delayed product launches have also dogged the company, but addressing the issue requires a balancing act. Stores need the games on time, but companies risk alienating consumers if they launch them with problems that could have been sorted out. California-based Flagship Studios, developer of Hellgate: London, a PC game set in a post-apocalyptic London 20 years from now, learned the hard way. When the game was released last year, it was riddled with bugs that disrupted playing. Blogs and websites proliferated for disgruntled players to gripe. But even a "patch" released to fix the problems caused uproar when it wiped players' previous scores. Now some gamers refer to other games released before they're perfected as "Flagshipped." That's the kind of brand recognition companies could do without, and Flagship was winding up its business as of mid-August. But with one Flagship founder already back in business as head of the new Runic Games, the story shows another parallel between games' developers and players: even if you die a horrible death, there's still a chance to get up and continue.





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