Consolidation in the Gaming Industry During the Economic Downturn

by: Bruce Everiss

In The Times last week there was an article titled “M&A (Mergers and Acquisitions) deals worth $90billion collapse as volatility makes valuations impossible” which would seem to be bad news for the massive game industry consolidation that we are currently in the middle of. So what is going to happen?

The game industry has been expanding massively over the last three years. This is not just one area that is prospering, the growth is across a number of areas:

  • The largest growth area has been in casual gaming. Immersive interactive entertainment that doesn’t require the commitment of hardcore games and which appeals to a very wide demographic.
  • The biggest ever game console war is running between three giant companies, Sony, (NYSE:SNE) Nintendo (OTCPK:NTDOY) and Microsoft (NASDAQ:MSFT), that are totally committed. Their brains, money and brands are being thrown at maximising sales worldwide.
  • Virtual worlds are growing in popularity exponentially. Not just World of Warcraft and Warhammer Online, but also Maple Story, Habo, Runescape and many others, each with millions of users.
  • Nintendo has deliberately set about making the appeal of video games universal. This has led to a runaway success where the company has not been able to manufacture enough to keep up with demand. Its approach is now being widely imitated across the whole industry, further fueling growth.
  • Online has gone from being peripheral in games to being a fundamental element. Less and less games are stand alone. This has greatly increased the potential of what can be done with gaming, especially on the social side. And unlike, say Facebook, gaming has robust, successful and proven business models.

Amongst all this massive success there has been a continuous stream of M&A activity as the industry consolidates. There are very good reasons for this:

  • Global game publishing has huge efficiencies of scale. The business model gets better and better the bigger a publisher is. Risk is reduced and spread. Optimum IP assets can be used. The very best staff paid for. Capital acquired more easily and cheaply. Sales into all possible territories maximised. Overheads spread against a consistent product stream, and more. Smaller companies are therefore at a huge competitive disadvantage.
  • The world’s big entertainment media companies have no option but to move into gaming in order to survive. Gaming has the fundamental advantages of interactivity, connectivity and non linearity. The older entertainment media cannot compete and are on the way out. Film, television, books, newspapers and recorded music are all in big trouble. For the moment, many of the old media companies have ready access to capital to buy into gaming. As their traditional business models whither away they will no longer have this capital. So this is a finite window of opportunity for them. Soon the tables will be reversed and the big gaming companies will be able to buy up old media companies for their legacy IP.
  • Bad management. There are a lot of people in senior decision making positions who got there by accident or good luck as the industry expanded from zero. So many sub optimal management decisions are made. Consolidation tends to boot out the weakest management.
  • Innovation and diversification. The game industry has continually fragmented into new areas and genres. This is usually led by smaller firms and start ups. So bigger companies mop up the smaller companies in these new areas to acquire expertise, market share and IP. We are seeing this in music gaming right now.

So will this force for consolidation be negatively impacted by the current economic climate? My guess is that in the short term it will as people adjust to the new realities. But over the next eighteen months or so the consolidation will be far greater than it would have been without the economic downturn. Here’s why:

  • Gaming will be largely unaffected by the poor economy. It is very cost effective entertainment for the whole family. I see it winning out over more expensive entertainment such as film. This will make games companies into even bigger takeover targets.
  • The economic downturn has reduced the length of the window of opportunity for old entertainment media companies to buy into gaming. Their business performance will drop even more sharply as gaming continues to rise. If they don’t act soon it will be too late.
  • Scarcity and cost of capital will give big companies a bigger competitive advantage over small ones.
  • Game stocks and shares have, quite wrongly, gone down in value alongside all other sectors. This means that there are some incredible bargains to be had.
  • There are quite a few lame duck video game companies that have worthwhile IP and market share but which don’t work as businesses because of bad management. They could hang on in good economic times but the current situation will find them out. They are ripe for takeover and one of the biggest effects of the economic downturn will be the weeding out of under-performing management.

Since the start of the downturn we have seen Electronic Arts (ERTS) withdraw from its attempt to buy Take Two (NASDAQ:TTWO). This is because there offer is now a massive over valuation and it will be able to buy it for far less with far less resistance being put up. Electronic Arts has the money in the bank for this deal. We have also seen Warners increase its stake in Sci/EIDOS. This is classic and bears out much of what I have said above, soon it will own the whole company.

There are some companies that will be out shopping.  Electronic Arts, Activision/Vivendi (NASDAQ:ATVI) and Ubisoft (UBI). There are some that will be on the shopping list. Take Two, THQ (THQI) and Sega (OTCPK:SGAMY) for instance.

We live in interesting times.

Disclosure: None