In November 2002 Angel Studios was purchased by Take
Two for $28 million in cash and 235,000 shares of stock. A month
earlier Activision purchased Luxoflux for $9 million and 110,000
shares of stock. That same year Infogrames (now Atari) purchased
Shiny for a surprising $47 million, and who can forget Microsoft's
purchase of Rare for a whopping $375 million? And the list goes
on: Massive Entertainement, Rainbow Studios, Barking Dog, Black
Box, Shaba Games, Gray Matter, Treyarch, Outrage, Volition, Digital
Anvil, Westwood Studios, and more. All have been purchased by a
major publisher and experienced the thrill of the end game.
For many developers, selling their studio is the final prize for
a race well run. But what do you really know about how a deal goes
down and whether or not you are a good prospect? What is it that
will make your studio attractive? How will your company be valued?
And perhaps most importantly, what can you do to prepare?
In this two-part series we will discuss the acquisition process
as it relates specifically to the game industry. It is based on
interviews with key executives from both sides of an acquisition
transaction: independent game studios who have been purchased and
the publishers who purchased them. Interviews were also conducted
with attorneys and investment firms that deal in mergers and acquisitions
within the game and software industries. And finally, research was
conducted to quantify specific transactions and acquisition details.
In this first segment we will explore the relationship between
developers and publishers and the motivations of each to enter into
an acquisition. Beginning with a condensed history of game developer
acquisitions, which you will find surprisingly informative, we will
then look at why developers sell their companies and why publishers
are interested in buying them.
In the final part segment, we will then look at how a developer's
monetary value is determined, how the deal is put together, and
what can go wrong during the acquisition process. We will end the
series by considering the future and what the prospects might be
like for you to one day play The End Game.
Disclaimer
You should understand that mergers and acquisitions are complex
business relationships that require the help of legal and accounting
professionals. The information contained in this article is intended
to give you a basic overview of this process as it relates specifically
to the interactive game business. Neither Dan Lee Rogers nor BizDev,
Inc. makes any representation or warranty of any kind, whether expressed
or implied, with respect to the accuracy or completeness of the
information. All information is provided on an "as is"
basis, including, but not limited to, warranties of merchantability,
non-infringement, or fitness for any particular use.
Acquisition History in the Game Industry
Much of the information included in the table below was collected
from financial data released by publishers as required by the Security
and Exchange Commission (SEC). Notwithstanding this, I am thankful
for the input provided by numerous individuals as well. Please note
that information from non-public sources is speculative and presented
only in an atmosphere of more fully understanding the dynamics of
the industry.
By overlaying the acquisitions in this table with major industry
events (such as the introduction of the PlayStation 2) you can imagine
how environmental factors could have affected each transaction.
Microsoft's purchase of Rare in September 2002 could be an example
of this.
$375 million dollars in cash (the purchase price of Rare) is the
most paid for any developer to date. Although Rare was a proven
developer of hit games, it appears to be an unusually large sum
for a development studio. However, when you consider environmental
factors, such as Microsoft's goal to establish itself as a premium
console manufacturer (Xbox), it is more easily understood. Rare
not only added positive net income to Microsoft Game Studios, but
it helps secure their position in the console market. And if indeed
this goal is met, then not only will the acquisition have a positive
effect on Microsoft/Rare's future product sales, but on the sales
of all Microsoft Xbox products.
|
DATE
|
COMPANY
|
PRODUCTS
|
ACQUIRING
COMPANY
|
TERMS
|
1991 |
Distinctive |
4D Boxing, Hardball, Test Drive
|
Electronic Arts |
$11 million ($785K in cash)*
|
1992 |
Origin |
Wing Commander, Ultima |
Electronic Arts |
$35 million stock (estimate)*
|
1992 |
Westwood |
Kyrandia |
Virgin |
$5 milllion value (estimate)*
|
1994 |
SONY PLAYSTATION
LAUNCHES |
1995 |
Iguana |
Turok |
Acclaim |
$5 million cash + undisclosed
stock |
Oct-95 |
Sculptured Software |
Star Wars, Mortal Kombat, Jack
Nicklaus Golf |
Acclaim |
$30 million in stock |
Oct-95 |
Probe |
Die Hard, Back to the Future,
X Men |
Acclaim |
$30 million in stock (estimate)*
|
1995 |
Papyrus |
NASCAR |
Sierra |
$40 million stock (approx.)*
|
1995 |
Impressions |
Ceasar II, Lords of the Realm
|
Sierra |
$8 million stock (approx.)*
|
1995 |
Bullfrog |
Populous, Syndicate, Magic
Carpet |
Electronic Arts |
$25 million (estimate)* |
1996 |
NINTENDO
N64 LAUNCHES |
Apr-96 |
Headgate |
PGA Championship Golf |
Sierra |
$8-10 million stock* |
Sep-96 |
Mission Studios |
Jet Fighter |
Take Two |
$1,674,478 cash, 182,923 stock
(value $440,000). Promissory note value |
Jun-96 |
Formgen |
Duke Nukem |
GT Interactive |
1,030,000 shares GT stock |
Jul-96 |
Humongous |
Freddie Fish, Putt Putt |
GT Interactive |
3,458,000 shares GT stock |
Dec-96 |
DMA |
Lemmings |
Gremlin |
£4.2 million |
Apr-97 |
Berkley Systems |
You Don't Know Jack |
Sierra |
$25 million stock (approx.)
|
Jul-97 |
Maxis |
Sim City |
Electronic Arts |
$125 million value stock |
Sep-97 |
Raven |
Solidier of Fortune |
Activision |
Value 13 million, 1,040,000
shares |
Sep-97 |
Odd World |
Abe's Oddysee |
GT Interactive |
$7 million (TCI portion ) (estimate)
|
Oct-97 |
SingleTrac |
JetMoto, Twisted Metal, Twisted
Metal II and WarHawk |
GT Interactive |
$5.4 million in cash and 700,000
shares of stock valued at $7.2 million, (total value of
$12.6M) |
Aug-98 |
Westwood |
Command and Conquer, Lands
of Lore |
Electronic Arts |
$122.6 million (majority to
Westwood) |
Sep-98 |
Crystal Dynamics |
Gex, Soul Reaver |
Eidos |
$47.5 million US (£28.4) |
Dec-98 |
Talonsoft |
Battleground, Art of War |
Take Two |
1,033,336 shares (accounted
as a pooling of interest |
Dec-98 |
Reflections |
Driver, Distruction Derby |
GT Interactive |
2.28 million shares of common
stock |
Dec-98 |
FASA |
MechWarrior |
Microsoft |
Undisclosed |
1999 |
SEGA DREAMCAST
LAUNCHES |
Jan-99 |
Legend |
Mission Critical, Death Gate
|
GT Interactive |
$13.5 million stock |
Mar-99 |
Gremlin |
Grand Theft Auto, Realms of
the Haunting, Loaded |
Infogrames |
$36.8 million cash |
Sep-99 |
DMA (Owned by Infogrames) |
Grand Theft Auto, Realms of
the Haunting, Loaded |
Take Two |
$11 million cash (assumed DMA
debt) |
Apr-99 |
Access Software |
Links |
Microsoft |
Undisclosed |
May-99 |
Pacific Coast and Power |
Activision |
THQ |
$10M in stock (estimate) |
Oct-99 |
Neversoft |
AMDK, Tony Hawk Pro Skater
|
Activision |
700,000 shares stock (est.
value 10M) |
Nov-99 |
Bungie |
Myth |
Take Two |
$5 million cash for 19% |
2000 |
SONY PS2 LAUNCHES |
Jun-00 |
Bungie |
Oni, Myth, Halo |
Microsoft |
Est. value $20-$40 million
(based on Take Two sale of 19% @ 5M cash, 5.8 sale of
Bungie assets)* |
Jul-00 |
Pop Top |
Railroad Tycoon II, Tropico
|
Take Two |
559,100 shares (est. value
$5.8M) |
Jul-00 |
LTStudios |
Startup with multiplayer concepts
|
Argonaut |
£300K for 30%, 9.5% bond,
remaining 70% purchased 9-2001 for a nominal sum |
Aug-00 |
Volition |
Freespace, Red Faction |
THQ |
890,100 shares common stock
+ 109,900 shares common (options)+ 500K debt assumed (est
value $21.25M) |
Oct-00 |
Just Add Monsters |
Kung Fu Chaos |
Argonaut |
£200,000 cash and 400,000
stock plus a deferred £210,000 in Loan Notes |
Dec-00 |
Digital Anvil |
Freelancer |
Microsoft |
Undisclosed |
2001 |
MICROSOFT
XBOX LAUNCHES |
Jan-01 |
Red Zone |
NFL Gameday |
Sony |
Undisclosed |
Jan-01 |
Naughty Dog |
Crash Bandicoot, Jak and Daxter
|
Sony |
Undisclosed |
Feb-01 |
Blue Byte |
The Settlers |
Ubi Soft |
Value 13 million Euros ($8.2
M US) |
May-01 |
Ensemble Studios |
Age of Empires |
Microsoft |
926,077 shares common stock
(est. value $83M) |
Jul-01 |
Red Storm |
Rainbow Six |
Ubi Soft |
$43 million value |
Jan-02 |
Particle Systems |
Powerdrome, SubWar 2050 |
Argonaut |
£2.4 million in total plus
3.5M in Argonaut shares |
Jan-02 |
Gray Matter |
Return to Castle Wofenstein
|
Activision |
$3.2 million in stock |
Jan-02 |
Rainbow Studios |
Motocross Madness, Splashdown
|
THQ |
Total value est. $44.6M (1,287,000
shares of stock plus performance incentives) |
Apr-02 |
42-Bit |
Rally Championship 7 |
Warthog |
Value £400,000 (in Warthog
shares), futher 700K shares based on performance |
Mar-02 |
Shaba Games |
Wipeout, Big Hurt Baseball,
Magic: The Gathering |
Activision |
387,932 shares of common stock.
Value $7.4 million |
Apr-02 |
Shiny |
MDK, Matrix |
Infogrames |
$47 million (31M cash, 16.2
promissory notes) |
May-02 |
Outrage |
Decent PC |
THQ |
Undisclosed |
May-02 |
Z-Axis |
Dave Mirra Freestyle BMX |
Activision |
$12.5 million in cash and 373,385
shares of stock. Total value $20.9 million |
Jun-02 |
Black Box |
NHL Hits, Need for Speed, Sega
Soccer |
Electronic Arts |
14M rumored value* |
Aug-02 |
Barking Dog |
Global Operations, Homeworld:
Cataclysm, Treasure Planet |
Take Two |
$3 million cash, 242,450 shares
restricted stock (total est. value $9M) |
Sep-02 |
Rare |
StarFox, Donkey Kong |
Microsoft |
Total $375 million cash, $100m
of which to Nintendo |
Oct-02 |
Luxoflux |
True Crime, Vigillante, Streets
of LA |
Activision |
$9 million cash |
Oct-02 |
Treyarch Invention |
Tony Hawk, Spider-Man |
Activision |
1,228,442 shares common stock.
Total value $18.2 million |
Oct-02 |
Massive Entertainment |
Ground Control |
Vivendi Universal |
Undisclosed |
Jan-03 |
Infinity Ward |
Call of Duty |
Activision |
Undisclosed |
Nov-02 |
Angel Studios |
Smuggler's Run, Midnight Club,
Red Dead Revolver, Transworld Surf |
Take Two |
$28 million cash, 235,679 shares
restricted stock (total est. value $38M) |
Dec-02 |
Zed Two |
Pillage |
Warthog |
£1.5 Million over 3 years,
contingent on performance* |
2003 |
Fever Pitch |
Starlancer (former Digital
Avil developers) |
Warthog |
Value $ 300,000 Warthog shares
|
Sep-03 |
Pivotal Games |
Conflict Desert Storm |
SCi |
Value £2.4 million (Sci already
owned 10%)* |
|
 |
 |
 |
*
Information speculative
|
Why Developers Sell Their Studios
Without surprise, financial security is the most common reason
for independent developers to sell their companies. But this should
not be confused with a take-the-money-and-run scheme where one sells
his company and retires to a beach in the Bahamas. Occasionally
a developer will leave shortly after an acquisition, but in general
this is not in line with a publisher's expectation. Publishers expect
to see a significant return on their investment, and acquisitions
are structured to ensure this through the continued participation
of key employees.
Many of the developers we spoke with sold their companies out of
growing concern for growth and the complexities of working with
multiple publishing partners. Generally, their collective motives
fell into these categories:
- Concern over growth
- Concern over technology changes
- Leverage marketing and distribution
- Benefits for employees
- Personal growth
Concern Over Growth
Many developers who have sold their studios concluded that a single
publisher partner was necessary in order to simplify business relationships
and provide long-term financial stability. Also, an underlying concern
was that their selling-price was at an all-time high.
As one developer explained, "As your size grows dramatically,
projects can get behind and publishers may refuse to pay, some may
cancel projects, and others may go out of business. When you're
smaller it may be possible to weather these events with personal
cash, loans, etc., but as a larger developer a "Perfect Storm"
of these events can deliver a really serious blow".
For a developer, sustained growth becomes increasingly complex
and risky as the studio grows, since most publishers require non-compete
agreements that prevent them from working freely within the industry.
To keep teams busy, they often worked with publishers that were
less stable financially then themselves. So as their burn rate increased,
mistakes and wrong turns were more costly and deadly.
Technology Changes
The transition from one console generation to the next is a powerful
catalyst to secure business relationships.
For some, during the transition from PS1 to PS2, their motivation
for selling was based on concerns about the implications of technology
changes. One developer put it this way: "The amount of time
it took to develop a game was doubling. The amount of people it
took was doubling. Hence the cost was going up about five times.
And yet the cost of the software was unchanged if not descending.
So the risk on each product was going up and the potential profit
per person per year was going down. We sold the company partially
to mitigate that risk."
As we move into the next generation of console systems (PS3 and
Xbox 2), many developers believe it will be harder and more costly
to develop and maintain leading-edge technology. This is especially
true when you consider that publishers such as EA and others are
investing millions of dollars in technology that can be used throughout
their company. In the future, the ability for an independent developer
to compete primarily on technology may be more difficult, and this
could encourage some to look for secure publishing partners.
Leverage Marketing and Distribution
For other developers, especially in the formative years of the
industry, distribution and marketing needs played a significant
role in their decision to sell. Papyrus, as example, had built strong
development and marketing teams, and initially sold their products
through Virgin Interactive (via a 3rd party distribution deal).
After Sierra acquired them in 1995, sales and profits increased
due to Sierra's strong distribution channel and in-house manufacturing.
Employee Benefits
All of the developers we spoke with were concerned about the long-term
welfare of their employees. As a small company, it was challenging
to provide the level of health insurance, job security, and retirement
benefits offered by publishers. Additionally, since many had distributed
stock or options to employees, the liquidity of this benefit was
ultimately dependent on an acquisition.
Personal Growth and Achievement
A less tangible but equally compelling reason for selling was the
realization of a life-long dream. Most of the individuals we talked
with had been in business for several years prior to their acquisition.
Selling their company was a benchmark both in self-actualization
and industry recognition of their achievements.
Why Publishers Purchase Game Developers
Publicly owned publishing companies have an insatiable appetite
for growth and net profits. Each is on a full-time mission to increase
their revenue, trim their operational costs, and take the advantage
from their competitors. Like a global sports game, they are engaged
in a winner take all competition for the hearts and wallets of game
consumers. If your company can assist them in this endeavor then
you could be an acquisition candidate.
But until a publisher sees material value, there is little chance
that you'll find an interested partner. Publishers generally purchase
developers for these reasons:
- Development expertise
- Financial growth
- Competitive advantage
- Proprietary technology
- Intellectual property
Development Expertise
Most publishers are interested in working with teams with proven
capabilities, and they tend to acquire developers with whom they
have worked with in the past. For most, they purchase studios in
order to increase or upgrade their development ability, and all
the publishers we spoke with agreed that the talent, the culture,
and the experience of the team were among the most valuable assets
a studio could offer.
Growth
A driving reason for purchasing an independent developer is to
increase the publisher's net income. Since a public company's performance
is measured by growth and profitability, if, by acquiring your company,
they can increase net profits they are rewarded by their stockholders
and the Stock Market. The higher the perceived value, the higher
their stock price. The higher the stock price, the more money the
stockholders will receive.
This point can be illustrated using our previous example of Rare
and Microsoft. Prior to its acquisition, Rare had sales averaging
1.4 million units per title, with more than 90 million units sold
since the company was founded.i
If we assume that Rare is capable of continuing to deliver 8.4 million
dollars annually to Microsoft's bottom line in the future, then
this would reflect positively on Microsoft's annual net earnings:
1.2 Million Units Annually (slightly lower than their sales average)
× $35 Wholesale Price per Unit
× 20% (An estimate of profitability per unit)
--------------------------------------------
= $8.4 Million Dollars Annually in Net Income
For Microsoft, $8.4 million dollars in additional annual net income
is fairly insignificant, but if you consider that their investors
value every incremental net income dollar at a multiple of 21.77
times that numberii, it is more
meaningful. Loosely defined, this revenue stream is valued by Microsoft
shareholders at $182,868,000 (21.77 × $8.4M). While this is
still far below the $375 million that Microsoft paid for Rare, it
does help explain how positive net income is valued.
Publishers also grow by opening new markets and genres. For example,
although Electronic Arts dominates the sports genre they have little
penetration in the 3rd person action genre (Crash Bandicoot,
Spyro, Ratchet and Clank). If EA believed that they could
earn significantly more revenue by competing in this market, it
could be motivation to purchase an independent developer that specializes
in this genre. The more profitable the developer, the more attractive
they would be.
Finally, financial growth can also be obtained by acquiring a team
to which a publisher has major financial commitments, most often
in the form of on-going royalty payments. Electronic Arts' acquisition
of Black Box may fall partially into this category. Black Box was
the independent developer responsible for EA's hit series Need
For Speed, and no doubt, EA was paying Black Box significant
royalties as a result.iii By purchasing
Black Box, EA recaptured these royalty payments and acquired a proven
development team.
Competitive Advantage
It is often advantageous to purchase a developer that has been
successfully operating in a space where a publisher is having difficulty.
It is even more attractive if by doing so they can take market share
from their competitors or make it more difficult for them to compete.
Activision's acquisition of Infinity Ward in January 2003 accomplished
just this. A significant number of Infinity Ward's staff came from
Electronic Arts where they were key developers on the hit product
Medal of Honor. By acquiring Infinity Ward, Activision not
only secured a proven team of specialized developers for their own
World War II series, Call of Duty, but they also struck a
blow to EA.
Proprietary Technology
Developers who own technology that publishers perceive as superior
are often candidates for acquisition. Such was the case with Luxoflux.
Activision was attracted to Luxoflux based appreciably on their
cross-platform technology and their ability to bolster Activision's
internal development capability.iv
Proprietary technology is attractive to publishers, but it is often
weighed against a make-or-buy decision. Electronic Arts, more than
any other publisher, is capable of developing highly advanced technology
in-house. But if a developer can help them enter a market more quickly,
then it can be a catalyst for purchase. Jerry Bowerman, chief operating
officer of EA Vancouver, felt strongly that even in light of EA's
capabilities, technology was still the key, "If they don't
have a non-compete, and they own the technology, and they shipped
a hit, then they are going to get acquired."
Sierra's purchase of Headgate Studios is an example of this. In
1996, when Headgate was purchased, Sierra was expanding its Front
Page Sports line of products. Although Headgate had not yet shipped
a game, Sierra believed that Headgate's golf technology would allow
them to enter this segment of the sports market more quickly and
with less risk. For them, the purchase was justified based on future
sales in a genre where they had no prior presence.
Intellectual Property
When Electronic Arts purchased assets from Virgin Interactive in
1998 for $122.6 million dollars, they were interested in the properties
created by Westwood Studios, and in particular, the Command and
Conquer franchise. Command and Conquer has been one of
the best selling real-time-strategy games of all time, and by adding
it to their portfolio, Electronic Arts immediately became a leader
in this category.v While $122.6 million dollars was sizable,
EA could justify it based on forecasted sales of it and other Westwood
properties. Ownership of Westwood's IP was a key to the acquisition.
The acquisition of DMA gave Take Two ownership of Grand Theft
Auto franchise, which proved later to be an incredibly profitable
purchase. Sierra's acquisition of Papyrus was based substantially
on the license that Papyrus had negotiated with NASCAR. And perhaps
the most recent example of an acquisition motivated by a license
is that of Shiny by Atari for $47 million dollars. Atari was keenly
interested in acquiring the rights to The Matrix, so much
so that they took out a loan in order to finance the purchase.vi
Dating and Marriage
Developers often refer to their publisher relationships using the
analogy of dating and marriage. One developer told us that when
a publisher and developer sign a development agreement for a single
product, it is very much like a first date. At this point neither
party knows too much about the other. Their attraction is based
on what they perceive the other can do for them, and the date can
either go well or terribly wrong. If it goes well, then there is
likely to be a second date, a third, and perhaps, if the two continue
to find each other attractive, marriage (or acquisition). Our developers
cautioned young developers to consider every project and relationship
a potential marriage. They advised others to "end well"
on every project, since one never knows if the relationships forged
on one of these "dates" might turn out to be something
more permanent.
One of the most significant aspects of an acquisition is the permanence
of the relationship. Once an acquisition is competed, it is nearly
impossible to unwind the relationship. Borrowing from a well known
expression affords us the ability to pass on a bit of wisdom: What
two companies join together is nearly impossible to pull apart.
Because of this permanence, certain aspects of the relationship
should be carefully considered:
- Culture
- Management
- Employees and redundancies
- Location
- Price
- Deal structure and performance incentives
Culture
For both publishers and developers, culture is an important component
of the purchase decision. EA's Jerry Bowerman explained it this
way, "…we look at culture very carefully. What would
happen if we purchased a company that had been in business for years
and during that time they never worked on the weekends? Here at
EA we do whatever it takes to get a product out on time. So that
would cause a lot of problems for both of us."
Not only is the work schedule an important aspect of culture, but
issues can include whether employees have private offices or cubicles,
whether snacks are free or paid for by the company, whether the
Christmas party is small or elaborate, and literally hundreds of
other subtle procedures and policies. No matter how insignificant
these may be, all contribute to the heart and soul of the developer's
culture.
Both parties want to make the transition as easy and painless as
possible, since distractions are costly, translating into poorer
product and late deliveries. The two must carefully consider the
operational procedures of the other and whether their marriage will
work. If in the process of an acquisition a publisher destroys a
developer's culture, then they end up killing the very thing that
they worked so hard to get.
Stuart Moulder, Microsoft's GM agreed. "Assume that most
publishers are purchasing a developer to gain the benefits of the
developer's creative talent (rather than just for IP or some other
reason). Then a publisher needs to understand the developer's culture,
respect it (it's that culture that is at the heart of the developer's
success) and its people."
Management
Independent developers are used to calling their own shots, making
decisions quickly, and taking risks in order to grow their companies.
For many, the idea of having to report to a "manager"
is foreign and troublesome. But, once a developer is acquired they
are likely to lose a significant amount of the freedom that they
enjoyed as an independent.
For Rainbow Studios, one of the prime attractions to THQ was that
Rainbow would be allowed to work autonomously. At the same time,
Mark DeSimone (Rainbow President) also knew that Rainbow would be
giving up ultimate control, especially in terms of the products
they would be allowed to build. But they were reminded that in the
process of working as an independent studio, they were dependent
on their ability to convince someone other than themselves that
their ideas were sound. So things didn't change that much.
Naughty Dog's Jason Rubin has been pleased with the level autonomy
that Sony has allowed them continue to enjoy. He believes that this
has a lot to do with the healthy relationship that Sony and Naughty
Dog had established prior the acquisition. This is what he had to
say about life post-acquisition: "I don't look at my job
at Naughty Dog as being any less important. I still try to make
the best games possible and I still work just as long and hard at
it."
Once a developer is acquired there are significant changes to policy
and procedures that restrict a founder's ability to react to market
conditions. And this can be an issue that is surprisingly tough
to swallow. One of the worse things an independent developer can
do is to give up control of their company on paper but not emotionally.
Employees and Redundancies
An independent developer's employees are its most valuable assets.
How they are treated, how their stock options are dealt with, how
their health and retirement benefits are considered are sensitive
issues to be discussed during the negotiation.
Because retention is an important issue for both the buyer and
seller, key employees are often offered performance and retention
incentives as part of the purchase. Who pays for these programs
is decided in the negotiation, but clearly both parties know that
retaining know-how is critically important.
While retention is critical to the success of a merger, it makes
little sense for a publisher to retain a developer's employees in
areas where the publisher has established leadership. A developer's
sales, marketing, accounting and finance, and IT employees are often
made redundant soon after an acquisition.
Location
Publishers know that creativity is closely tied to the developer's
work environment. As a result, many developers continue operating
from their same office after the acquisition, their lease or property
being transferred to the publisher. However, it is important to
understand that once an acquisition is complete a publisher has
the authority to move or shut down any facility they own (unless
there is a contractual obligation in place to prevent it).
EA's move of Westwood Studios in early 2003 is an example of this.
Prior to the acquisition, Westwood (Virgin) had invested in a new,
50,000 square foot building in Las Vegas. The building included
motion capture facilities, comfortable offices, and was a showcase
not only for the game industry but for Las Vegas as well.
After the acquisition Westwood continued to operate from this facility,
but in 2003, EA closed it and relocated key employees to Los Angeles,
where they were consolidating operations with other west-coast studios.
While this has surely been an adjustment for Westwood's employees,
they along with other LA-based EA teams will enjoy a new 250,000
foot campus in Playa Vista.
Employees at Bungie may have faced a similar experience. After
their acquisition by Microsoft in 1999, Microsoft opened Bungie
West in Seattle, relocating many long-time Chicago natives there.
Price
Surprisingly, price is one of the easier issues for the parties
to agree on. It is made easier primarily because both parties employ
attorneys and accounting professionals who have standardized methods
for assigning value to a developer's assets.
David Lee, a partner at the law firm White & Lee in Silicon
Valley explained. "One of the things we do is to help sellers
determine a valuation that is justifiable. Obviously we want them
to get the highest price possible. We also want to make sure that
they have a clear understanding and expectation of what life will
be like in the new company."
In order to define a fair price it is important to understand the
basic concepts of valuation, which are detailed in the next section.
Deal Structure and Performance Incentives
The implications of mergers and acquisitions are highly complex.
Seasoned tax attorneys and accountants expend significant amounts
of energy and expertise to understand the financial impact that
an acquisition will have on the parties. The information included
below is a generalization intended only to help you understand the
basic concepts and structures.
How a deal is structured, and in particular, the tax implications
for both the buyer and seller, are key issues. As with all acquisitions,
the parties must decide whether to structure their deal as an asset
sale, stock sale, whether it will be a tax-free or taxable transaction.
Whenever possible, the parties try to maximize the overall benefits
and minimize the tax implications. Generally, buyers prefer to purchase
assets and to leave the developer's liabilities behind. But what
developers need to keep in mind is that as a seller of assets, they
are taxed on the gain. As a result, sellers (developers) prefer
to sell their stock (rather than assets) and rid themselves of their
liabilities.
Cash Only. Regardless of how the deal is structured, a
buyer may want to fund the acquisition with cash, their own stock,
or a combination of both. In the case of Rare, public records show
that the acquisition was a cash sale whereupon Rare received $275
million from Microsoft (Nintendo was paid another $100 million).
Stock Only. In other deals, a developer may not get any
cash up front. Such was the case with Headgate Studios, which was
purchased by Sierra in 1996. In this deal, Headgate was given an
undisclosed amount of restricted stock, which prevented Headgate
from selling for a certain period of time. Obviously, there was
less liquidity with restricted stock, but Headgate evaluated the
risk and determined that market conditions were favorable for this
type of a transaction. And it paid off. Shortly after the acquisition,
Sierra was sold to CUC and Headgate's restrictions were lifted.
For George Metos of Sculptured Software, in a similarly structured
acquisition by Acclaim, things seemed to go in the opposite direction.
Sculptured was purchased by Acclaim in October 1995, and shortly
after the acquisition Acclaim restated their income. Naturally,
the stock price dropped significantly. Sculptured was able to re-negotiate
and came out okay in the end-but there were scary moments in between.
Cash and Stock. Many deals are a combination of cash and
unrestricted or restricted stock. The acquisition of Angel Studios
by Take Two in November 2002 is a good example. In this deal, Take
Two gave Angel Studios $28 million in cash and 235,679 shares of
restricted stock. The total value of the deal was $38 million.
The acquisition of Barking Dog by Take Two in August 2002 was similar.
In this deal, Take Two paid Barking Dog $3 million in cash and 242,450
shares of restricted stock.
Debt Assumption. A publisher may also assume the debts of
a developer, as was the case with Volition when they were purchased
by THQ in August 2000. In this deal, Volition was given 890,100
shares common stock, 109,900 shares common stock (in the form of
options), and THQ assumed $500,000 in debt incurred by the company.vii
Incentives
Publishers often build incentives into deals that translate into
additional income based on future performance by the studio. This
mechanism is especially useful when the price difference between
what a publisher is willing to pay is a significantly less than
what the developer is asking.
As an example, if our fictitious developer, PlayWare, Inc. has
an asking price of $20 million and a significant amount of this
is based on anticipated net sales, then a publisher may respond
with a counter-offer, saying, "We'll give you ten million
dollars now, and if you hit that sales number, we'll give you the
other $10 million that you are asking for."
Performance incentives were used in Activision's acquisition of
Luxoflux in October 2002. In this deal, Luxoflux was purchased for
$9.0 million in cash, but the terms also specified that an additional
165,000 shares of Activision stock could be issued to Luxoflux equity
holders and employees over several years, depending on the "satisfaction
of certain product performance requirements and other criteria."
viii
Conclusion To Part 1
Acquisitions move silently beneath the waves of our industry. While
finalizing this article Electronic Arts announced the acquisition
of NBA Street Series creator NuFX. The announcement comes
as no surprise to industry insiders because NuFX is a proven hit
maker and its relationship with EA has been forged over time. Yet
it is likely that both parties evaluated the opportunity based on
criteria described in this article. And in the end they concluded
that an acquisition was in their best interest.
But the process of determining a price for NuFX was an additional
effort similar to what will be described in detail in our concluding
segment. In this final article we will discuss many of the technical
aspects of a developer acquisition, including valuation and the
specifics activities that both parties undergo during the process.
Stay tuned.
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i Rare, founded in 1985, grabbed the attention
of the game world in 1994 with its creation of 'Donkey Kong
Country'. The game became the biggest- selling 16-bit title
in history. Rare has since become one of the premiere developers
in the world, with sales averaging 1.4 million units per title
and nearly 90 million games sold since the company was founded.
Five of its top 20 all-time-best-selling N64 titles include
'GoldenEye 007', the second-best-selling game in North America,
with worldwide sales topping eight million. Junipermedia,
2004.
ii 21.77 was Microsoft's forward
P/E ratio in early February 2004. It is used here as an example
only.
iii On January 27, 2004 Reuters reported
that Need for Speed Underground had already sold 5.5 million
units, and was the top selling EA product during the holiday
2003 season. While NFS Underground was developed by Black
Box as a wholly owned EA company, one can assume that had
the acquisition not occurred, EA would have paid Black Box
sizable royalties for this product.
iv Activision's Quarterly Report, November,
2003: "… we have also continued our focus on establishing
and maintaining relationships with talented and experienced
software development teams. During fiscal 2003, we bolstered
our internal development capabilities with the acquisitions
of two privately-held interactive software development companies,
Z-Axis and Luxoflux."
v February, 11 2003 Electronic Arts Press Release:
"The Command & Conquer line of games is one of the
most popular franchises in gaming history. To date, the franchise
has sold more than 21 million units worldwide on multiple
platforms, and the series has landed in several editions of
the Guinness Book of World Records as the best-selling computer
strategy game series of all time."
vi Atari's 2003 annual report notes
in connection with the Shiny Acquisition, the Company obtained
a $50.0 million medium-term loan from Infogrames SA.
vii 05.09.2000 THQ Inc. (NASDAQ NMS: THQI) announced
that it had acquired revolutionary game developer Volition,
Inc. As consideration for the transaction THQ issued approximately
890,100 shares of common stock, assumed existing Volition
stock options providing for the future issuance of approximately
109,900 shares of THQ common stock, and assumed approximately
$500,000 in net liabilities. The acquisition was consummated
on August 31, 2000 and will be accounted for as a pooling
of interests.
viii Activision 2003 Annual Report.
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Notes
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