The Price of Innovation

Matt Richtel - International Herald Tribune

Buying Innovation Or Inventing: a Game Maker's Choice

Creating a video game costs about $20 million. So for $2 billion, Electronic Arts could develop 100 new titles.

Instead, it wants to pay $2 billion for Take-Two Interactive, best known for one particular game, "Grand Theft Auto."

It is one very successful game, to be sure. The various versions of "Grand Theft Auto" have sold nearly 65 million copies, making it one of the best-selling game franchises in the industry.

Electronic Arts is good at putting out reliable sequels to its best sellers, like "Madden NFL" and the "Sims" series. Those stalwarts generate consistent annual revenue. In its fiscal 2007, EA had 24 titles that each sold more than one million copies, and four games - "Madden NFL 07," "Need for Speed Carbon," "FIFA 07" and "The Sims 2 Pets Expansion Pack" - each sold more than five million copies. The company said it just had its best holiday season ever.

But Electronic Arts, or EA, has been plagued for several years by criticism that it is not doing enough to create new hit games. Its new chief executive, John Riccitiello, has vowed to turn that around and, indeed, the company says it has more new titles coming out this year than at any time in its history.

The bid for Take-Two has analysts asking whether EA is having so much trouble building new hits on its own that it must spend $2 billion for someone else's ideas. To some, it suggests that the company faces more challenges in developing new hit games than it has let on.

"The proposed acquisition of Take-Two now opens the possibility that it comes from a place of weakness, which is a very different message than Electronic Arts has sent to the street in the last month," said Evan Wilson, an analyst with Pacific Crest Securities, who has a hold rating on Take-Two shares.

Daniel Ernst, an analyst with Soleil Hudson Square Research who has a $30 price target on Take-Two's stock, said Electronic Arts could sorely use the new intellectual property. He said that during the fiscal year ending next month, the video game industry will have grown 51 percent globally, while EA will have grown only 25 percent.

And he said EA had had trouble developing breakaway hits and the quality of its new games had consistently lagged behind that of other publishers.

"They haven't created new franchises that bring new customers to them," he said.

Take-Two has balked at EA's $26-a-share offer, even though it is a 50 percent premium over the stock's closing price Friday of $17 a share. Its executives said they would not even enter negotiations until April 29 - the date of the release of "Grand Theft Auto IV," the next iteration of the company's crown jewel.

Some Wall Street investors gambled Monday that EA - or a different suitor - would be yet more generous. Take-Two's stock closed at $26.89, up nearly 55 percent from Friday's close. For Take- Two investors, there is no guarantee that EA will raise the ante, or stick around until "Grand Theft Auto" hits stores.

Warren Jenson, the chief financial officer at Electronic Arts, said that he did not expect the company to raise its bid. On the contrary, he said, Take-Two becomes less valuable over time because its assets will be harder to integrate in time for the holiday season.

"This is a depreciating asset. The longer we wait, the less value it has," Jenson said.

Jenson said that if Take-Two's board sticks with its decision to reject the takeover bid, EA is "keeping open all options." Jenson declined to elaborate, but the clear intimation is that his company could go directly to shareholders and bypass Take-Two's board.

He said the takeover offer was not an indication that Electronic Arts was struggling to develop its own intellectual property. He disputed the assertion that EA could spend $2 billion on its own game development rather than buying innovation.

"I don't think that argument holds water because there's only one 'Grand Theft Auto,' " he said. Take-Two also has some other noteworthy games, like "Bioshock," "Max Payne" and "Midnight Club," he said. At the same time, EA has, in addition to its game sequels, a slate of new titles coming out, including "Spore," a long-awaited game from Will Wright, the creator of "SimCity" and "The Sims," as well as "Dead Space" and "Saboteur."

"Creativity is very much alive and well at Electronic Arts," he said.

The additional risk in buying Take-Two for "Grand Theft Auto" is that Take-Two's creative talent may not come along for the ride.

Rockstar Games, the studio that makes "Grand Theft Auto" for Take- Two, is not under long-term contract and could become a free agent, industry analysts said. Jenson said he believed EA could provide the right incentives and environment to keep the Rockstar team.

Strauss Zelnick, executive chairman of Take-Two, said in an interview that he thought the $2B bid undervalued the long-term prospects of the company. He argued that Take-Two, under its year- old management, had essentially put behind its considerable regulatory, legal and financial hurdles. "We're not in play right now," Zelnick said.

At the same time, Take-Two's board has done some planning for a possible takeover. In mid-February, the board voted to allow accelerated vesting of some management shares in the event of a change of control.

----

More game news

Copyright 2012 by International Herald Tribune