Overview
I've written a lot about gaming: console manufacturers, game developers and the companies that house them. Most of the talk has been about one console versus another (i.e., Wii vs. PS3 vs. Xbox 360) and the ramifications for the game developers that write for them (i.e., ERTS). I'd like to take a step back and look at a shift in the gaming landscape, where the value stack is rapidly changing and where winners and losers should sort themselves out fairly quickly. I'd also like to offer up a straw man for how the industry might shape up over the next few years, using Majesco (NASDAQ: COOL) as a vehicle for illustrating how these changes are impacting companies with broken business models, and to draw some parallels with what is happening with Microsoft and Vista in the Consumer Era of Computing.
My thesis after distilling the online data:
- Offline game distribution and marketing will become less and less important as the online distribution model takes hold;
- Console design and manufacturing will become increasingly important as it serves as the window into the user's online gaming experience;
- Developers that can rapidly and efficiently develop multiple titles for
multiple platforms will win the day, as price per unit will fall in an
online distribution world but where winners will more than compensate
by higher sales volumes; and
- The "long tail" of gaming will emerge, as legacy titles are made available on the Internet in a low-cost and efficient manner, much as how Amazon has brought a long-tail book archive into our home and how the value of film libraries has skyrocketed.
So the value is in the platform and the content, not the means for delivering the content, as the Internet will render the offline distribution model increasingly obsolete. Which is squarely where COOL finds itself. Much to the chagrin of its shareholders.
Game Development - Complicated, Costly, and a Failed Experiment
Majesco recently bounced back from a near-death experiment with big-budget game development, as discussed in its recent earnings release. From GameSpot 01/30/2007:
Aided by solid sales of Jaws Unleashed, distribution deals with both
Valve and Trymedia, and the critical success of the DS title Cooking
Mama, Majesco reported a balance sheet that company officials say holds
signs of a turnaround.
Majesco president and interim CEO Jesse Sutton said that the company
was in the midst of a new approach toward the marketplace that has
already served the company well over the past year.
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Majesco CFO John Gross also addressed the company's new apprach,
saying, "We have transitioned away from the big-budget games and
dramatically decreased our development costs and operating expenses,
thereby significantly reducing our use and loss of cash."
For a taste of the dynamics of the game development and publishing business, take a look at this insightful and detailed post from Japanmanship 02/22/2007. As it relates to COOL's earnings announcement, ok, but what does yet another strategy shift mean for the future? In 2005 it was the push to develop first-party titles, spending big cash to license expensive properties and signaling a shift from value-oriented games towards the high-end. That didn't last long and almost pushed COOL to the financial brink. So now it is heading back to its roots - licensing properties, acquiring the rights to third-party developers IP and leveraging its experience in product packaging, marketing and distribution at the value-oriented price point. Focusing on "affordable, mass market" games for the DS and the Wii. But what about enduring value for shareholders, as embodied by either leading-edge IP or a robust distribution pipeline that will fuel earnings for years to come?
Game Licensing - Long-term Value through Control of IP
The issue of enduring value raises the inconvenient fact that COOL's popular Cooking Mama property is not its own, but was licensed from the Japanese company Taito, which, in turn, sourced the original game development from a Japanese firm called Office Create. And these licensing deals, per Majesco's most recent 10-K (dated 01/29/2007), are generally 2-3 years in duration. Now Cooking Mama has been doing pretty well - 242,000 units sold as reported by VGCharts.com. But if Cooking Mama really takes off, demonstrates longevity and the potential for leveraging the sequel cycle, doesn't it stand to reason that Taito may want to assert greater control over its property? It is not as if Majesco doesn't understand these risks. The following is an extract from the Risk Factors section of the aforementioned 10-K filing. Please note the text I have underlined for amplification:
If we are unable to maintain or
acquire licenses to intellectual property, we may publish fewer titles and our
revenue may decline.
Many of
our video game titles, are based on, or incorporate, intellectual property and
other character or story rights acquired or licensed from third parties. We
expect that many of our future products will also be based on intellectual
property owned by others. The cost of acquiring these licenses is often high,
and competition for these licenses is intense. Many of our competitors have
greater resources to capitalize on licensing opportunities. Our licenses are generally
limited in scope to specific platform and/or geographic territories and
generally last for two to three years. We may not be able to obtain new
licenses, renew licenses when they expire or include new offerings under
existing licenses. If we are unable to obtain new licenses or maintain existing
licenses that have significant commercial value, at reasonable costs, we may be
unable to sustain our revenue growth in the future other than through sales or
licensing of our independently created material.
This doesn't seem like good news. It is almost setting them up to be victims of their own success, where they create a market (like bringing the very Japanese Cooking Mama to the U.S. market). And what happens if Taito changes their tune and re-assesses Majesco's worth in the value stack? And, unfortunately for COOL, it appears that changes are afoot that could hasten this reassessment - acquisition. During 2006, a controlling interest in Taito was acquired by SQUARE ENIX, another Japanese game publisher. The implications for Taito - and, therefore, Majesco - is that SQUARE ENIX has a U.S.-based publishing operation. And they have experience developing and distributing successful games worldwide, such as the Final Fantasy series. From the SQUARE ENIX Annual General Meeting 06/24/2006:
"Our Games (online) segment recorded increase and profit, and we have no plan of changing our strategy. We have been making for further enhancement of such strategy. I mean by the term of "transitional period" that we have been trying to challenge various business models mainly in Games (offline) segment."
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The purpose of the Taito acquisition is to have more touch points with customers. Looking at our competitors, game arcade business is a profit-making source. We seek to expand our customer base not only in game arcade business but also in all other business segments given increasingly lower birthrates."
So now SQUARE ENIX is running the show. And if this wasn't enough to make COOL shareholders concerned, check out these words as extracted from a SQUARE ENIX Management briefing reviewing the prior nine-month fiscal period dated 01/30/2007:
"In the console game software business, there are only 40 to 50 development staff. The reason why this business has been consistently making a loss of 500 million to 1,000 million yen annually with this number of staff is attributable to its practice of purchasing third party game software products for resale to the market.
"SQUARE ENIX releases 10 to 20 titles a year in Japan, while Taito Corporation releases 80 to 100. The difference is that Taito Corporation relies more heavily on the resale of third-party products. This practice has produced accumulated losses, and we have been scaling back the purchase of third-party products from the fal o