Nintendo Video Game

Video Game Industry Analysis March 11, 2005 the best strategy for entry at this point, until software standards are set and an initial shakeout occurs. Communications. Massively Multiplayer Online Games (MMOGs) involve players scattered in all geographies. Thus, the communication tools within games are important for both interacting during play and recruiting players for a game session. Most of these tools are currently embedded within games themselves, but a few standalone tool suppliers are emerging and we believe that “best of breed” and Video Game Industry Analysis March 11, 2005 Table of Contents Introduction 4 History of Video Games 4 Overview of Industry Growth Drivers 6 Industry Analysis 8 Part I: Low interest VC investment sectors Hardware 11 Video Game Software 13 Infrastructure 16 Part II: High interest VC investment sectors Video Game Software 19 Infrastructure 27 Enabling Technology 29 Conclusion 41 Video Game Industry Analysis March 11, 2005 Introduction Our goal in this report is to describe and analyze the video game industry. We do so from the point of view of a venture capital firm, and therefore look to identify opportunities where new entrants, such as venture-backed http://www.gamespot.com/gamespot/features/video/hov/p2_01.html Our methods and approach Video Game Industry Analysis March 11, 2005 Two different events in the 1970’s were catalysts that moved the video game industry towards mainstream America. In 1971 the first arcade game was released. While the game was considered difficult to play, a seed was planted with the public. In 1972 Magnavox began producing the Odyssey, which was the first home television game system. The Odyssey system came with several game cartridges, all playing some version of table tennis. More importantly, however, Pong was released in 1972. The Pong “stand alone” units that were placed in bars and taverns were tremendously successful. In 1977 Atari released their Video Computer System (later called the 2600) to great results. Finally, in 1978, Nintendo entered the industry with the release of several arcade games. The nascent console age had begun. The first large wave of American adoption The 1980’s were the start of the modern video game era with the release of two hugely popular and successful games – Namco’s Pac Man and Atari’s Space Invaders. One factor that contributed to the success of the home gaming system was the triumph of the arcade. Specifically, US arcades generated revenues in excess of five billion dollars in 1981 alone. The next major console was released in 1982 with the debut of Colecovision. A large part of Colecovision’s success can be attributed to the game licenses obtained from Nintendo, specifically Donkey Kong and Donkey Kong Junior. Following a lull through much of the mid-1980’s, Nintendo shook up the video game industry with the release of their 8-bit Entertainment System (NES) in 1986. Following the release of NES, Nintendo dominated the industry through the rest of the 1980’s with huge hits like Super Mario Brothers and Tetris. In 1989 Nintendo created a new http://www.videogames.org http://www.gamespot.com/gamespot/features/video/hov/p4_02.html http://www.gamespot.com/gamespot/features/video/hov/p8_01.html rcade games usher in the “video game” Video Game Industry Analysis March 11, 2005 Nintendo released the N64 following tremendous success in Japan. The cycle of improved consoles continued to move quickly as Sega released the Dreamcast, a 128-bit system in 1999. Sony and Microsoft push the technology further The release of the 128-bit Playstation 2 in 2000 and Microsoft XBox in http://www.gamespot.com/gamespot/features/video/hov/p10_03.html The Future of Online Games, Greg Costikyan intendo and Sega are marginalized by more advanced technology Video Game Industry Analysis March 11, 2005 Growth of Broadband ll of these various drivers are fueling the industry’s recent and rojected expansion Video Game Industry Analysis March 11, 2005 controlling the software sector, similar to the console sector. Electronic Arts has recently signed exclusive deals with the NFL and ESPN and also purchased nearly 20% of Ubisoft, a French game developer. Ubisoft itself just recently announced a deal to purchase several of Microsoft’s sports games. This industry consolidation and tie-up of exclusive licenses is aturation of the industry has also driven consolidation Video Game Industry Analysis March 11, 2005 Enabling Technology : the supporting technology that creates the overall gaming experience Each sector is an integral part of the industry and intertwines with the others. Within each sector, we have also identified numerous sub- segments. It is within these segments that we will look for interesting market opportunities and investment ideas. In order to do this screen for investment ideas, we used the following framework to look at each sector. Framework for Industry Screen: a variant on Porter’s Five Forces This framework is similar to Porter’s Five Forces, but is slightly different as it focuses on barriers to entry and the ability of new entrants (namely Video Game Industry Analysis March 11, 2005 Figure One – Industry Screen Growth Rate : (Must provide opportunity to gain share quickly) Is the sector growing significantly? Is it mature or still nascent? Competitive set : (Must be able to enter for low cost and gain share with Video Game Industry Analysis March 11, 2005 Hardware We have defined Hardware to encompass the device on which the game is played. Hardware is typically a commodity entity in the sense that it adds Wedbush Morgan Securities, The Definition of Insanity The PC industry is too rice competitive and mature for venture investment. Game Consoles are an area of low interest as it requires extensive technology and capital investment for success. Video Game Industry Analysis March 11, 2005 ibid. andheld consoles are of medium interest – with a truly hybrid device representing a otential opportunity. Otherwise, low interest Video Game Industry Analysis March 11, 2005 device. However, as the product does have a graphics chip, it is aimed at serious gamers. Given its recent introduction, its adoption rate is http://www.redherring.com/Article.aspx?a=4930&hed=Indie+game+developers+get+cutthroat evelopers and ublishers are the two roups that create ames Video Game Industry Analysis March 11, 2005 Publishers – Console/PC/Handheld The publishers generally commission and pay for the development of a game, in much the same way that a television channel works with a production company to create a program. Because publishers have the finances to fund the majority of projects, they control which products Developers Publishers Marketing Distribution Consumer Production As a simple example of how the relationship between publisher and developer works consider the following. The developer gets a five million advance to create the game and ten percent royalty based on the publisher’s revenue following deductions. The developer will see royalties after the game has generated fifty million in revenue for the publisher. If a game sells for $30, it must sell one million units before the developer sees royalties. The video game software industry is dominated by large, international publishers, none more so than Electronic Arts (EA). Over the past three years the average company in the industry has seen an 8% increase in their stock price, while at the same time EA has increased by 123%. The following example shows the strength of position that EA holds. At the http://www.obscure.co.uk/publishing.shtml http://www.redherring.com/Article.aspx?a=4930&hed=Indie+game+developers+get+cutthroat DFC Intelligence Game Industry Brief Console/PC/Handheld evelopment and ublishing are low interest Video Game Industry Analysis March 11, 2005 ESPN football title. To counter this move by Take-Two, EA acquired the licensing rights of the NFL for all developing, publishing and distribution of interactive football games. This type of maneuvering is why we think this is a difficult segment for start ups. EA essentially locked out other publishers from producing NFL games for the next five years, in similar fashion to deals EA has with professional soccer and golf (Tiger Woods). Because this industry is very mature and dominated by large international players, we feel that there is little opportunity for venture backed companies. It takes an enormous amount of capital to lock up the increasingly exclusive content and without such deals it will be Wall Street Journal, 12/14/04 “Electronic Arts Acquires Rights to Produce NFL Games” http://www.redherring.com/Article.aspx?a=4930&hed=Indie+game+developers+get+cutthroat Wedbush Morgan Securities, The Definition of Insanity C/Console game development is a “hits” business, like movies Video Game Industry Analysis March 11, 2005 In addition to the maturity of the industry, the sector is characterized by a “hit or miss” structure with creates significant challenges. A single game can cost in excess of ten million dollars to develop, requiring hundreds of thousands of units sold to recoup this investment. Because this is a hits business (many of the most successful games are franchises with developed consumer loyalty), and game sales are subject to consumer or a technology investor. ublishers still dominate the business because of the large capital requirements Video Game Industry Analysis March 11, 2005 its core a technology company, so it would not be an attractive opportunity for a tech-based venture capital firm. Internet connectivity Online games use the existing telecommunications infrastructure as their nternet connectivity is becoming a commodity business Gamer MVNO is one opportunity in this sector, which is otherwise of low interest. istorically, the aggregator model has not worked. Video Game Industry Analysis March 11, 2005 developers and publishers and offer them directly to consumers and wireless providers. However, as exclusive content is being signed up in Content is a critical complement to games or aggregators. Video Game Industry Analysis March 11, 2005 Video Game Software Developers and Publishers – Wireless/Online The roles of software developers and publishers are much the same in the wireless and online space as in the other sectors, but at this point on a smaller and emerging scale. Developers still design and sell games to publishers or aggregators, while publishers still are the gate keepers to the end product. In the wireless and online space, it is more common to see companies that are both developers and publishers. While the majority of the software space is relatively mature and established, there are still likely to be early stage investment opportunities in this area. http://www.tomshardware.com/hardnews/20050202_173201.html Wireless and Online segments will present opportunities Online gaming has large growth redications, but unlike in the past, internet connectivity is now ready for the market Video Game Industry Analysis March 11, 2005 the fifty dollar cost of a console game. Gamers are more willing to take chances and try a new game at this lower price point as well, which means MOG developers are an opportunity Video Game Industry Analysis March 11, 2005 Sierra Entertainment (sierra.com) is a unit of Vivendi , and is the developer of one of the most popular online games, Half Life . Vivendi also owns Blizzard Entertainment (blizzard.com), the creator of the Warcraft series of games. Sierra and Blizzard were icons in online game creation before being purchased by CUC International in 1996. CUC was one of the two predecessor companies to Cendant (the large travel and real estate services company). Cendant eventually sold their games division to Vivendi. Both companies have thus had deep pockets to develop their games for years, dating back to the start of online gaming. Epic Games (epicgames.com) and Digital Extremes (digitalextremes.com) are the developers behind the Unreal series of games. Atari – formerly Infogrames – (atari.com) is the publishing partner. Together these companies have created an established franchise, and in addition, the Unreal game engine is one of the leading game engines (as discussed in the enabling software section). Epic is a private company that appears to have never taken any outside funding to date. As another example of how smaller private development shops can reach success as MMOG developers, Infinity Ward (infinityward.com) and Gray Matter Studios (gmistudios.com) worked with Activision , their publishing partner to create new versions of the Call of Duty series of games. This example demonstrates the opportunity that exists for new Video Game Industry Analysis March 11, 2005 Below are some emerging MMOG developers who have recently launched their first games or are in the process of doing so. We have focused on European or American companies, who may provide investment opportunities. There are also many additional Asian developers. Based upon public press information, none of these companies have been funded. We believe that up and coming developers like these represent the primary opportunities for a venture capital firm in this sector, as new games and game play will grow with the large market opportunity. Nicely Crafted Entertainment (nicelycrafted.com/corporate) is an independent British developer of MMOG games, including Time of Defiance. CCP (ccpgames.com) is an Iceland based game developer that was established in 1997 and released Eve , its only MMOG game to date. Cryptic Studios (crypticstudios.com) is a California based developer that worked with NCSoft (ncsoft.net), an Asia game publisher to distribute City of Heroes. This game has won a lot of gaming awards and the company appears to be growing though it is being sued by Marvel (the comic company) due to the game content. Guild Software (guildsoftware.com), a Milwaukee-based company recently released its first MMOG, Vendetta-Online in November, 2004. Iron Will Games (ironwillgames.com) released its game Ashen Empires. The company is located in Austin, and was founded in 2004. The company is not well capitalized as it is soliciting donations for help in supporting and maintaining Ashen Empires Video Game Industry Analysis March 11, 2005 Investment in the overall online game sector Figure Three shows online gaming venture capital activity in the 2000- COMPANY AMOUNT COUNTRY E-Pub (Uproar)$0.5 Hungary Netamin$1.9 US/Korea There$37.0 US Nevrax$11.0 France Barrysworld$3.0 UK Mythic$32.0 US Terra ICT Sdn BHD$16.1 Malaysia Prizepoint$2.8 US Zona$1.2 US Artifact$4.5 US Wild Tangent$51.0 US VR-1$13.6 US Gamania$10.6 Taiwan GamesSpy Industries$15.0 US Unibox Korea$7.0 Korea Taewool$5.0 Taiwan iWin$30.0 US Gamesville$14.0 US Gamers.com$11.0 US Turbine Entertainment$13.0 US Butterfly.net$9.2 US Source: Commerzbank, 2003 Wireless Wireless gaming is also an attractive segment for venture capital investing. Throughout this section we are using the terms wireless gaming and mobile gaming as synonyms. In general we are speaking of gamers playing games on handheld devices, particularly cellular phones. This is a There has been significant VC investment along all arts of the online ame value chain Video Game Industry Analysis March 11, 2005 significant market with huge growth potential, currently with revenues of approximately $345 million (2004), and projections of over a billion for ignificant investment and consolidation within mobile games n initial shakeout may be coming and will help define the market leaders Video Game Industry Analysis March 11, 2005 Figure Four – Recent Acquisitions in the Game Industry Recent Acquisitions in the Game Industry Date Target Acquirer Jan. '05MindXMobile Media Co. AS Jan. '05Downtown Wireless Jamdat Mobile Inc. Dec. '04Indiagames Ltd.Tom Online Inc. Dec. '04Cellus USA Inc.Airborne Entertainment Dec. '04Elkware GmbHInfoSpace Inc. Dec. '04Macrospace Ltd.Sorrent Inc. Dec. '04IOMO Ltd.InfoSpace Inc. Oct. '04Tira WirelessAirborne Entertainment Oct. '04Digital-Red Mobile Shanda Interactive Aug. '04Blue Beck Ltd.MForma Group Inc. Aug. '04FingerTwitch Inc.MForma Group Inc. Aug. '04Treasure Base Tom Online Inc. July '04Atlas Mobile Inc.InfoSpace Inc. May '04MobileGame KoreaMForma Group Inc. Source: TheDeal.com and wire reports Figure Five – Recent Venture Financing Dialing for Dollars: The Mobile Game Industry Financings - February 2005 DateCompany/Amount ($mill.)RoundLead investors uarters Nov. '04Digital Bridges Ltd. $18.00 3Apax Partners, Argo Global Capital Aug. '04MForma Group Inc. 2Draper Fisher Jurvetson Kirkland, Wash. Aug. '04Digital Chocolate Inc. 2Sutter Hill Ventures, Chengwei Ventures San Mateo, Calif. Aug. '04In-Fusio SA 6Insight Venture Partners Bordeaux, France July '04Sorrent Inc. 3BA Venture Partners San Mateo, Calif. July '04Airborne Entertainment Inc. N/AInsight Venture Partners Montreal Jun. '04MForma Group Inc. 1General Catalyst Partners, Bessemer Venture Partners Kirkland, Wash. Jan. '04Kayak Interactive Inc. 11.8 1VantagePoint Venture Partners San Mateo, Calif. Dec. '03Jamdat Mobile Inc. 4Benchmark Capital Los Angeles Source: The Deal Video Game Industry Analysis March 11, 2005 While we believe that this will eventually be a winning sector for venture capital investment, some signs point to the fact that the sector may not be growing quite as rapidly as some estimate. For example, data indicates that among all wireless users, only 5.8% use their handsets for gaming, and within the 18-24 age demographic, only 13.8% are playing wireless games. Figure Six below (data as of 2003) shows that online gaming is the least used feature among wireless users, and Figure Seven shows that the majority of wireless gamers play less than once a month. Successful players in this segment will have the ability to convince gamers that their content is valuable and not simply a time-waster. Figure Six – Wireless Game Downloads Monthl Wireless Downloads b Device T Pictures/VideoMusic/RingtonesApplicationsGames All Devices171632 Basic\Enhanced Phone171632 Smart Phone/PDA Phone18652 Laptop w/wireless Modem16734 Laptop w/Wi-Fi7049102 Source: Telephia Figure Seven – Frequency of Mobile Game Play How Often Do Mobile Gamers Play? More than once a day8.90% Once a day5.70% Several times a week14.50% Several times a month28.70% Once a month or less42.20% Source: Telephia (Q3 2003 in top 35 U.U. mobile markets) Some interesting companies in this sector are: Digital Chocolate (digitalchocolate.com) develops entertainment and problem solving software for mobile phones. Digital Chocolate is backed by Kleiner Perkins and Sequoia Capital, and is based in San Mateo, California. obile game adoption is still uncertain Video Game Industry Analysis March 11, 2005 Exit Games ( exit-games.com) with offices in Germany and California, and has developed a full service solution for mobile multiplayer gaming. Exit games has had significant success in Europe and is just entering the US market. Another company working to connect mobile gamers in both essaging is an area of interest as standalone tool companies begin to emerge in the sector. Video Game Industry Analysis March 11, 2005 Video Game Industry Analysis March 11, 2005 Enabling Technology Enabling technology presents one of the most exciting areas of opportunity for venture capital investing in the entire video game industry. In general, enabling technology is the behind the scenes services, software, and hardware that allow the game to be played, or adds certain complimentary features to the gaming experience. We believe that enabling services, enabling software, and enabling hardware all are areas full of potential investment opportunities. Advertising / Content Services One of the most compelling areas within enabling services is the broadly defined video game advertising. Video game advertising can be broken into two segments, in-game product placement and in game advertising, and so called “advergaming”, where the game is itself the advertisement. Advergaming There are a number of firms that develop advergaming products, and many started as branded website games. We believe this is an interesting sector as companies look for more ways to advertise their brands to consumers. Additionally, in the age of DVRs where traditional advertising is losing http://www.usatoday.com/money/media/2005-01-17-disney-advergaming_x.htm technology presents many potential opportunities “Advergaming” is a rowing segment Video Game Industry Analysis March 11, 2005 significant minority interest in 1996. In 1999 Red Sky acquired itraffic, and then was taken private in 2001 by Seneca Investments. Finally, in 2003 Red Sky Interactive became a wholly owned subsidiary of Omnicom Corp. YaYa Media (yaya.com) also enables leading brands to develop valuable relationships with consumers through innovative and interactive entertainment solutions. American Vantage Companies acquired YaYa in April 2003. Another company in the space is Skyworks (skyworks.com), which is a private company that has never taken outside funding. In-Game Advertising Another interesting segment of video game advertising is in-game product placement and in-game advertising. This segment is particularly interesting given that consumers are spending less time watching television and more time playing games, a medium where the consumer’s eyes are always on the screen. This is also a very powerful segment, as game use is dominated by the 18-34 year old demographic, which is highly sought after by consumer product groups. The segment started out as simple in game product placement with examples like a character wearing a Puma t-shirt or the outfield wall of a baseball field having static advertisements. However, in-game advertising has evolved into a dynamic function, changing based on the game, product cycle, or even time of day. Massive Incorporated (massiveincorporated.com) is the dominant player in this evolving sector. http://news.com.com/2100-1024_3-5415623.html n-game advertising reaches a key demographic Video Game Industry Analysis March 11, 2005 One concern facing in-game advertising is gamer response to advertising. For most gamers, games are an escape, a way to enter another world, see http://clickz.com/experts/ad/lead_edge/article.php/3487586 There are only a few in-game marketing articipants, but that is expected to grow Video Game Industry Analysis March 11, 2005 on delivery of a service, not just a game. Online platforms aid in the delivery of that service by enabling games’ usage and uptime. These platforms are still being developed as is all of online gaming and so there http://www-1.ibm.com/grid/announce_227.shtml Online platforms will reduce the cost and increase the speed of game development Video Game Industry Analysis March 11, 2005 of these types of companies, a new entrant faces a very fragmented market. “Bandwidth” services will be needed as online gaming grows. However, what hosting will look like as gaming grows is unclear. As demands on servers grow there will be an increasing need for hosting services. Also, the demand for private servers is likely to grow over time as clans and subgroups of players proliferate. Since the technology or service delivery standard has yet to be developed, there is an opportunity for a new entrant osting services is a ragmented marke ublishing platforms will help online game developers Video Game Industry Analysis March 11, 2005 Figure Eight – WildTangent Development and Distribution Platform WildTangent is the leading North American online platform and publisher, but it has competition from several Asian companies as well as North American online game aggregators, whose technology fulfills the distribution portion of WildTangent’s service, but not the development platform side. WildTangent (wildtangent.com) has raised over $60 million in venture funding to build its platform and build game relationships with partners and customers including Coke, Sony and Toyota. Many of the company’s Figure Nine - Zona’s MMOG Video Game Industry Analysis March 11, 2005 has raised $4 million in VC funding in January 2003 from DigaComm and Crossbow Ventures. Webzen (webzen.co.kr) is a Korean company that is another leader in the online publishing space. Webzen is public (NASDAQ: WZEN) and has recently announced an expansion of its North American presence. It has a past record of success in Asia and recently was named the published for All Points Bulletin , which is an MMOG to be developed by David Jones, the creator of Grand Theft Auto NCSoft (ncsoft.net) is another Korean online publisher (it is a public sian companies are the leaders in online ublishin Video Game Industry Analysis March 11, 2005 Currency/Product Exchange Services Another sector of enabling services is exchange or auction services for goods of value within a game, for example a weapon, a suit of armor or such. Internet Gaming Entertainment Ltd., (IGE) (ige.com) is one company in the space and eBay (eBay.com) also has auctions running for http://www.ige.com/corporate.aspx?id=press&lang=en nabling Software is an emerging area where capital can make a difference or game “goods” is a new opportunity Video Game Industry Analysis March 11, 2005 Figure is sourced from the website of Kynogon, an AI software developer. Many of these pieces may be accomplished by the same software, and we do not mean for this graphic to be illustrative of the entire industry. Rather it highlights some of the components we will discuss. We believe that any of these areas which are critical to game play and offer software tools are an area of interest. Many of the participants in these sectors have been established for some time, but are private companies run by owner operators. The recent ure Ten - The Software components of games Source: Kynogon website Video Game Industry Analysis March 11, 2005 Alias (alias.com) is another leading company in the space, but like Discreet or Avid, does not likely offer an investment opportunity as it has significant investors in Accel-KKR and the Ontario Teacher’s Pension, who purchased a large stake in the company in 2004. There are, however, a number of smaller private companies in the space, such as Newtek (newtek.com), PixoLogic (zbrush.com), and SciTech Software (scitechsoft.com). The complexity of graphics has also created several “Best of Breed” point solutions. For example, IDV (idvinc.com) is a leading company in the space that focuses on software that aids the creation of trees. As other examples, Singular Inversions (facegen.com) a private Canadian company, has developed face shaping technology, as has Lifemode Interactive (lifemi.com). This large number of players and ragmented and diverse. Opportunities are abundant and a “one stop solution” provider may be welcomed by the market. Video Game Industry Analysis March 11, 2005 nabling Hardware is of interest, articularly as technology advances Video Game Industry Analysis March 11, 2005 are being asked to do more. For cell phones, this includes new functions such as image/video processing and compression. Given that trend, graphics or game processing may simply be an additional function for advanced cell phone chips. There are a number of companies in this sector and we believe the leaders who will emerge will be those that artners are appealing as chip size matters Video Game Industry Analysis March 11, 2005 developer platform for device manufacturers, but has not announced shipment of product. Nazomi (nazomi.com) is another fabless startup in this space. The company is backed by NEA and Redwood. Another VC funded company, which offers DSP solutions for multimedia applications in mobile devices is ChipWrights (chipwrights.com), which has been funded by BancBoston and Rock Maple Ventures, among others. Finally, NeoMagic (neomagic.com) is a public company (NASDAQ: NMGC) in the same sector, though it is trading at less than a dollar (as of 3/8/05). Several Asian companies also supply chips in this market, including Sunplus (sunplus.com) and Takumi (gshark.com). Conclusion Our goal in this report was to perform an analysis of the video game interest in order to find areas of opportunity for venture capital investors. We have developed an framework to use as a screen and have analyzed all the major sectors of the industry. In the end, we have found several areas that are likely to present investment opportunities: MMOG/Online Game Development Wireless Game Development and Publishing Communications and Messaging Tools Advertising and Content Services Online Platforms (Hosting and Publishing) Currency and Product Exchange Services Enabling Software (Developer Tools) Enabling Hardware (Multimedia Processors)