Hostile Waters

"Further transactions seem inevitable" was my conclusion when Activision and Vivendi merged to create new super-publisher Activision Blizzard last December - although it hardly took psychic powers to recognise that the industry was facing into a time of serious, high-level consolidation.

Few people, however, expected that the next major move would come as early as this February - or that it would come courtesy of Electronic Arts, fresh from the $620 million acquisition of Bioware and Pandemic but still in fighting form and ready for round two.

Activision Blizzard's merger, of course, sets the backdrop for this deal. While, according to EA boss John Riccitiello, the possible merger of the two firms was already on the table a year ago, there's little doubt that the emergence of a new publishing superpower is at the back of EA executives' minds when considering this deal. Moreover, the same macro factors in the market which drove the Activision Blizzard deal are still as true now as they were last year, and every bit as relevant to EA and Take-Two as they were to Activision and Vivendi Games.

This is an industry ripe with potential for acquisitions - both the friendly boardroom type, and the hostile stock market type. As games increasingly demonstrate their power as media properties and as media corporations in other sectors watch viewers trickle away from movies and TV, games companies are increasingly on the radar of vast corporations such as Viacom, Disney and News Corporation.

For leading games firms such as Electronic Arts, this is a frightening prospect. It may be an 800 pound gorilla in videogames, but it's still much smaller than the world's huge media corporations - arguably small enough to be an acquisition target, and certainly small enough to be at risk from the kind of competition that would be created by a large media conglomerate hoovering up smaller, cheaper games industry firms. Acquisitions are one key way to muscle up - denying potential rivals of easy entry points to games, and bulking up EA's own portfolio into the bargain.

Smaller firms, too, are feeling the squeeze. As the industry's budgets grow - be they development budgets, hiring budgets or marketing budgets - it's increasingly hard for small publishers to compete properly with their larger rivals. One of the only solutions available to them is to merge with another - or to face being bought out by a bigger rival. The alternative may well be simply to fall by the wayside, unable to play an active role in a market that's simply priced itself beyond their means.

Merging Traffic

As such, it's not hard to see why EA is in an acquisitive mood. The firm's re-organisation into labels has seemingly been designed from the ground up by Riccitiello to accommodate acquisitions more effectively than EA was previously capable of managing - it can't have escaped EA's own executives, after all, that it bears the unfortunate reputation of killing almost every studio it's ever purchased. Bioware and Pandemic, the company clearly believes, are working examples of this new policy in progress; successfully acquired and slotted into the label model in an incredibly short space of time.

Now EA is hungry for more, and there's no question that Take-Two is a logical second course for the publisher. It is, after all, a smaller publisher with a number of superb key franchises and a few well-established publishing brands such as Rockstar - which would, in theory, fit seamlessly with EA's label model. Indeed, Riccitiello acknowledges that Sam Houser's structure for Rockstar was a key inspiration for EA's own new internal structure, which certainly implies a good fit.

What makes this such an attractive prospect for EA isn't just the upsides to Take Two's portfolio and performance, though. It's also the company's significant downsides - ranging from the cloud that still hangs over its head in the wake of its run-ins with the SEC in recent years, through to its greatest bugbear of all, the inability to shake investors' perceptions that it is simply "the GTA company". Despite the success of a number of other franchises, Take Two's other products are still seen by the markets as snacks between GTA iterations, and it's likely that any sign of GTA faltering will be greeted with a collapse in share price.

Those problems would, of course, simply go away as part of the EA structure. Nobody can criticise Electronic Arts' corporate governance in recent years, and concerns over Take-Two's management in the wake of SEC investigations and financial impropriety would be meaningless if its brands became EA labels. GTA, meanwhile, would certainly be a heavy hitter even on EA's slate, but it would be easily balanced out be the firm's other huge franchises - an influence on the ERTS stock, but not the primary factor in the stock's value, as it has been for TTWO.

No matter how much you dislike the much-maligned word "synergies", it obviously applies strongly to this case. Electronic Arts wants to get bigger - it wants scale, it wants revenue and it wants to own IP. Take-Two, meanwhile, is faced with a seriously rocky future on the stock market, with investors liable to bail at the first hint that GTA IV isn't selling up to expectations, or that subsequent sequels may not be well received. A major owned IP, a hugely risky stock and an increasingly bearish market all spell acquisition (or, pessimistically, disaster) for Take-Two - and a good fit with another game publisher may well be better for everyone involved than a takeover by a media corporation seeking to buy into the market.

Which raises the question - why has Take-Two said no? It first refused to negotiate with EA in January, then refused a $25 offer on February 15th before finally refusing the current $26 offer last Friday. The company's stated reason is that it wants to wait for the launch of GTA IV before entertaining any discussions - presumably in the hope, or belief, that it can drive a better bargain out of EA at that point.

Hard Bargain

Two factors contribute to that belief. Firstly, Take-Two's management may feel that GTA IV is going to outperform expectations, driving its stock price upwards and forcing a better deal from EA. Secondly, the firm may be hoping that further bidders will enter the fray - although few market analysts see that as a realistic expectation at this point in time, and it's probably worth discounting it entirely.

This boils down, then, to simple haggling over value. Take-Two's management believes that there is growth potential in its shares in the coming months which would force EA's bid upwards. Electronic Arts, by taking the aggressive step of opening this bid up publicly to TTWO shareholders, is betting that they don't share the same optimism.

EA almost certainly has a point, and it's tough to see Take-Two shareholders refusing the offer that's been placed before them. By refusing this offer, they're essentially betting that GTA IV will outperform expectations, and that in the wake of that performance, EA (or another bidder) will be prepared to pay an even higher premium for Take-Two - or, indeed, that the uplift to Take-Two's shares will somehow be continued even through the relatively tough GTA-less quarters that will follow. It's an exceptionally risky gamble, and not one that any sensible investor is going to want to take.

Electronic Arts' own intervention, too, makes a big difference at this point. By announcing its interest, it has driven TTWO's value upwards - and it won't have escaped the notice of investors that its new value now incorporates both the expectation of a takeover and the anticipated performance of Take-Two's biggest game in a very long time. Even at that, EA is still offering a premium for the stock. Consider the likelihood that the stock will collapse badly should EA withdraw its interest, or GTA IV fail to meet market expectations (or, indeed, both), and the ability to cash out at a profit will be hugely appealing to shareholders.

The question, really, is not whether this deal has legs - it's how much of a fight Take-Two's management plan to put up. It's unlikely that they'll squeeze a significantly better deal out of EA, and even more unlikely that another suitor will enter the ring. A fine line is being walked here - while EA claims that it's not considering any other similar purchases at present, it's still entirely possible that the firm could drop its acquisition plans entirely if Take-Two's management manages to find a way to mount serious resistance. That wouldn't be a great situation for Take-Two's managers either, of course - they'd open themselves to the serious risk of another shareholder revolt or class action suits if they scared off a suitor who was genuinely offering a good deal.

The rest of the industry, meanwhile, will watch with interest to see how this deal proceeds. It stands to become yet another landmark in games industry consolidation, and a further stark warning to the industry's small and mid-level publishers - this business is growing increasingly hostile to those without significant scale to back them up. Specialisation is one route that's open to smaller firms, but for the majority of game publishers, even those up to the size of Take-Two, mergers and acquisitions are the only safe path to a secured future. Whatever way the EA / Take Two deal goes, my earlier prediction stands - further transactions seem inevitable.

The following is a collection of links to all of the GamesIndustry.biz coverage of this story so far:

EA will succeed

Screen Digest analyst Ed Barton says that the premium and importance of scaling indicate EA's Take-Two bid will win out.

Houser inspired new EA structure

EA has held up Rockstar as one of the models for its label organisation.

Riccitiello pulled plug on prior deal

Transaction would have gone forward last April, but EA structure wasn't ready.

Synergies will benefit Take-Two

EA thinks it can help the company sell more games.

EA waited until GTA IV was complete

Says it wanted to ensure that proposal did not disrupt development.

Take-Two willing to negotiate

Calls EA's offer opportunistic and insufficient.

Sports games may justify purchase

Analyst Michael Pachter thinks eliminating competition in the sports genre is impetus for EA's offer.