Last month I looked at GTA developer DMA Design and its pinball ownership history. Continuing the Extreme M&A series I want to take a look back at another industry-defining case study. However, this one comprises a transaction which actually failed to complete and which, in contrast to the DMA transactions, highlights the limited vision of the industry and what was possibly its greatest missed opportunity.
In 2002, a troubled Vivendi, under intense pressure from the stock market, put its Vivendi Universal Games division (Sierra Games, Universal Interactive and Blizzard) up for sale. Vivendi was selling a number of its business units to reduce its $37bn of debt and get rid of some of its more burdensome “non-core” subsidiaries. It initially valued VUG at a lofty $1.6bn. VUG’s sales and operating profits were $696m and $19m respectively in 2001 and hit $842m and $67m in 2002. VUG was the sixth largest games publisher in the world (the no.2 PC publisher). Its games properties included PC franchises Starcraft, Warcraft and Diablo, the 12m user network games service Battle.net and console hits Spyro and Crash Bandicoot. World of Warcraft had been announced in 2001 and was on track for its 2004 release. VUG also had the rights to a number of major licenses including The Lord of the Rings, The Hulk and The Simpsons and was unique amongst western publishers in having a foothold in the nascent Asian games market.
However, over the course of the following year VUG’s valuation plummeted, purportedly bottoming out at $800m. Although numerous interested parties had conducted due diligence on VUG, few formal bids were thought to have been submitted and none that reached Vivendi’s minimum $800m let alone $1.6bn. In the mean time, and as a direct result of its increasingly unwanted status, VUG was facing an exodus of key staff from its European and American offices, including several senior Blizzard staffers. Rather than let the business go for a pittance, Vivendi decided to stop the sale proceedings and rebuild VUG’s battered corporate ego.
And what a decision that was. Since then, and largely thanks to the phenomenal success of World of Warcraft, Vivendi’s games division has generated over $3.5bn, currently has the highest profit margins and is the fastest growing publisher amongst the top 10. So why on earth couldn’t Vivendi sell it in 2003?
Nobody, not even Vivendi nor the senior Blizzard staff that left to form Flagship Studios, anticipated the level of success recorded by WoW. However some of VUG’s suitors reportedly had actually discounted WoW’s potential, even ascribing it a neutral or negative valuation (no doubt influenced by the massive investment in WoW’s development). Few of the suitors had any experience of the MMOG market and worse, many exhibited deep scepticism about the MMOG market. Perhaps, due to a fear of the unknown, they obstinately held onto the view that the market was saturated despite the contradictory evidence of many years’ consistent and strong market growth.
However there also appeared to be concerns about VUG’s core publishing business and the impact of such a protracted sale process. VUG was unusually weighted towards the PC, a market of diminishing retail value but it also ended up facing a general product shortfall in 2003 and, as a result, the group recorded a 28% revenue decline and losses. Companies often underestimate the impact of M&A (and fund-raising) efforts on their ongoing business. Valuation enhancement strategies prioritising short-term profit over long-term growth, distracted senior staff, middle management departures and uncertainty for everyone else – all took their toll and highlight how important well-prepared, quick and efficient transaction processes are.
The VUG sale also demonstrates the difficulty of determining the true value of a business. Especially when faced with novel and higher risk/reward business models, it is often easier to become risk averse and focus on short-term costs rather than longer-term potential. With a new wave of interest in games companies from other media industries and with network technology continuing to push the industry in unexpected new directions, it is likely that unease about, and an ignorance of, market change will continue to result in the sort of mistakes made by VUG’s suitors being repeated.