The Way Things Work

Developers

Create/design the game Fund the developers Market the game Channel the game to the consumer

Publishers

Distributors
Platform Royalties PS2/Nintendo: Royalties for hardware and manufacturing Xbox: Royalties for hardware; manufacturing optional

Cyclical Camaraderie

1995 Playstation Nintendo 64 Handheld 0.6 1.2.0 2.0 1.4.6 4.4 2.7.2 4.1 3.6.0 3.6 7.3.2 2.6 6.9
2000 Playstation 2 GameCube Xbox Handheld

Source: NPD/UBS

2001 6.2 1.2 1.4 7.7

2002 8.6 2.3 3.2 7.0

2003E 9.7 2.5 3.5 7.5

2004E 7.5 2.0 3.5 8.0

2005E 5.5 1.5 3.0 9.0

1.1 6.9

Logistical Prowess
Industry Specific High supply vs. low demand
60-80% more SKUs compared to last year
Smaller packaging leads to more shelf space Publishing has higher margins than distribution PC games have higher margins than console games Firms set aside reserves of around 20% for returns/underselling Company Specific 75% of sales are sequels or expansions 60-65% publishing / 35-40% distribution
Sneaking Around The Neighborhood
Market Capitalization Electronic Arts Take Two Activision THQ Eidos Atari Midway ERTS TTWO ATVI THQI EIDSY ATAR MWY 13.96B 1.55B 1.07B 616.33M 349.38M 303.36M 145.84M P/E 42.34 16.16 26.60 89.22 N/A 8.12 N/A

In A League Of Their Own

The Untouchables Sony
Playstation, Playstation 2 Developer & Publisher Xbox & PC Developer & Publisher GameCube, GameBoy, GameBoy Advance Developer & Publisher

Microsoft

Nintendo
The Lost One Vivendi Games Potentially top tier gaming company Potent franchises: Half-Life, Counter-Strike, Warcraft/Starcraft
Sales By Geography & Platform

64.50% 7.80%

64.31%
9.50% 2.00% 16.10% 6.84% 2.55% 4.16% 10.15%

5.80% 6.19%

United States

Canada

Europe

GameBoy

GameCube

Grand Theft Market Share

#1 Selling Game of 2001: Grand Theft Auto III

8.5 million copies

#1 Selling Game of 2002: Grand Theft Auto: Vice City

9 million copies

Grand Theft Bundle Pack for PS2/Xbox coming up Grand Theft Auto in Japan Grand Theft Auto 4 in October 04

Anatomy Of A Company

Three Primary Divisions Rockstar Games (Mostly proprietery)
Gathering (More outside developers)
Mafia Hidden & Dangerous Chrome
Grand Theft Auto Max Payne Midnight Club Manhunt State of Emergency
Gotham Games (Mainstream/budget)
Conflict Desert Storm Celebrity Deathmatch

Welcome To The Family

TDK Mediactive (2003/$22.3M) Frog City (2003/$3.6M)
PopTop Software (2000/$5.8M)
Tropico developer Access to Mac market Midnight Club
Railroad Tycoon developer
Destineer Games (2003/$6.7M)
Angel Studios (2002/$40.1M)
Gathering of Developers (1999/$10.4) Max Payne (2002/$28M) Duke Nukem (2000/$7.7M) Next: Vivendi Games?
Barking Dog Studios (2002/$7.6M) Techcorp Limited (2001/$0.6M)
HK firm that designs accessories

Full Service Packaging

Acquiring TDK Mediactive for $22.7M
FY02 Sales: $42.4M FY02 EPS: ($0.36)
Access to mass market gaming Access to decent franchises
Shrek The Muppets Pirates of the Caribbean Star Trek

No internal studios

On The Horizon
Max Payne 2 (PC) GTA Double Pack (PS2) Grand Theft Auto III (Japan) Hidden & Dangerous 2 (PC) Conflict Desert Storm 2 (PS2) Railroad Tycoon 3 (PC) Starsky & Hutch (All) MTV Celebrity Deathmatch Chrome (PC)
Max Payne 2 (PS2/Xbox) Manhunt (PS2) GTA Double Pack (Xbox) Mafia (PS2, Xbox)
Duke Nukem Forever (PC) Grand Theft Auto 4 (PS2)

Always A Risky Business

Failure of a hit game will result in disaster Console software demand is slowing Few titles lead to most revenues Overwhelming dependence on the Playstation 2
Only because thats where the market is Duke Nukem Forever in production for forever Being sued for shooting rampage by teens in UK
Delays in hit game productions

Legal controversy

Financial Highlights
Q303 Revenue ($156M) up 27% YoY
Publishing: $93M / 9% YoY Distribution: $62M / 69% YoY
Net Margin increase from 7.0% to 9.8% (LTM) DSO decreased to 38 from 48 (LTM) Virtually no debt $225M in cash
Free Cash Flow To Equity (FCFE)
Risk Premium Beta (via Bloomberg; 2 yrs vs. S&P) 30 Year Bond Cost of Equity Assumed HyperGrowth Rate Assumed Stable Growth Rate 4.77% 1.33 5.07% 11.41% 15.00% 4.50%

Worth The Hype?

Intrinsic Value (w/o R&D) Intrinsic Value (w/ R&D) Current Share Price Upside Potential $38.41 $42.05 $36.07 14.22%

Techniques For Survival

One solid title a year
Sequels/expansions are usually guaranteed moneymakers
Developers under multiple platforms Distribution deals overseas Quality control Plenty of luck

The Recommendation

Long-Term Short-Term Buy Price Target Price Buy Buy $34 $40