Following in the footsteps of Square Enix's purchase of Eidos, Broadpoint AmTech analyst Ben Schachter thinks that Asian game companies are increasingly looking to the Western market for acquisitions. Schachter notes that the Asian gaming companies, particularly in China, are well capitalized and would like to expand in the U.S. and Europe.
He commented, "Compared with prior video game cycles, there is currently a relative abundance and diverse group of publicly-traded Asian video game firms operating across the continent, with the largest companies concentrated in China and Japan. During the past 10 years, investors have seen at least eight Asian online game companies (mostly in China) list their shares publicly for the first time, many on U.S. exchanges. The proceeds from these IPOs coupled with solid operating fundamentals (for some) and high profit margins (some Chinese online game operators have EBITDA margins in the 50-75% range) have left many of these companies with large net cash balances. We believe that several of these Asian companies are considering expanding/investing in Western markets, and thus represent potential acquirers for U.S. and European video game companies and publishers."
Schachter added, "It is important to note, however, that we have no knowledge of any specific discussions or pending transactions. Rather, we believe U.S. investors should be aware of the large levels of capital accumulating at many of these Asian companies, as well as the various factors that could serve as catalysts or obstacles to possible deals."
He notes that the major obstacles would be the cultural differences, business models that have worked there but are unproven here, and the fact that expanding/investing in the U.S. may be too expensive for some. On the other hand, Schachter also sees some possible synergies for Asian companies that wish to acquire Western game companies. The growth of social gaming over the last year in particular could lead to some interesting possibilities.
"Although still small in absolute terms, the market for social/casual-style games on platforms such as Facebook could provide an opportunity for Asian companies to leverage their experience in browser-based/PC gaming, while also introducing new game models to U.S. audiences (cultural differences will limit the synergies). Social games are often free-to-play at first, with consumers purchasing various game/character upgrades, typically via micro-transactions (a model that many of the Asian online game companies use in their core businesses)," Schachter pointed out.
So which companies are being targeted? Schachter believes THQ and Take-Two "represent the most likely public company acquisition targets for Asian game companies." THQ already partnered with Chinese online game operator Shanda Games to release an online version of Company of Heroes to the Chinese/Korean market sometime this year, and an online version of WWE is also in the works for the Korean market for the 2011 fiscal year. THQ's market cap is just $376 million, whereas Chinese operators like Netease and Shanda Games have market caps of $4.9 billion and $2.9 billion, respectively.
One obstacle that may make Chinese investors think twice about THQ, however, is its licensing reliance. "In FY'09, we believe that THQI generated 60%-70% of its revenues from licensed content (as opposed to wholly-owned intellectual property). Although THQI has some solid licenses (Nickelodeon, WWE, UFC, etc.), the possibility for complications due to any change of control provisions in these license agreements might dissuade potential acquirers," Schachter said.
As for Take-Two, the publisher's stable of IP might make it more appealing, but as Schachter describes, the GTA publisher has its own problems too: "In contrast to THQI, TTWO has a strong portfolio of wholly-owned IP franchises, most notably Grand Theft Auto, but also including BioShock, Max Payne, L.A. Noir, and Midnight Club, among others. Owned-IP titles have the potential to be much more profitable than licensed games, and while we believe this characteristic of TTWO's business makes it more appealing to acquirers, TTWO has plenty of other issues that could prevent a deal. TTWO's most critical issue in the near-term is its struggling Sports business (TTWO's unprofitable contract with the MLB contract is expected to expire in 2012). Even adjusting for Sports, TTWO has struggled to make money in any year without a major GTA release. However, we do note that TTWO's management is probably more open to a deal than most other management teams. Additionally, TTWO's management has more experience in Japan and working in the culture than any other western game company."
