Joystick envy

Vidgame boom has private investors lining up

The billions of dollars from private equity that have flooded the film industry in the past several years are finding a new target: videogames.

As these investor behemoths continue to look for attractive targets, they’re overcoming previous biases that vidgames are a niche for nerds. Double-digit growth rates in sales this year, driven by the launch of the Wii, Xbox 360 and Playstation 3, don’t hurt.

“In film, if you have a large enough portfolio, you have a return characteristic that’s steadier than videogames, but with a lower upside,” observes Thomas Tull, chairman of Legendary Pictures and co-founder of Brash Entertainment, a new private equity-backed videogame publisher.

“Videogames are a little more volatile, but there’s much more upside and the opportunity to build a whole company. The potential multiples are very interesting.”

Tull isn’t the only one who’s intrigued. The vidgame biz now has five such significant companies, most founded this year, backed by hundreds of millions of private equity:

  • Brash is backed by $400 million, much of it from investors who also put money into Legendary. It is publishing games exclusively based on movie, TV and music licenses and has a distribution deal with Warner Bros. Home Video.

  • British publisher Codemasters was recently bought out by venture capital firm Benchmark and received a $100 million investment from Goldman Sachs.

  • Gamecock came out of the gate earlier this year and is making a slate of original games, backed by $100 million from private investors.

  • In late 2005, two of the biggest indie developers, Bioware and Pandemic, were merged by private equity firm Elevation Partners and backed an investment of $300 million.

  • Foundation 9 Entertainment, a collection of videogame developers, last year received a commitment of up to $150 million from Francisco Partners.

Industryites say several other venture- or private equity-backed game companies are already being formed, and much more money is expected in the next year or two.

“Other sectors of the media business are under pressure and looking for new ways to grow,” observes Bret Pearlman, a partner in Elevation who’s closely involved in Bioware/Pandemic. “But videogames are still, at their core, a growth business.”

Putting private money into the videogame space isn’t as simple as into the film sphere, though, where funds are typically co-financing movies already being made by traditional studios. Instead, investors are putting their money into privately held publishers and developers. They’re rare in the vidgame biz, where all the biggest publishers are public companies and most successful developers are owned by publishers.

That means privately funded, independent publishershave to operate differently. Despite the hundreds of millions behind them, companies like Brash and Gamecock don’t have the resources of an Electronic Arts or an Activision. Brash has 50 employees; Gamecock is building up to 20. EA boasts 8,000.

As a result, these indie players outsource most or all of the activities that traditional publishers do inhouse, from marketing to distribution to, most notably, production. They essentially act as financing intermediaries that greenlight games, control costs and oversee their production at independent developers.

Gamecock, in particular, is attempting to upend the traditional model. Rather than build a “balanced” portfolio with licensed properties, franchise sequels and a few risky original games, it is working entirely on new properties, including the politically charged party game “Hail to the Chimp,” and trying to spend significantly less than the $20 million and more many publishers are spending on their biggest releases.

“The first ‘Halo’ cost under $5 million at a time when most games cost between $10 million and $15 million,” says Gamecock topper Mike Wilson. “When big public publishers get involved and need something bigger and better on a deadline, you get a huge budget and make the worst choices.”

While indie publishers are smaller than their competitors, indie developers are actually bigger than their brethren. By the time they’re successful enough to have $100 million or more in the bank, most developers get bought by a major publisher.

In order to succeed against inhouse developers, who typically get plum assignments on the most valuable franchises, indie developers are trying to mix simple “work for hire” projects with internally developed properties that they partially finance and find a publisher to distribute.

Like a lot of studios, publishers are eager to take on well-made games in order to better monetize their marketing and distribution departments. And they particularly like developers with their own capital. While indie developers have traditionally had to pitch publishers in the hopes they would get financing — like a producer without a studio deal — Bioware/Pandemic and Foundation 9 are more akin to a New Regency or DreamWorks Animation, which simply need a studio to distribute movies they finance themselves.

“We have the capital we need to self-fund our games, so we don’t ask a publisher whether they can provide funding, but rather, what strengths they have to help us bring the game to market,” says Bioware/Pandemic CEO Greg Richardson. His company moved its hit game “Mercenaries” from LucasArts to EA for a sequel coming out this year.

Nevertheless, it’s no coincidence Foundation 9 and Bioware/Pandemic are both collectives of multiple developers with numerous projects going on at once.

“The key word for us is ‘portfolio,’ ” says Foundation 9 topper Jon Goldman. “That allows us to predict our returns much better than a team working on one or two games, and to then make some bets on original properties. These latter are less than 10% of our portfolio, but when they take off, they are much more than 10% of our returns.”

Unlike the big publishers, which are ideally looking for franchises that can produce sequels as often as every year, most indie game companies cite examples like “300” and “Guitar Hero,” the movie and game franchises, respectively, that upended their industries by becoming huge hits on relatively small budgets.

While the vidgame biz will always want titles like “Halo 3” that cost upwards of $25 million, they argue strongly that there’s room for more innovative games that cost less, particularly if they’re made by indie developers not micromanaged by a big publisher.

Call it the “Miramax” theory of videogames.

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