CD-ROM biz on the rebound

The entertainment side of the new media business grew up thanks largely to the venture capital industry, which funded many a startup company. In the early days — meaning three years ago — high-tech entertainment meant CD-ROMs. As low profit margins, limited shelf space and industry consolidation squeezed companies out of the CD-ROM biz, the money men turned their attention to the Internet.

Online brought the promise of commercial transactions and real-time gameplay. A year ago, venture capitalists were nearly unanimous in their writeoff of the CD-ROM business in favor of the Net.

However, with the World Wide Web slow to mature as a vehicle for either entertainment or commerce, the VCs — who in 1995 pumped $1.24 billion into software and information services companies — are backing off from investments in online companies.

Surprisingly, some investors are again looking favorably on the CD-ROM. Canaan Partners and U.S. Venture Partners, which invested $6 million in vidgame company Palladium several years ago, have teamed up with Scripps Ventures to infuse another $9 million into the Northern California company. Palladium’s titles include “Pyst,” a satire of the popular CD-ROM game “Myst”; “Family Gathering,” which allows users to trace their genealogy; “Wishbone and the Amazing Odyssey,” based on the PBS kids series; “Nine Worlds,” an astronomy title narrated by Patrick Stewart; and “Bears at Work,” a kids title based on a book by Gage Taylor.

Industry observers have applauded the Palladium investment, and some are acknowledging that the CD-ROM, given up for dead a year ago, may still prove a worthy investment.

“A lot of money is going into companies that are developing portable platforms,” said Mike Yocco, an analyst at Paul Kagan & Associates. “People are getting back into PC games.”

Yocco sees a resurgence in popularity for PC-based vidgames. “Even though there’s a tremendous flood of product that’s still out there, PC game sales are accounting for a large portion of overall revenues at companies like Electronic Arts and Activision.

“The online gaming industry is in turmoil right now,” he added. “There’s a lot of reluctance to develop strictly for an online project, especially when you look at the potential payoff for a CD product that can be ported to a dedicated platform.”

Venture capitalists agree with Yocco that online gaming hasn’t yet lived up to its potential. “Online gaming isn’t ready for the near term. Bandwidth problems aren’t solved, and functioning at 28.8 (bauds) is still slow. You need very deep pockets to have the staying power,” said David Johnston, a partner at Seattle venture capital firm Phoenix Partners.

“CD-ROM is still viable,” Johnston said. “It will migrate to DVD (digital videodisc).” Among companies in which Johnston has made investments is Cloud 9 Interactive, headed up by former Disney exec Debra Streicker-Fine.

“Debra is an exceptional manager and I like what she’s doing with the Learning Adventures series. But I also like the company’s contract work with branded characters, like Print Shop Studio and work for Marvel Comics. It’s tough for a VC to sit back and watch companies as they build, but have no revenues for a year. But it’s a completely different case with a company like Cloud 9, that has licensed product people recognize,” said Johnston.

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