IBIS Capital's Tim Merel
An investment bank director's views on the deals the industry is likely to see in the future
Tim Merel works with IBIS Capital, an investment bank focused on digital, media and communications. He is a corporate finance director with industry, investment banking, turnaround and growth experience across digital media, technology and telecommunications across Europe, North America and Asia Pacific for NewsCorp, Aegis Group and Ernst & Young.
His background is software engineering, law and business from Yale and the University of Sydney, and he is particularly focused on the videogames industry.
Q: From an investment perspective, what are the prevailing trends that you see?
Tim Merel: It's no secret that the big are getting bigger, the middle is getting squeezed and the small end holds a lot of potential. The scale of the videogames industry has been understood by most investors for a while, but the dynamics are changing incredibly quickly.
At the big end the major franchises are attracting increasing amounts of investment and generating increasing returns, but this doesn't come without risk. The gaming equivalent of Eddie Murphy's Pluto Nash ($100m cost, $4.4m revenue) is what scares the money men, so the risks of launching new franchises or making a mess of existing franchises becomes enormous.
The concern is that this end of the industry goes the same way as Hollywood, with accountants and lawyers running the show and the creatives and techs being managed like execution monkeys. Hopefully the majors are smart enough not to let this happen.
In the middle, where good-but-not-great games often lurk, the scale of blockbusters can't be matched in terms of investment. This can have an impact on game quality, although it doesn't have to, but definitely has an impact on marketing and distribution. The economics of this space have become increasingly challenged, so from an investment point of view what should be a lower risk investment actually becomes higher risk than a blockbuster franchise.
In other words, you invest less, but dollar for dollar the returns you are likely to see for the risk tend to be worse. This is part of the reason why many of the majors are concentrating on their big franchises to the exclusion of almost everything else. It is also driving many good independent studios out of business on a global basis, which I think is very sad for some excellent shops and for the industry generally.
At the small end, and I would include casual and mobile games here, there is a large investment opportunity which the investment community and the majors are increasingly recognising. Think of EA buying Playfish or Bigpoint being bought by GMT and the GE/NBC Universal Peacock fund. However, I don't think the investment model for this sector works fully yet, as many players in this space have very high valuations compared to relatively low revenues and profits.
I've seen companies where this is justified by high growth and substantial revenues, but others where I really struggle to understand why they are worth what someone is paying for them. The right balance between risk and reward in this part of the market hasn't yet been properly sorted by the majors or many in the investment community, which of course means that there is a real opportunity for those that do figure it out.
Q: So where do you see the investment opportunities?
Tim Merel: To state the obvious, the majors are doing exactly the right thing by investing in and acquiring big franchises. In the short-to-medium term that makes perfect sense, but in the long term I think they're going down a very risky path. If the gaming business is all about innovation and new unimagined gaming experiences driving growth, churning out the 25th incarnation of most franchises won't cut it. If the majors effectively become utilities, then they run the risk of becoming like traditional media companies. Cash generative, but declining and cost driven.
I think another opportunity for the majors is to add a new investment approach to everything which isn't obviously a big franchise. A little like the Time Warner Ventures model of making multiple early stage financial bets in related businesses, but applied specifically to gaming. So financial stakes are taken in multiple companies that look promising, where one of a small slate should give a big enough home run to pay for those that don't succeed ten times over. This model could be applied to casual gaming, mobile gaming, console games with smaller development budgets and innovative new approaches to gaming (like what ThatGameCompany is doing with their unusual games and a small Californian team).
The other area which I think is interesting is the commercialisation of gaming along the lines of the emerging Hollywood model. The best example I know of in Hollywood is the Transformers franchise, which I understand originated out of the corporate consulting division of one of the big Hollywood talent agencies: General Motors told the agency that they wanted a major vehicle (no pun intended) to help sell more cars.
The agency came up with the Transformers idea, with the following plan. First, get Michael Bay to sign up to a General Motors bankrolled film where he could film lots of explosions. Second, get Hasbro to provide the core franchise and co-invest for licensing and merchandising. Third, get the production and distribution studios. Fourth, take Michael Bay out to GM's secret prototype facility where he could pick the cars as the stars of the film (if you watch, you’ll see that the cars get more screen time than the actors, even Megan Fox!).
It was only at this stage that writers and actors were hired. The result is a 90-minute car ad which was the biggest box office smash of the year because of the marketing muscle behind it, and which is now a huge pan-media franchise in its own right. That said, it didn't really stop GM getting into difficulties...
I also like what the Spanish company Zed is doing with Planet51, where they have all the downstream capabilities (mobile gaming, MMO, console game etc) and have moved upstream into film to capture all the value themselves. There is still a lot of risk, but by leveraging it across multiple 100 per cent-owned revenue streams including gaming, the relative returns should be better.
However this doesn't always work, as with the Final Fantasy film (which I actually enjoyed despite its faults, both financial and otherwise). The major game companies are becoming equally commercial about how they develop new franchises to reduce the huge financial risks, and this is a potential way for them to match risk and reward better.
In the middle, the solution seems to be either dream outrageously big and take major risk capital (like RealtimeWorlds with APB), or get bought out by someone with the muscle to take on the majors. This could be one of the majors themselves, or one of the big media companies that is late to the gaming industry, but which brings significant brands, media and cash to the table. Otherwise I think this is an increasingly tough space to operate as an independent.
At the small end, it should be about doing things as quickly, cheaply and with as high quality as possible on tiny budgets. There is a huge community of small companies developing innovative casual and even console games in this space. So if you develop a console game for say $200,000, you could make it work economically by selling less than 100,000 units.
For the casual gaming portals like Spil, traffic isn't so much of a question as how to make money from it. I have never like the word "monetisation" as I don't know what it means (I prefer good, old-fashioned "sales"), but the casual games companies have had varying success in making their ad sales models work.
The exception that proves the rule is of course Bigpoint, where they offer the equivalent of PS2 quality games delivered via a web browser. The beauty of their model is that probably less than 1 per cent of their revenue comes from advertising, with most revenues coming from the sale of one-off virtual items/currency and subscription/premium monthly sales (there's that "sales" thing again). They're also really good at balancing those items you pay for so that they don't make the rest of the gaming experience weaker for the free players.
But then again Bigpoint isn't really small any more, which goes to show the value of its model for investors. This is really a consistent theme at the smaller end, as anything which has a Direct Debit or direct payment element (like iPhone apps) is much more investible and therefore more attractive for those looking to sell their companies for a good return.
Q: What do you think will be the successful funding routes for gaming?
Tim Merel: Investments in blockbuster franchises are already the preserve of public companies and mega-private equity, as nobody else has the muscle or can manage the risks. In terms of huge franchise exits, I suspect this means that we will see less of them.
Many of the medium sized studios are living on borrowed time, although the best will survive. Some will adapt to the changes in the industry by exiting to major gaming or media companies to become internal studios to develop franchises (either existing or based on media company brands), while others will go to the wall.
The JV model is also possible, but requires a lot of work from an advisory perspective to make happen. If you haven't navigated the space inside large corporates before, doing this by yourself is challenging. With the right advisor who understands what both you and the corporate need, this isn't easy but it is achievable.
Investment in this middle ground is only for the very brave - like the investors in Realtime Worlds - who are comfortable with the high risk and potentially high rewards. In the same way that financial investors have become increasingly uncomfortable with the hit driven film model, many are equally uncomfortable with the hit driven games model.
The serial nature of gaming development for independents (so develop one, commercialise it, then if it succeeds use the proceeds to develop the next one) scares the life out of most investors. If you have a flop, it's not easy to make your money back. I think there could be an opportunity here for investment in shops which develop platforms for parallel games development, both their own and that of third parties. So act as a Mecca for talent, acting like a kinder, friendlier mini-major. This should be easier to implement for medium-sized online players than traditional independents.
At the smaller end it's all still to play for, so I don't think anyone has the silver bullet here yet. My view is that bootstrapping is good for small teams, as the chances of raising VC money are slim. Angel investment is possible, but if you can do it yourself with your own money and make reasonable returns, there is no shame in not shooting for the moon.
In some ways this is like the very early days in the eighties when companies like SSG in Australia made good livings from their passion for games development, without necessarily walking away as multi-millionaires.
The model which I think holds great potential at the small end is the majors setting up dedicated investment funds (as opposed to the standard publisher model) to provide the capital required for development (effectively a VC 'A' round), then picking the best developments for significant marketing and distribution support as the equivalent of a 'B' or 'C' round. Basically gaming majors acting as corporate VCs like Intel Capital or SAP Ventures. Right now most aren't set up for it, but with the right people and approach there is a lot they could do here.
Q: And the bottom line - given the current economic climate, are you optimistic about the future of investment in gaming?
Tim Merel: I wouldn't be so focused on it if I wasn't!
Tim Merel is director at IBIS Capital. Interview by Phil Elliott.