2009 Interactive Industry Report - 2009.06.29

LOS ANGELES | SAN FRANCISCO | NEW YORK | BOSTON | SEATTLE
Industry Report
Entertainment Software Publishing and Retail

INDUSTRY REPORT
July 2009
Money for Nothing

How Ancillary Revenues Can Extend The Console Cycle
Entertainment Software Publishing and Retail
We expect favorable industry dynamics over the next several years to provide the foundation for entertainment software
publishers to grow revenues by nearly 10% per year, with the top publishers realizing a much higher rate of earnings growth
during this period. In this report, we analyze the fundamentals of the interactive entertainment industry and detail our criteria and
methodology for identifying its champions.
Michael Pachter Edward Woo, CFA

(213) 688-4474 (213) 688-4382
michael.pachter@wedbush.com edward.woo@wedbush.com
Wedbush Morgan does and seeks to do business with companies covered in its research reports. Thus,
investors should be aware that the firm may have a conflict of interest that could affect the objectivity of
this report. Investors should consider this report as only a single factor in making their investment
decision. Please see page 206 of this report for analyst certification and important disclosure information.
ACKNOWLEDGEMENT
We thank our good friend, Junkwaffle, for the fabulous cover art and for demonstrating that there is
tremendous value to entertainment that is digitally delivered, even though it is intangible and nearly
impossible to trade in at GameStop.
We also thank the folks at GameTrailers.com and especially at GameTrailers TV for giving us many of the
ideas discussed in this report.
It is important to acknowledge the contribution from media sites IndustryGamers.com, Edge-Online,

Kotaku.com, bitmob.com, VentureBeat.com, gamesindustry.biz, eurogamer.net and gamasutra.com for
keeping us on our toes and always asking us to think about the industry in real-time.
Finally, we feel we must call out NeoGAF.com and its members, for challenging virtually everything we say
as being wrong, and for making us re-think many positions over the years.
i Interactive Entertainment Industry Report Michael Pachter (213) 688-4474

Edward Woo, CFA (213) 688-4382
TABLE OF FIGURES......................................................................................................................................5
EXECUTIVE SUMMARY.................................................................................................................................7
DEFINING THE INDUSTRY ..........................................................................................................................17
INDUSTRY SIZE: THE ADDRESSABLE MARKET OPPORTUNITY...........................................................21
GEOGRAPHIC MARKETS................................................................................................................21
HARDWARE AND SOFTWARE SALES SPLIT ................................................................................23
SOFTWARE VS. OTHER ENTERTAINMENT SECTORS ................................................................23
DEMOGRAPHIC TRENDS............................................................................................................................26
WIDENING AGE DEMOGRAPHIC ...................................................................................................26
RAPID TEEN GROWTH....................................................................................................................28
FEMALE MARKET ............................................................................................................................28
INCREASING YOUTH INCOME .......................................................................................................28
HARDWARE PLATFORMS ..........................................................................................................................30
HOME CONSOLES...........................................................................................................................31
WHY THIS IS LIKELY THE LAST CONSOLE CYCLE ......................................................................49
HANDHELD, PORTABLE AND MOBILE CONSOLES......................................................................52
MONEY FOR NOTHING ...............................................................................................................................59
ONLIVE COULD CHANGE THE LANDSCAPE.................................................................................61
THERE MAY NOT BE ANOTHER CONSOLE CYCLE (BUT LOTS AND LOTS OF CONSOLE
SKUS) ...............................................................................................................................................62
DIGITAL DOWNLOADS ARE HERE AND NOW ..............................................................................64
THE WII PLUS (HD) IS COMING (EVENTUALLY) ...........................................................................65
THE XBOX 360 COULD END UP A WINNER, EVEN IN THIRD PLACE..........................................67
THE NEW, DIGITAL PSP IS NOT QUITE DEAD, YET, (OR IS IT?).................................................69
THE NEW DSI WILL ADVANCE THE BRAND..................................................................................69
BLIZZARD IS THE PRESENT AND FUTURE OF ONLINE GAMING...............................................70
IN-GAME ADVERTISING IS NOT A BIG DEAL ................................................................................73
DIGITAL DOWNLOADS WILL LIMIT GAMESTOP’S GROWTH.......................................................75
FREE-TO-PLAY GAMES HAVE POTENTIAL...................................................................................79
MOBILE PHONE GAMES ARE A FAD .............................................................................................80
POST SCRIPT—LESSONS NOT LEARNED FROM THE LAST CONSOLE CYCLE.......................81
CONCLUSION ..................................................................................................................................82
INDUSTRY CONSOLIDATION .....................................................................................................................83
M&A DOESN’T MAKE SENSE..........................................................................................................83
COMPETITION FROM MEDIA COMPANIES DOESN’T MAKE SENSE ..........................................84
Michael Pachter (213) 688-4474 Interactive Entertainment Industry Report 1

VIDEO GAME HARDWARE FORECAST .....................................................................................................89
PERSONAL COMPUTER VIDEO GAMES........................................................................................95
SOFTWARE ECONOMICS ...........................................................................................................................97
RETAIL PRICING TRENDS...............................................................................................................97
PRODUCTION COSTS ...................................................................................................................101
SOFTWARE GENRES ................................................................................................................................106
CONTENT OVERVIEW ...............................................................................................................................115
BRAND ............................................................................................................................................115
GAME PLAY ....................................................................................................................................117
GENRE ............................................................................................................................................117
TARGET DEMOGRAPHIC ..............................................................................................................120
“BUZZ” .............................................................................................................................................123
CONCLUSION.................................................................................................................................123
SOFTWARE GROWTH FORECAST ..........................................................................................................124
INVESTING IN SOFTWARE PUBLISHERS................................................................................................131
INDUSTRY PRICE PERFORMANCE..........................................................................................................132
HISTORICAL INDUSTRY RETURNS..............................................................................................132
REVENUE SIZE AND GROWTH.................................................................................................................134
COMPANY STRATEGIES...........................................................................................................................136
PLATFORM FOCUS........................................................................................................................136
DEVELOPMENT ASSETS...............................................................................................................139
DEVELOPMENT SYNERGIES........................................................................................................140
THIRD-PARTY DISTRIBUTION ......................................................................................................141
GEOGRAPHIC DISPERSION OF REVENUES...............................................................................141
ONLINE STRATEGIES....................................................................................................................142
INTELLECTUAL PROPERTY STRATEGIES ..................................................................................143
CONTENT COMPARISON ..........................................................................................................................148
BRAND BUILDING ..........................................................................................................................148
TOP BRANDS OF 2008 ..................................................................................................................148
TOP BRANDS BY COMPANY.........................................................................................................149
ACCOUNTING ISSUES...............................................................................................................................152
CAPITALIZED SOFTWARE DEVELOPMENT AND PREPAID ROYALTIES ..................................152
RESERVES .....................................................................................................................................154
UPSTARTS AND STARTUPS.....................................................................................................................156
2 Interactive Entertainment Industry Report Michael Pachter (213) 688-4474

COVERED PUBLICLY TRADED INTERACTIVE ENTERTAINMENT COMPANIES ................................. 158
ACTIVISION BLIZZARD (ATVI) ...................................................................................................... 159
ELECTRONIC ARTS (ERTS).......................................................................................................... 162
MAJESCO ENTERTAINMENT (COOL) .......................................................................................... 165
MIDWAY GAMES (MWYGQ) .......................................................................................................... 168
NINTENDO (7974.JP / NTDOY.US)................................................................................................ 171
TAKE-TWO INTERACTIVE SOFTWARE (TTWO).......................................................................... 174
THQ (THQI)..................................................................................................................................... 177
UBISOFT ENTERTAINMENT (UBI.FP)........................................................................................... 180
BEST BUY (BBY) ............................................................................................................................ 183
BLOCKBUSTER (BBI)..................................................................................................................... 186
GAMESTOP (GME) ........................................................................................................................ 189
OTHER RELATED INTERACTIVE ENTERTAINMENT COMPANIES ....................................................... 192
CAPCOM (9697.JP) ........................................................................................................................ 193
GAMELOFT (GFT.FP)..................................................................................................................... 193
GIANT INTERACTIVE GROUP (GA) .............................................................................................. 194
GLU MOBILE (GLUU) ..................................................................................................................... 194
GRAVITY (GRVY) ........................................................................................................................... 195
KONAMI (KNM)...............................................................................................................................195
MAD CATZ INTERACTIVE (MCZ) .................................................................................................. 196
MICROSOFT (MSFT)...................................................................................................................... 196
NAMCO BANDAI HOLDINGS (7832.JP)......................................................................................... 197
NCSOFT (036570.KS) .................................................................................................................... 197
NETEASE.COM (NTES) ................................................................................................................. 198
PERFECT WORLD (PWRD) ........................................................................................................... 198
PLAYLOGIC ENTERTAINMENT (PLGC)........................................................................................ 199
SEGA SAMMY (SGAMY) ................................................................................................................ 199
SHANDA INTERACTIVE ENTERTAINMENT (SNDA) .................................................................... 200
SONY (SNE) ................................................................................................................................... 200
SOUTHPEAK INTERACTIVE (SOPK) ............................................................................................ 201
SQUARE ENIX (9684.JP) ............................................................................................................... 201
TECMO KOEI HOLDINGS (3635.JP).............................................................................................. 202
THE9 LIMITED (NCTY) ................................................................................................................... 202
TIME WARNER (TWX).................................................................................................................... 203
VIVENDI (VIV.FP) ........................................................................................................................... 203

WALT DISNEY (DIS) .......................................................................................................................204
WEBZEN (WZEN) ...........................................................................................................................204

TABLE OF FIGURES
Figure 1—Top 20 Entertainment Software Publishers - U.S. Retail Sales 2007 – 2008 ($ millions) .....18
Figure 2—U.S. Retailer Console and PC Software Market Share 2007 – 2008 .......................................20
Figure 3—Worldwide Interactive Entertainment Sales 2004 – 2011E ($ millions)..................................22
Figure 4—Addressable Market for U.S. Software Publishers 2004 – 2011E ($ millions) .......................23
Figure 5—U.S. Entertainment Sectors 2003 – 2008 ($ billions) ...............................................................24
Figure 6—Primary Video Gamer by Age and Gender ...............................................................................29
Figure 7—2008 Video Game Software Sales Market Share by Platform Type........................................30
Figure 8—U.S. Console Cycles and Hardware Launches ........................................................................33
Figure 9—U.S. Cumulative Hardware Unit Sales ......................................................................................34
Figure 10—U.S. Annual Hardware Unit Sales ...........................................................................................36
Figure 11—U.S. Software Sales by Platform .............................................................................................38
Figure 12—Console Installed Base (U.S. and Europe) .............................................................................39
Figure 13—Console Installed Base (Worldwide) ......................................................................................40
Figure 14—Sony PlayStation 2 Unit Sales (2000 – 2011E) .......................................................................41
Figure 15—Nintendo GameCube Unit Sales (2001 – 2008) ......................................................................43
Figure 16—Microsoft Xbox Unit Sales (2001 – 2007)................................................................................44
Figure 17—Microsoft Xbox 360 Unit Sales (2005 – 2011E) ......................................................................45
Figure 18—Sony PS3 Unit Sales (2006 – 2011E).......................................................................................47
Figure 19—Nintendo Wii Unit Sales (2006 – 2011E) .................................................................................48
Figure 20—Nintendo Game Boy Advance Unit Sales (2001 – 2008)........................................................53
Figure 21—Nintendo DS Unit Sales (2004 – 2011E)..................................................................................54
Figure 22—Sony PSP Unit Sales (2004 – 2011E) ......................................................................................56
Figure 23—U.S. Console Price History ......................................................................................................58
Figure 24—Average U.S. Console Ownership by Household ..................................................................89
Figure 25—Console Unit Sales U.S. and Europe (2004 – 2011E) ............................................................91
Figure 26—Console Unit Sales Japan and Worldwide (2004 – 2011E) ...................................................92
Figure 27—Console Dollar Sales U.S. and Europe (2004 – 2011E) .........................................................93
Figure 28—Console Dollar Sales Japan and Worldwide (2004 – 2011E) ................................................94
Figure 29—PC Entertainment Software Sales (2004 – 2011E) .................................................................95
Figure 30—Average U.S. Retail Software Price by Platform ....................................................................97
Figure 31—Sample Gross Margin Calculation ........................................................................................ 105
Figure 32—U.S. Video Game Software Market by Genre ....................................................................... 106
Figure 33—U.S. Top Video Game Software - Strategy/Role Playing Games ........................................ 107
Figure 34—U.S. Top Video Game Software - Sports/Extreme Sports ................................................... 109
Figure 35—U.S. Top Video Game Software - Action/Shooter ................................................................ 111
Figure 36—U.S. Top Video Game Software - Racing.............................................................................. 112
Figure 37—U.S. Top Video Game Software - Fighting/Simulations ...................................................... 113
Figure 38—U.S. Top Video Game Software – Family/Children/Other.................................................... 114
Figure 39—Percentage of U.S. Publishing Sales by Genre (2008) ........................................................ 118
Figure 40—Percentage of U.S. Console Software Genre Sales by ESRB Rating (2008) ..................... 121
Figure 41—Percentage of U.S. Console Software Publisher Sales by Ratings (2008) ........................ 121
Figure 42—Percentage of Total U.S. Console Software Sales by Rating ............................................. 122
Figure 43—Worldwide Interactive Entertainment Software Sales (2004 – 2011E) ............................... 124
Figure 44—Software Unit Sales U.S. and Europe (2004 – 2011E) ......................................................... 126
Figure 45—Software Unit Sales Japan and Worldwide (2004 – 2011E) ................................................ 127
Figure 46—Software Dollar Sales U.S. and Europe (2004 – 2011E) ...................................................... 128
Figure 47—Software Dollar Sales Japan and Worldwide (2004 – 2011E) ............................................. 129
Figure 48—Key U.S. Publicly-Traded Interactive Entertainment Software Publishers........................ 131

Figure 49—Industry Stock Performance (1996 – 2009) ..........................................................................133
Figure 50—Publishing Revenues 2005 – 2008 ($ millions).....................................................................134
Figure 51—Total Revenues 2005 – 2008 ($ millions) ..............................................................................134
Figure 52—Covered Companies Publisher Sales Mix by Platform........................................................138
Figure 53—Domestic vs. International Revenues ...................................................................................142
Figure 54—Top Interactive Entertainment Software Brands (U.S. $ Sales 2006 – 2008) .....................149
Figure 55—Publisher Top Brands (U.S. $ Sales 2008)............................................................................150

EXECUTIVE SUMMARY
Since the launch of the Xbox 360 in late 2005, interactive entertainment
software sales have grown by over 60%. Sales of legacy generation console
software declined by 71%, more than offset by growth of “next generation”
software. Even though there will be many new games created for the PS2, we
expect legacy generation software sales to decline to less than $1 billion in
2009, compared with almost $25 billion in overall software sales this year. The
current generation is fully underway, with overall growth in 2009 of 4%
expected in the U.S. and Europe. We define “next generation” as software for the
Nintendo DS and Wii, for the Sony PSP and PS3, and for the Microsoft Xbox 360,
and will refer to this as “current generation” throughout this report. Because console
prices remain relatively high, we expect the transition to continue for several more
years, with the market for interactive entertainment growing at double-digit rates
through 2011. Beyond 2011, we expect revenues from non-traditional sources
(online games, casual games, mobile phone games, downloadable content, and in-
game advertising) to contribute meaningfully, offsetting slowing growth of packaged
goods software sales.
The current generation began without fanfare in 2004. That year, Nintendo
reinvented its handheld Game Boy Advance as a dual-screen device, with a touch
screen allowing the consumer to interact with video game content in a different way.
Few observers appreciated that the Nintendo DS signaled a change in game play
that previewed the company’s plans for its console (the Wii) introduced in 2006. In
early 2005 (December 2004 in Japan), Sony launched the PlayStation Portable
(PSP), intending to capture share in the handheld market from Nintendo. Later that
same year, Microsoft launched the Xbox 360, offering true high definition gaming. In
late 2006, Sony and Nintendo launched the PS3 and the Wii, respectively, and the
current generation was in full gear. Although the last of these launches completed
the beginning of the current generation cycle, they by no means marked the end of
the current cycle. All major software publishers made a distinct effort to extend the
value of the “legacy” system in 2007 and 2008 by continuing to develop games for
the PS2. Perhaps the most successful of these new games were the music-themed
rhythm games, Guitar Hero and Rock Band.
The last video game software cycle began with a dip. Annual industry software
sales, reflecting combined sales of console, handheld and PC games in the U.S. and
Europe, declined by 9% in 2000, followed by growth of 4%, 15%, 12%, and 11% in
2001 – 2004, respectively. The current console cycle began with a similar dip, as
sales declined by 3% overall, with a rebound to 6% growth in 2006. After a relatively
modest beginning, the current cycle became a force, with 25% sales growth in 2007
and 20% growth in 2008. The 2008 figures were dramatically impacted by foreign
currency translation (all of our sales figures are stated in U.S. dollar terms). Two
factors contributed to the robust results in 2007 – 2008: first, while consumers were
slow to adopt current generation technology due to supply constraints, they chose to
continue purchasing legacy generation software while waiting to replace their old
consoles. While last generation software sales declined by 71% between 2005 and
2008, the category still contributed almost $2.5 billion in overall sales (11% of the
total) in 2008, compared to only $550 million (4.2% of sales) for legacy software at a
similar point in the last cycle. The second reason for robust sales growth is the rate
of adoption of the Wii, with non-traditional households buying Wiis and Wii software

at historically high rates. At the same time, sales of the relatively high-priced PS3
have been unimpressive, with the more moderately priced Xbox 360 performing
about as expected.
In the last console cycle, the installed base of legacy generation hardware (PS2,
GameCube and Xbox) peaked at around 115 million units in the U.S. and Europe.
Total console and handheld software sales grew from $6.6 billion in the U.S. and
Europe in 2000 to $11.2 billion in 2005, representing a compound annual growth rate
of 11%. This growth rate accelerated between 2005 and 2008 to over 22%, and we
expect growth to average in the low double-digits over the next three years (partially
offset by continuing declines in PC software sales), reflecting unprecedented levels
of software sales growth.
Phenomenal sales growth and underperformance of video game publisher stocks
has triggered heightened investor interest in the dynamics of the video game
“console cycle”. In this report, we explore industry fundamentals, forecast industry
sales growth by segment and geographic area, and compare several publicly traded
publishers to uncover the industry’s likely top performers over the next several years.
As packaged goods sales growth inevitably slows, we expect significant contribution
from five non-traditional sources of revenue: online subscription games (MMOs),
casual games, mobile phone games, digital downloads, and in-game advertising.
Later in this report, we forecast the overall market size for each of these non-
traditional sources, and attempt to quantify their impact on publisher earnings over
the next decade.
Ultimately, we expect console hardware sales to be closely correlated to the
quality and quantity of the underlying available content. There are two key
differences in the current console cycle: first, the emergence of the Wii as the
industry leader; and second, console prices are significantly higher for the PS3
and Xbox 360 than they were for the PS2 and Xbox, allowing Nintendo to
exploit the mass market audience early on with its low-priced (and innovative)
Wii. It is clear that Sony made a conscious decision in allowing Microsoft to gain a
first mover advantage with the 2005 introduction of the Xbox 360, as it chose to
forego potential PS3 sales in order to dominate the high definition DVD market.
However, by focusing on winning the Blu-ray/ HD-DVD battle, Sony was forced to
price its PS3 too high, and the company inadvertently allowed Nintendo to gain an
all-but-insurmountable advantage. This decision may preclude Sony from winning
the “console war”, and most certainly has increased Microsoft’s options to sustain its
first mover advantage over Sony. PS3 sales have been quite weak due to its
relatively high price, and although sales have increased steadily over the last two
years, we expect Sony to remain in third place until the PS3 price is competitive with
the other two consoles.
In contrast, Nintendo began the cycle (in late 2006) with a modestly priced console.
The Wii was offered at an initial price of $249 in the U.S., and came bundled with Wii
Sports. Nintendo continued to offer high quality content, innovating with Wii Fit in
late 2007 in Japan and in early 2008 in the U.S. and Europe. With its low relative
price (the PS3 launched at $499/599 and remains at $399 as of this writing), the Wii
outsold its competitors by a large margin in 2007 and in 2008. Nintendo made a
strategic decision in the planning stage, choosing to forego competition based solely
on microprocessor speed and graphics capability, instead emphasizing game play
and an innovative control mechanism. Because its console was less expensive to
produce, Nintendo was able to pass along the cost savings to consumers.

The Xbox 360 and PS3 are differentiated from the Wii insofar as they have the ability
to display game content in high definition (1080p). In contrast to past cycles,
providing “cutting edge” high definition features may have resulted in slower adoption
by the masses, especially given the depth of the global recession, and the relatively
slow sell through of the two high definition consoles may persist until penetration of
HD monitors accelerates. In prior console cycles, new consoles were compatible
with standard format televisions, so the only hardware required in order to play the
new games was the console itself. While the current generation consoles will
operate satisfactorily on normal 4:3 format 480p televisions, most games for the PS3
and Xbox 360 are designed for 16:9 formats in 1080p high definition. We believe
that ultimately, most console purchasers will desire the full benefits of the current
generation experience, but expect most consumers to defer purchasing a PS3 or an
Xbox 360 until they have purchased an HD monitor. Nintendo positioned itself to
exploit the slower adoption of current generation technology, as its Wii console does
not require an HD monitor. In that respect, the global recession served to benefit
Nintendo at its competitors’ expense. To date, overall console adoption is running at
the same rate as in the past cycle, with slower sales of the PS3 and Xbox 360
(compared to their predecessors) exactly offset by more robust sales of the Wii
compared to the GameCube. There were roughly 78 million current generation
consoles sold worldwide as of year-end 2008, with 16 million PS3s, 23 million Xbox
360s and 39 million Wiis. This compares to 78 million legacy consoles sold
worldwide at year-end 2003, with 54 million PS2s, 12 million Xboxes and 12 million
GameCubes. It is clear that Nintendo is winning the current console war, and equally
clear that Sony sales are sorely behind the level of its last console.
There have only been two “real” console cycles before the current one—the
PlayStation cycle that began in 1995, and the PS2 cycle that began in 2000. In each
of these cycles, advances in the quality of content drove robust sales growth, as
advances in processing power allowed content to be richer and more complex. In
the current cycle, quality for current generation games was noticeably better from the
outset, leading to solid attach rates notwithstanding light hardware sales for the PS3
and the Xbox 360. The surprise has been the software attach rate for the Wii, which
is running at or above Xbox 360 attach rates notwithstanding the lack of high
definition graphics. As quality for current generation games continues to improve, we
expect to see hardware sales remain stable or even increase, resulting in an
unprecedented tail for software sales growth. For the first three years of the current
cycle, high prices for current generation consoles and more prudent planning from
the publishers kept demand for last generation PS2 games from falling off a cliff.
PS2 software sales declining only 11% in 2006, 27% in 2007, and 31% in 2008,
compared to a 37% decline in PS1 software sales in 2001 (the year after the launch
of the PS2). This slow rate of decline for legacy software resulted in an overall sales
gain of 6% in 2006, 25% for 2007, and 20% for 2008, notwithstanding slow PS3
sales and limited supply for the Wii through year-end 2008. High development costs
and long lead times caused conservative publishers to limit the quantity of software
developed for the Xbox 360 and PS3, and market penetration for these new
platforms has lagged penetration by their predecessors. At the same time, the
modestly priced and innovative Wii has captured consumers’ imaginations, and the
console was consistently sold out from its late 2006 launch until the beginning of this
year. We believe that as a greater number of games are developed for each
console, current generation software sales will accelerate. We expect PS2 software
sales to decline sufficiently (around 64%) to be almost irrelevant to overall software

sales growth, with PS2 software comprising less than 4% of overall software sales in
2009.
We believe that the Xbox 360 and the PS3 are far more similar than their
predecessors were, and think that the economics of game development will limit the
amount of third party exclusive content for either console. In a perverse way, the
similarity between the two platforms will likely serve to lower the costs of porting
software from one platform to the other, and we anticipate that virtually every third-
party title produced for one will be produced for the other. The lack of differentiation
between the PS3 and the Xbox 360 has in part allowed the Wii to gain a competitive
advantage—due to its differential control mechanism and relatively simple
components, publishers must make a separate SKU for the Wii, further differentiating
the console. Because of its superior library of first party titles and relatively low price,
we think that the Wii will again capture the greatest share of the hardware market in
2009.
Although we believe that digital content offers the potential for tremendous
growth, we do not expect a significant revenue contribution from sales of
digital content for another few years. Digital content takes five forms: online
gaming, casual games, mobile games, downloadable content, and in-game
advertising. The first three of these will grow at a relatively stable rate over the next
several years, while the latter two will grow exponentially for traditional publishers
once penetration of the current generation consoles exceeds 50% of the ultimate
installed base (likely in 2009). Of course, Activision Blizzard is the exception to the
bolded rule above, with approximately ¼ of its revenues and ½ of its profits derived
from its World of Warcraft online game. We discuss the growth of digital revenues at
length in the section beginning on page 59.
Industry Forecast
• We estimate that the interactive entertainment industry generated worldwide
sales of $40 billion in 2007 and $44 billion in 2008. We estimate that the
addressable market opportunity for U.S. software publishers is $23 billion in 2008
(packaged software only) and we expect sales to grow at a nearly double-digit
pace for the next three years. We note that the Japanese market remains
virtually closed to U.S. and European publishers, with only minor inroads made
by Electronic Arts and Take-Two, and do not anticipate significant contribution for
the U.S. and European publishers in the near future.
• We forecast the combined U.S. and European software markets to grow at
a 9% CAGR over the 2009 – 2011 period. Our forecast assumes console
software sales (i.e., Xbox 360, PS3 and Wii) of $17 billion in 2009, growing to
$20 billion in 2010 and to $22 billion in 2011. We expect handheld software sales
(i.e., DS, DSi and PSP) of $4.2 billion in 2009, $4.6 billion in 2010 and $4.8 billion
in 2011. We believe that the top-performing software publishers will capture a
disproportionate share of top-line growth, will deliver operating leverage, and will
grow EPS at a higher rate during this period.
• We expect growth to be driven by higher console penetration rates (particularly of
handheld platforms), with lower “tie ratios” (a tie ratio is the number of software
units sold per hardware console) offset by higher overall game pricing.
• In 2009, we forecast that U.S. interactive entertainment software sales (at $12.2
billion) will still be only around 40% the level of movie box office, rentals and

sales (approximately $32 billion in the U.S. in 2008), indicating that there is
significant potential for further growth.
• Several demographic trends and market drivers will fuel rapid growth of
interactive entertainment software sales. The most compelling of these trends is
the expanding age demographic of the interactive game consumer (as evidenced
by the typical Wii purchaser), accompanied by an increasing level of disposable
income and the propensity to spend that income on entertainment.
Hardware Forecast
• Total last generation (PS2, Xbox and GameCube) hardware shipments through
the end of 2008 reached 125 million units in the U.S. and Europe (the
addressable market for U.S. and European publishers). By comparison, 32-/64-
bit (PSOne, N64 and Saturn) shipments in the U.S. and Europe totaled only 93
million units during the analogous 1995 – 2003 period.
• We expect current generation hardware shipments through the end of 2009
to reach 100 million units in the U.S. and Europe. By comparison, shipments
of the last generation consoles in the same regions totaled only 88.5 million units
during the analogous 2000 – 2004 period. This clearly indicates that the current
cycle is far more robust than the last cycle, especially given the relatively high
price points for the three major consoles.
• Even more dramatic is expected penetration of handheld hardware. We
project cumulative DS, DSi and PSP sales in the U.S. and Europe to total 101
million units by year-end 2009, compared to GBA and GBA SP sell through of
only 43 million units in the analogous 2000 – 2004 period.
• By the end of the current cycle, we expect increased console and handheld
penetration rates in every major geographic segment, due to strong
demographics, additional functionality, increased market segmentation, and
much higher marketing spending. Now that Sony has won the high definition
DVD format war, we expect PS3 adoption steadily to increase in correlation with
HDTV household penetration. We believe that Microsoft can maintain its first
mover advantage by continuing to lower prices and by continuing to enhance its
offering on Xbox Live.
• The current generation consoles have increased multimedia functionality, with
high-definition DVD playback on the PS3 and Xbox 360, high definition display
for both, online gaming capability for all three consoles, and access to Internet
content downloads for all three. Ultimately, we expect the current generation of
game machines to appeal to a much wider audience, driving the percentage of
households that own at least one console from 52% during the 128-bit cycle to
60% during the next cycle. Innovations with peripherals such as Rock Band,
Guitar Hero and Wii Fit have converted new households into video game
households, and we expect the trend to continue.
• Our growth forecast assumes that the number of consoles owned by each
household will hold relatively steady, decreasing slightly from 1.40 to 1.38 during
the next cycle. In contrast with the last cycle, we think that the second console of
choice in most households ultimately will be the Nintendo Wii, driven by
innovative game play and a deep library of proprietary content. Because of its
low price, we expect a large number of dual console households to buy the Wii
first. We do not expect as many households to purchase both a PS3 and Xbox

360 as purchased the PS2/Xbox combination last cycle, given the similarities
between the consoles.
• We expect the dominant console at the end of the this cycle to be the Wii, as we
think that the console’s low price point, innovative control mechanism, and
compatibility with standard definition televisions will provide it with a competitive
advantage over the next two years. We expect Nintendo to sustain this
competitive advantage by introducing a high definition version of the Wii, perhaps
as early as the end of 2010, in order to convert its large installed base into true
“next generation” households. We think that the PS3 will capture significant
market share, primarily due to Sony’s victory in the high definition DVD format
war, and will end up in second place by 2015. Although Microsoft’s Xbox 360
enjoyed a first mover advantage, we think that its market position will fade to third
place due to lack of penetration in Japan. We expect the Wii to capture 49%
share of the U.S. and European market by the end of 2009, followed by the Xbox
360 at 29% and the PS3 at 22%. By the end of 2011 (the extent of our current
forecast), we see Nintendo “winning” the console war by maintaining its share,
with 48% of this market. We expect Sony to pull even with Microsoft, each with
26% market share. Notwithstanding the projected finish, we truly believe that all
three manufacturers should be considered “winners”, with Microsoft selling twice
as many Xbox 360s as Xboxes and building a robust Xbox Live business, and
with the other two companies generating significant profits from their respective
shares. These estimates do not include console sales in Japan, which we expect
to be dominated by Nintendo with over 65% market share through 2011.
Software Forecast
• One of the primary drivers of Sony’s success during the last two cycles was its
ability to provide a greater quantity of high-quality titles than its competitors. In
addition to a large first party library (Gran Turismo, SOCOM Navy Seals, The
Getaway, God of War, Ratchet and Clank and Jak), the company was successful
in securing enormous third-party software development support for the PS2. The
three most successful single platform titles of all time, Take-Two’s Grand Theft
Auto III, Grand Theft Auto: Vice City, and Grand Theft Auto: San Andreas
debuted exclusively on PS2 and have so far sold over 42 million units on the PS2
alone, each selling approximately twice as many units as the best selling Xbox
and GameCube games. The Xbox was effectively discontinued in 2006 with the
launch of the Xbox 360, while demand for PS2 hardware and software remained
strong in both 2006 and 2007. Because Sony sold over 18 million PS2s in 2006
and 2007, it was able to maintain the price of the PS2 at $129 through March of
this year. We do not expect meaningful contribution from PS2 software sales
after 2009, but note that catalog sales of PS2 games may comprise 2 – 3% of
overall software sales in the future.
• We do not expect Sony to secure significant third party exclusivity for PS3 titles
over the next few years, and expect the company to continue to focus its internal
development efforts on blockbuster games. At the same time, we think that the
company will maintain solid overall software market share by virtue of the
growing installed base for the PS3 and PSP, offset by continued PS2 software
sales declines. For 2009, we expect software sales for Sony consoles to account
for 31% of all game software sold worldwide.

• We expect the PS2 tie ratio to end up at around 12.5 units of software for each
hardware unit sold, exceeding the 10.8:1 tie ratio of the highest-selling console of
the last cycle, the PlayStation (PSX or PSOne). We expect the Xbox and
GameCube tie ratios to end up close to the PSOne’s, and expect both to be
significantly higher than the number two console of the last cycle, the N64. It
appears that the tie ratios for the PS3 and the Xbox 360 will approach or exceed
that of the PS2, likely ending at least at 10.3:1 and 11.9:1, respectively by 2011.
• We believe that a wildcard for current generation console sales will be the
hardware manufacturers’ ability either to develop content internally or to
secure third-party commitments for software designed exclusively for a
single platform. Nintendo has a large advantage over its competition with a
deep library of internally developed games/brands (e.g., Mario Brothers, Zelda,
and Pokemon), all of which will be offered exclusively for the Wii. Microsoft
developed Halo 3 as an exclusive on the Xbox 360, with third party titles like
Gears of War, BioShock and Mass Effect selling well early in the cycle. The
company’s other exclusives have received good reviews, but have not (so far)
driven sales of hardware to the same extent as the Halo. Sony enjoyed a large
first-mover advantage in the last cycle, with a handful of contractual exclusives
(including the Grand Theft Auto games). In the current cycle, we expect the
playing field between Sony and Microsoft to be more level, and think that
Nintendo will have the largest library of exclusives.
• Notwithstanding the efforts of the three console manufacturers to deliver
compelling exclusive content, we expect the ultimate outcome of the
console wars may have been decided by Nintendo. The company’s
revolutionary decision to forego high definition graphics capability in favor of
innovative controls captured the imagination of consumers early in the cycle, and
its introduction of innovative peripherals has so far allowed it to sustain its
competitive advantage.
• Developing video games has become an increasingly complex endeavor. Most
video games created for the legacy consoles (the PlayStation and N64) could be
built in less than one year (we estimate that the average development time was
six to nine months) and cost less than $1 million to produce. In the last
generation, the average console game required 18 to 36 months to finish, and
cost an average of $4 million. Thus far in the cycle, current generation console
games require between 24 and 36 months to develop, and average development
costs have risen to between $8 – 10 million, with some economies obtained if
games are developed for both the Xbox 360 and the PS3 simultaneously. We
believe that the first efforts for most current generation games cost more than
$10 million (with some games costing as much as $20 million), but most
publishers have quickly advanced along the learning curve, with average costs
declining in over the last two years.
• PC software sales in 2006 had U.S. and European sales declining by only 3%
(due to strong sales of online games), though in 2007, declined 11%, and (largely
due to foreign currency translation) in 2008, declined 14%. We think that the
market for PC games may have approached a bottom, and expect PC software
sales to decline by only 2 – 3% per year over the next three years.

Investing in Software Publishers
• With the economic downturn, the historical gains in share prices for the
major publishers were all but wiped out. The average forward multiple for a
video game publisher has historically been 25 – 50% higher than the overall
market multiple, reflecting the superior growth prospects for the industry and the
tremendous earnings leverage generated by massive early investments in R&D.
However, as of this writing, most of the public video game publishers trade at or
below the market multiple, reflecting investor concern about the health of the
industry.
• We believe that the interactive entertainment industry offers secular
dynamics that will provide extended and sustainable growth. Several
publishers stand poised to capitalize on this growth, providing investors with an
opportunity to participate. In this section, we analyze historical returns for the
industry, and compare and contrast the publishers in order to provide insight into
how their different strategies and assets produce different risk and return profiles.
• The universe of publicly traded entertainment software publishers includes
companies with market capitalizations ranging from under $50 million to over $30
billion. The industry offers two large-cap companies (Nintendo and Activision
Blizzard), one mid-cap company (Electronic Arts), three small-cap companies
(Take-Two, THQ and Ubisoft), and one micro-cap company (Majesco) to
consider as investment opportunities. Over the last three years, six micro cap
companies (Acclaim, Atari, Bam!, Interplay, Midway and 3DO) declared
bankruptcy or ceased operations.
• The publishers with the greatest success in creating and nurturing high-
quality branded entertainment software are Nintendo, Activision and
Electronic Arts. Nintendo is unquestionably the most successful creator of
entertainment software over the past 20 years and captured the number one
position in U.S. sales among software publishers each year until 2001. Many of
the brands that Nintendo introduced in the 1980s and early 1990s for the NES
and SNES consoles are still dominant brands today such as Mario, Zelda, and
Donkey Kong. Similarly, Electronic Arts has built a portfolio of recurring revenue
streams by growing its library of established brands. Electronic Arts now
dominates the sports genre and its hit football, soccer, basketball, and golf
games (among many others) are best sellers year after year. Electronic Arts also
has expanded beyond the sports game genre and built successful brands in
many other genres, including the real-time-strategy genre (Command & Conquer
and Battlefield), strategy/RPG genre (The Sims), extreme sports (Skate), kiddie
(Harry Potter) and the driving genre (Burnout and Need For Speed). Activision’s
results are far more concentrated, with its top two brands (Guitar Hero and Call
of Duty) responsible for over 70% of its domestic sales. According to NPD, in
2008, Electronic Arts captured the highest market share for entertainment
software sales in the U.S., with its 20.3% market share slightly ahead of second
place Activision’s 16.7% share, with Nintendo in third place with 16.6% market
share.
• We believe that brand depth is one the most important indicators of a
publisher’s future prospects. Strong software brands provide a publisher with
sequel titles for several years and a deep library of brands provides a steady
base of recurring revenues. We note that all but one of the top 30 brands of 2008

is an established brand with a history of producing successful titles prior to 2008.
These mega-hit brands are the result of growing and developing successful
brands over several years. Possessing a deep library of solid brands is the first
step to producing one of these mega-hit brands in the future.
• Nintendo, Electronic Arts and Activision were the only publishers with
more than one brand that generated over $100 million in U.S. retail sales
during 2008. We chose a $100 million threshold because we believe that this
figure reflects potential lifetime sales of more than three million units, indicating a
bona fide “home run”. All of Electronic Arts’ top-10 brands generated more than
$57 million in 2008, demonstrating the company’s exceptional brand library.
Nintendo had ten brands generate more than $20 million apiece, with Activision
(nine), and Ubisoft (nine) right behind. Take-Two and THQ each had six brands
over the $20 million threshold, with Midway (two) and Majesco (one) rounding out
the rest. The $20 million level of U.S. retail sales, in our view, is a good proxy for
a worldwide million unit seller, reflecting a bona fide “hit” franchise that
contributes significantly to each company’s bottom line results.
• We have a positive outlook for sales growth over the next several years, and
expect the publicly traded publishers to maintain or gain market share throughout
the current cycle. We believe that the larger companies (Activision Blizzard,
Electronic Arts Nintendo, Take-Two, THQ and Ubisoft) are poised to deliver
operating leverage, particularly as the installed base of consoles grows
sufficiently to drive unit volumes higher for new software. We expect the smaller
companies to struggle to gain market share, with their future profitability
determined by their ability to grow revenues.
• We expect shares of the interactive entertainment publishers to trade
higher later in 2009, as investors gain greater comfort about the effects of
the recession. Our industry growth model projects combined U.S. and European
compound annual sales growth of 8.8% over the next three years, with a 4%
increase in 2009. We believe that earnings of the publicly traded publishers can
grow at a much higher rate, as the larger publishers have made a significant
investment in current generation technology, and are poised to deliver operating
leverage as their revenues grow.
• We note that publicly traded publisher stocks are trading at or below the
market multiple for the first time this decade. Historically, these stocks trade
at a premium to the market, as the rate of top line growth has consistently
exceeded overall GDP growth, and the companies have typically been able to
deliver operating leverage. As a result of the recession and confusion over the
timing of the next console cycle, investors appear to be concerned that top line
growth and operating leverage will lag the overall market, creating an investment
opportunity for those who see the industry growing as we forecast.
• We recommend that investors accumulate shares in publishers Activision
Blizzard, Electronic Arts, Majesco, Nintendo, Take-Two, THQ, and Ubisoft at
current levels.

SECTION 1: INDUSTRY OVERVIEW AND FORECAST

DEFINING THE INDUSTRY
The interactive entertainment industry consists of several constituencies: the

manufacturers of dedicated video game consoles and portable devices; the
publishers of packaged software products that can be played on consoles, handhelds
and PCs; the developers of packaged software; and the producers of games that can
be accessed digitally, whether through a mobile, Internet or direct download. This
report will primarily focus on packaged product sales, subscription game services,
and Internet downloads. Total hardware and packaged product sales in the U.S.,
Europe (comprising Europe, Middle East and Africa) and Japan totaled an estimated
$44 billion in 2008, with hardware sales comprising $17.7 billion and software sales
$26.4 billion of the total. U.S. sales represented about 44% of the total, Europe about
43%, Japan about 13%. Sales in Japan have trended down the last couple of years
because of relatively slow console adoption rates and declining tie ratios. Our report
speaks in general terms about only those sales generated from the three primary
markets for video games, the U.S., Europe, and Japan. On its face, our analysis
disregards sales from the rest of the world; however, we believe that the totals
reflected in our estimates represent a good proxy for worldwide sales. Historically,
rest of world sales have accounted for only a very small portion of total worldwide
sales, and the rest of world market has not necessarily been particularly lucrative for
the U.S. and European publishers. The markets with the greatest demand for video
game products (outside of the U.S., Europe and Japan) are Australia and Canada,
with combined demand comprising approximately 4% of the global total. We
estimate that rest of world sales (including Australia and Canada) totaled $4 billion in
2008, or about 9% of the total sales generated in the U.S., Europe and Japan, split
roughly 60% software and 40% hardware. Further, we believe that around 35% of
the estimated $2.4 billion in software sales consists of catalog sales with relatively
high distribution costs, and correspondingly low profits. We expect the rest of world
percentage to climb by 100 basis points per year for the next several years, with
increasing penetration in non-traditional markets such as South America, Eastern
Europe, and Scandinavia. As these sales grow, they will likely generate higher
profits for the U.S. and European publishers. Accordingly, we will incorporate rest of
world into our estimates in future industry forecasts.
Video game hardware includes dedicated game consoles for both home and
handheld use, as well as various accessories (e.g., controllers, peripherals and
memory cards) for these consoles. Game consoles are the machines or platforms
that play dedicated video game software. We include sales of game software for
personal computers (PCs) within our definition of video game software, but do not
include sales of PC hardware within our industry definition. Several “games” include
a peripheral as part of a bundle (notably Wii Fit and Guitar Hero). These games are
considered software, and are included in the software data published by the NPD
Group. In addition, although the origin of video game consoles is rooted in location-
based entertainment (e.g., arcade games and pinball machines), we consider this a
separate industry and do not consider these devices in our analysis. One area that
is rapidly expanding is mobile games played on cell phones. We do not include
these sales in our forecasts, as they do not generate significant revenues for any of
the U.S. and European publishers (except for Electronic Arts). Later in this report,
we discuss opportunities for cell phone game sales.

Our report and research coverage focuses on interactive entertainment software
publishers and retailers that derive a significant portion of sales from interactive
entertainment. The following is a more thorough description of the key players in the
hardware and software sectors and the various roles they play within the industry.
Figure 1—Top 20 Entertainment Software Publishers - U.S. Retail Sales 2007 – 2008 ($ millions)
2007 2008
Rank Publisher U.S. Sales Market Share Rank Publisher U.S. Sales Market Share
1 Electronic Arts $ 1,710 18% 1 Electronic Arts $ 2,356 20%
2 Activision (Corp) $ 1,583 17% 2 Activision Blizzard (Corp) $ 1,954 17%
3 Nintendo of America $ 1,382 15% 3 Nintendo of America $ 1,943 17%
4 Microsoft (Corp) $ 653 7% 4 Take 2 Interactive (Corp) $ 737 6%
5 Ubisoft $ 578 6% 5 Ubisoft $ 631 5%
6 THQ (Corp) $ 473 5% 6 THQ (Corp) $ 443 4%
7 Take 2 Interactive (Corp) $ 468 5% 7 Microsoft (Corp) $ 417 4%
8 Sony (Corp) $ 417 4% 8 Sony (Corp) $ 394 3%
9 Vivendi (Corp) $ 260 3% 9 Lucasarts $ 355 3%
10 Sega of America $ 221 2% 10 Sega of America $ 340 3%
11 Disney Interactive Studios $ 193 2% 11 Konami Digital Ent. $ 265 2%
12 Lucasarts $ 167 2% 12 Disney Interactive Studios $ 218 2%
13 Namco Bandai Games of America ( $ 154 2% 13 Namco Bandai Games of America ( $ 207 2%
14 Konami Digital Ent. $ 150 2% 14 Midway $ 157 1%
15 Capcom USA $ 124 1% 15 Square Enix Inc (Corp) $ 132 1%
16 Midway $ 102 1% 16 Bethesda Softworks $ 123 1%
17 Eidos Interactive (Corp) $ 92 1% 17 Capcom USA $ 103 1%
18 Atari $ 91 1% 18 Warner Interactive $ 94 1%
19 Square Enix Inc (Corp) $ 81 1% 19 Atari $ 85 1%
20 Majesco $ 65 1% 20 Majesco $ 83 1%
All Others $ 523 6% All Others $ 638 5%
$ 9,488 100% $ 11,675 100%
Source: The NPD Group/Retail Track and Wedbush Morgan Securities estimates.
Distributors
Distribution refers to the warehousing, handling, and transporting of games from a
publisher to a retailer’s shelves. Each major publisher distributes its own games to
the largest retailers, and many distribute their own games to all retailers. Some
publishers also use their own distribution assets to distribute games for other smaller
publishers–referred to as “third-party” distribution. The major hardware companies
also distribute the bulk of their software directly to retailers. National distributors,
such as Ingram Micro and Handelman, provide third-party distribution services to the
smaller publishers and also provide the larger publishers with access to small “mom
& pop” retail outlets. The industry trend this decade has moved away from third-party
distribution as publishers seek to capture a greater portion of the software value
chain. We estimate that third-party distribution declined from approximately 50% of
the retail market to less than 15% of the retail market over the last 10 years. We
estimate that distribution accounts for approximately 5 – 10% of the retail price of a
video game, whether captured internally by a publisher or paid to a third-party
distributor.
It is important to distinguish “distribution” from “co-publishing”. In the former case,
the distributor arranges for the placement of a publisher’s product in a particular
territory; in the latter, the “co-publisher” places its name on the packaging as if the
game were created by it, and is responsible not only for distributing the game but for
all associated marketing expenses. Co-publishers typically receive close to 30% of

revenues from a game, and operating margins are typically 10 – 15% after factoring
in marketing expense. Examples of co-published games are Electronic Arts’ Rock
Band, Activision’s Doom and Take-Two’s Elder Scrolls Oblivion.
Retailers
Video games are sold primarily through mass-market retailers such as Wal-Mart,
Best Buy and Target (over 50% of total U.S. sales) and through specialty retailer
GameStop, which has around 25% U.S. market share. The balance of game sales
take place at other toy and electronics retailers, as well as at other retail outlets and
online (Amazon has around 3% of the market). Figure 2 illustrates our estimates for
retailer market share of U.S. sales in 2007 and 2008, reflecting sales of console,
handheld and PC games. Console and handheld games comprised approximately
94.8% of the U.S. software market in 2008 (up from 86.5% in 2005), while PC games
totaled approximately 5.2%. We expect console and handheld games to capture
95.5% of the software market in 2009.
The retail environment for entertainment software has trended toward mass-market
retailers over the last several years. It is now common to see a sizeable video game
department within every destination retailer. We estimate that retail margins for new
games are 20% (not including vendor allowances), with higher margins on lower
priced “budget” or “value” titles. In the past, retail margins were as high as 30% on
all games, but since the introduction of the PS2 in 2000, software margins have
compressed. Overall retail margins for the video game category (reflecting the mix of
hardware, software, and accessories) can range from 15 – 25%, trending toward the
low end of the margin range early in the console cycle (shortly after the introduction
of new hardware), with margins expanding as the installed base grows. This is
attributable to a shift of product mix from a high percentage of hardware at high
prices and low margins (around 6 – 10%, including warranty revenue) early in the
cycle to a lower percentage as hardware prices decline and console sales flatten. In
addition, over the life of the console cycle, the amount of older “value” titles and used
software available allows retailers to capture incremental margins as high as 50%,
driving up average selling margins.
Specialty retailers have developed a competitive advantage over the mass
merchants due to their ability to offer a large number of used games to consumers.
We estimate that the market for used video games is approximately $2 billion in the
U.S. and around $500 million in Europe, with retailer GameStop capturing over 90%
market share in the U.S. Margins on used games have averaged between 45 –
50%, with some moderation toward the midpoint as GameStop has attempted to turn
its inventory faster. We believe that the total global market opportunity will approach
$3.5 billion annually in the combined U.S. and European markets by 2010, and
expect GameStop to capture at least 70% share, with some competition from
Amazon, Best Buy, Blockbuster and Movie Gallery, as well as from several European
retailers. We don’t consider any of GameStop’s competitors to be a real threat to the
company’s established market share leadership, but think that the existence of
competition, particularly from Amazon, could cause some downward pressure on
margins.
Retail margins in Europe tend to be somewhat higher than in the U.S., with UK
margins historically close to 30% earlier this decade, and continental European
margins in the low 20% range. There has been some margin pressure in the UK as
mass merchants have endeavored to gain market share through promotional activity,

and UK margins on new software have trended closer to 20% over the last two
years.
Figure 2—U.S. Retailer Console and PC Software Market Share 2007 – 2008
2007 2008
Rank Video Game Retailer Share Rank Video Game Retailer Share
1 GameStop 25% 1 GameStop 25%
2 Wal-Mart 24% 2 Wal-Mart 25%
3 Best Buy 14% 3 Target Stores 13%
4 Target Stores 14% 4 Best Buy 13%
5 Toys R Us 4% 5 Toys R Us 4%
6 Circuit City 3% 6 Circuit City 2%
7 Amazon.com 1% 7 Movie Gallery 2%
8 K Mart/Sears 1% 8 Blockbuster 2%
9 Movie Gallery 1% 9 Amazon.com 1%
10 Blockbuster 1% 10 K Mart/Sears 1%
All Other 12% All Other 12%
Total 100% Total 100%
Source: Wedbush Morgan Securities estimates.

INDUSTRY SIZE: THE ADDRESSABLE MARKET OPPORTUNITY
We estimate that interactive entertainment sales totaled $44 billion worldwide in

2008, consisting of $26.4 billion in software sales and $17.7 billion in hardware sales.
The nearly $4 billion Japanese software market remains challenging for non-
Japanese publishers, primarily due to cultural differences, and we expect the U.S.
and European publishers to continue focusing primarily on the U.S. and European
markets for the foreseeable future. We estimate that the addressable market
opportunity for U.S. and European packaged software publishers in 2009 is $23.5
billion, growing to over $29 billion by 2011. In addition, we estimate that the
addressable market for subscription online games and game-related downloads is
well over $3 billion, with U.S. and European publishers competing for as much as
70% share. We expect the subscription market to grow more rapidly than the
packaged goods market, as “new” models (such as Xbox Live subscriptions,
PlayStation Network, OnLive and WildTangent) are established in non-traditional
gaming channels, with the market opportunity likely exceeding $5 billion by the end
of the decade. Console, handheld and PC video games comprise a significant
portion of overall entertainment industry sales, comparing favorably with other
mainstream entertainment products such as movies, books, and music. With
comparable size and growth at a faster rate than these competing forms of
entertainment, we expect the interactive entertainment software sector to continue to
present a compelling investment opportunity over the next five to 10 years.
GEOGRAPHIC MARKETS
The interactive entertainment industry encompasses three primary geographic
markets: North America, Europe/Middle East/Africa, and Japan. We expect the North
American and European markets to be close to the same size in 2009 ($19.1 billion
and $17.8 billion in combined hardware and software sales, respectively), followed
by the smaller Japanese market ($5.7 billion). Several other large potential
geographic markets exist, notably Australia, the Middle East, and South America;
however, we estimate that total sales for all these markets combined amounts to less
than 10% of overall interactive industry sales. The software publishers that we cover
generally sell less than five percent of their products directly into these markets, and
retail presence for U.S. and European based companies is minor. Figure 3 illustrates
historic and forecasted interactive entertainment dollar sales by region for the three
primary markets.

Figure 3—Worldwide Interactive Entertainment Sales 2004 – 2011E ($ millions)
Japan
($ mil) Europe
North America
45,000
40,000
35,000
30,000
25,000
20,000
15,000
10,000
5,000
0
2004 2005 2006 2007 2008 2009E 20010E 20011E
On average, the U.S. software publishers generate approximately 60% of their sales
from the North American market and 40% from the European market, with European
publisher Ubisoft generating approximately 45% of sales from the U.S. market and
55% from Europe. Japanese publisher Nintendo (the only Japanese company we
cover) derives approximately 40% of its software sales from the U.S. and 40% from
Europe, with the balance from Japan. European sales comprise approximately 13%
PC games, 87% console and handheld games, down from a 25-75 split just three
years ago; we expect further degradation of the PC game component of European
sales over the next three years, with PC sales ultimately comprising less than 10% of
overall packaged software sales. It is rare for a U.S. or European publisher to realize
more than 5% of revenues from Japan; that market is generally closed to gai-jin
content. In 2006, we estimate that industry leader Electronic Arts derived
approximately 5% of total sales from Japan, with strong sales of FIFA World Cup
Soccer, and we think that performance was a high water mark for the company. We
think that overall Japanese sales for U.S. and European publishers declined to less
than 3% of overall sales in 2007 and to around 2% in 2008. Japan has been critical
to the overall growth and success of the interactive entertainment industry because it
is the source of the majority of console hardware and some of the industry’s best
development talent. Notwithstanding Japan’s overall importance to the market, we do
not expect U.S. or European software publishers to achieve significant market
penetration in Japan over the next several years, at least not until a foreign publisher
acquires a going concern in Japan. We believe structural and cultural barriers in the
Japanese market will preclude any U.S. or European publisher from generating
significant sales in that market in the near term. We believe that the addressable
market for U.S. and European publishers for the next several years will be limited to
the U.S. and European markets.

Figure 4—Addressable Market for U.S. Software Publishers 2004 – 2011E ($ millions)
Europe PC Software
Europe Console Software
($ mil) N.A. PC Software
N.A. Console Software
35,000
30,000
25,000
20,000
15,000
10,000
5,000
0
2004 2005 2006 2007 2008 2009E 20010E 20011E
HARDWARE AND SOFTWARE SALES SPLIT

Of the $44 billion in interactive entertainment sales in the three primary geographic
markets last year, we estimate that 40% of this amount, or $17.7 billion, was
attributable to sales of dedicated game console hardware. The remaining 60%
consisted of sales of console, handheld and PC entertainment software. Software for
dedicated consoles comprised 41% of overall worldwide industry sales, 13% for
handhelds, and 6% for PCs. Of the over $26 billion in worldwide entertainment
software sales in 2008, we believe that the $23 billion from the North American and
European markets defined the immediate addressable market opportunity for U.S.
and European software publishers. Figure 4 illustrates our forecast of the
addressable market opportunity for U.S. software publishers through 2011.
SOFTWARE VS. OTHER ENTERTAINMENT SECTORS
We estimate that U.S. retail sales of interactive entertainment hardware and software
totaled $19.5 billion in 2008, with software sales comprising 60% of the total. The
8.5% compound annual sales growth for software over the past 10 years has
resulted in the interactive entertainment segment being among the largest sectors
within the entertainment industry. In 2008, the U.S. market for interactive
entertainment was larger than both the U.S. movie industry (box-office receipts) and
the U.S. music recording industry. We note that total film industry revenues are much
larger when VHS and DVD rentals and sales are included (we estimate that these
revenues added over $22.4 billion to the total in 2008); the market for video game
rentals is much smaller in comparison, at approximately $1.0 billion in 2008. The
U.S. interactive entertainment industry is significantly smaller than the total book
publishing industry ($24 billion); however, book publishing includes sales of
reference materials and textbooks that do not compete directly for entertainment
dollars. We estimate that the total sales of books intended for leisure or

entertainment amounted to over $9 billion in 2008. Figure 5 compares the size of
these competing sectors of the U.S. entertainment industry in 2008, illustrating how
interactive entertainment competes with the largest sectors of the entertainment
industry.
Figure 5—U.S. Entertainment Sectors 2003 – 2008 ($ billions)
$20
$18 2003 2004 2005
$16 2006 2007 2008

$14
$12
$10
$8
$6
$4
$2
$-
Video Movies (box Movies Movies Books* Music
Games office) (rentals) (purchases)
* Includes trade, book club, paperback, and other sales.

Sources: The NPD Group/Retail Track, MPAA, AAP, RIAA, DEG, and Wedbush Morgan Securities
estimates.
We expect interactive entertainment to be the fastest growing U.S. entertainment

sector over the next five to 10 years. We forecast U.S. interactive entertainment
software sales to grow by approximately 9% per year over the next three years, and
expect hardware sales to decline by almost 25% annually, as hardware prices are
expected to decline. We project that all other entertainment products sales (other
than video game software, mobile game software, MMOs and digital downloads) will
grow in the 0 – 2% range over the same time period. Using our projected growth
rates, we forecast that the U.S. interactive entertainment industry in 2009 will
continue to be larger than books, box office and music, becoming the second largest
major entertainment sector in the U.S.
We note that the U.S. retail market for movie rentals and sales for home use was
approximately $22.4 billion in 2008 according to Digital Entertainment Group. We
estimate that $15 billion of this amount represented sales of movie and television
DVDs to an installed base of approximately 95 million DVD console owners. This
translated to approximately $157 in DVD software purchases for each DVD console
owner, below our estimate of around $200 in game sales per U.S. current generation
console, but almost three times higher than our forecast for sales of video game
software for each console and handheld owner in 2008 (when last generation
consoles are included). Of course, our forecast does not account for “retired” game
consoles, so the figure is more likely closer to twice as high. Nonetheless, the size of
the home DVD market suggests that the video game market could continue to grow
at a double-digit rate for several more years. We believe that the entertainment value
of interactive entertainment software makes the purchase of video games a

compelling value proposition for consumers, and expect sales growth to increase
dramatically as household console penetration increases.
We also think it is important to consider video game software purchases in the
context of all entertainment spending. When books, music, movies and video games
are added together, total U.S. spending on entertainment content totaled over $75
billion in 2008. The portion spent on video game software, at around 15% of the
total, has the potential to grow at a faster rate than any of the other entertainment
categories for many years to come.

DEMOGRAPHIC TRENDS
In addition to fundamental market drivers, we expect a broadening demographic is

the most important factor that will determine the size of the interactive entertainment
software market. This broadening demographic includes the aging of the pre-existing
video game customer, rapid growth of the teen and twenty-something population,
growth of the female gamer market, penetration of the Wii among people over 40,
and the increasing disposable incomes of teens and pre-teens. We believe that these
demographic trends will continue to drive sales growth in both the hardware and
software sectors of the industry.
WIDENING AGE DEMOGRAPHIC
The primary demographic driver behind the industry’s growth is the dramatic
expansion in age profile of the interactive game consumer. Video game
consumers typically enter the market as children as young as six years old. In the
1970s through the early 1980s, most consumers were introduced to interactive
entertainment in arcades. In the early 1980s, home consoles began to proliferate,
and a group of “Atari kids” grew up playing video games at home. In the late 1980s
and early 1990s, Nintendo emerged as the console manufacturer of choice, and a
new generation of gamers was born. Since 1995, PCs have become prevalent in
U.S. households, and an increasing number of consumers were first exposed to
graphically complex video games through the PC. Internet connectivity has created
yet another group of gamers who are aficionados of online games. Widespread
Internet use led to broader distribution of “casual” games, with very small files
available for download (often for free), and increasing penetration of flash-based
casual video games. The availability of wireless downloads has created yet another
market for casual games played on cell phones. Finally, the introduction of the Wii,
with its innovative control mechanism, appears to have expanded the market to older
consumers who have never played video games before. Once they have entered the
market, video game customers typically remain market participants long after their
adolescence ends, and the increasing slate of product offerings (casual games, cell
phone games, Wii games, etc.) should expand the age demographic further.
The first mass-market generation of interactive consumers (and now the oldest)
started playing video games with the release of the Atari home console during the
late 1970s. We estimate that the age range of video game consumers in the late
1970s was approximately 8 – 20, with a mean age of 11 (or an average year of birth
of 1967). Since the 1970s, succeeding generations of video game consumers have
embraced more advanced game systems and complex technology. Some older
consumers dropped out of the market each year, replaced by a larger number of
children receiving their first DS or PlayStation consoles. The mean member of the
original generation of “Atari kids” is now over 40 (with an emerging group of
“Nintendads” approaching their mid-30s), and many still play games on PCs or on
home consoles. We believe that the age demographic of 90% of gamers now ranges
from 6 – 40, dramatically broader than the demographic of the late 1970s.
It is difficult to assess the “average” video game customer’s age. We have seen
forecasts placing the average age of video gamers as high as 29, although we
believe that these figures include casual gamers who play games like solitaire and
backgammon on their PCs. Our best guess is that the average age of console

gamers is between 23 – 25 years old, but we think that the bell curve for game play
is flattening, and that 80% of active gamers are between 8 – 35. We believe that this
average age is likely to increase modestly (to around 27) once the current generation
consoles have fully penetrated the market, some time in 2010 or 2011. The impact
of the Wii is a wild card, as it is clear that the console’s ease of use and intuitive
game play has attracted large numbers at the high and low ends of the age
spectrum. We also think that greater penetration of casual and arcade-style games
on the consoles (such as Xbox Live Arcade) will attract a greater number of older
and younger gamers.
As the high end of the gamer age range increases, the number of overall video game
consumers continues to increase. More important, in a “normal” economy, people
over 22 tend to be employed, and those who are employed generally have a
significant amount of disposable income. People in their 20s are also generally quite
self-indulgent, and we believe that they are willing to spend a large portion of their
disposable income on entertainment. As the average age of video gamers expands
beyond 22, we expect to see acceleration in spending per user. This phenomenon
differentiates the present console cycle from past cycles.
We see continuing expansion of the age demographic for at least another 20
years, as the oldest gamers stay interested in games well into their 60s and
children continue to embrace games. Over the next ten years, we envision a
generation of “Nintendads” who grew up in the 1980s playing on the Nintendo
Entertainment System and who will have kids of their own playing games in the next
decade. We think that these fathers (average age 35 by 2010) will enjoy playing
video games with their own children, and expect this phenomenon to further expand
the average age of video game consumers when it occurs. We believe that this
phenomenon has already manifested itself in the widespread early appeal of the
Nintendo Wii.
One of the drivers for the “stickiness” of video gaming has been the convergence of
multimedia in games, with surround sound, music soundtracks, and movie footage
interspersed throughout the game. We envision incremental demographic expansion
as the PS3 and Xbox 360 consoles have embraced high definition as the graphics
standard. Of particular importance is the cost of high definition monitors: for early
adopters, the expense of the monitor has tended to accelerate the adoption of any
technology that provides HD content. As prices for HD monitors decline over time,
we expect household penetration to increase and HD content, including video
games, to proliferate. We believe that HD, music, movie footage, and similar features
appeal equally to gamers young and old, and anticipate that the market will continue
to expand until the upper end of the age range is no longer able to manipulate the
game controller (if there is one!). We think that Nintendo will join the HD revolution in
the next two years, and will announce or launch a high definition version of the Wii
(see discussion beginning on page 65).
Over the past few years, online console gaming has proliferated, further enhancing
the social experience of game play. Player-vs.-player gaming through services like
Xbox Live and PlayStation Network have made games far stickier than in the past,
with over 35 million unique accounts opened on the two networks combined. The
introduction of casual, arcade, and mobile phone games has made video gaming
ubiquitous, with gamers in airports, offices, bus stops, and everywhere else. This
expansion of the potential market should result in sustainable growth for software
sales significantly above the GDP growth rate for at least another decade.

RAPID TEEN GROWTH
The core video game consumer is an early teen to mid-20s aged male. Historically,
this demographic (known as “hard core” gamers) has purchased a disproportionate
number of games and formed the target audience for many of the industry’s best-
selling titles, driving a proliferation of testosterone-charged games. We expect this
group to continue to grow at least through the middle of the next decade. According
to the National Center for Health Statistics, more than four million children were born
in the U.S. every year from 1989 to 1993. This is the highest number of births over a
five-year period since the baby boomer years of the 1960’s. The oldest members of
this group are 20 this year, and the youngest are 16, and we expect them to drive
sales of the current generation consoles in 2009 and beyond.
FEMALE MARKET
Notwithstanding the historical strength of the male demographic in the interactive
entertainment industry, the largest area of future growth is likely to be the female
market. Over the next five years, the “casual” phase of the current video game cycle
should hit its stride, with a proliferation of games that target female audiences. Some
of the most popular games of the past few years have been the music-themed
games Guitar Hero and Rock Band, and we note that there were several sleeper hits
developed for the Wii, such as Carnival Games, Jillian Michaels’ Fitness Ultimatum
and Game Party. Because of the widespread popularity of the Wii and the
performance of such non-violent games, we expect to see the continuation of an
overall industry trend toward games with a non-violent focus. Mass-market games
are clearly the focus of most publishers, as evidenced by the success of popular
titles such as: Pokemon, The Sims, and Mario Brothers. In addition, many publishers
are focusing on licensed content from mass-market sources, such as Harry Potter,
SpongeBob SquarePants, Simpsons, Shrek, Spider-Man, etc. As more games target
the mass-market, we expect the trend toward more female gamers to continue. We
estimate that over 30% of all primary gamers in households are female, up from the
low teens just a few years ago. The Entertainment Software Association (ESA)
estimates that female users (either primary or secondary) make up only 35% of the
console market and 43% of the PC market. An increase of 5% penetration in these
platform compositions by female gamers could translate into as much as $1 billion of
incremental annual revenues to the industry each year.
Contributing to growth of the female gamer market is the emergence of casual online
games and cell phone games. We think that these games are more socially
acceptable choices for women, and their ubiquity provides demographic expansion
opportunities. At the same time, advances in technology (such as the Nintendo DSi
and iPhone) have allowed developers to create games that are less competitive in
nature, such as Nintendogs, Super Monkey Ball and Brain Age that may have
greater appeal to the female market.
INCREASING YOUTH INCOME

Another positive demographic trend for the industry is increasing disposable income
for children ages 8 to 14, frequently referred to as “tweens”. Tweens make up one of
the largest segments of the interactive entertainment market. An indication of how
pervasive interactive gaming is in the tween consciousness can be gleaned from
their reading habits – the top three periodicals read by males in this age group are all
gaming magazines (GamePro, Nintendo Power, and Game Informer). According to

magazine publisher information, Game Informer is the 16th highest circulation
magazine in the U.S., with over 3.5 million monthly subscribers (just behind People’s
3.7 million and ahead of Time magazine). Increasing incomes of this group and their
rising influence on household spending means more money spent on interactive
entertainment. We believe that spending for this age group has increased 300% in
the last decade (a 12% CAGR) and estimate that the 27 million tweens in the U.S
directly influence more than $120 billion of family spending.
Figure 6—Primary Video Gamer by Age and Gender
Age Range %
under 18 25%
Female
18-49 49% 40%
50 and older 26%
Male
Total 100% 60%
Average Age 35
Source: Entertainment Software Association

HARDWARE PLATFORMS
Video games are played primarily on three major hardware platforms: home
consoles, handheld gaming devices, and PCs, with hybrid devices such as cell
phones and iPod Touch units beginning to generate significant interest and drive
additional revenues. Home consoles capture the greatest share of the global
interactive entertainment market. In 2008, we estimate that approximately 56% of all
packaged video games on a unit basis were console games. We estimate that video
games sold for the handheld and PC platforms accounted for roughly 30% and 13%
of the market, respectively. Over the last five years, the console market has declined
only slightly from a 61% share, and the handheld market has grown from a 15%
share, while PC games have declined in market share from 24%. Over the next five
years, we expect console games to capture roughly 70% of all software sales, with
handhelds capturing around 20% and PCs capturing 10%.
Figure 7—2008 Video Game Software Sales Market Share by Platform Type
Home Console Handheld Console PC Software Total
North America 76% 18% 6% 100%
Europe 68% 19% 13% 100%
Japan 47% 46% 7% 100%
Worldwide 69% 22% 9% 100%
As Figure 7 illustrates, dollar sales by platform vary widely across the three primary
geographic markets. Although the home console is the largest platform within all
three primary markets, the degree of dominance of home consoles varies widely. In
Europe, while home console software sales are strong, the market for PC software
remains relatively robust, and handheld software has just begun to capture market
share. We believe that this is due to slow console adoption in Eastern Europe and
Scandinavia, with Western European adoption rates similar to those in the U.S.
Meanwhile in Japan, home console software has lost market share, while sales of
handheld software have grown dramatically. PC software barely registers in Japan,
at 7% of total sales, and the U.S. has followed Japan’s lead with a precipitous
decline in PC game software sales over the last several years as a percentage of
overall sales. We think that Japan is the trendsetter for adoption of handheld
software, and while we expect that category to grow in North America and Europe,
we think that European adoption rates for console software and pricing on console
software will allow that category to dominate throughout this cycle.

Market share trends in Europe should mirror U.S. sales by 2012, with each region
generating approximately around 70% market share from console software sales.
We expect to see PC software sales decline more slowly in 2009, due to the
introduction of more online content and casual games. We note that the quality of
games created for both home consoles and handhelds is now competitive with PC
game quality.
The prevalence of online games should extend the life of PC gaming. The
phenomenal success of World of Warcraft, with over 11 million subscribers, has led
to the impending introduction of several new online games. The success of these
new titles and the stickiness of WoW should affect whether the PC software market
is stable over the next five years or whether it declines. We discuss the MMO market
beginning on page 70.
The adoption of handheld consoles in Japan is a trend worth noting. The devices
have always performed well in the region, but the increase in market share for
handheld games was dramatic in 2004 through 2008, doubling from 21% to almost
46% in just a few years. The U.S. market appears to be several years behind the
Japanese market in this category, with the European market catching up only slightly
faster. We think that U.S. market share for handheld games may have peaked at the
current 18% level, with European market share for the category peaking at the
current 19%. While we don’t expect dramatic increases in the market share for
handheld games, we see the category contributing significantly to overall software
growth.
The following are our views and analyses of these competing platforms. We include
forecasts for each platform within the specific platform descriptions and present a
summary hardware forecast for the home and handheld consoles at the end of this
section.
HOME CONSOLES
Over the last 30 years, we estimate that more than 100 dedicated gaming consoles
were introduced to the video game market. Of these various console platforms, only
a handful proved economically successful. The business model of choice is a “razor-
and-blade” economic model. Under this model, consoles (the razors) are sold at very
low or negative gross margins with the expectation that the console manufacturers
will recoup their investment by charging royalties to publishers on software produced
or from online services and downloads (the blades). Because the stakes of console
introduction are quite high, this model dictates that only a few consoles capture
enough market share to succeed, with those that do dominating the market. The
winners have historically been those manufacturers that penetrate the market most
deeply while keeping manufacturing costs low. Over the last 30 years, the clear
leader was Sony, with more than 130 million PS2s sold. We estimate that PS2
production costs averaged well below $100 per unit, compared to the current PS3’s
$450 per unit. In the last cycle, Sony had a cost advantage over Microsoft (estimated
to be more than $50 per hardware unit) that allowed Sony the luxury of competing on
price.
The tables have turned in the current cycle. In late 2005, Microsoft introduced the
Xbox 360 at a $299/399 price point. Sony and Nintendo launched current generation
consoles in late 2006, with the PS3 priced at $499/599 and the Wii priced at $249.
Microsoft wasted little time in exploiting its cost advantage, cutting the price of its
Xbox 360 Pro in 2007 to $349 and again in 2008 to $299, and introducing an
“Arcade” version (sans hard drive) at a $199 price point. We estimate that

Microsoft’s cost of production for the Xbox 360 Pro version (with a 60 Gb hard drive)
is close to its $299 cost, and estimate that the company loses no more than $25 on
its Arcade model, and makes a slight profit on its $399 Elite model (with a much
larger 120 Gb hard drive).
In contrast, Sony has had difficulty keeping up in the present console cycle. The
PS3 likely cost far more than its $499/599 launch price to produce, and although the
price of the core model (with a relatively large 80 Gb hard drive, built-in Wi-Fi and a
Blu-ray drive) is currently $399, we estimate that Sony continues to lose money on
each unit sold. Although it is reasonable to conclude that the inclusion of Wi-Fi and
Blu-ray (as well as a slightly larger hard drive) should justify the $100 higher price
point when compared against the Xbox 360 Pro, consumers have as yet to embrace
the more expensive PS3.
Meanwhile, Nintendo has dominated the present cycle, with its $249 Wii (which
includes its Wii Sports game) allowing it to undercut pricing for the core models
offered by its competitors. We estimate that the Wii costs under $150 to produce,
and that Nintendo makes a solid profit on each unit sold.
Console Cycles
Since 1985, console manufacturers have introduced new hardware technology
approximately every five years. We think that practice will end in the current
cycle. In the past, new hardware was referenced by the prevailing CPU technology
of that era (i.e., 8-bit, 16-bit, 32-/64-bit or 128-bit console cycles). This convention is
no longer used to describe the current consoles, as the architecture of the three new
consoles differs markedly from prior consoles. The five-year time period that has
defined each of the prior three console cycles is not coincidental: the lag in time was
both a function of the time necessary to create new hardware (typically based upon
manufacturers waiting for the commoditization of components) and the time
necessary for hardware manufacturers to recoup their investment via software sales.
Although it is likely that the leaders in each cycle (Nintendo in 1990 – 95, Sony in
1995 – 2000 and 2000 – 05) would have preferred a longer tail on the cycles,
competition from upstarts (Sony in 1995, Microsoft in 2001 and 2005) triggered a
rush to introduce a new console sooner than consumer demand may have justified.
It is apparent that consumers didn’t crave new consoles in late 2005, given the
relatively slow ramp of the Xbox 360 and continued strong demand for the PS2. In
fact, the PS2 outsold the Xbox 360 or held relatively even in the U.S. until early 2008,
when the Xbox 360 moved ahead for good. We think that pricing had a lot to do with
the relatively slow start of the Xbox 360, given that no successful console had been
priced above $300 in the past. We believe that in the past, the pace of technological
advancement drove innovation in the functionality of consoles, leading manufacturers
to build “better mousetraps” as soon as they were able. While consumer appetite for
something new has provided support for new hardware introductions every five
years, it is less apparent that consumers will be ready to support another launch in
2010, as many are just showing a desire to adopt “next generation” consoles now, a
full 3 ½ years into the current cycle.

Figure 8—U.S. Console Cycles and Hardware Launches
U.S. Life Cycle

U.S. Launch Units Sold
Date CPU Manufacturer Console (mil) % Growth
Oct-85 8-bit Nintendo NES 36.3 Actual

Total 36.3
Jan-89 16-bit Sega Genesis 18.5 Actual

Aug-91 16-bit Nintendo SNES 20.0 Actual
Total 38.4 +6%
May-95 32-bit Sega Saturn 1.4 Actual

Sep-95 32-bit Sony PlayStation 30.2 Actual
Oct-96 64-bit Nintendo N64 18.0 Actual
Total 49.5 +29%
Sep-99 128-bit Sega Dreamcast 4.1 Actual

Oct-00 128-bit Sony PlayStation 2 46.0 Projected
Nov-01 128-bit Microsoft Xbox 14.3 Actual
Nov-01 128-bit Nintendo GameCube 11.7 Actual
Total 76.1 +54%
Nov-05 Next-gen Microsoft Xbox 360 30.0 Projected

Nov-06 Next-gen Nintendo Wii 45.0 Projected
Nov-06 Next-gen Sony PS3 28.0 Projected
Total 103.0 +35%
Figure 8 illustrates the most recent console cycles and the dominant consoles within
those cycles (note that the “Units Sold” includes U.S. sales over each console’s life
cycle, not just the initial five-year period).
Each prior console cycle in the U.S. resulted in increasing sales and a larger installed
base. As discussed later in this report, we think that the term “console cycle” is a
misnomer, insofar as it implies that this is a cyclical business. We estimate that
console software sales (excluding handheld software) in the U.S. and Europe
combined will rise from approximately $1.3 billion in 1990 to over $22 billion in 2011,
resulting in a compound annual growth rate of almost 15%.
In the 1995 and 2000 console cycles, demand and price points for both hardware
and software were relatively high, with hardware prices dropping in the second full
year of each cycle. In the latest cycle (which began in 2005), price points started at
unprecedented levels, with the Xbox 360 priced 33% higher than the Xbox and the
PS3 priced at 200% of the PS2’s introductory price. In contrast to earlier cycles,
hardware pricing held for quite a while, with the Xbox 360 remaining at $399 until mid
2007, then cut by only $50, or 12% (in contrast to a 33% price cut six months after
the Xbox launched). Microsoft cut price another $50 in mid-2008. The PS3 price
was cut to $399 in mid-2007 as well, but has remained there as of this writing (see
figure 23 for a console price history). In contrast to other cycles, Sony and Microsoft

have offered several different SKUs for each console (five apiece for the PS3 and
Xbox 360); our reference to price cuts is for the most popular models. At today’s
prices of $399 and $299, the PS3 and Xbox 360 are more than double the price of
their predecessor console ancestors at a similar point in the past cycle (the middle of
the fourth full year of the cycle).
Price elasticity of demand dictates that lower price points will spur sales growth, as
the target audience shifts toward a lower socioeconomic demographic (typically
defined as “mass-market” or more casual gamers). In past cycles, console hardware
sales typically peaked three years after each console’s introduction, and software
sales tended to peak in the fourth year. The end of the fifth year historically marked
the introduction of new console hardware, with a dramatic decline in both hardware
and software sales for the older systems, as consumers tended to defer purchase
decisions until they were able to acquire the current generation technology.
This cycle is different. Because it is eminently clear that no new console is planned
for launch in 2010 (the fifth year of the current cycle), we do not expect hardware or
software sales to peak any time soon. Rather, we expect that hardware and
software sales will peak, as they have in the past, in the year prior to the introduction
of a new console; this cycle, we think that will happen several years from now, if at
all. Hence, we believe that the “peak” of the cycle will be in year n-1, with “n”
representing the launch of a next generation console. As we believe that will not
occur until 2013 or later, we calculate year n-1 as 2012 or later.
The console manufacturers have signaled this to be the case by maintaining console
pricing well above historical levels three and one-half years into the current cycle.
We expect hardware prices to continue to decline in future years, with consoles
selling for $149 for at least a year prior to the introduction of a true next generation
console.
Figure 9—U.S. Cumulative Hardware Unit Sales
(mil)
100
90
80
70
60
50
40
30
128-bit Next-
20 32/64-bit Gen
16-bit
10
8-bit
-
85
87
89
91
93
95
97
99
01
03
05
07
E
09
11
19
19
19
19
19
19
19
19
20
20
20
20
20
20
The one- to two-year period of overlapping hardware cycles is called the “console
transition” period. Figure 9 shows console unit sales during the last four console

cycles and illustrates the timing of past console transitions, with a flat “tail” to the end
of each cycle followed by a rapid ramp in sales for the succeeding console. We think
that it is noteworthy that the ramp up of both the 32/64-bit cycle and the 128-bit cycle
was steeper and more sustained than either of the prior two cycles. This suggests to
us that the technological improvement of each console compared to its predecessors
was more dramatic than in past cycles, drawing an ever-increasing number of
consumers to the console. We do not expect the five-year trend to continue going
forward, as we believe that the “law of diminishing returns” will ultimately result in
smaller incremental gains in game play and graphics resolution in future generations.
As the software development time and effort required to fully exploit faster
microprocessors and faster graphics cards drives up the cost of game development,
we expect game developers and publishers to become more selective about games
produced, with a decreasing number of titles available for this generation’s consoles.
As shown from the significantly higher slope of the curve for the current cycle, we
expect this cycle to last somewhat longer than past cycles. We believe that
significant advances in microprocessor speeds and the amount of data that
processed per cycle have advanced the art of video game publishing and
substantially increased the entertainment value of the medium. In our view, the
steep increase in demand for 128-bit machines was a function of better games, pure
and simple. We discussed this phenomenon in our industry report entitled “Content
is King,” published seven years ago, and elaborated upon it in our industry report
entitled “The Great Console Cycle Myth,” published six years ago. In our 2004
report, “The Definition of Insanity”, we questioned the wisdom of a premature
truncation of the 128-bit cycle in order to gain first mover advantage, and elaborated
on this question in our report four years ago entitled “Field of Dreams”.
Notwithstanding our concerns, Microsoft chose to introduce its current generation
console, the Xbox 360, in late 2005, and sales of Xbox software declined
precipitously in 2006 as a result.
Our views from the last seven years have been borne out over the first few years of
the current cycle. Hardware prices held up significantly longer for the 128-bit
consoles than for any predecessor console. The first price cuts for the PS2 came
almost 19 months after the console was introduced (from $299.99 to $199.99), and
the second price cut came 12 months later (to $179.99). The price point dropped to
$149.99 a staggering 43 months after the console’s debut, and was maintained for
an additional 23 months. Sony cut the price of the PS2 to $129.99 in April 2006, six
months prior to the launch of the PS3, in order to maintain demand for the legacy
console, and cut price to $99.99 in April 2009, a full 30 months after the PS3
launched. In contrast, the original PlayStation (a 32-bit machine) price was cut to
$149.99 barely 24 months after introduction, and was further discounted at retail 48
months after launch. We calculate the average selling price for PS2s sold to be
approximately $180/unit in the U.S. over the first eight plus years since launch,
compared to an average price of $134 for the original PlayStation over a similar
period. Even at these higher prices, we expect that by year-end, Sony will have sold
31% more PS2s worldwide than PlayStations at a similar point in the latter console’s
life cycle.
We believe that Sony chose to keep the price point of the PS2 higher longer because
it was generating substantial profits from hardware sales, especially after redesigning
the device in late 2004. If our estimates are close, Sony generated over $500 million
in gross profit from PS2 hardware sales in 2006. PS2 sales continue to be strong for
the next two years, even without a price cut. Now that Sony has cut price to $99, the

PS2 is well-positioned for penetration into new geographic markets. The company is
well on its way to fulfilling its stated goal of a ten-year console cycle with the PS2,
and it has repeated this mantra when referring to the PS3’s potential life.
In contrast, production of the Xbox was discontinued early in 2006, fulfilling
the “five-year cycle” vision for Microsoft. Unlike Sony, which has a production
cost that is far lower than the wholesale price of its current generation console,
Microsoft likely lost money on every Xbox produced. We think that the company
focused on building and sustaining its first mover advantage in the next cycle, and
chose to truncate additional losses from the current cycle.
Figure 10—U.S. Annual Hardware Unit Sales
25
20
(mil units)
15
Next-Gen
10
128-bit
5 32/64-bit
16-bit
8-bit
-
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009E 2011E
Historically, console transitions have been difficult for software publishers because
consumers have tended to slow their purchases of existing hardware and software
while waiting for the new consoles to launch. This was particularly evident and
painful for software publishers in the transition from 16-bit systems to 32-/64-bit
systems in 1995. That year, console and handheld software sales in the U.S. and
Europe declined 35% to $2.3 billion from $3.6 billion the prior year. We believe that
a key contributing factor to this decline in software sales was the level of support
given to the PlayStation launch, with most U.S. and European publishers developing
an inordinate number of titles for the new platform. The U.S. and European
publishers learned very little from their experience in 1995, and again rushed to
support the 128-bit hardware launch in 2000. Again, software sales in the U.S. and
Europe declined significantly from the prior year. Sales of console and handheld
software dropped from $7.2 billion in 1999 to just under $6.6 billion in 2000, a decline
of 9%. Importantly, the year 2000 marked the slowing of a phenomenon experienced
in 1995, where current generation (i.e., 16-bit) software sales declined by almost
50% (from over $2.5 billion to under $1.3 billion). In 2000, current generation (i.e.,
32/64-bit) software sales decreased 21%, from $6.0 billion to $4.8 billion. It appears
that this trend began to reverse in 2005, with current generation software sales down
only 3%, and the modest decline continued in 2006 with only a 13% decline. The

modest declines are attributable to rapidly growing contribution from the handhelds,
which are somewhere in between “current” and “next” generation. Increasing sales
of current generation software offset declines in software sales for legacy systems in
2006, leading to overall software sales growth that year. In 2007, current generation
console sales declined by only 38%, with over 45% growth in handheld and current
generation software sales. This rapid shift from legacy to current generation
software drove overall sales growth of 25% for the year.
Figure 10 illustrates the annual sales of hardware systems in the U.S. for the past
three console cycles and our estimate for the coming cycle. Note the severe drop off
in sales during the last two console transitions (1995 – 1996 and 2000 – 2001). The
drop off in the most recent transition (2005 – 2006) was not as steep, as Sony
continued to promote the PS2 and publishers continued to create software for the
legacy platform.
The continued strength in software sales for last generation consoles was
most likely due to the order of launch for the current generation consoles.
Microsoft launched first, releasing the Xbox 360 in November 2005. At the time of
launch, we estimate that last generation’s Xbox had only 21.8% market share in the
U.S. and Europe, compared to the PS2’s 63% share. This contrasts with the launch
of the PS2, where Sony had 65% market share and was first to launch. There was
significant developer support for the PS2 in 2005, and it appears that only the Xbox
faithful dramatically slowed their purchase habits. The 2005 decline in Xbox software
sales was consistent with our forecast (we forecast a decline of 11%, and Xbox
software sales declined 13%), with a relatively modest 9% decline in 2005 PS2
software sales. The early decline in PS2 software sales implied more dramatic
declines in 2006, which did not materialize, likely due to significant publisher support
for the PS2 platform in 2006.
The U.S. and European publishers did not repeat their past mistakes a third time.
Though we expected only modest software support from U.S. and European
publishers when the first of the current generation consoles was launched in 2005,
the consumer appeared not to care about the limited offering on the Xbox 360, and
many consumers deferred purchases of current generation software, triggering a
decline in overall industry sales in 2005. Most publishers attempted to harvest
investments in current generation technology throughout 2006 and 2007, allowing
the publishers the opportunity to harvest profits from an extension of the past cycle.
As a result, the transition between the past and current cycles was less dramatic
than it was in the past.
Prior Console Transition
Prior to the Xbox 360 cycle, the industry last completed a console transition between
2000 and 2002, when the generation of 32-/64-bit hardware was phased out and
replaced with 128-bit technology. Figure 11 illustrates U.S. software market by
platform technology over the last several years (and our forecast of the next three
years), highlighting the shift in the U.S. console market from 32-/64-bit systems to the
128-bit machines.
In 2005, 128-bit software comprised 96% of total U.S. console software sales, up
from 57% in 2001. 128-bit software sales dropped to 71% of total U.S. console
software sales in 2006 and declined to 31% in 2007 and 14% in 2008, as publishers
chased market share on current generation consoles. This contrasts with 32-/64-bit
software market share of 84% in 2000 (the year of the PS2 launch), 43% in 2001,
14% in 2002 and 5.6% in 2003. The staying power of the last generation software

and corresponding slower ramp in sales of current generation console software
supported higher average software selling prices for both sets of software, slightly
lengthening the transition between console cycles.
Figure 11—U.S. Software Sales by Platform
$14,000
$12,000
$10,000
($ millions)
$8,000
Nexgen
128 Bit
$6,000 32/64 Bit
$4,000
$2,000
$-
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010E 2011E
128-BIT CONSOLES
As in prior console cycles, the 128-bit cycle did not generate sufficient software sales
to support three successful consoles, with Sony’s PS2, Nintendo’s GameCube, and
Microsoft’s Xbox all clamoring for market share. While most industry observers have
generally declared Sony’s and Microsoft’s efforts successful, declaring Nintendo’s a
failure, we disagree. In our view, success should be measured by profitability, and
based upon that metric, only Sony was wildly successful. It is important to note that
Microsoft lost billions of dollars garnering its 18% hardware market share (and 20%
software market share) during the 128-bit cycle, while Nintendo was generally
profitable throughout with only 17% market share. The dominant console of the 128-
bit cycle was the PS2, garnering approximately 65% of worldwide 128-bit hardware
unit sales through 2006 and over 67% software market share. Xbox and GameCube
production ceased in 2006, giving Sony an opportunity to gain share in a declining
market for current generation software sales.
Although PS2 sales in the U.S. started slowly in 2000, the sheer volume of titles
available for the PS2 (which was backward compatible and allowed the playing of a
large number of PlayStation One games) gave the console a huge first-mover
advantage and made it the most popular choice among 128-bit machines. We
believe that Nintendo’s software offering allowed it to capture a dominant market
share among young gamers, keeping the company close to Microsoft in the
worldwide hardware rankings. Although much was written about Nintendo’s third
place position in the last console cycle, pundits frequently overlook the company’s

dominance in the handheld arena, with over 73 million Game Boy Advance hardware
units sold worldwide and 27 million Nintendo DS hardware units sold at the end of
2006 (when the GameCube was discontinued). The strength from its handheld
offering allowed Nintendo to remain profitable throughout the last console cycle.
Nintendo-produced first party software captured the dominant share of software
sales for these devices, driving its profitability. We believe Microsoft’s challenge to
gain share in the 128-bit console cycle was due in large part to lack of support from
Japanese software developers, compounded by the company’s late entry and its
relatively light line-up of first-party software. Microsoft has clearly established itself as
a long-term player in this market, and learned much from its mistakes in the last
cycle. The company was better prepared for its launch of the Xbox 360 (discussed
below), and has gained significant share in the current generation.
Figure 12—Console Installed Base (U.S. and Europe)
120
100
PlayStation
GB Advance/SP
80
DS/DSi
(million units)
PSP
PlayStation2/PS2
60
Xbox
GameCube
40 PS3
Xbox 360
Wii
20
-
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010E 2011E
(million units) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010E 2011E
PlayStation 52 57 61 62 64 64 64 64 64 64 64 64
GB Advance/SP - 8 17 30 43 51 57 59 60 60 60 60
DS/DSi - - - - 1 6 15 33 54 70 84 98
PSP - - - - - 6 11 18 26 35 41 47
Handheld Subtotal - 8 17 30 44 62 83 110 139 164 185 205
PlayStation2/PS2 2 12 27 41 51 63 72 80 85 88 90 90
Xbox - 1 6 11 18 22 22 22 22 22 22 22
GameCube - 1 5 9 13 16 17 17 17 17 17 17
Current Gen Subtotal 2 15 37 61 82 101 112 120 125 128 130 130
PS3 - - - - - - 1 6 13 22 32 43
Xbox 360 - - - - - 1 8 14 22 29 36 43
Wii - - - - - - 2 13 32 49 65 79
Next-Gen Subtotal - - - - - 1 11 34 67 100 133 164

Figure 13—Console Installed Base (Worldwide)
140
120
PlayStation
100 GB Advance/SP
DS/DSi
(million units)
80 PSP
PlayStation2/PS2
Xbox
60
GameCube
PS3
40 Xbox 360
Wii
20
-
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010E 2011E
(million units) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010E 2011E
PlayStation 72 78 82 83 85 85 86 86 86 86 86 86
GB Advance/SP - 12 25 42 58 67 73 76 76 76 76 76
DS/DSi - - - - 2 10 27 52 77 96 114 130
PSP - - - - 2 9 17 27 38 51 60 69
Handheld Subtotal - 12 25 42 61 86 117 155 191 223 250 275
PlayStation2 6 20 38 55 68 82 93 101 107 110 112 112

Xbox - 1 6 12 19 23 23 23 23 23 23 23
GameCube - 2 7 12 17 21 22 22 22 22 22 22
Current Gen Subtotal 6 23 51 79 104 126 138 147 153 155 157 157
PS3 - - - - - - 1 8 16 26 37 49
Xbox 360 - - - - - 1 8 15 23 30 37 44
Wii - - - - - - 3 18 39 59 77 93
Next-Gen Subtotal - - - - - 1 12 40 78 115 151 186
Sony PlayStation 2
Sony’s PlayStation 2 (PS2) hit store shelves in Japan in March 2000. Retailing for
approximately $370, Sony sold nearly one million units at the Japanese launch. Sony
followed with a U.S. launch of 500,000 units, retailing for $299 each, in October
2000. The company had originally anticipated shipping one million units for the U.S.
launch, but due to microprocessor production problems, it scaled back initial
shipments into the U.S. The company launched the PS2 in Europe in November
2000, also with a reduced initial shipment. Sony’s lowered shipments angered
customers, publishers, and retailers in the U.S. and Europe, who were counting on
much higher volumes for the holiday season. In particular, the U.S. and European
publishers were hard hit by the low initial shipment, as many devoted an
extraordinarily large portion of their development budgets to launch titles. The PS2
represented a significant technological advance over its predecessor, the PSOne, as
it was capable of several multimedia functions, including DVD playback, CD audio,

as well as the potential for Internet connectivity. The company also chose to make
the PS2 fully backward compatible, allowing new PS2 owners to enjoy game play
from their cumulative library of PSOne games. Notwithstanding the relatively light
launch, the company ramped its manufacturing capacity dramatically, selling over 14
million PS2s worldwide in 2001.
Sony enjoyed a large first-mover advantage, and the PS2 was the dominant console
of the 128-bit cycle by a large measure. Sony received tremendous third-party
software development support for the PS2, and we believe that this was the deciding
factor in the console war this cycle. Many titles released only (or initially) for the PS2
performed quite well, such as Sony’s Gran Turismo 3: A-Spec, Gran Turismo 4,
SOCOM Navy Seals I and II, and God of War 1 and 2; Square Enix’s Final Fantasy
and Kingdom Hearts I and II; and Take-Two’s Grand Theft Auto 3, Grand Theft Auto:
Vice City, and Grand Theft Auto: San Andreas. Figure 14 illustrates unit sales of PS2
hardware by geographic area.
Figure 14—Sony PlayStation 2 Unit Sales (2000 – 2011E)
(mil) Japan
20
Europe
18 U.S.
16
14
12
10
-
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010E 2011E
Until late in 2004, Sony’s strategy for competing in the console business was to
generate profits from software royalties (approximately $8 per unit on average for the
PS2, higher now for the PS3). Consoles were sold at a small profit, allowing Sony to
gain market share and receive more software royalties once the installed base of
console owners continued to purchase software. In late 2004, the company was able
to redesign the PS2 and cut its manufacturing costs dramatically, while maintaining
the price of the device at $149. We estimate that for the first time, Sony was able to
generate substantial profits from hardware sales, with $600 – 700 million in gross
profits in 2005. When the company cut the price of the console to $129 in 2006, its
gross profits from hardware likely declined to around $500 million. This compares to
our estimate of $1.5 – 1.6 billion in gross profit from software royalties.
We think that Sony learned a difficult lesson from its experience with the Betamax
video recorder in the early 1980s—Sony’s product was technologically superior to

rival Panasonic’s VHS format, but VHS won market share by sacrificing margin and
forsaking software royalties in order to drive unit sales. With the PS2, Sony
embarked upon a strategy of securing wide support for its format, despite claims of
technological superiority by its competitors, Nintendo and Microsoft. The company
tried to do the same with the PS3 (discussed below).
Nintendo GameCube
Nintendo launched the GameCube in November 2001. At the time of launch,
Nintendo chose a small form factor (a cube) and chose to compete on price, with its
console debuting at $199 compared to its competitors’ launch pricing of $299. In
support of the GameCube, Nintendo capitalized on its internal development strength
and targeted its loyal fan base, composed of players in their twenties who grew up
playing Nintendo games and younger players who favored more family friendly
games. Notwithstanding its oft-stated desire to appeal to hardcore gamers,
Nintendo’s product offering tilted toward E-rated games. The GameCube’s appeal
as a kiddie device was made more apparent given the fact that the device did not
include DVD playback functionality, a more adult feature included in its competitors’
128-bit consoles. We believe that Nintendo made several strategic errors at launch.
First, it launched its console prior to the release of its most popular content, striving
to “keep up” with competitor Microsoft. Second, it failed to include DVD functionality,
leading to a lower price point than its competitors, and created the perception that
the GameCube was an inferior device. Third, it depended too heavily on internally
developed content that was high quality but skewed too far toward a younger
audience. Fourth, it made its device too “cute”, giving it the appearance of a toy and
appealing to younger consumers as a result. Fifth (and finally), it chose to change
the format of its medium from cartridge-based to disc based, eliminating the potential
for backward compatibility. Accordingly, we believe that the GameCube’s failure to
capture share close to Sony’s, and failure to surpass Xbox sales is explainable.
Nintendo adroitly managed to avoid these mistakes with the launch of the Wii (see
our discussion below). With a strong lineup of games featuring the ever-popular
Pokemon, Zelda, Metroid, Donkey Kong and Super Mario Bros. franchises,
GameCube sales were solid, if not spectacular, but insufficient to allow it to rise
above the number three console position worldwide, well behind the PS2 and only
slightly behind the Xbox.

Figure 15—Nintendo GameCube Unit Sales (2001 – 2008)
(mil)
7
Japan
6 Europe
U.S.
5
-
2001 2002 2003 2004 2005 2006 2007 2008
In essence, Nintendo “invented” the razor-and-blade business model, having

competed in the video game arena since 1985 with its NES, SNES, and N64
systems and with the various iterations of Game Boy prior to entering the 128-bit
console wars. In addition, the company has significant development strength,
enabling it to provide exclusive content for its consoles. Also, Nintendo was able to
secure modest support from Japanese third-party developers for the GameCube,
notably with the Resident Evil series of games from Capcom. Figure 15 illustrates
unit sales of GameCube hardware by geographic area.
Microsoft Xbox
Microsoft launched the Xbox in November 2001 for a retail price of $299. With a
$500 million marketing budget and agreements with more than 150 video game
developers, Microsoft immediately became a major player at the outset of the last
console cycle. Though the Xbox was technically superior to the PS2 and GameCube,
with a significantly faster microprocessor, Microsoft had trouble capturing market
share from Sony and struggled in its efforts to overcome Nintendo for second place
in the console wars. Although its year late start hampered its prospects for success,
we believe that a bigger problem for Microsoft was the lack of Japanese developer
support for the Xbox, with very few major Japanese developers developing titles
exclusively for the Xbox. We note that one of the big keys to Sony’s success during
its first console cycle was the company’s ability to convince influential game
companies Square and Enix (since merged) to publish their blockbuster games on
the PlayStation and not on the Nintendo 64. Despite significant obstacles, Microsoft
was able to capture 20% of the 128-bit console market through 2006 (a level that we
consider a success for a first effort). From a standing start, Xbox hardware sales
peaked at approximately 7 million units in 2004. The company matched Sony’s
pricing, and cut the price of the hardware to $199 in 2002 and to $149 in 2003. Sony
cut the PS2 price to $129 in April 2006, and Microsoft chose instead to discontinue
the Xbox in favor of the Xbox 360.
Microsoft pioneered a strategy that differed from its predecessors—rather than being
focused on the razor-and-blade business model, the company focused on driving the

home Internet connection from behind the PC in the home office to behind the
television in the living room or den. This strategy was apparent from Microsoft’s
laser focus on Xbox Live, its subscription service for online gaming. The company’s
consistent mantra was that gaming is a social experience, and that an ever-
increasing number of consumers will choose to play online against one another
rather than play alone. We were skeptical at the outset, but consistent inroads made
with Xbox Live Arcade and Xbox Live Marketplace suggest that the online business
is much larger than we originally thought, so we changed our view.
Once the Xbox was discontinued in 2006, the number of Xbox SKUs dropped by
around 75% in 2007, and new Xbox games disappeared altogether in 2008.
Worldwide Xbox software sales were only $226 million in 2007 (down 77% year-
over-year), and only $36 million in 2008. Figure 16 illustrates historical worldwide
Xbox hardware sales by region.
Figure 16—Microsoft Xbox Unit Sales (2001 – 2007)
(mil)
8
Japan
7
Europe
6 U.S.
-
2001 2002 2003 2004 2005 2006 2007
Xbox 360
Microsoft released its entry this generation, the Xbox 360, in November 2005, with a
simultaneous worldwide launch. The console’s technical specifications were a huge
advance in graphics capability: it has three symmetrical core CPUs running at 3.2
GHz each (each over 4x faster than the Xbox CPU); a custom ATI graphics
processor that allows 500 million polygons per second (faster than the then state-of-
the-art PC graphics process that allowed 380 million polygons, and 4x greater than
the original Xbox); 512 Mb of RAM (8x the current Xbox); and some backward
compatibility. The device utilizes a DVD-ROM drive, with the now defunct HD-DVD
drive as a separate accessory. The Xbox 360 was released with a deep slate of
“launch” titles (available at or near the launch date), with a handful of exclusive titles
developed by Microsoft Game Studios and a few third party publishers.
The Xbox 360 sold out from the day of launch through early April 2006. In part,
the sell out was attributable to incredible demand for the console, and in part

attributable to lack of supply. According to company reports, Microsoft shipped
1.5 million Xbox 360 units in 2005, although according to the NPD, only 610,000
found their way into U.S. living rooms. The company stated that it sold 10 million
consoles as of the end of 2007, although again, NPD figures showing U.S. sales of
4.5 million units suggest that the overall sell-through figure was likely closer to 9
million. In its most recent quarterly report, cumulative worldwide shipments have
reached 30 million units, although again, the installed base in the U.S. suggests a
somewhat lower figure. The initial price of the “Pro” model of the console (fully
equipped with a 20 Gb hard drive) was $399.99, with an “Arcade” version (no hard
drive) available for $299.99. In 2007, Microsoft introduced an “Elite” version of the
console, with HDMI output, a high definition video cable, and a 120 Gb hard drive for
$479.99. The company cut prices for all three versions in 2008, with the Pro version
cut to $299.99, the Arcade model at $199.99, and the Elite model at $399.99.
Microsoft’s monthly U.S. sales are still dominated by sales of the Pro model, with
slightly more Arcade units sold compared to the Elite version.
Microsoft appears on track to selling approximately 8 – 10 million Xbox 360 units
annually for the next few years. At that rate, the installed base should end up around
45 million by 2010, or more than twice the installed base of the original Xbox. As of
the end of 2005 (a comparable point in the last cycle), the combined U.S. and
European installed base for that generation’s hardware was only 101 million units, so
Microsoft’s performance this cycle represents a significant improvement over the
prior cycle.
Figure 17—Microsoft Xbox 360 Unit Sales (2005 – 2011E)
(mil)
Japan
Europe
10
U.S.
-
2005 2006 2007 2008 2009E 2010E 2011E
PS3
Sony released its current generation console, the PlayStation 3 (PS3), in
November 2006, with a simultaneous worldwide launch. The company surprised
many with a launch price of $599.99 for the 60 Gb SKU, with a 20 Gb model (since
discontinued) offered for $499.99. Like the Xbox 360, the technical specifications of
the PS3 were mind-numbing. The device has a 3.2 GHz “cell” microprocessor

running simultaneously over seven cores, with 512 Mb of RAM and a 550 MHz
graphics processor. The improvement over the PS2 is staggering, given that the
former device ran at only 295 MHz, with 32 Mb of RAM and a 150 MHz graphics
processor. Sony’s console features a Blu-ray High-Definition DVD-ROM drive,
allowing it to play CDs, DVDs, or high definition DVDs (not to be confused with
Toshiba’s now defunct HD-DVD format).
There has been some debate about whether the PS3 is more powerful than the Xbox
360. Sony has claimed technological superiority, but Microsoft has countered that
since the PS3’s memory must be allocated across seven cores compared to the
Xbox 360’s three cores, the Xbox 360 will actually outperform its counterpart. Our
lay view of the two devices is that both provide significantly more power than is
required to run the games designed for them to date, and that the two are
comparable to one another.
The more important differentiating factor, in our view, was the inclusion of the Blu-ray
drive. Sony made a bet that Blu-ray would be the technology of choice for movie
studios when films complete the migration from standard DVD format to HD format.
Blu-ray is a partnership between Sony and Matsushita (and several others), and
competed directly with the HD standard sponsored by Japanese rival Toshiba. The
Blu-ray format became the de facto standard early in 2008, when Toshiba
announced that it intended to discontinue its HD-DVD format. The Blu-ray format (54
Gb discs) is more than sufficient to host the most complex video game (typical files
are between 1 – 4 Gb, and most file sizes are under 9 Gb—we note that the DVD
format supported by the Xbox 360 will hold up to 9 Gb files). However, most films
recorded in DVD format require approximately 1Gb of storage per hour of content,
while most HD recordings require 6 – 7 Gb of storage per hour. Thus, once film
migrates to the Blu-ray format, the disc drive included in the Xbox 360 will be unable
to play HD movies. Sony’s plan was that when it prevailed in its bid to establish Blu-
ray as the uniform standard for HD movies, the inclusion of a Blu-ray drive in its PS3
would potentially drive sales of the console to consumers interested in both games
and HD movies. The ability to play DVDs was a factor in the early advantage
enjoyed by the PS2 over the GameCube (which could not play DVDs), and helped
Sony with its first mover advantage over Microsoft in the current generation.
Unfortunately for Sony, its victory in the Blu-ray/HD-DVD format wars did little to help
it establish the PS3 as the dominant console early this cycle. The inclusion of a Blu-
ray drive drove Sony’s cost of production at least $100 higher than Microsoft’s, and
the inclusion of a Cell processor drove costs even higher. As of this writing, the least
expensive PS3 is still priced at $399.99, or $100 above the Pro Xbox 360 model and
$200 above the Arcade version. At the same time, Blu-ray players have come down
in price to around $200, and are widely expected to come down in price further this
holiday. Households without an HDTV (approximately 65% of households) do not
perceive a need to switch to the Blu-ray format yet, and the spike in sales Sony (and
we) expected when Blu-ray prevailed did not materialize.

Figure 18—Sony PS3 Unit Sales (2006 – 2011E)
(mil)
14 Japan
Europe
12
U.S.
10
-
2006 2007 2008 2009E 2010E 2011E
Wii
Nintendo launched its current generation console, the Wii, in November 2006,
Although observers were initially skeptical, consumers embraced the device in
record numbers, and enthusiasm has continued to build. The Wii uses a DVD-
ROM drive, is backward compatible with all content originally released for the N64,
the Super NES, and the original Nintendo Entertainment system (through software
downloads), plays all GameCube games, and is significantly more powerful than the
GameCube, but not as powerful or feature-packed as the PS3 or Xbox 360. The Wii
launched at a lower price than its competitors, at $249.99 (including a game), and
pricing has held for the 30 months since launch.
Nintendo chose to compete with the others through innovations in game play,
devising a motion-sensitive controller (the “Wii-mote”) that allows the player to
interact directly with characters and items on the screen (much like a mouse). The
company has a competitive advantage based upon its considerable library of high
quality content, and the early success of the Wii encouraged third party development.
In our opinion, the Wii has been successful due to two factors: first, it is priced
significantly lower than its competitors’ products; and second, the company’s
redesign of the console’s controller, a cordless remote-control-like device designed
to be used with only one hand, allows for a unique style of game play that is not
available from the competition. A small sensor placed near the monitor, along with an
accelerometer chip and infrared pointer inside the controller, allow tracking of its
position and orientation. This allows the player to manipulate the action on screen by
physically moving the controller itself. For example, in Red Steel (a launch title from
Ubisoft), players are able to wield an in-game sword by actually swinging the
controller from side to side. Wii golf games allow players to swing an imaginary club,
race cars are steered with a turn of the wrist, and guns are aimed in shooter games
by pointing the controller at the target.
Coincident with the publication of this report, Nintendo is launching Wii Motion Plus,
an accessory for the Wii-mote that adds a second accelerometer to the motion-
sensitive control scheme. With the Wii-mote and Wii Motion Plus, golfers who tend

to slice in real life will slice in a golf game using the Wii Motion Plus; tennis players
will be able to put top spin on a shot.
Nintendo’s strategy has proved brilliant. The company capitalized upon its
software development strength, acknowledged an unwillingness to compete in the
console wars “at any price”, and to date, has exceeded sales of the PS2 over a
comparable period. Nintendo is well on its way to establishing the Wii as the best
selling console of all time (the record holder is the PS2 with over 136 million
cumulative consoles sold since its October 2000 launch). As we noted in our report
five years ago (The Definition of Insanity), Microsoft paid a significant financial price
to compete with Sony in the last cycle, and spent even more to compete this cycle
(although with much better financial results). At the same time, Sony has seen its
market dominance erode, generating losses from its computer entertainment division
for the first time in over 12 years. Nintendo, on the other hand, leveraged its
dependable revenue stream from its first party software sales and from its market
dominance in the handheld arena, and endeavored to be a major player in the
console wars, without feeling compelled to finish in first place. As a practical matter,
the Wii’s low price point and novel game play drove Nintendo into first place in 2008,
and it appears that strong sales of the device will be sustainable for years to come.
Figure 19—Nintendo Wii Unit Sales (2006 – 2011E)
(mil)
Japan
Europe
20 U.S.
15
10
-
2006 2007 2008 2009E 2010E 2011E
We believe that Nintendo has begun to capitalize on a demographic that is

likely to emerge over the next several years: a growing number of
“Nintendads”, who grew up playing Nintendo games 20 years ago, and who are
just beginning to have children of their own. We think that Nintendo’s decision to
make the Wii compatible with older Nintendo titles will encourage these Nintendads
to play older Nintendo games and updated versions of Nintendo classics with their
own children.
It now appears to us that over the long run, Nintendo will devote the resources
necessary to finish in first place in the current generation. We think that even if the
PS3 and Xbox 360 end up priced lower than the Wii, the company will maintain its
first place position due to another factor, dual ownership of consoles. In the last
cycle, many consumers purchased both a PS2 and an Xbox, largely due to the high

quality exclusive content offered on the PS2 and the better graphics and online
functionality of the Xbox. In the current cycle, there have been only a few exclusive
titles, and we believe that the graphics of the PS3 and Xbox 360 are sufficiently
similar as to largely eliminate the need to own both. Xbox Live is still a differentiator,
but Sony’s PlayStation Network had an impressive re-launch in 2008, and is gaining
ground fast. Ultimately, we think that most traditional video game households will
decide to own either a PS3 or an Xbox 360, and believe that most consumers who
opt to purchase a second console will choose the Wii. The lower price point and
innovative control scheme for the Wii flipped the order of the “second console”
choice, with most households that will ultimately own two consoles choosing the Wii
first.
A wild card in the current cycle is the potential for a mid-cycle product launch
from Nintendo. We expect Nintendo to consider introducing a “Wii-HD” sometime in
2010, providing a console that has graphics that compare favorably to the PS3 and
the Xbox 360. In our view, component costs are likely to decline sufficiently to justify
such a launch, and Nintendo could offer a console that is priced competitively with its
competitors’ consoles, while offering access to the extensive library of Nintendo first
party content. We believe that the publishers would welcome such an introduction,
as it would allow for relatively easy ports of games already produced for one of the
other major consoles. We don’t expect any announcement of a mid-cycle new
product until sales of the Wii begin to decline. That most likely won’t be apparent
until early in 2010, and we expect a “Wii-HD” announcement as early as the E3 Expo
in 2010.
WHY THIS IS LIKELY THE LAST CONSOLE CYCLE

There is a commonly held misperception that consoles can only support
software sales growth for a five-year period, and that current generation
console software sales will drop dramatically in 2010. As is fully explained in
our industry report six years ago (The Great Console Cycle Myth) we disagree
with this belief. We think that the basis for this misperception is historical, as each
prior generation console was replaced after five years. However, it is important to
note that this pattern has occurred only four times (in 1990, 1995, 2000 and 2005).
While four data points is certainly a meaningful sample, we do not think that it is
statistically significant. Rather, it is clear to us that Sony learned from its past
experience, and chose to defer the launch of its current generation console until
2006, notwithstanding that it ceded the first-mover advantage to Microsoft. Sony’s
patience allowed it to sustain a high level of PS2 game sales, with PS2 software
sales down only 30% in 2007. This compares to a 50% decline in PSOne software
sales at the outset of the last cycle. Notwithstanding Sony’s strategy to use PS2
software profits to fund a slow transition to the PS3, the company stumbled with the
PS3 launch, and lags in a distant third place as of this writing.
The past four transitions occurred for different reasons. The first transition occurred
in 1990, when Nintendo chose to replace its 8-bit Nintendo Entertainment System
(NES) with its own 16-bit Super NES. At the time, Nintendo’s first-party software
dominated the available software for both platforms, and the company was in a good
position to truncate the NES cycle, as consumers had few alternatives. The next
transition occurred in 1995, when Sony decided to compete with Nintendo head-to-
head through the introduction of its 32-bit console, the PlayStation One. Nintendo
had previously announced its intention to skip development of a 32-bit console in
favor of developing a 64-bit console (the N64). Sony, in an attempt to preempt

Nintendo’s technological advantage, chose to introduce its 32-bit console two years
before the launch of the N64 in order to gain a first-mover advantage. In order to
gain this advantage, Sony acquired first-party development capability and enlisted
the support of third-party publishers (notably, Electronic Arts). These steps allowed
the PlayStation to launch with a significant number of titles available, and the console
attracted a large number of purchasers (over 27 million) in the two years before
launch of the N64. Concern over competition led to the third console transition, in
2000, when Sony launched the 128-bit PS2, again in order to gain a first-mover
advantage over Nintendo and Microsoft. Both Nintendo and Microsoft launched
consoles in 2001, and although both were technologically superior to the PS2,
neither console was backward compatible. Also, Sony’s pre-emptive launch ensured
that it would have a leadership position in terms of the number of software titles
available for the PS2 when the Xbox and GameCube were launched a year later (an
advantage of over 3 to 1). We believe that Sony’s decision to include backward
compatibility as a PS2 feature was one of the key reasons for the console’s
dominance in the last cycle. The fourth console cycle began in 2005, with Microsoft
launching its Xbox 360 late in the year in order to obtain a first-mover advantage over
Sony. Microsoft’s console is a technological wonder, and its games are visually
stunning, but the company’s zeal to launch a year ahead of the competition led to
undersupply at retail, with an installed base of approximately 2 million four months
after the worldwide launch. At the same time, Microsoft discontinued production of
the current generation Xbox, limiting its potential for profitability from software
royalties and ceding the mass-market opportunity to Sony.
It is important to briefly review Sony’s business model for participating in the video
game product cycle. Sony has adopted a razor-and-razor blade model, whereby it
sells consoles at close to its cost (the “razors”), and makes a profit on each unit of
software sold for those consoles (the “razor blades”) by controlling the manufacture
of the software. At the outset of the current cycle, Sony was indifferent as to whether
it sold Trac-2 razor blades (PS2 software) or Mach 3 razor blades (PS3 software), so
long as it maximized the total number of razor blades it sold. By extending the life of
the last cycle, Sony expected to be in a position to generate maximum annual
royalties. Neither Microsoft nor Nintendo exploited their respective installed bases in
the same way as Sony, placing each at a competitive disadvantage. Sony continued
to sell a large number of PS2s, allowing it to generate significant profits from the sale
of hardware, and giving it an opportunity to slow the rate of sales decline for its
legacy software while the current generation cycle is well under way. Of course, the
ramp in sales of the PS3 sorely lagged the ramp of the PS2 six years earlier, eroding
the competitive advantage Sony sought to gain by extending the PS2 cycle for
another few years.
When the Sony PlayStation was introduced in 1995, it represented a paradigm shift
in console technology. The PSOne offered an amazing 48-fold increase in
information processing capability over its 16-bit predecessors, and advances in game
play and graphics triggered a significant increase in the number of units sold.
Worldwide, the PSOne sold over 100 million units, dwarfing the penetration of its
predecessors, the Nintendo Entertainment System (NES) at 60 million units, the
Super NES at 46 million units, the N64 at 30 million units, or the Sega Genesis at 26
million units.
The PS2 had even more impressive results, penetrating over 130 million households
to date (according to Sony). We expect that the number of households that intend to
purchase a console in the current cycle will increase by approximately 25% over the

10-year period following the last cycle’s midpoint due to a combination of increasing
household affluence, aging of the target demographic, and demographic expansion
by the Wii. We also expect the number of consoles per household to increase
slightly over the next four years, due to the price point and differential game play
offered by Nintendo’s Wii. Accordingly, by the end of 2013, we expect that more
than 175 million worldwide households will own at least one current generation
console.
Most consumers do not readily “abandon” their last generation consoles until a new
console is purchased. Rather, these devices typically remain connected to the living
room TV until replaced, albeit with decreasing annual software sales per household.
We believe that the appropriate analogy is to the PC market, where individual
consumers aren’t buying 3.2GHz machines for $499 at the same rate as they
replaced PCs in the past because they don’t need them. Until an application exists
that will compel consumers to replace their existing PCs, they won’t. We believe this
analogy holds for the current generation video game consoles; until an application
(game software) exists that will compel consumers to replace their existing consoles,
they won’t, especially if they don’t have an HD monitor. As we believe that the “killer
app” is high definition, we think that abandonment of current technology will be highly
correlated to household adoption rates of HDTV, currently at around 35% in the U.S.
and at around 15% in Europe. This factor appears to have benefited Nintendo so far
in the current console cycle, as its Wii console does not require an HD monitor.
In the preceding paragraphs, we pointed out that the U.S. and European publishers
chose to abandon the PSOne audience prematurely, instead devoting resources to
the development of compelling content for the PS2. Because of a relatively thin
lineup of games in 2000 and beyond for the PSOne, U.S. software sales for that
platform declined from $2 billion in 1999 to $1.7 billion in 2000, $1.06 billion in 2001,
and under $600 million in 2002. The drop-off in European sales was more dramatic,
declining from almost $2.3 billion the prior year to $1.5 billion in 2000, $600 million in
2001, and $440 million in 2002. The U.S. and European publishers collectively
captured over 65% of the PSOne software market at the time, meaning that the
decision to abandon the PSOne and support the PS2 caused a decline in collective
annual revenues of over $2.2 billion between 1999 and 2002. Full support of the
PS2 in 2006 mitigated the decline in software sales, with combined U.S. and
European sales for the platform declining only 11%, from $5.4 billion to $4.8 billion.
We expect a similar long tail for the current cycle, with solid sales for several years,
and only a modest decline once the “next” generation consoles are announced.
The important question is when this phenomenon will occur. As we discuss in
our 2007 “Curb Your Enthusiasm” industry report, the relatively low adoption
rates for current generation consoles indicates that support for the consoles
will extend well beyond 2010. The economics of game development and the
tremendous capital required to produce the consoles virtually compels all
constituents to milk the current cycle for all that it’s worth. Sony appears to believe
that the cycle will last far beyond 2010, hence its “late” introduction of the PS3 and
insistence on maintaining relatively high console price points well into 2009. We
think that PS3 and Xbox 360 sales will peak only when HD monitor sales peak, likely
early next decade (again, Wii sales are likely to be robust and steady over the next
several years). At that time, we think that the tail on the current cycle will be quite
long, and much like PCs, consumers will have little reason to upgrade to yet another
console until software development capability is able to harness the power of the
existing hardware.

HANDHELD, PORTABLE AND MOBILE CONSOLES
There is some confusion about the size of the market for handheld games. Many
industry observers refer to “handheld”, “portable” and “mobile” games
interchangeably, intending to describe games played on a device that can be carried.
We believe that the “handheld” market consists of three distinct subsets: handheld,
describing devices that offer a gaming experience designed for dedicated devices;
portable, describing devices that offer a gaming experience similar to home console
gaming; and mobile, describing hybrid devices that function as cell phones in
addition to allowing downloads of ever more complex games.
Over the past 10 years, Nintendo’s Game Boy, Game Boy Advance and DS consoles
have dominated the market for handheld or portable games (around 70% of
hardware units and over 70% of software sales in 2008), generating over $4.1 billion
in retail software sales last year. We expect worldwide sales of DS software over
$4.1 billion in 2009. Since the introduction of the Game Boy in 1988, several
companies have attempted to launch and support handheld consoles with little or no
success. The most recent failure is the Nokia N-Gage hybrid cell phone and
handheld gaming console, which generated total U.S. retail software sales of under
$5 million since its October 2003 launch, or the equivalent of two days of sales for
Nintendo handheld software. Although sales of Sony’s PSP have slowed somewhat
after a very strong start, the device continues to sell well. Sony positioned the PSP
as a portable device, with many games appearing on both consoles and the PSP.
PSP software sales worldwide were just under $1.7 billion in 2008, and are expected
to approach $1.9 billion in 2009.
Cell phone game downloads present a solid opportunity, with sales of approximately
$2 billion worldwide. We do not expect overall mobile phone sales to approach the
level of portable and handheld game sales over the near term, as memory and
battery constraints limit mobile phone technology to simpler games. We note that
with the increase in adoption of “smart” phones, games are becoming more complex
and are approaching the game play found on the DS.
Game Boy Advance
Nintendo launched the first widely successful handheld, the Game Boy, in 1989.
After selling over 50 million of the devices and over $200 million per year in software,
the company introduced the Game Boy Color in 1998. The latter device sold almost
50 million units in only three years, and software sales increased to over $1.6 billion
in 2000 alone. Nintendo further improved upon its Game Boy technology with the
introduction of the Game Boy Advance (GBA) in Japan in March 2001 and in the
U.S. and Europe a few months later. The GBA was a giant technological step up
from the older Game Boy/Game Boy Color technology, with a 32-bit processor
compared to the 8-bit unit found in the Game Boy Color (GBC). The processor speed
and memory in the GBA were comparable to the system specs for the Sony
PlayStation. The GBA sold over 25 million units in its first two years, and generated
worldwide software sales of over $1.7 billion in 2002.
In late March 2003, the company launched an improved version of the GBA, named
the GBA SP (for “special”). With the GBA SP, Nintendo further improved the device
design by placing a hinge in the middle of the console (a “clamshell” design allowing
proper positioning of the screen and a protective cover for the screen when the
device is not being used). Perhaps the most significant improvement in the GBA SP
was a front-lit screen (the poorly lit GBA screen was among its biggest drawbacks).
Another benefit was its rechargeable batteries, which eliminated the need to

constantly replace its predecessor’s two AA batteries. The GBA SP was compatible
with all GBA and GBC software, and launched at an MSRP of $99.99, with a price
cut to $79.99 in 2004. The GBA SP sold over 40 million units, and software sales
peaked at just under $2.4 billion in 2004.
Nintendo constantly tinkers with its product design, and introduced a new, smaller
GBA SP called the GBA Micro in 2005, with a 2¼” screen compared to the 3” screen
on the GBA SP. The Micro was priced higher than the GBA SP at $99.99, and the
device was intended to be “pocket” sized. The device did not have a significant
impact in the marketplace.
We classify the GBA line of products as handheld devices, as opposed to portable
devices. Few, if any of the games created for the GBA or for the DS (discussed
below) are created in the same form for consoles, with the same level of game play.
As we believe that Sony’s PSP (discussed below) has targeted a different market
niche, we never expected any serious competition for the GBA/GBA SP/DS. The
primary market for handheld consoles is the 8-to-12-year-old gamer and Nintendo’s
software dominates this market segment. As is more fully discussed in the next
section, Nintendo expanded this demographic with the DS. The company produced
approximately 1/3 of all GBA software units sold, and received tremendous third-
party support for the handheld platform, most significantly from THQ, which captured
approximately 30% of U.S. GBA software sales. Figure 20 illustrates historical Game
Boy Advance hardware sales by region.
Figure 20—Nintendo Game Boy Advance Unit Sales (2001 – 2008)
(mil)
Japan
18
Europe
16 U.S.
14
12
10
-
2001 2002 2003 2004 2005 2006 2007 2008
DS
Nintendo released the Nintendo DS (for dual-screen), in November 2004, and the
device sold through extremely well. The DS was a departure from the GBA SP,
offering two 3” front-lit screens in a clamshell design, with the lower screen activated
by touch. The DS permitted developers to expand the game play experience for

handheld devices, as consumers are able to control characters with a combination of
buttons, fingers, and motions of a stylus. The DS debuted at a price of $149.99, and
the price dropped to $129.99 in 2005. In mid-2006, Nintendo tinkered with the DS
design and introduced a “Lite” version of the product, with a brighter screen and a
streamlined form factor. The DS Lite was a phenomenal success from the start, with
sell through volumes double the level of its predecessor in the first ten months
following launch. DS games are typically priced between $30 – 40, compared to
pricing on GBA games of between $20 – 30. The DS offered full backward
compatibility, allowing consumers to play over 1,200 GBA and GBC software titles.
We believe that backward compatibility served to drive an inordinate number of
“replacement” sales, with consumers who previously owned the GBA or GBA SP
trading up to the DS. Accordingly, “tie ratios” for the device (the number of software
units sold for each hardware unit) trended slightly lower for the DS than for the GBA
SP in the early months following introduction. Tie ratios rebounded last year, and
through March 2009, annualized U.S. tie ratios for the DS averaged around 2.1 units
of software for each unit of hardware, comparable to the 2.0 tie ratio for the GBA/SP.
Figure 21—Nintendo DS Unit Sales (2004 – 2011E)
(mil)
30
Japan
25 Europe
U.S.
20
15
10
-
2004 2005 2006 2007 2008 2009E 2010E 2011E
Sony PSP
Sony launched its first portable gaming device, the PlayStation Portable (PSP) in late
2004 in Japan, followed by a March 2005 launch in the U.S., and a European launch
in September 2005. The PSP is a 170 x 69mm device (approximately 6.7” x 2.7”)
with a 4.3” diagonal LCD screen. The medium for game play is a UMD (universal
media disc). The name UMD reflected Sony’s intentions to create a device that would
play more than just video games. We also think it is important to note that the UMD
is a 1.8 gigabyte capacity, 60mm disc, remarkably similar in size to the Sony
MiniDisc, the company’s failed attempt to capture share of the music market. To
date, there are over 450 video game titles available and hundreds of movies

available on UMD format. In addition, there are thousands of movies available for
download to the PSP, stored on a Sony memory stick. Early consumer response to
movie content on UMD was underwhelming, and we expect the number of movies
offered in that format to decline in 2009 and beyond. However, we envision that the
offering of movies available (each film is around 400 Mb) will continue to expand
through downloads.
The PSP debuted for $249.99, including a bundled copy of the Spider-Man 2 movie,
and this price point held for its first year. In March 2006, Sony lowered the price to
$199.99, and this price point held for another year. The device is now priced at
$169.99, and we do not expect another price cut until well after the PSP Go is
introduced. Software for the PSP typically retails for $40, or $10 on average higher
than Nintendo DS software and $15 on average higher than GBA software. We
believe that royalty rates for PSP games are competitive with other formats (around
$7, including manufacturing, for a full-priced game, compared to an estimated $5 for
GBA games and $6 for DS games), and that development costs are low
(approximately $1 million per title). This means that a modest seller can generate
large margins for publishers, making a proliferation of content more likely going
forward. The PSP is not backward compatible with any other Sony game device.
At E3 last month, Sony formally announced the PSP Go (after several months of
rampant news leaks). The PSP Go (with a U.S. launch in October) is a slightly
smaller version of the current PSP with the biggest difference being the elimination of
a physical media player (no UMD), and the inclusion of 16Gb of flash memory. While
the device looks promising, we believe the $249.99/€249.99 price point may limit
adoption though this is another step towards digital distribution of games as all future
PSP games will be available for downloading at release.
Sony’s original strategy for the PSP was its third try (following its failed
attempts with both the Betamax and with the Sony MiniDisc player) to induce
music publishers and movie studios to pay royalties for the privilege of placing
content in a format playable only on Sony devices. The Betamax failed due to
competition from the technologically inferior Panasonic VHS format, which allowed
movie studios to publish royalty-free. The MiniDisc player failed for similar reasons,
as music publishers did not feel particularly compelled to pay Sony for the production
of discs when the CD format was universally accessible at extremely low fabrication
costs. This time around, Sony failed to capture strong third party video game
software support, and although it has sold a relatively large number of PSPs to the
video gaming community, the device has not captured a large tie ratio for software,
averaging only around 1.2 units per PSP in 2008. Should the company have greater
success with its redesign (without the UMD format) Sony will likely once again
approach movie studios and music publishers, this time, perhaps, with greater
success.
Of course, Sony has an uphill struggle given the incredible popularity of Apple’s iPod
Touch and iPhone, each of which offers downloads of both music and filmed content.
We believe that in order to be competitive with the iPod or iPhone, the PSP must be
enhanced by including a larger storage medium in order to allow content downloads.
We expect Sony to offer this feature in future versions of the device.

Figure 22—Sony PSP Unit Sales (2004 – 2011E)
(mil)
14 Japan
Europe
12
U.S.
10
-
2004 2005 2006 2007 2008 2009E 2010E 2011E
Mobile Gaming
Nokia introduced its hybrid cell phone/video game device in late 2003, and the
device failed miserably. Tiger Telematics launched its hybrid GPS/video game
device, the Gizmondo, late in 2005 with similar results. These devices offered hybrid
functions, and attempted to compete with cell phones, which had superior download
capability and a deep slate of content available through cell service providers and
dedicated mobile gaming portals.
For the last several years, we have been skeptical about the potential for mobile
downloads. Initially (back in 2002), mobile devices were bandwidth, storage and
battery constrained. As bandwidth has improved with 3G networks and flash memory
has come down in price, there is significantly greater potential for mobile downloads
today than there was even three years ago. We estimate that the U.S. market for
mobile downloads was under $1 billion in the U.S. in 2006, including downloads of
ring tones, wallpaper, greeting cards and games, but not including music. With the
advent of smart phones (mobile devices with wireless access, built-in Internet
browsers and relatively large storage capacity of 1 Gb or more), the potential for
mobile downloads has increased exponentially. We estimate that the market for
downloads has tripled to $3 billion in 2008, and will continue to grow this year.
However, we remain skeptical about the long-term growth potential for this market.
Game downloads represent no more than two-thirds of the mobile download market.
We note that industry leader EA Mobile generated estimated revenues of $180
million in 2008, largely due to strong sales of mobile games offered on the iPhone.
At an estimated ASP of $4 per game, EA Mobile’s revenues equate to approximately
45 million game downloads, or over half the level of unit sales for all other
portable/handheld game devices in the U.S. in 2008 (the total was 79.5 million units
sold). If our estimate of $2 billion for the total mobile game download market is close,
consumers are currently downloading over 500 million games annually, and EA
Mobile has a 9% market share. We think that EA Mobile may grow its market share

somewhat over the next few years, with international market expansion opportunities.
We also expect mobile games to continue to outsell portable/handheld software
sales, given the ubiquity of Internet enabled wireless devices and the low price points
for software. However, it is difficult to conceive of a world where smart phone owners
download billions of games, so we question whether the mobile game download
market will continue to grow much beyond another 50% or so. Considering that our
forecast for U.S. portable/handheld software unit sales is still below 115 million units
in 2011 at an average price point of over $20 per unit, it should be easy to
understand our skepticism that the mobile games download sales will substantially
surpass handheld/portable games in the foreseeable future.
We are skeptical about sustainable growth of this segment for several reasons.
First, cell phones are carried primarily as communications devices, and battery life is
important to most users. We think it unlikely that many consumers would risk being
“out of reach” by draining the battery on their cell phones in order to complete
another level of Bejeweled. Next, cell phones are somewhat memory constrained
(although memory is getting cheaper all the time), limiting the complexity of games
that can be downloaded. Third, bandwidth is a constraint, with more complex games
taking longer to access and creating risk of glitches in the transfer. Fourth, the user
interface can be a constraint, with the touch screens offered by the iPhone and
BlackBerry Storm offering perhaps the most user-friendly interface, but with the
control schemes of other smart phones quite game unfriendly. Fifth, and finally, we
(and Apple) think that the ubiquity of devices such as the iPod could ultimately create
an alternative to mobile phone games, with a shift in the business model for
publishers. Apple has had early success in branding its iPod Touch as an
entertainment device, and it is clear that games form one component of its plans.
Further adding to our skepticism is the business model used by most mobile content
publishers. While EA Mobile and Gameloft are pure play games publishers with
some notable exclusive content (such as Tetris) and access to a deep catalog of
Electronic Arts and Ubisoft titles, respectively, most others are full-service mobile
download publishers offering a variety of entertainment, SMS messaging, greeting
cards, ring tones, ring backs, etc. The publishing side of the business has grown
more competitive over the past year, with the introduction of the iPhone App Store.
Apple has encouraged commoditization of the content offered, and as a result, there
are thousands of titles available for download, with no easy way for consumers to
find a particular title. We think that publishers will have little choice other than to
sacrifice margin for market share, paying up for a spot on the App Store deck, or
cutting price to as low as $0.99 in order to drive volume.
We expect the cell service providers (other than AT&T, which has a different model
for the iPhone) to willingly accept higher margins in choosing among content
providers, and ultimately believe that the economic rent available to the mobile
content publishers will be bid away, so that only the strongest survive.
Ultimately, we do not see mobile gaming as direct competition for
portable/handheld games. Rather, we see the emergence of mobile gaming as
an opportunity to convert more casual gamers (primarily women) into more
active gamers, much in the way that EA.com has capitalized on its Club Pogo
web audience to convert users to other EA product offerings.

Figure 23—U.S. Console Price History
Sony PS2
O c t- 0 0 Launched at $299
M a y-0 2 C u t to $ 1 9 9
M a y-0 3 C u t to $ 1 7 9
M a y-0 4 C u t to $ 1 4 9
N o v -0 4 P S 2 S lim in t r o d u c e d
A p r-0 6 C u t to $ 1 2 9
A p r-0 9 C u t to $ 9 9
N in te n d o G B A - N o L o n g e r In P r o d u c tio n
J u n -0 1 L a u n c h e d a t $ 9 9
M a r - 0 3 C u t t o $ 7 9 , G B A S P in t r o d u c e d a t $ 9 9
S e p -0 4 G B A C u t to $ 5 9 , G B A S P C u t to $ 7 9
M ic r o s o ft X b o x - N o L o n g e r In P r o d u c tio n
N o v -0 1 Launched at $299
M a y-0 2 C u t to $ 1 9 9
M a y-0 3 C u t to $ 1 7 9
M a r-0 4 C u t to $ 1 4 9
N in te n d o G a m e C u b e - N o L o n g e r In P r o d u c tio n
N o v -0 1 L a u n c h e d a t $ 1 9 9
M a y -0 2 C u t to $ 1 4 9
S e p -0 3 C u t to $ 9 9
N in te n d o D S
N o v -0 4 L a u n c h e d a t $ 1 4 9
A u g -0 5 C u t to $ 1 2 9
J u n - 0 6 D S L it e in t r o d u c e d
A p r - 0 9 D S i in t r o d u c e d $ 1 6 9
Sony PSP
M a r-0 5 Launched at $249
M a r-0 6 C u t to $ 1 9 9
A p r-0 7 C u t to $ 1 6 9
S e p -0 7 P S P S lim in t r o d u c e d
M ic r o s o ft Xbox 360
N o v -0 5 L a u n c h e d a t $ 2 9 9 (C o re )/3 9 9 (P ro 2 0 G b )
M a y-0 7 N e w X b o x 3 6 0 E lit e ( 1 2 0 G b ) a t $ 4 7 9
A u g -0 7 C u t t o $ 2 7 9 C o r e , $ 3 4 9 P r e m iu m , $ 4 4 9 E lit e
O c t- 0 7 L a u n c h e d A rc a d e a t $ 2 7 9
J u l- 0 8 C u t t o $ 2 9 9 P r o , t o la u n c h n e w P r o w / 6 0 G b a t $ 3 4 9
S e p -0 8 C u t to $ 2 9 9 P ro w / 6 0 G b fro m $ 3 4 9 , A rc a d e to $ 1 9 9 fro m $ 2 7 9 ,
Sony PS3
N o v -0 6 L a u n c h e d a t $ 4 9 9 (2 0 G b )/5 9 9 (6 0 G b )
J u l- 0 7 C u t t o $ 4 9 9 f o r 6 0 G b , in t r o d u c e 8 0 G b a t $ 5 9 9
O c t- 0 7 C u t t o $ 4 9 9 f o r 8 0 G b , in t r o d u c e 4 0 G b a t $ 3 9 9
A u g -0 8 C u t t o $ 3 9 9 f o r 8 0 G b , in t r o d u c e 1 6 0 G b a t $ 4 9 9
N in te n d o W ii
N o v -0 6 L a u n c h e d a t $ 2 4 9

MONEY FOR NOTHING
Introduction
Two years ago, we based our industry report, Curb Your Enthusiasm, on our thesis
that several things could go wrong with the current generation console launches.
This year, the launches are well behind us, and our theme has shifted focus. During
2007 and 2008, there was some measure of euphoria among investors, who
apparently believed that all of the risk is behind the video game publishers. It
became apparent in late 2008 and early 2009 that while a great deal of risk had been
eliminated, the “good news” many expected (rapid industry growth, industry
consolidation, the advent of digital downloads) are taking somewhat longer to
materialize than most anticipated. In our view, investors were overly optimistic about
the ramp of current generation consoles, tie ratios, alternative revenue streams from
sources such as online games, the advent of in-game advertising, and the ease of
delivering downloadable content.
We waited two years to issue this report, as we carefully considered how likely
these expectations are to materialize. By taking twice as long as we normally do
between reports, we were able to observe one large successful merger (Activision
and Vivendi Games), one large failed merger (Electronic Arts and Take-Two), two
companies absorbed by others (Atari and Eidos), and one company declare
bankruptcy (Midway). It appears to us that after a mid-cycle transition year in 2009,
video game software sales will rebound in 2010, about the same time as we see
traction for ancillary revenue streams.
Video game publishers are positioned to capitalize on the increasing
acceptance of digital distribution. More consumers than ever before are
connected to the Internet, whether through traditional PCs, or through smart phones,
handhelds, or even consoles. Both the PS3 and Wii come with built-in Wi-Fi,
although both consoles have lagged far behind the Xbox 360 in convincing
consumers to connect and download. However, after only a year of effort, Sony has
come close to matching Microsoft in online-enabled console accounts, even though
the PS3 has a much smaller installed base than the Xbox 360.
Over the next five years, we envision exponential growth of digital delivery.
We have consistently believed that digital downloads would be driven by the
adoption of Internet-ready devices, and now, almost four years into the current
console cycle, that adoption has reached critical mass. Once the console
manufacturers and publishers increase the amount of content available for download,
we believe that it is only a matter of time before digital downloads become the norm.
There are several obstacles to digital delivery. First, the current generation
consoles are storage constrained. The typical Xbox 360 owner has an original
console (the Pro version) with a 20 Gb hard drive and an average game size of 7 Gb.
The typical PS3 owner has between 60 – 80 Gb of storage, and an average game
size of 7 – 15 Gb. And the average Wii owner has no hard drive, with only a flash
memory accessory. Because of the storage constraint, we do not see the current
installed base downloading large game files in large numbers any time soon.
Second, bandwidth is a constraint for large file sizes. Only 26% of U.S. households
and under 20% of European households currently have broadband Internet, meaning
long download times for large game files. We expect broadband penetration to

accelerate over the next five years, with well over 50% of households having access
to broadband by the middle of the next decade.
Third, digital files have no resale value. Because many consumers value the option
to trade in games (we estimate that as many as 50% of console games in the U.S.
are ultimately traded in), digital delivery will be limited to an “opt-in” service, where
the purchaser will likely have the choice of a physical disc or digital delivery. This will
limit the penetration of digital delivery for several years, with a likely maximum of
50% of all purchases digitally delivered in the latter half of the next decade.
Finally, there is no clear cut aggregator for digital downloads. Music downloads have
services such as iTunes to provide a wide variety of content. In order to download
games, it is likely that consumers will visit the Wii Shop Channel, PlayStation
Network or Xbox Live Marketplace to find games. These services have expanded
significantly over the last year, and it is likely that most games available for download
will be available on each console manufacturer’s respective website. For PC games,
services like privately-held Valve’s Steam service serve as aggregator.
We no longer think that the “winner” of the current console cycle has any
relevance. Microsoft’s penetration this cycle, while already well beyond its
penetration last cycle, lags leader Nintendo. As of the end of the first calendar
quarter this year, Microsoft had a worldwide installed base of 25 million consoles,
while Nintendo’s penetration was already at 50 million in a shorter period of time.
Sony sorely lagged the others with only 19 million consoles shipped, and an
estimated 17.5 million sold through at the end of March.
Instead we think that the “winners” of the current generation cycle will be
those manufacturers who achieve overall profitability. It is clear, at least thus far
in the cycle, that Sony’s Blu-ray DVD strategy was a drain on its early profits. The
company miscalculated in building in many features that are nice to have, but which
apparently were not sufficiently valued by consumers. As a result of offering a
feature-rich console, Sony’s cost of production was higher than its competitors by a
large measure, and it was forced to pass along the bulk of its higher costs in the form
of a higher selling price. Due to its high price point, traction for PS3 sales has thus
far failed to materialize.
On the other hand, the Wii, with its relatively low price point, was a smashing
success out of the gate. We estimate that production costs for the Wii are well below
its wholesale price point, meaning that Nintendo is able to generate a profit for every
box sold. The Xbox 360, priced in-between the Wii and the PS3, has the benefit of
being farther along a declining cost curve by virtue of its one-year head start, and we
estimate that Microsoft is close to breakeven on each console sold. Microsoft’s Xbox
Live service is likely profitable, and its games division is most certainly profitable.
Thus far in the cycle, Nintendo is making the most money, with Microsoft a distant
second, and with Sony still losing money. Sony’s CEO, Sir Howard Stringer, is
committed to profitability, but this commitment has so far kept PS3 prices high, with
the console costing slightly more to make than its average selling price. As long as
the cost of production exceeds wholesale pricing, any price cuts will serve to
increase the losses generated by Sony’s game division. Every $1 in lower wholesale
pricing will trigger an incremental $1 loss at Sony, at least until production costs are
well below average wholesale pricing.
In its May earnings conference call, Sony forecast sales of 13 million PS3s, up from
an average of 9.5 million in each of the last two years. The increase in volume

suggests to us that a price cut is planned for later in the year. We note that a cut of
$50 in average price will trigger a loss of $650 million annually, assuming that 13
million consoles sold is a steady state goal. Thus, until Sony is able to get its
production costs substantially lower, it will have difficulty achieving profitability.
On the other side, Microsoft has made a big bet with its Xbox Live service, and views
the service as a potential differentiator for the Xbox 360. Microsoft has managed to
achieve a material penetration with its Xbox Live service, with over 17 million
members and an estimated 11 million “Gold” members paying $50 per year to play
online. We think that the $550 million in Gold fees substantially exceeds the cost of
the service, and estimate that Microsoft generates at least 50% operating profits on
this figure. Should the company be able to maintain or grow its installed base, it
could see profits rise dramatically through game and other content downloads.
Can the Wii maintain its #1 position? Nintendo remains an enigma. Some have
branded the Wii a fad, while others think it is a placeholder for consumers who
ultimately intend to purchase one of the other two “next generation” consoles. We
expect the Wii to outsell its competitors by a large margin for at least two years, but
have difficulty predicting whether Wii demand will remain strong or will fade
thereafter. We expect Nintendo to tinker with its hardware some time in the
foreseeable future, likely offering high definition graphics in a future version of the
console. Should it fail to do so, we think that the other two consoles will become far
more competitive as prices come down.
Will the PS3 lose? Without question, Sony’s console is off to a slow start, and it
may have fallen sufficiently far behind that it will not be able to recover. The price
point for the PS3 remains high ($399 for the preferred model as of this writing), far
above the prices for the Wii ($249) and Xbox 360 ($299), and well above comparable
console prices in any prior cycle (an average of $199). Consumers have been
trained to wait for console price drops, and so far this cycle, Sony has been
uncooperative, with no meaningful price cuts since October 2007. Until the price of
the PS3 is below $300, we do not expect sales of the console to exceed monthly
sales of the Xbox 360.
We believe that it is a mistake to expect this console cycle to develop in the
same way as past cycles. We expect digital distribution of content to affect the
outcome of the current generation console cycle, and in the pages that follow,
offer our observations. Our predictions are intended to provoke discussion, and
are our best guesses as to what will happen. We have structured our discussion in
terms of events that we believe may occur far in the future, and in some cases much
later than commonly held perceptions. The ultimate outcome of the console wars will
be impacted by a variety of factors. In addition to the emergence of digital
distribution models, these include pricing, timing, competition, and most importantly,
third-party support. This cycle, third parties include the movie studios and
advertisers.
ONLIVE COULD CHANGE THE LANDSCAPE

In mid-March, 2009, we were given a private demo of OnLive. We were blown
away. The OnLive service consists of a server-based gaming platform and a simple
device that compresses and decompresses the game file to allow a low latency
transmission of the game from server to user’s television or PC. Game files reside
on central servers, and users access the game by logging into their OnLive accounts

and playing either single-player or multi-player games. We demoed both, and the
results were utterly impressive.
The secret to OnLive is its compression technology. Provided that the user has
high speed Internet access, signals between OnLive servers and the user interface
make the round trip journey in 80 milliseconds or less (less than 1/10 of a second).
The games we demoed ran at around 25 milliseconds, according to the company. At
this transmission rate, most games feel as if there is no lag whatsoever, and the
game we played (Crysis) felt as if we were playing on a fully-optimized gaming PC.
It is not clear to us that OnLive will dominate any time soon, but we are
confident that this breakthrough technology will ultimately be widely adopted.
In our view, the “killer app” for the technology is videoconferencing, which will likely
attract widespread demand and which can be bundled with Internet or telephone
service at a meaningful up charge. With close to zero latency, we envision
tremendous demand for OnLive as a videoconferencing service, and think that
broadband Internet providers like Verizon or AT&T would find the service appealing
as a way to increase penetration and revenues.
Regardless of the ultimate killer app, it is clear to us that there is a future for
server-based gaming. OnLive should appeal to those households that have not yet
purchased a current generation console, and if the company is able to get pricing
right for its business model, it is likely that it will penetrate some portion of the tens of
millions of households that have not yet adopted current technology. The trade-off
between buying a new console and subscribing to the OnLive service is the
perceived present value of a console (around $300, using the current price of the
Xbox 360 as a proxy). If the OnLive service is priced below $5 per month (our best
guess as to the trade-off between buying a new console and subscribing to a
service), it is likely to succeed. If it is priced much higher, it will likely face consumer
resistance.
While we think OnLive is promising as a standalone service, we think that it
will likely end up part of an expanded service offering from a much larger
company. Microsoft could buy OnLive (the company bought WebTV from the
creators of OnLive) and integrate the service into its Internet hub strategy. Apple
could buy the company as part of its AppleTV rollout. Verizon or another broadband
provider could buy the company for its videoconferencing capability, and could offer
games as an add-on to the videoconferencing service. The possibilities are endless,
but the technology is quite appealing, and we are confident that OnLive will end up
as part of the video game culture some time next decade.
THERE MAY NOT BE ANOTHER CONSOLE CYCLE (BUT LOTS AND

LOTS OF CONSOLE SKUS)
Conventional wisdom dictated that after a brief transition period, consumers
would wildly embrace current generation console technology, and rapidly
accelerating software sales growth would follow. There was a certain Field of
Dreams mentality among the console manufacturers—if we build it, they (the
consumers) will come. Conventional wisdom turned out to be wrong—consumers
embraced “old” technology, with demand for the Wii outstripping supply for a full two
years past launch, but demand for the “new” technology offered by the Xbox 360 and
PS3 has sorely lagged expectations. Through May 2009, U.S. sell through of Xbox
360 and PS3 combined totaled only 23 million units, 9 million units (or 30%) behind
the pace of Xbox and PS2 sales over a comparable period last cycle. Clearly, some

of the early anticipated demand for current generation technology was satisfied by
the Wii, but the Wii’s output and game play is strikingly similar to the legacy
consoles, with only the control scheme and price point a differentiator. Due to the
phenomenal success of the Wii, cumulative sales of the three current generation
consoles are running 10% above the level of combined sales in the last cycle over a
similar period, but it is clear that consumers have not “wildly embraced” the current
generation consoles.
To us, the cumulative sell through pattern suggests that the life cycle of
current generation consoles still has years to play out. While we admire and
respect Nintendo’s accomplishment in taking an insurmountable lead in the console
race, it appears to us that Nintendo has done so by attracting non-traditional
households to gaming. We estimate that over half of Wii households are non-
traditional, meaning that they would not have bought a console but for the novelty
and innovation offered by the Wii. While this is a good thing, insofar as it expands
the ultimate market for video games, the early success of the Wii has created a
misperception that Sony and Microsoft will never see a spike in sales, and that the
Wii will dominate forever. When placed in the context of a longer console cycle than
in the past, it is not clear that Sony and Microsoft should be written off.
There are several differences between this cycle and past cycles that may be
sufficient to trigger an outcome that differs from conventional expectations.
Perhaps the most significant difference is console pricing in the current cycle. The
average console (as of this writing) is priced at $283, with the Wii maintaining its
launch price of $249.99, the core Xbox 360 priced at $299.99, and the core PS3
priced at $399.99. We expect each manufacturer to cut price by $50 before year-
end, so the average console price should end 2009 at $233, a full $100 higher than
the average console price at a similar point in the last cycle. More importantly, the
average price point at year end will remain over $200, which is widely considered the
“mass market” price point for consoles.
In past console cycles, approximately 90% of ALL consoles purchased were
sold at price points below $200. Consumers have been trained to wait until
console prices come down, and with the Wii remaining at launch pricing for 2 ½
years and the last PS3 price cut approaching its two-year anniversary, it is clear that
those consumers who have waited for a reduction are still waiting. We think that
once the “next” generation consoles (the PS3 and the Xbox 360) are priced below
$200, we will see a dramatic increase in unit demand.
Another factor affecting the adoption of the Xbox 360 and PS3 is the
penetration rate of HDTV. Approximately 40% of U.S. households and 20% of
European households have purchased HDTVs, limiting the size of the addressable
market that can appreciate the stunning graphics capability of the Xbox 360 and
PS3. The global recession has limited HDTV adoption, but we expect a rapid
increase in the rate of adoption between now and the end of 2010. If this increase in
adoption rates coincides with intelligent price reductions for the Xbox 360 and PS3,
we expect to see a similarly rapid increase in console sell through. Our industry
growth model forecasts a modest increase in combined Xbox 360/PS3 console sales
in the U.S. and Europe, from 14.7 million in 2008 to 15.9 million in 2009 and to 16.6
million in 2010. Should price cuts be deeper than we expect, these adoption rates
could increase faster than we have forecast.
In summary, fewer people will buy consoles at high prices than will buy them
at low prices. At the outset of the current cycle, we think that many industry

observers believed that “hardcore” gamers had deep pockets, and would line up to
pay any price for a current generation machine. The launch of the PS3 in Europe
demonstrates the limits on this thesis, with over 600,000 units sold in just three days,
followed by a drop off to 100,000 units over the succeeding week. It is clear that
people considered $599 for a PS3 expensive.
Of course, nobody should expect console pricing to remain high forever. Another
fallacy in conventional wisdom was the belief that a slow start means a slow finish.
To paraphrase Sir Isaac Newton, what starts out high priced, must come down.
While we do not expect rapid price cuts for the current generation consoles, we do
not expect them to remain at twice the price points of the last generation consoles
forever. Instead, we expect regular price cuts for the PS3, and believe that the
console will ultimately be priced at the “magic” price point of $99. However, a cut in
price to this level requires that Sony achieve dramatic manufacturing economies, and
may take five years or more to materialize. Because we believe price cuts for all
three consoles are inevitable, we think that consumer demand for all three will grow
over time.
The solution to console pricing is in the manufacturing, with console
redesigns driving cost savings for the manufacturer. In prior cycles, we saw two
PSOne SKUs and two PS2 SKUs, with only one Xbox SKU. Thus far in this cycle,
we have seen five PS3 SKUs and five Xbox 360 SKUs, and we expect another PS3
SKU later this year (the rumored PS3 Slim). Manufacturers have a huge incentive to
redesign their consoles to use less expensive components. At the same time, the
potential for downloading digital content has grown in inverse proportion to the cost
of storage, so we should expect to see ever-increasing hard drives in the new
console SKUs. Many expect Microsoft to offer a completely new Xbox 360 in late
2010 (with the launch of Project Natal); we would not be surprised to see a terabyte
of storage offered as standard fare by the end of next year.
The endgame for the console manufacturers is the re-positioning of their devices as
Internet and Entertainment hubs in the living room. Microsoft is farthest along,
creating access points for Netflix, Facebook, Last.fm and Twitter via its Xbox Live
dashboard. Sony and Nintendo each have a built-in web browser, with access
through a keyboard peripheral, but these browsers are not widely used, and are
certainly not accessible to the technologically unsophisticated. With the advent of
new console SKUs, we envision the migration of the boxes into multi-media devices,
with games, Internet access, IPTV, DVRs, and VOD for movies and TV built in.
DIGITAL DOWNLOADS ARE HERE AND NOW

We think it will take several years until digital downloads of complete console
games becomes a reality. However, Nintendo has already begun downloads of its
retro classics, while Microsoft has built a sizeable business with downloads of arcade
games through its Xbox Live Arcade. The core PS3 SKU has a 80 Gb hard drive,
while the core Xbox 360 has a 60 Gb hard drive. Game files are typically between 7
– 10Gb in size, so the average current generation console owner would have
capacity for only a handful of games through download. As hard drives get larger
with each new console SKU, it is likely that we will see an acceleration of digital
downloads of full games, pressuring the retail packaged goods model.
Games that are downloaded do not have a physical disc that can be traded in at the
local GameStop. The number of games traded annually is striking; we estimate the
overall used game market to be $2 billion in the U.S., with an average ticket of

around $20 per used game. This means that an estimated 100 million units of used
games are traded in each year, representing around 1/3 of all games sold annually.
Thus, the option value of trading a game is quite high, and we can only surmise that
1/3 of game consumers place some measurable value on the ability to resell a game.
This option is eliminated with downloads. We think that the resale option will
ultimately serve to lower demand for digital downloads, and expect that packaged
goods will continue to be offered over the next ten years, with migration to digital
content absorbing much of the overall growth of video game sales.
Another factor limiting the likely adoption of digital downloads is the lack of portability.
With a physical disc, consumers can take games to different locations (to play with
others, or to loan the game to a friend). Digital downloads eliminate portability.
Again, we believe that consumers will perceive some value to portability, meaning
that some portion of consumers will prefer packaged products to downloads.
Until storage capacity in the installed base grows sufficiently to allow full game
downloads, we expect to see a meaningful increase in sales of creeping
downloads (selling a game in installments). We think that the poster child for this
scenario is Grand Theft Auto IV on the Xbox 360, a game first sold in physical form,
with additional levels sold periodically thereafter through downloads. Notably, after a
tepid embrace of its first downloadable “episode”, Take-Two decided to offer the first
and second “episodes” in a combined physical package, with the two episodes
allowing full game play without the purchase of the original GTA IV game disc. This
model reinforces our belief that packaged goods will capture the majority of game
purchases for the next ten years.
In ten years, we envision a world where the typical console has a terabyte or
more of storage, and where full game downloads are the norm. As stated
above, there will always be a sizeable number of consumers who value the trade-in
option and portability, and we expect those consumers to favor physical goods over
digital downloads. Thus, we expect that digital downloads will represent less than
50% of total game sales ten years hence. If we’re right about game sales growing at
above GDP rates for the next ten years, it is likely that by 2019, packaged goods
sales will grow modestly (around 3% per year, to $30 billion in the U.S. and Europe)
and that digital goods sales will grow exponentially (greater than 50% per year, to
over $20 billion). These combined rates of growth suggest overall game sales
growth of 8 – 9% per year for the next ten years, creating an opportunity for the
publicly traded publishers to grow revenues and to dramatically grow earnings.
THE WII PLUS (HD) IS COMING (EVENTUALLY)

Nintendo is smart. Very smart. The company decided to avoid cutting-edge
technology, and chose not to offer a console that competes graphically or
technologically with either the Xbox 360 or the PS3. Rather, Nintendo offered a
completely different game play experience. Nintendo chose to build a console in the
current cycle that used relatively inexpensive, commodity components, and to
compete against its better capitalized rivals by changing the control scheme. Its Wii
console has sold an amazing 50 million units in its first 30 months, ahead of the all-
time leader, the PS2, at a similar point in the console cycle.
The company’s big gamble was on its controller innovation, allowing one-
handed game play and encouraging the development of content unique to the
Wii. Whether Wii owners are playing Ubisoft’s Red Steel, a shooter/adventure game
where the player wields the controller as if it were a sword or a firearm, or EA’s Tiger

Woods PGA Golf with Wii Motion Plus, the game play experience is different from the
other consoles. Games such as this are not offered on the other consoles, and the
unique nature of the game play afforded by the controller has driven sales of the
console. Both Microsoft and Sony have announced plans to develop similar
controller schemes, but it is unlikely that either will erode Nintendo’s competitive
advantage.
In our view, Nintendo’s success with the Wii will last for another two years.
Perhaps its biggest advantage is its deep library of first party content, including
Mario, Zelda, Metroid, Pokemon and several others. Its other big advantage is its
demographic focus on younger gamers. While this demographic is not likely to grow
dramatically (see our discussion on demographics on 26), it is a robust group that
has largely be ignored by Sony and Microsoft in their quest to capture older and
more affluent gamers. We also believe that a generation of “Nintendads” has
emerged that has helped Nintendo secure a sizeable niche following. Further, the
innovative controller and peripherals such as Wii Fit and Wii Motion Plus have led to
the development of several third-party exclusive titles, as the prohibitive cost of Xbox
360 and PS3 development limited the porting of these titles to the other consoles.
If Nintendo hopes to build on its momentum thus far in the cycle, it will likely
take steps to capture further market share from Sony and Microsoft when the
PS3 and Xbox 360 begin to address the mass market. We expect that the PS3
will be priced below $300 some time in 2010, and that the core Xbox 360 SKU will
crack the $200 barrier. We think that Nintendo is likely to release a “next” generation
console of its own that is competitive with the current generation consoles offered by
Sony and Microsoft at that time, in order to attract both new console owners (who
have been waiting for the appropriate price to purchase a “next” generation console),
and to retain those Wii owners who may consider a trade up.
Our vision is that Nintendo will wait until the cost of a console with technical
specifications similar to the Xbox 360 (1080p output at 60 frames per second) is
sufficiently low that it can launch close to the $199.99 price point. We would expect
such a console to be fully backward compatible with the current Wii, but would
expect the new console to have additional features and functionality. It is possible
that Nintendo will redesign the existing Wii controller (the “Wiimote”) to include built-
in Wii Motion Plus, and also possible that the Wii Plus (our best guess for the name
of the Wii HD) will include a hard drive.
In our view, if Nintendo can offer such a device by year-end 2010, it will be in a
position to seriously damage Sony’s chances of a comeback this cycle. We would
expect publishers to support such a move, given that the cost of porting an Xbox 360
game to the new Wii Plus HD format would likely be lower than the cost of building a
ground up Wii game (we estimate under $5 million). Should Nintendo be able to
convince publishers like EA and Take-Two that the Wii Plus should be supported by
the entire EA Sports catalog and by the next installment of Grand Theft Auto, it
should be in a position to successfully convince consumers that the Wii Plus is the
last console they will ever need to purchase.
Of course, the timing of such a launch will depend upon several factors, including the
cost of production, the price points of its competitors’ consoles, and the willingness of
publishers to support a launch. We believe that each of these factors will shift in
Nintendo’s favor eventually, and are targeting fall 2010 for a Wii Plus announcement.

One factor that is likely to work in Nintendo’s favor is the rate of adoption of
HD technology. Households have been slow to purchase HD monitors, and many
non-HD households selected a Wii as their console of choice over the last two years.
Once Wii households switch to HDTV, consumers may consider the Wii as “old”
technology (due to its standard definition output), particularly if Microsoft and Sony
are successful in convincing developers to make similar games for their consoles
once they add a comparable controller as a peripheral. It is hard to know whether
this scenario is likely until we have more information about pricing and launch dates
for Microsoft’s Project Natal and Sony’s eye-toy-like controller, so until we are able to
assess the competition and the content available, we won’t know for sure.
The open question in our mind is whether the Wii’s early success will be sustainable.
It is likely that due to its relative price advantage and unique game play, the Wii
attracted many consumers who ultimately intend to purchase a PS3 or Xbox 360, but
who either cannot afford to do so now, or who intend to wait until pricing and
software support justify a purchase of one of the other two consoles. We believe it is
highly likely that a large percentage of early Wii purchasers intend to ultimately own
two consoles. In the last console cycle, these “two-console” households tended to
purchase either the Xbox or the PS2 as their primary console, and made a later
purchase of another console as the secondary console. In this cycle, we believe that
two-console purchasers are buying their “secondary” console (the Wii) first, and will
likely purchase their “primary” console (the Xbox 360, PS3, or the Wii Plus) later. If
Nintendo hopes to capture a significant share of this substantial market opportunity, it
must offer a console that is comparable to those offered by its competitors.
Nintendo has seen a more rapid sell-through profile for the Wii than for any console
in history. In sharp contrast to the delayed sell-through we project for the PS3, we
think it is likely that the Wii has experienced an accelerated sell-through, with as
many as 50% of lifetime units sold in the first two full years following launch. It will be
nearly impossible to know whether this thesis is correct until well after the fact, but
the decline in Wii sales we are seeing in mid-2009 could be a signal that consumers
are considering an upgrade to a competitor. If so, Nintendo is likely to offer a
competitive product sooner, rather than later.
THE XBOX 360 COULD END UP A WINNER, EVEN IN THIRD PLACE

Microsoft has positioned itself to thrive, securing a more dominant position this cycle
through its decision to launch the Xbox 360 a full year ahead of the PS3 launch.
Demand for the Xbox 360 has remained stable since launch, and we believe that
Microsoft’s first mover advantage will allow it to sustain its lead over Sony in the U.S.
and Europe for at least another three years. Pricing continues to be a problem for
Sony, and Microsoft has managed pricing brilliantly, lowering price when it can and
consistently pricing below the PS3.
In order to drive demand, the company focused upon building its Xbox Live
service. The service attracted 2 million users in the last generation, or around 10%
of all console owners. Microsoft recently announced that 20 million users (over 65%
of 360 owners) had signed up for the Xbox Live service, consistent with the
company’s vision for a completely connected gaming experience. This percentage
has been consistent throughout the current cycle, and we think that it is a sustainable
figure. Two-thirds of Xbox Live members pay for the privilege, paying up $50 per
year to have access to online game play as Gold members. With Gold membership

comes additional perks, such as access to Netflix streaming (for Netflix members)
and, later this year, access to Last.fm.
One driver behind consumer acceptance of the Xbox Live service was the expansion
of the Xbox Live Marketplace. This feature allows Xbox Live subscribers to download
game upgrades (microtransactions), download demos of games and movies,
personalize their home pages and add pictures, and play retro classic games through
Xbox Live Arcade.
Xbox Live has been a success to date, and Microsoft continues to differentiate
from the free PlayStation Network offered by Sony. Under the latter service,
Sony offers an open platform to encourage game development, downloadable
services and content, community tools (such as live chat), and a marketplace, all free
of charge. The key difference between the online services offered by Microsoft and
Sony is their breadth of offering. Microsoft has diligently built Xbox Live for almost
eight years, while Sony’s service is in its infancy. Microsoft’s user base is generally
hardcore, and accustomed to online access of game content. Over the past year,
Microsoft partnered with Netflix to allow streaming of older movies to Netflix
customers who were also Xbox Live Gold members. With over 10 million members
(only 1 million of whom are Xbox Live Gold members), the Netflix installed base has
an incentive to purchase an Xbox 360 and to join Xbox Live. Later this year,
Microsoft will add Facebook, Twitter and Last.fm applications to its dashboard. While
the PS3 has an Internet browser (making it technologically capable of offering each
of these services), the user interface is somewhat more difficult than the one
presented by the new Xbox experience.
We expect Microsoft to gain market share, primarily at Sony’s expense, during
the current cycle. Microsoft has sold 30 million consoles from its November 2005
launch through the end of March, and appears on track to sell approximately 9 million
per year going forward. Sony has sold 22 million consoles since its November 2006
launch, and expects to sell 13 million consoles (a 30% increase over last year’s level)
in 2009. In order to accomplish this goal, Sony must take some action to drive sales.
We expect a price cut later this year, accompanied by a bundle of first party software.
Going forward, we think that Microsoft and Sony will sell a similar number of
consoles in the U.S. and Europe, with Sony maintaining its advantage in Japan.
The key measure of success, in our view, is profitability. Microsoft has managed
to lower its production cost for the Xbox 360 to the point where it is breaking even or
generating a small profit. Its Xbox Live service, while robust and costly to maintain,
generates a significant profit, with an estimated 13 million Gold members worldwide
paying over $600 million per year. We expect the pace of game and movie
downloads to increase exponentially over the next few years, and estimate that
Microsoft generates over $100 million in profit annually from downloads. We expect
consumers to purchase over 90 million units of Xbox 360 software this year,
generating further profitable revenues of over $1 billion.
Most importantly, we think that Microsoft has positioned the Xbox 360 to be an
Internet and Entertainment hub in the living room. With the rollout of Project
Natal (the new and innovative control mechanism that allows players to use their
bodies as game controllers) expected in late 2010, we think that Microsoft will
position itself as a centerpiece of the living room. We expect Natal to appeal to non-
gamers, not as a game control mechanism, but as an Xbox Live dashboard
controller. Project Natal essentially allows users to interact with the television screen
by pointing, and will allow users to manage the dashboard with a swipe of their

finger. We envision the addition of Internet television, video on demand, and open
Internet access over the coming years, once Microsoft has decided how best to
monetize its product offering. With an installed base of 30 million and counting,
Microsoft has a huge first mover advantage over competitor AppleTV for dominance
in the living room. Should the company succeed in convincing consumers to use their
Xbox 360s for access to other entertainment, Microsoft will be in a good position to
grow its revenues far beyond those generated from gaming.
THE NEW, DIGITAL PSP IS NOT QUITE DEAD, YET, (OR IS IT?)
For its first few years of existence, the media was fixated on the “battle” for
portable dominance between the Sony PSP and the Nintendo DS. Now, it’s
fixated on the “battle” between the iPod Touch and the PSP. The phenomenal
performance of the DS made the PSP’s performance appear poor, although the PSP
actually performed quite well. By the end of its fourth full year, the PSP’s installed
base reached approximately 40 million units, hardly a disappointment. With the
introduction of the iPhone and the iPod Touch and the availability of games through
Apples App Store, the media has shifted its focus in the handheld wars to Apple, and
has pronounced the PSP dead, once again.
Sony’s response is the introduction of the PSP Go, a download only device with
16Gb of internal flash memory, with a slot for a Sony Memory Stick to allow for
additional storage. The PSP Go is a full-featured multi-media device, with the ability
to download music, movies, television shows, and, of course, games. It is not
significantly different in function from its predecessor, the PSP 3000, but differs in
that it does not have a disc drive and will not play UMD-based games or movies.
Sony’s PSP software sales have been lagging, and the PSP Go appears to us to
address that problem by encouraging the download of other forms of entertainment.
PSP software sales were over $1.3 billion in 2006, but sales growth has stalled, with
only $1.7 billion in 2008 sales. Year to date, U.S. PSP software sales (through May)
are down 37%, suggesting that consumers are not carrying the device as a primary
gaming platform. We believe that Sony introduced the PSP Go to reinvigorate sales,
and we think that Sony is hopeful that the multi-function PSP Go will replace iPods
for many consumers.
It is true that Sony’s vision of the PSP as a multimedia device has yet to come true.
Sales of UMD movies were quite disappointing, with many studios withdrawing
support for films in the UMD format. Similarly, the evolution of Sony’s music
download service has been quite slow, and consumers have as yet to embrace the
memory stick as a storage medium.
The PSP’s performance has been disappointing in the context of comparison to the
DS. We expect PSP Go sales to be somewhat constrained at its $249.99 price point
(compared to the PSP 3000’s price of $169.99), but expect sales to grow in inverse
proportion to the price point. Once the PSP Go is priced below $150, we think that
Sony may see a rebound in overall portable hardware and software sales.
THE NEW DSI WILL ADVANCE THE BRAND

The new Nintendo DSi was launched earlier this year, with a slot for physical media,
and with flash memory that allows users to download games and store photographs.
Although the DSi is positioned as a download device, we continue to believe that
Sony and Nintendo have targeted different markets with their handheld hardware.
Sony appears to us to have positioned the PSP Go to appeal to an older

demographic looking for a portable entertainment experience, and Nintendo appears
to have positioned the DSi to appeal to a younger demographic looking for a
handheld gaming experience with some additional features (such as playful
photography) that may appeal to pre-teens. In our view, there is room for both to
succeed with their respective strategies. So far, Nintendo’s success with the DS has
far exceeded our most optimistic expectations, and we think that the DSi is
positioned to expand upon the DS demographic by appealing to somewhat older
gamers.
DS sold through approximately 100 million worldwide units since 2004, becoming the
best-selling handheld game device of all time. Over the last three years, Nintendo
has seen annual sales of 30 million units per year, ahead of the Wii and PS2 in
overall sales. The DS is one of the primary reasons we expect the current generation
console cycle to be the biggest ever. For the five year period ending in 2003, global
handheld software sales averaged $1.75 billion annually. Over the next five years,
global handheld software sales averaged over $4.5 billion per year, with DS software
sales contributing 50% of all sales. DS software is expected to generate over $4
billion in global sales this year, or 15% of all video game software sold worldwide.
The DSi is priced somewhat higher than its predecessor, debuting at $169.99. We
think that the relatively high price point of the PSP Go may help Nintendo to sell DSi
units, but ultimately, we believe that the hardware must come down in price if
Nintendo intends to achieve its global sales forecast of 30 million units.
It is not clear whether Nintendo added download capability to the DSi in response to
rampant piracy of DS software (which has been particularly onerous in Europe), or
because the company intends to advance into the digital age. Perhaps the answer is
some combination of both, but we see the introduction of the DSi and the PSP Go
opening the door to digital downloads of full games, and believe that as soon as
storage is no longer a constraint for the consoles, we will see increased downloads
of full games to all gaming devices.
BLIZZARD IS THE PRESENT AND FUTURE OF ONLINE GAMING

Six years ago, we said that we thought that online gaming is a joke. Five years
ago, we acknowledged that online gaming is not so funny, but were still relatively
unimpressed. Four years ago, we remained unimpressed, noting our belief that
Microsoft’s focus on online gaming was a strategic error, while acknowledging that
there is potential for online gaming to grow into a meaningful niche. Notwithstanding
the remarkable success of MMOGs such as World of Warcraft, we remained
convinced that the vast majority of game play will be done offline. Three years ago,
we began to think that we could have been wrong (perish the thought), and
acknowledged that online gaming may, indeed, have some potential. Two years ago,
we acknowledged that online gaming is something to be taken seriously.
Today, we acknowledge that online gaming is real, and is here to stay. Lines
between MMOGs, games played through server farms (like GameSpy), games
played on Xbox Live, and games played solo while the player’s console or PC is
connected to the Internet are becoming blurred. Digital content downloads are
becoming prevalent, even in single-player households. “Always on” console Internet
connections enable gamers to sample game demos, and even to download beta
versions of new games. In addition, growth of casual Internet games has been
explosive, and the quality of these games has improved dramatically. We think that
as console manufacturers, publishers and consumers are offered an incentive to be

online all the time, the nature of game play and the business models for the
manufacturers and publishers will undergo a dramatic shift.
For the last several years, we have questioned the potential for online gaming
as a source of revenues. We now believe that the opportunity is real, but it
appears to be developing differently than most expected. Many observers
define “online” games as MMOGs, and expect these to grow in popularity, rivaling
and even surpassing console games. In the western world, we do not see this
happening. We continue to believe that MMOGs will appeal only to a relatively small
niche of gamers in the Western world, perhaps approaching 20%. While there are
notable U.S. and European successes online, such as World of Warcraft with about
5.5 million subscribers in the U.S. and Europe, these successes are few. Notably,
WoW’s greatest potential lies in the East, with over 6 million subscribers. The rest of
the MMO community consists of around 10 million active subscribers to dozens of
other games. Despite the well-intentioned efforts of games like Lord of the Rings
Online, Age of Conan and Warhammer: Age of Reckoning, few western games have
attracted even 1 million subscribers, and the MMO opportunity appears to be
destined to be dominated by Blizzard.
We expect Blizzard to capitalize on its first mover advantage, and to exploit a
similar strategy with Starcraft. The company created World of Warcraft as an
RPG only after enjoying phenomenal success with its Warcraft series of RTS games.
It is slated to offer the second installment of the immensely popular Starcraft RTS,
and we think that it is likely that history will repeat itself in late 2010 or early 2011
with the launch of a World of Starcraft MMO. Should it choose to, Blizzard can
capitalize on its installed base of subscribers, servers and call centers, and can roll
out a multi-million player MMO overnight. We think that a World of Starcraft MMO
would certainly cannibalize World of Warcraft subscribers, but in the aggregate, we
would expect the two games to attract a greater number of subscribers than WoW
does today.
The area with the most explosive growth is MMOG play in Asia. While China
and Korea have been relatively small markets for console games, both countries
have seen dramatic growth of online gaming, with an estimated 10 million monthly
subscribers to one or more MMOGs. Although subscription rates are generally lower
in Asia, these subscriptions add up to a $500 – 700 million recurring revenue
streams, typically by the minute. The potential for revenues through
microtransactions can double the annual revenue opportunity. As the emerging
middle class in China grows to a size comparable to the middle class in Europe
(likely some time in the middle of the next decade), China alone may support video
game sales approaching $7 billion annually. The potential of this market is too large
to ignore, although most U.S. and European publishers have done a credible job of
ignoring it so far.
Although we think that the publishers will largely succeed in growing overseas
revenues through international expansion, we are concerned about their ability
to compete with MMOGs. In our view, the global market for video games is likely to
grow far beyond the $23.5 billion we have forecast for U.S. and European software
sales in 2009. Should the Chinese middle class embrace video games, we think that
their first experiences will be playing MMOGs, and there are few U.S. and European
publishers actively participating in this genre (World of Warcraft being the large
exception).

The console and handheld markets in the U.S. and Europe will provide ample growth
opportunities for U.S. and European publishers over the next several years, with
software sales expected to increase from over $22.5 billion in 2008 to over $50 billion
by 2020. Over that same period, we conservatively expect MMOG sales in Asian
markets to grow at a 25% compound annual growth rate, from an estimated $500
million to as much as $7 billion. We think that a 25% CAGR is sustainable in Asia,
given the rapid emergence of the Chinese middle class, driven by GDP growth in the
high single digits. We think that this potential is too big to ignore.
The market is definitely not being ignored by several Asian companies.
Netease, Tencent, Perfect World, Giant Interactive, The9 Ltd., Webzen and NCSoft
are all chasing this market, and given cultural differences between Western and
Eastern consumers, we think that their head start may give them an insurmountable
advantage if the U.S. and European publishers continue to wait for the market to
develop.
Our concern about the U.S. and European publishers is long-term. Although we
expect dramatic console software sales growth over the next several years, we
believe that the current generation cycle may be the last. If that is true, we expect
software sales growth to revert to the high single digits, reflecting combined GDP and
demographic growth in the U.S. and Europe. Should the U.S. and European
publishers desire to grow revenues at a higher rate, we believe that they must pursue
the Asian markets. In order to access these markets, we think that they will have to
offer MMOGs.
Demonstrating its commitment to maintaining its first mover advantage in
Asia, Blizzard appears poised to monetize its Battle.net service. In the past,
Blizzard allowed gamers to play multiplayer games like Warcraft and Starcraft
against one another through a free, hosted site called Battle.net. Going forward, it
appears that there is potential for Blizzard to charge for multiplayer gaming, whether
through tournament entry fees or some other mechanism. The Battle.net experience
is similar to multiplayer gaming on Xbox Live, and it is clear from the success of that
service that gamers are willing to pay for the privilege of playing against one another.
Should Blizzard attempt a subscription offering similar to Xbox Live, we could see a
large bump in revenues from online gaming.
On the console front, Microsoft is the clear leader. Microsoft has over 20 million
Xbox Live members around the world, and an estimated 13 – 14 million of them pay
$50 annually for the privilege. This yields subscription revenues of $650 million
annually from Xbox Live, with an ever-increasing revenue stream from content
downloads.
We expect content downloads over the Xbox Live service to grow to an annual level
of somewhere $300 – 500 million, and expect subscription revenues to grow by $50
– 100 million per year. Thus, on a single console, we envision “online” revenues,
unrelated to MMOGs, of over $1 billion. Sony has rolled out its free PlayStation
Network, and offers a similar experience. The PSP Go will be a download only
device, and will allow users to access many forms of digital entertainment. Nintendo
has as yet to develop an online offering, and may sorely lag its rivals for several
years. However, the company recently launched the DSi, a new handheld that
allows content downloads. The Wii Channel allows downloads of older Nintendo
titles, albeit with limited storage on the console itself. With the increase in
subscription revenues and content downloads, we could see total online gaming
revenues on the consoles approach $2 billion in a matter of years.

Sony’s free PSN may have some potential. We think that if the online experience
is free, the potential audience for online games would be several hundred million
people. Once a fee is charged, we think that the potential audience drops to
something closer to 15 million, and if the fee is substantial (say, $40 per month), the
potential audience drops to 1 million or fewer.
Thus, we think that the area of online gaming with the greatest potential is the
area of casual games. These games typically require little instruction, take several
seconds to several minutes to complete, and tend to be addictive in nature. It is our
view that all gamers are casual gamers, and a subset of the casual games audience
likes to play hardcore games. Every gamer starts out playing simple games, and the
most hardcore gamer typically advances to more complicated games over a period of
years. Playing games is like anything else; proficiency requires practice.
In our view, the “hook” necessary to make online gaming ubiquitous is the
development of compelling casual games. Electronic Arts has focused on this with
its Pogo.com subscription service, and it has spent hundreds of millions of dollars in
an effort to traverse the gap between mobile gaming and casual online gaming.
Once consumers become accustomed to logging on to a website in order to play
games, the lines between online and console are likely to become blurred.
In order for this to occur, the consoles must become Internet access devices. All
three current generation consoles make connecting to the Internet simple.
IN-GAME ADVERTISING IS NOT A BIG DEAL

For the last several years, much was expected from in-game advertising. The
in-game advertising model allows advertisers to target and reach a desired
demographic with dynamic ads placed within games. The publishers and console
manufacturers can benefit greatly if these sources are fully exploited over the next
several years, but the division of the profit pie will remain up in the air until one party
or the other takes steps to exploit the opportunity.
The delivery of in-game advertising requires a persistent online connection in order
for ads to be truly dynamic. Although all three current generation consoles are
equipped with online capability, an online connection is not required in order to
access game content. As a result, advertisers are only able to target and measure
page views for those gamers who have connected their consoles to the Internet, and
then only while these consumers are logged on. Microsoft has done an admirable
job, with two-thirds of all consoles connected to its Xbox Live service. The company
bought an in-game advertising company, Massive, in 2006, in order to facilitate the
delivery of in-game ads to its Xbox Live members. Of its 20 million Xbox Live
members, we estimate that 14 million are Xbox Live Gold members, most of whom
are online whenever the Xbox 360 is in use. Thus, we believe that Microsoft may be
able to monetize the in-game advertising opportunity more quickly than other console
manufacturers or publishers.
Sony, on the other hand, has over 20 million PlayStation Network accounts, but it is
not clear whether the company has the ability to deliver dynamic ads to its members
in the same way that Microsoft can.
Microsoft is experimenting with the delivery of ads through some of its innovative
offerings, such as 1 vs. 100. In that “game” (which is interactive, and plays like the
television show), Microsoft proposes to offer full one-minute commercial breaks
(similar to the television show). Because 1 vs. 100 is still in its beta phase, it is not

clear to us whether the delivery of differing ads will be targeted to specific groups of
consumers, but it is clear that Microsoft has the technical expertise to do so if it
chooses. Assuming that its experiment is successful, we think it is only a matter of
time before Microsoft offers similar targeted advertising to publishers.
In the absence of a persistent connection, the publishers will have to rely on an
alternate measurement mechanism. We believe that advertisers will be reluctant to
agree to pay television-like advertising rates in the absence of proof that a gamer has
actually viewed the ad delivered. For example, a gamer playing the latest Tony
Hawk Ride game may tire of the experience after level 7 is completed. Advertisers
who chose to place content on a billboard on level 8 would not reach this particular
consumer, and would likely be unwilling to pay for the privilege of placing an
advertisement within the game. As such, we think that a rate card for such a game
could only be established if the publishers were able to demonstrate to advertisers
that a measurable percentage of players actually viewed their ads.
We note that a company like TiVo is able to track user preferences by compelling its
users to connect to the service via a once-per-day upload of program guide data.
The company tracks user activity, and extrapolates from this activity to recommend
other programs. If this same intelligence capability were applied in the video game
context, we believe that educated guesses about consumer behavior would be close
to the mark, and that in-game advertising could be both delivered and measured in
such a way as to command premium advertising rates. This would be true of all
games, whether single player, multiplayer, or MMOGs.
Another way to do this is to establish a Nielsen-like ratings system, whereby several
thousand households opt-in to participate in having their gaming habits measured.
We believe that this type of a system will be implemented before the majority of
gamers are online all of the time, as we think the publishers will be motivated to
make this happen.
According to dated information from Massive, in-game advertising can generate as
much as $2 per unit in royalties for game publishers. This number is somewhat of a
mystery, as Massive never publicly disclosed how much advertisers pay for
delivering ads into game networks. Using $2 per software unit as a proxy for the
value that could flow to publishers, we envision a potential market for in-game ads of
approximately $500 million in the U.S. and Europe by 2011, based upon our forecast
of 621 million units of software sold, with perhaps 40% of games susceptible to the
insertion of ads within the game. In the event that ads are more finely targeted in the
future, we could see this number increasing exponentially, as ad rates would be
more closely correlated to page views and hours played than to unit sales. If
measurement of user behavior improves dramatically, we could see in-game
advertising throw off revenues of somewhere between $2 – 10 billion annually.
Viewed from the publisher’s perspective, in-game advertising has the potential to add
significantly to margins. The large U.S. and European publishers are expected to
generate operating margins of between 10% and 30% in 2009. If the average game
sold has an average wholesale price of $30.10 (our model predicts a weighted
average retail price of $37.62, discounted to reflect retail margin), publishers will
generate operating profits of $6.02 per unit at the midpoint of the expected operating
margin range. If 40% of these games are in-game ad enabled, the expected royalty
across all games will be $0.80 per unit, contributing 2.7% to average operating
margins.

We have not modeled a dramatic increase from in-game advertising revenues
for the publishers we cover over the next three years, as we see growth from
this source stalling. Ultimately, although we think that in-game advertising could
total as much as $1 billion annually in the U.S. alone. However, we see little traction
from the category, and note that most of the publishers we cover have stopped
talking about the potential of in-game advertising revenues altogether. We think that
one of the reasons for stalled growth is the inability of the publishers and console
manufacturers to determine a fair split of in-game ad revenues, with advertisers
remaining on the sidelines until a champion is able to develop an acceptable rate
card. Until one dominant player emerges to create a business model acceptable to
all (we suspect that this will be Microsoft), we think that in-game advertising will be a
slow growth business.
DIGITAL DOWNLOADS WILL LIMIT GAMESTOP’S GROWTH

There is a commonly held perception that used game sales limit new game
sales growth, and that digital downloads will replace packaged products sales,
killing off GameStop in the process. As a general rule, used game sales don’t
negatively impact new games sales. The commonly held perception is that
GameStop (the industry leader in used game sales, with an estimated 90% market
share in the U.S.) “pushes” used games on unsuspecting customers lined up to
purchase new games. This perception (perpetuated by publisher executives) has led
many to conclude that GameStop’s used game business largely replaces sales of
new games. We do not believe this to be true.
On the contrary, we think that used game sales benefit new game sales by providing
currency to gamers with less disposable income, thereby enabling the purchase of
additional games. The vast majority of used games are not traded in until the original
new game purchaser has finished playing, typically well beyond the window for a full-
retail priced new game sale. Thus, while there may be some limited substitution of
used game purchases when GameStop employees “push” used merchandise upon
consumers lined up to buy new games, the vast majority of used game purchases
occur more than two months after a new game is released. Other than the potential
impact at holiday (when new game lives are extended beyond the typical two month
sell-through pattern), used game sales just don’t impact new game purchases very
much.
To the extent that there is a substitution effect, we estimate that fewer than 5% of
new game sales are impacted. By our reckoning, more than one-third of all games
purchased in the U.S. end up as used games. If we’re right, then one-third of game
consumers derive some currency from the trade-in of games, and if these trade-ins
occur at GameStop, they should position the trade-in customer to buy more new
games than he/she would otherwise normally purchase. Because the average used
game value is around 20% of the new game price, we think that used game trade-ins
fuel incremental sales of over 6% of total new game sales, suggesting that the
cannibalization from the used game “push” is more than offset by the benefit from
used game currency.
Notwithstanding our views, publishers seem determined to end the practice of
used game sales, with the rush toward downloadable content a precursor to
full-game downloads in the next several years. Over the last several years, we
have seen an increase in the number of map packs, downloadable levels and other
downloadable content available for retail sales. This “DLC” (for downloadable
content) has, without question, cut into the addressable market for packaged

products. Conventional wisdom holds that the rush to DLC is a precursor to full-
game downloads, with the inevitable conclusion that once full-game downloads are
offered, they will spell the end for GameStop. Publishers are interested in eliminating
the potential for used game sales, and have concluded that digital files are difficult, if
not impossible, to resell as used games.
The publishers’ reasoning concludes that if games are downloaded, they cannot be
resold, and games that are downloaded will not be purchased as packaged goods at
GameStop. As more games become available for download, their availability will
inevitably lead to a shift in purchase patterns away from packaged goods and in
favor of download. Necessarily, any growth in game downloads will reduce the
addressable market for GameStop. Many industry observers have concluded that
like the music industry, the video game industry will rapidly adopt full downloads,
resulting in the end of consumer retail sales of packaged goods.
Nothing could be further from the truth—Full game downloads are not
imminent, and will not widely substitute for packaged goods sales until a
significant portion of the installed base purchases consoles with much larger
hard drives. As we discuss elsewhere in this report, average console game files are
quite large, with Xbox 360 game files typically 5Gb or larger, and with PS3 games
often exceeding 10Gb in size. The average Xbox 360 has a hard drive of only 20
Gb, with only a small percentage of consumers owning the “Elite” version of the
console with its 120 Gb hard drive. Similarly, the average PS3 has a hard drive of 80
Gb or smaller (the preferred launch SKU was 60 Gb), meaning that very few full-
game downloads could be stored by the average consumer.
We expect the console manufacturers to address limited storage capacity with
the next wave of console SKUs. We expect Microsoft to launch a new version of
the Xbox 360 with the introduction of Project Natal (its camera-based motion control
mechanism), some time in late 2010 or early 2011. This new version is likely to have
a significantly larger hard drive; we can only guess as to the size, but we expect a
hard drive of 500Gb or larger to come standard with the new Project Natal Xbox 360
SKU. At the same time as hard drives get larger, we expect to see an expanded
offering of full-game downloads, available at the same price as the competing
packaged product, but offered through Xbox Live or the PlayStation Network.
Publishers will benefit in two ways: first, full-game downloads will generate higher
margins, with the console manufacturer taking an estimated 30% of the retail price
instead of 20% to the manufacturer and 20% to the retailer for a packaged product
sale; and second, insofar as digital downloads will not enter the market again as
used games.
The increased incidence of digital downloads does not necessarily mean an
end for GameStop. In our view, one of the drivers of new game sales is the
perception on the part of many consumers that the game will have value when the
purchaser is finished playing it. The consumer may choose to trade in the game for
nominal credit at his local GameStop, or may choose to give the used game to a
friend. While it is true that most gamers do not trade in games, we note that the used
game business is a substantial one.
We estimate that GameStop sells around $2 billion in used games each year in the
U.S. At an average retail price of $20 (to make the math simple), this represents 100
million used games that are traded in each year. Given that GameStop’s business is
primarily conducted in the U.S., we think it is relevant to compare this figure to 2008
overall U.S. video game unit sales of around 270 million units. Given that used

games can be sold more than once, the used figure we calculated represents around
one-third of all new game sales on an annual basis.
We believe that the large percentage of games traded in reflects the size of the
consumer market for trading in games. In other words, if one-third of all games are
traded in, it is likely that one-third of all consumers value the proposition of a used
game market, and are attracted to used games as a currency for new game
purchases. We do not believe that this market will evaporate; rather, we think that
demand for packaged products will continue, even after a substantial percentage of
the installed base has upgraded to new consoles with very large hard drives.
In our view, the video game market is likely to grow at or above a 7.2% rate for
the next ten years, at least doubling over that time. We envision digital
downloads to account for all of the growth. The “rule of 72s” says that if demand
for video game software averages 7.2% for ten years, the industry will exactly
double. We think that this is highly likely, and think that digital downloads will grow
exponentially during that period, limited only by the storage capacity of current
consoles. We envision a world in ten years with twice as much demand for used
games, but with only a constant level of packaged product sales, due to growth of
digital downloads.
If we are right, GameStop is positioned to thrive for many years to come.
Assuming that the company manages slowing growth effectively, GameStop should
see its packaged products sales flatten over the next few years. At the same time, it
should see demand for used games grow with the overall market, while the available
supply of used games (which must be packaged products) stalls. Simple economics
dictate that if demand for a product doubles over time, while the available supply of
that product remains static, pricing must go up.
Thus, we see the potential for GameStop to generate flat new game sales, but see
the company selling a similar number of used game units at ever-increasing prices
over the next ten years. Should the company manage its SG&A costs effectively, it
should generate profits from higher used game pricing that are sufficient to offset its
escalating costs, resulting in relatively stable earnings over a ten-year period.
Therefore, notwithstanding the conventional wisdom that GameStop will be
doomed by digital downloads, we think that the company may see its earnings
grow for a few more years, then flatten out and remain relatively constant.
Company management has downplayed the potential for digital downloads, impairing
their credibility with investors, and GameStop’s multiple has suffered as a result.
Once the company acknowledges that digital downloads are coming, we think that
investor confidence will return to the extent that management sets out a plan to
continue to grow earnings.
Although not technically within the definition of our “Money for Nothing”
section, we thought it appropriate to discuss the threat from used game
competition in this section. Recently, several large companies have begun
testing used game concepts that have been interpreted by many investors as a
threat to GameStop’s market share. Amazon has begun a trade-in program
(managed by a third-party fulfillment partner) where consumers are offered free
postage round trip, and are offered credit for anything on the Amazon website. Wal-
Mart has partnered with a third party to install kiosks at some stores that validate the
disc traded in, and provide consumers a voucher that can be redeemed for cash or
merchandise in the store. Best Buy is testing a concept on a limited basis similar to

Wal-Mart’s, with kiosks in a test market and vouchers for merchandise within the
store.
We do not expect any of these programs to capture significant market share
for quite some time. In our view, GameStop has a real and sustainable competitive
advantage due to the makeup of its “core” customer. GameStop welcomes boys
under 18 to hang around in their stores and to test games, and provides a generally
pleasurable experience within the store for teenagers. In contrast, Best Buy is not
particularly friendly to young teens, and Wal-Mart is not a desirable place for young
teens to hang out. Both Best Buy and Wal-Mart are relatively inconvenient to get to
for kids without cars, while GameStop’s strip mall penetration makes them a short
bike or skateboard ride away for most kids.
The key to GameStop’s competitive advantage lies in the fact that its core customer
is more likely to trade in games than most other demographics. Boys under 18 are
more likely to be unemployed than the core demographic at Best Buy or Wal-Mart,
and are generally more self-indulgent. An unemployed 14 year-old seeking
immediate gratification has few options when a “must have” game is released, other
than to trade in a handful of older games. We estimate (in an unscientific manner)
that around 70% of all used games traded in at GameStop are traded in by boys
under 18. The other 30% is traded in by every other demographic. In our view, Best
Buy and Wal-Mart will have difficulty attracting these trade-in customers (and likely
do not desire them), and we therefore estimate that the addressable market for their
kiosk offering is limited to “everyone else”.
Amazon is a different story. Although Amazon does not offer immediate gratification,
the barriers to its ability to reach boys under 18 are lower. Anyone with an email
account and a credit card (perhaps 1/3 of the GameStop trade-in clientele in the
under 18 group) can be reached by Amazon. In the Amazon model, the consumer
enters the games intended for trade-in, and prints out a postage-paid mailing label.
Credit is posted to the consumer’s account when the discs are received in good
condition. Because Amazon makes it so convenient for consumers, we think that it
has some potential to capture market share.
The bigger issue for GameStop is the threat that one or more of these
competitors will compete on price. Few products sold by Best Buy, Wal-Mart or
Amazon generate margins as high as the 50% captured by GameStop on used
games. Because each competitor’s program is in the test phase, we cannot yet
determine whether any intend to compete on price. However, each has the ability to
discount used games (or pay higher trade-in prices) to the point that they generate
only a 30 – 40% margin. It is likely that each company’s third party partner will seek
10% or so margin, but we think that any of the companies would be happy to price at
a 30 – 40% gross margin, and to generate a 20 – 30% net margin after paying its
partner. We estimate that round-trip postage will cost Amazon an incremental 10%,
so the company may not be willing to discount as steeply as the others.
Notwithstanding, we think that should any of these companies be serious about
gaining market share, discounting is likely
If one of GameStop’s competitors competes based on price, GameStop has
two choices: either match pricing, or lose market share. We expect Best Buy,
Wal-Mart and Amazon to capture between 5 – 10% market share over the next
several years (assuming all three decide to roll the test program out). At that level, it
is inevitable that some GameStop customers will notice if one or more of the
competitors offers higher trade-in prices or lower used game prices. We would

expect some portion of GameStop sales to be price protected in such a case. For
example, if the average GameStop transaction involves a trade-in for $10 and a
subsequent sale for $20 (50% margin), we think it is likely that one or more of its
competitors will offer $11 for the trade-in and charge $19 for the used game (around
a 40% margin) in order to attract more merchandise and to capture market share.
The math here is a bit fuzzy, as we are dealing with a hypothetical. However, we
think that a 10% margin discount is likely, and believe that such a discount will cause
at least 10% of GameStop’s used game customers to seek a price match. Such a
result would cause GameStop to lose 1% margin on its used business (10% discount
offered to 10% of its customers). GameStop’s used business in North America is an
estimated $2 billion this year, so a 1% margin hit would represent $20 million in lost
pre-tax profits, or an EPS cost of around $0.08 per share. If one or more of its
competitors discount by 20%, it is likely that even more customers will notice. In that
case, we envision price protection of 20% offered to as many as 20% of GameStop
customers, resulting in a 4% margin hit, or around $0.32 per share.
We don’t expect this to materialize overnight. In our view, the test marketing by
GameStop’s competitors will last through 2009, and a widespread rollout will not
occur until 2010. Our best guess is that the EPS hit will be $0.04 or so in 2010, and
an incremental $0.04 – 0.08 for the next year or two, before the market stabilizes.
GameStop can combat this margin hit by being more aggressive with used game
promotions, sacrificing margin in favor of greater velocity of used game sales at
higher overall prices. If it chooses this strategy, it can actually grow its used game
gross profits, albeit at lower margins. We don’t expect a conclusion to the onslaught
from competitors for several more years, and will update the used game market in
next year’s report.
FREE-TO-PLAY GAMES HAVE POTENTIAL

A business model has emerged in Asia that provides online game play for free
to consumers, with microtransactions generating hundreds of millions of
dollars for the sponsors. Perhaps the biggest cash generator of the free-to-play
genre is Kart Rider, published by Nexon of Korea. The game purportedly has over
100 million players in Asia, and most of the users don’t pay anything to play. A small
percentage (perhaps 5%) purchase items (such as tires and wheels) for their carts,
and we have seen reports that the game has grossed over $200 million from these
microtransactions in just a few years. Another popular game is Combat Arms, where
players can purchase over 100 real world guns, grenades, rockets, camouflage, etc.
This game is available in the West.
Companies like Electronic Arts are pursuing the Free-to-Play genre with a
vengeance. EA has introduced NBA Street, FIFA Online and Battlefield Heroes in
the last several months, and has several more games under development for rollout
in the next few years. The company appears committed to participating in the
explosive growth of this genre, particularly in Asia.
Of course, the question is “how big is this market, and when will it develop”.
There is little publicly available information about the free-to-play sector, other than
the occasional press release from one of the Korean or Chinese gaming companies.
It is our view that the market is over $1 billion annually at present, and is growing at a
rate of greater than 25%, suggesting that this will be a $3 billion or larger market by
2014. It appears to us that Electronic Arts is intent upon capturing a meaningful

share, with 5% of the market justifying the considerable development expense that
the company has incurred to date.
We intend to monitor the Free-to-Play genre closely, and expand our coverage
in next year’s report. Companies like Acclaim are focused on this sector, and we
expect to see considerable market expansion beyond Asia in the coming year. Our
“guess” about the market potential is just that, and we will monitor to see if the
market is growing faster or slower than we have estimated.
MOBILE PHONE GAMES ARE A FAD

For several years, industry pundits have estimated that the mobile phone game
market would grow to over $10 billion, cutting into the market for handheld
games. We disagree. The market for mobile phone games is likely closer to $2
billion at present, with rapid unit growth offset by ever-lower pricing for games. While
it is true that Apple’s estimated 31 million iPhones and iPod Touch units have
downloaded over 1 billion “apps”, it is not evident that more than 20% of these
downloads are games. According to Mobclix.com, the average price for games sold
through the iPhone app store is under $2, suggesting that this enormously successful
platform has generated under $400 million in game downloads in its first year.
We expect mobile phone game sales to grow at 25% per year for a few years,
then expect sales to cool off. As competing handsets emerge, such as the Palm
Pre, we think that new “app” store models will emerge, and we expect the mobile
phone game market to grow to perhaps $4 – 6 billion over the next three to five
years. While this appears to be a considerable opportunity, we think that the nature
of the app store, which is an Internet based open forum, may limit the ability of the
major game publishers to participate. A few small private companies (notably
ngmoco and Digital Chocolate) have consistently released games in the top 50 on
Apple’s best seller lists. However, at last count, there were over 1000 games
available for the iPhone, with several new games added each day. In order to
capture market share, a publisher would have to capture the attention of consumers,
either through advertising, word of mouth, or paid listing (it is not clear whether Apple
accepts payment for slotting on its game dashboard).
We do not expect any publisher to dominate the mobile phone game market. In
our view, Electronic Arts’ emphasis on mobile games is misplaced. The company
acquired JAMDAT in 2005 for over $600 million, and while it has been able to double
revenues from its EA Mobile division over the last three years to almost $200 million
annually, we estimate that the division is barely profitable. Competing firms Gameloft
and GLU Mobile have struggled to grow (or even to generate) profits, as competition
on the iPhone is fierce. Moreover, the iPhone has a unique business model, wherein
the handset maker (Apple) runs the game download service for an estimated 30%
fee, leaving 70% to the game’s publisher. Most other game downloads are
administered by carriers with Verizon or Sprint capturing a greater share of the retail
sale. Until there is a better business model for mobile phone game downloads, we
do not expect any publishers to become wildly popular.
The perception that mobile game downloads spell the beginning of the end for
handheld gaming platforms is a myth, in our view. The Nintendo DS has a
wealth of proprietary software, and its CPU is sufficiently sophisticated that games
developed for it are more complex than the average iPhone game. While it is likely
that mobile phones will include ever more powerful CPUs in the future, we don’t
expect parents to purchase such phones for their young children any time in the next

five years. The average iPhone requires a data plan of over $100 per month, far
above the amount that most parents are willing to pay for a child under 16 (the sweet
spot for the Nintendo DS). Similarly, we think that the PSP Go, positioned as a
multimedia player with a far more powerful CPU than the iPhone, will maintain its
niche, without significant cannibalization of sales from mobile games.
POST SCRIPT—LESSONS NOT LEARNED FROM THE LAST

CONSOLE CYCLE
Chasing the new consoles—As we stated in each of our last six industry reports,
Electronic Arts, Activision, and THQ managements have repeatedly stated their
intention to “harvest” the last cycle through 2010. Each management team has
repeatedly publicly lamented its participation in the console transition from PSOne to
PS2, commenting on mistakes made in “abandoning” the PSOne in favor of the PS2.
Each pledged not to make the same mistake again, and each devoted significant
resources to PS2 game development well into the current cycle. At the same time,
the three publishers were quite conservative with the launches of the Xbox 360, PS3
and Wii, with only a handful of titles produced at launch for each. The only publisher
that “chased” a new console was Ubisoft, with an impressive 10 Wii titles released
over the first several months following launch.
In hindsight, the publishers appear to have made a mistake. The Wii has been a
runaway success, with the PS3 sorely lagging sales expectations. As the current
cycle entered its third year (in 2008), decisions made two years prior to fully support
the PS3 turned out to be in error. Companies that chose to support the Wii benefited
mightily, with Ubisoft’s casual division growing from virtually nothing in 2005 to over
€300 million in revenue in 2008, largely due to strong sales of Wii games. Other
companies that had solid Wii sellers were Take-Two, with its Carnival Games brand,
and Midway, with Game Party. Of the three publishers that supported the PS3, only
Activision had any meaningful success on the Wii, largely because its Guitar Hero
game was such a runaway hit on the platform.
Licensed properties and sequels are sure-fire sellers—Over the course of this
decade, we have seen a decline in original intellectual property in video games, with
increasing emphasis on licensed content and sequels. In 2003, there were only
three new original brands that finished in the top 30, and in 2004 there were only two.
In 2005, the only new brand to finish in the top 30 was a licensed property. In 2006,
there were three new brands (Guitar Hero, Gears of War and Cars), with one a
licensed property. In 2007, two new brands cracked the top 30, both for the Wii (Wii
Play and Petz), and in 2008, two more new brands made the cut, also for the Wii (Wii
Fit and Imagine). This pattern suggests to us that video game publishers are
reluctant to take risks with new content as each console cycle matures. They appear
to believe it a safer route to develop content based upon well-known brands such as
Harry Potter, Lord of the Rings, Spider-Man, SpongeBob, Scooby Doo, Yu-Gi-Oh,
and Dragon-Ball Z, or to focus on sequels to proven brands such as Need for Speed
and Tony Hawk. To some extent, this decision appears wise, as the “mass market
phase” of a console cycle (which we expect to begin in late 2010) typically brings
more casual gamers into the market. It is true that each of these brands accounted
for at least a million units sold in past years, and each produced a million-unit seller
in its most recent iteration. However, we are not convinced that merely licensing a
successful brand from another genre will necessarily guarantee successful video
game sales, and we are equally unconvinced that sequels to popular games will sell
well in all cases.

The problem faced by the publishers is the pace of discounting. For the first
three years of the current cycle, game pricing has held up remarkably well, with
many games holding launch pricing for six months or more. Beginning in 2009, we
began to see pricing crack, with heavy discounting of several holiday titles, and in
particular, discounting of the Guitar Hero World Tour and Rock Band bundles. It
appears to us that retailers are quick to request discounts, and in many cases,
consumers have been trained to wait for discounts. It is understandable when
disappointing performers at holiday are deeply discounted, but we believe that the
true test of game pricing will occur this holiday, when we will see whether the
recession impacts demand.
We believe that the publicly traded publishers have begun to demonstrate
pricing discipline, instead of training consumers to wait for price cuts. New
game pricing is holding up, with highly successful games like Call of Duty 4: Modern
Warfare and Call of Duty: World at War holding launch pricing for more than a year
and for six months, respectively. We think that rapid price cuts and discounts on
premium titles in the past led to consumers waiting for discounts. Over the last two
years, we have seen more discipline in pricing, with a greater number of “collector’s
edition” games selling for a $10 premium, and little consumer resistance to very
expensive bundles such as Guitar Hero World Tour for $189.99. In our view, the
publishers simply cannot afford to allow game discounting, given prohibitively high
development costs. Most observers expect front-line pricing to remain at $59.99, but
it is not clear how rapidly prices will fall once these games are on the shelf. We have
seen relatively modest discounting of Xbox 360 games in the 43 months since
launch, and equally modest discounting of Wii and PS3 games. Very few games are
priced at $19.99 (primarily “party” games), and most have been sticky at the $39.99
price point.
Shorter games entail lower risk—As development costs continue to escalate,
publishers have an incentive to cut expense wherever possible. The biggest
component of development expense is manpower, so it follows that shorter games
are less expensive to develop than longer games. It follows logically that if shorter
games are less expensive to develop, they require fewer units sold in order to break
even, thus entailing lower risk. Shorter games have two disadvantages: first, they
are more susceptible to rental; and second, they are more susceptible to poor
reviews. Because the average rental outlet offers a week of game play for only $6,
consumers can play a short game through to completion in two to three weeks for far
less than the retail cost of the game. Interestingly, one of the best selling games of
all time, Call of Duty 4: Modern Warfare, was one of the shortest, with an estimated
10 hours of game play. Consumers appeared not to mind, as the multiplayer
component of the game allowed countless hours of enjoyment. It will be interesting
to see if this year’s sequel, Modern Warfare 2, is equally short.
CONCLUSION
The big takeaway is that digital content is growing in popularity, and that the
publishers are well positioned to charge money for nothing as they collect on
digital distribution. We think that Microsoft is well ahead of the others in the
delivery of downloadable content, and expect Sony to make steady progress over the
next two years. Nintendo appears genuinely unconcerned with downloads to the Wii
this cycle, but its recent launch of the DSi suggests that there is an overarching
download strategy being developed in Kyoto. Over the next 10 years, we think that
downloadable content will comprise a full 50% of all console and handheld games
played, accounting for virtually all of the industry’s growth over that period.

INDUSTRY CONSOLIDATION
M&A DOESN’T MAKE SENSE

For the past six years, there have been persistent rumors about imminent
consolidation of the video game publishers, with the most common rumor
involving several of the major media companies. To date, only one U.S.
publisher has been acquired, while several have gone out of business. During the
last console cycle, 3DO and Acclaim declared bankruptcy, BAM! and Interplay faded
away, startup Gizmondo (Tiger Telematics) ceased operations, and Atari, Infogrames
and Majesco were financially weakened to the point of irrelevance. In the current
cycle, Atari and Infogrames merged, Midway declared bankruptcy and Brash
Entertainment ceased operations. Over the last eight years, Sega merged with
Sammy, Square merged with Enix and subsequently acquired Eidos (who had earlier
been acquired by SCi), TDK was acquired by Take-Two, Electronic Arts acquired
Digital Illusions, and Vivendi-Universal Games was carved out of the GE-VU joint
enterprise. The only major acquisition on the media front was Vivendi’s merger of its
games unit into Activision (to form majority controlled Activision Blizzard. Other
acquisitions have been far more minor and strategic, including the News Corp
acquisition of online video game site IGN, Viacom’s purchase of social networking
site Xfire, MTV’s purchase of Gametrailers.com and Harmonix, Warner Bros.
acquisition of TT Games, Disney’s acquisition of Junction Point Studios, Microsoft’s
acquisition of Massive and Google’s purchase of Adscape.
The economics of game development have made publishing an increasingly costly
endeavor, and the hit driven nature of the business has made it difficult to predict
winners and losers among the publishers. Smaller publishers, such as Atari and
Midway, have struggled to compete with the larger publishers for consumer dollars
and retail shelf space during the current cycle, even though each had a relatively
strong lineup of proven intellectual property, and both declared bankruptcy over the
last two years. Exacerbating the problem is the cost of obtaining intellectual property
rights from “sure-fire” sources, with royalties for new licenses rising in cost
substantially.
In the past, we consistently believed that the most likely acquirers would be either
Electronic Arts or Microsoft, due to the former’s desire to expand into digitally
delivered gaming and the latter’s desire to control more first party content. Electronic
Arts’ acquisition of JAMDAT and its minority investments in Neowiz and The9 Ltd.
reflected that company’s plans, and we continue to expect EA to focus on Asian
acquisitions. Should Microsoft choose to expand through acquisition, we believe it
will do so as a way to expand its Xbox Live presence (such as its acquisition of
Massive). We do not believe that Electronic Arts plans to pursue an acquisition of
Ubisoft, notwithstanding its almost 20% stake in the European publisher.
Notwithstanding that the current generation began almost four years ago, we
continue to believe that it is premature for an acquisition of a U.S. publisher by
a media company. In our view, the uncertainty involved in choosing winners and
losers in the current cycle is too great, and media companies have become
increasingly risk-averse. We therefore believe that discussions of consolidation at
this time are premature. The significant challenges posed by the current cycle, with
the PS3 sorely lagging its rivals and with Wii sales far outpacing even the most
optimistic expectations at the start of the cycle, has left most publishers

overleveraged in R&D. We believe that a prudent company such as Viacom or
Disney is likely to defer an acquisition decision until it has more visibility regarding
the costs of such an acquisition. The high costs of current generation console
development has kept profits in check for most companies for the last three years,
and though we believe that companies such as Electronic Arts are in a very strong
position to grow revenues and earnings over the next several years, this conclusion
is likely not as apparent to a potential acquirer. Because Electronic Arts expenses its
development costs, it is in a position to grow earnings dramatically in 2010.
However, we believe that a prudent Viacom or Disney Board of Directors would
prefer to wait until the earnings leverage from R&D investment has been
demonstrated before making an acquisition, as it will have significantly more
information about the future costs of doing business.
One overarching concern for a media company should be the status of current
license arrangements, and what happens to those licenses upon a change of control.
We discuss our views about likely acquisition targets more fully in the Industry
Consolidation section immediately following.
COMPETITION FROM MEDIA COMPANIES DOESN’T MAKE SENSE

Another area of discussion is looming competition from media companies. Some of
the major media companies appear to covet the profits that are generated by video
game publishers, and these companies appear to believe that the value added in
publishing is more attributable to the underlying intellectual property than to
execution. We disagree.
Companies like Disney and Warner Bros. have begun to bring video game
development in house, with each showing solid early results. Disney has
developed DS and Wii games in house, and has published Disney-owned properties
with relatively solid results for the last two years. For example, games based on
Disney properties High School Musical and Hannah Montana sold around 1 million
units in the U.S., both quite respectable figures, with very low development costs.
We think that Disney will continue to experiment with games by taking baby steps,
making incremental investments in studios and bringing more development in house
over the next few years. We do not expect the company to make a large-scale
acquisition in order to compete. The test of the company’s resolve will come when it
releases the animated film Toy Story 3 in 2010, with an internally developed game
accompanying the film. Recent Pixar-produced predecessors Ratatouille and WALL-
E performed well at the box office, but games produced by THQ were
underperformers, with around 4 million units sold of each. While we think that Disney
is far behind THQ in learning how to succeed in the video game publishing business,
it will be interesting to see if its internally produced Toy Story 3 game sells more than
4 million units. Of course, Disney will make more money from an internally produced
game, given that it will not share any profits with THQ, so it is possible that the
company will consider a 3 million unit seller an overwhelming success.
We feel the same about other media companies, and note that Warner Bros. has
recently produced LEGO games based upon the Batman, Star Wars and Indiana
Jones franchises, and will release a LEGO version of Rock Band later this year. We
think that the company has taken a prudent approach, exploiting a particular
expertise of its TT Games subsidiary, and developing content that is consistent with
its expertise. Warner will face its test in future years, when it develops games based

upon the Lord of the Rings franchise, which it recently took in-house from Electronic
Arts.
Perhaps the greatest media company success has been achieved by Viacom unit
MTV/Harmonix Games release Rock Band. In under two years, the franchise has
generated $1 billion in game sales, and we expect this fall’s Beatles Rock Band to be
one of the best-selling games of the year. We think that the media companies will
“stick to their knitting” and produce content based upon owned intellectual property,
and expect those who have ramped up to continue to exploit competitive advantages
when those advantages exist.
We do not see imminent consolidation of the video game industry. We
discussed this in a preceding section, and in this section, we explore the
consolidation prospects for each of the major publishers.
Electronic Arts
Until the merger of Activision and Blizzard, Electronic Arts was the largest third party
video game publisher, with over 20% market share in the U.S. and Europe,
Electronic Arts is probably too large a target other video game companies. The
company’s share price declined precipitously in the past year, dropping from above
$50 to below $20 before settling in the low $20s. EA generates revenues in excess
of $4 billion, and has a current market capitalization of over $6 billion, with around
$2.5 billion in cash (around $8/share). Electronic Arts has a strong management
team, a stable lineup of game franchises, recurring revenue streams from its sports
franchises, a solid online presence, is the leading mobile gaming publisher, and has
a growing presence in the Asian market. Notwithstanding its recent restructuring and
downsizing, it is clear that the company intends to grow revenues and earnings for
the next several years. EA is exploring opportunities in online gaming, in-game
advertising, and other areas.
Electronic Arts currently spends approximately $850 million per year on game
development and around $400 million annually on other growth opportunities, giving
the company a technological head start over much of its competition, but severely
depressing its earnings potential until its investment is recovered via higher
revenues. This amount translates to roughly $2.75/share in after-tax expense, given
that the company currently expenses all of its development costs. Console games
for the PS3 and Xbox 360 cost an average of $10 – 12 million apiece to develop,
while Wii, DS and PSP games will cost less than half that amount. At 125 – 150
console, handheld and PC SKUs per year, Electronic Arts’ fully phased in R&D costs
are likely to remain at around $1 billion per year, or $2.30 per share, with the
investment in other opportunities representing a huge swing factor. A risk averse
acquirer will likely wait until it has greater visibility into the cost curve for software
development and into the revenue opportunities from “all other” before paying a
premium to enter the video game business.
Electronic Arts has a deep library of licensed content, including Harry Potter, plus a
myriad of sports licenses. It is not clear whether the licensors have the ability to
terminate relationships with Electronic Arts upon a change of control, although we
believe that this is standard fare in most licensing agreements. More problematic is
EA’s license arrangement with ESPN, calling for $850 million in advertising
guarantees over a 15-year period. We believe that media companies other than
Disney (parent of ESPN) would find the ESPN relationship problematic.

In our opinion, Electronic Arts has no interest in being acquired. Revenues and
operating margins consistently grew through FY:04 (ended March 31), but over the
last five years, the company has experienced stalled sales growth and declining
margins. We expect EA to grow revenues at least in line with industry growth this
year and next. Operating margins have contracted over the last five years, from an
industry leading 27% at its peak to only an estimated 10% in FY:10, with a rebound
to around 12% expected in FY:11 (after adjustments). The management team has
made a conscious decision to invest heavily in R&D, and the company should be in a
good position to deliver substantial operating leverage in FY:11 and beyond. As
such, we think that the company would command at least a 30% premium to the
current share price (around $22), and believe that any takeover would likely be
hostile. We think that company management shares our view that it is in a great
position to grow the business, and would likely perceive a takeover offer as a
distraction. We think that should a major media company make a serious offer to
acquire Electronic Arts, the latter would take steps to accelerate growth or to drive up
its share price, including an acquisition or stock buy-back. Accordingly, we view an
acquisition of Electronic Arts by a major media company as unlikely.
Activision Blizzard
Activision is equally unlikely to be an acquisition target. The company has a market
capitalization of over $16 billion, with around $3 billion in cash (around $2/share). Its
revenues exceeded $5 billion last year, and it has industry leading operating
margins. Company management appears focused upon growing revenues and
earnings over the next several years, and Activision is the world leader in online
subscription games.
Because Vivendi has over 50% control of Activision, the company is highly unlikely to
be acquired by another media company.
THQ
THQ is the least expensive of the “major” video game publishers, and may make an
appealing acquisition target for a media company, but because its other licenses
(with Pixar and World Wrestling) could possibly terminate upon a change of control, it
may be somewhat less attractive. The company currently holds the master license
for games based upon Nickelodeon properties. THQ has had tremendous success
with Viacom properties such as SpongeBob SquarePants, Jimmy Neutron, Rugrats,
Fairly OddParents and Avatar. Its WWE and Disney/Pixar licenses have paid
consistent dividends, with more than three million units of WWE sold each year and
solid but declining revenues from Finding Nemo, The Incredibles, Cars, Ratatouille,
WALL-E and this year’s Up. After a one-year hiatus in 2010, THQ has the rights to
produce a game based upon the next Disney/Pixar property in 2011, after which time
we expect its license agreement with Pixar to expire. In addition, it has several other
licenses, the most successful of which include UFC, Scooby-Doo and Bratz.
THQ has a market capitalization of approximately $400 million, with around $200
million in cash (around $3/share). An acquisition would be “bite sized” for most
media companies, with the net purchase price likely in the $300 - 500 million range.
For the reasons enumerated above, we continue to believe that an acquisition at this
time is premature.
Take-Two Interactive
We believe that Take-Two is a solid acquisition candidate for a company looking for
a strategic partner, and on a fundamental basis, we think that an acquisition may

make some sense to media companies. The stock is relatively inexpensive on an
earnings multiple basis, given its recent strong performance, but the company is
highly dependent upon one brand for the bulk of its earnings power. Take-Two might
attract potential suitors, as it has some of the best development talent in the
business, a stable of decent brands (including the best-known brand of all time in
Grand Theft Auto), and the always-desirable geographic proximity to major media
companies. In addition, Take-Two has almost no meaningful long-term licenses
other than its sports licenses, meaning that a media company could acquire Take-
Two with little risk of license termination.
Take-Two has a market capitalization of approximately $600 million, with around
$100 million in cash (about $1/share). The stock trades at a discount to its peer
group, likely due to its uneven earnings performance and its “one-hit wonder” status.
We continue to believe that an acquisition in the video game space is premature, and
think that an acquisition of Take-Two prior to the launch of the next Grand Theft Auto
installment (expected in late 2010) is unlikely. The stock trades at only 6x our EPS
estimate for next year (excluding cash, and adjusted for normalized taxes), and
should be considered “bite-sized” by a potential acquirer. At a 50% premium, an
acquisition would cost less than $1 billion. However, current management rejected a
bid of over 2x this figure less than a year ago, and notwithstanding the decline in
equities over the last several months, we think that a $1 billion offer (around
$14/share) would be rejected.
We think that the most likely acquirer for Take-Two is News Corp., which has a
similar reputation for producing edgy content. In addition, the company’s Fox
Network appears intent upon gaining share in sports from Disney’s ESPN brand. We
think that the ESPN license agreement with Electronic Arts is a powerful one, and
think that Take-Two’s unprofitable position in the sports video game market may be
an impediment to completion of a deal any time soon. However, Take-Two has
steadily grown its sports business and the quality of its games, with the business
likely to be profitable in 2012.
Majesco
Majesco is a relatively young company, and has not been consistently profitable. It is
primarily a distribution company, taking little development risk while co-publishing
titles developed by third parties. We think that it would be difficult for a media
company to evaluate its worth in an acquisition. Further complicating matters,
insiders hold almost 1/3 of the company’s shares, rendering an acquisition over the
next year unlikely.
Ubisoft
Ubisoft is a fine acquisition candidate, and reminds us of Activision three or four
years ago. The company has a large slate of owned (or fully controlled) intellectual
property, including ownership of the Tom Clancy stable of titles (including Ghost
Recon, Rainbow Six, Splinter Cell and the recently released EndWar). In addition,
Ubisoft owns brands such as Rayman, Red Steel, Assassin’s Creed, Haze, Driver
and the Petz line of games. The company has several strong relationships with
licensors, and has the second largest development studio in the world, behind
Electronic Arts. Ubisoft’s market cap is around $1.8 billion, with a small amount of
net cash. We think that an acquirer would be required to pay at least a 50%
premium, and believe that minority stakeholder Electronic Arts (with around 18% of
the stock) could be an impediment to an acquisition.

Ubisoft is unlikely to be acquired by a media company, as it is headquartered in
France, making consolidation difficult. We believe its most likely suitor is Electronic
Arts, but think that a completion of the creeping acquisition begun in 2004 is unlikely,
as the share price has risen since EA acquired its minority stake, while EA shares
have fallen by over 50%. More likely, we expect to see Ubisoft become more
aggressive as an acquirer, and think that a combination of Ubisoft and THQ makes
some sense, given the former’s European distribution strength and owned I/P, and
the latter’s U.S. distribution strength and powerful licensed content. Alas, we do not
expect the two companies to view the combination as attractively as we do, so we
assign a low probability of such a merger coming to fruition.

VIDEO GAME HARDWARE FORECAST
128-bit hardware shipments were 118 million units in the U.S. and Europe (the
addressable market for U.S. and European publishers) at the end of 2006. By
comparison, 32/64-bit shipments in the U.S. and Europe totaled only 86 million units
between 1995 and 2001. This increase translates into a compound annual growth
rate 6.5% higher than the 32/64-bit cycle, notwithstanding that the average price for
128-bit hardware was $193 compared to only $153 for the earlier cycle. This
hardware sales growth is much higher than our estimate of 2% per annum growth in
the GDP during the same period in these markets. We think that the overall potential
for the current cycle is far greater than the 128-bit cycle, with penetration through
year-end 2008 of 69 million, with sales of 33 million forecast for this year. As we
expect the current cycle to last well beyond 2012, we envision overall penetration of
more than 150 million consoles. Figure 24 illustrates the ratios of console sales to
households in the U.S. for the last three console cycles and our estimate for the
current cycle.
Figure 24—Average U.S. Console Ownership by Household
Average
Consoles
Peak Households Owned
Installed U.S. Households Consoles/ that Own (console
Cycle Period Console Cycle Base (mil) (mil) Household Consoles owners)
1985-90 8-Bit 36 89 0.41 31% 1.32
1989-95 16-Bit 38 93 0.41 33% 1.24
1994-00 32/64 Bit 50 98 0.51 38% 1.35
1999-06 128 Bit 76 110 0.69 50% 1.38
2005-11 Next-Gen 103 125 0.82 55% 1.50
We expect continued household penetration for current generation consoles,

increasing from 50% in the last cycle to 55% in the current cycle, primarily due
to our expectation that the Wii has expanded the gamer demographic. We
expect the number of consoles owned per household that owns a console to
increase to 1.5 units, higher than each of the last three cycles, as we believe that the
majority of households owning a Wii will ultimately purchase a second console.
It is possible that the percentage of households owning at least one console
will increase even more dramatically. This could occur as positive demographic
drivers and improved technological functionality drive increasing console penetration.
We estimate that during the 8-bit console cycle, 31% of U.S. households owned at
least one console. This percentage increased to an estimated 38% during the 32/64-
bit console cycle, and increased further to 50% in the last cycle. Last-generation
consoles offered increased multimedia functionality, including DVD playback and
Internet access, as well as a much broader range of high-quality content than earlier
generation machines. The current generation consoles include enhanced multimedia
functionality, wireless controllers, built-in online capability, high definition display, and
an HD disc drive (in the Xbox 360 and PS3). The combination of these features,

rapid adoption of high-definition television monitors, increased marketing, an aging
and more affluent addressable market, and the emergence of the mass-merchandise
retailers as a significant distribution channel, could drive penetration for the current
generation consoles to 60% or more. We estimate that the Wii will ultimately
penetrate close to 40% of U.S. households.
There is an ever increasing number of consumers who consider themselves
“hardcore”, leading us to conclude that the number of households owning
more than one console will possibly increase over the last cycle. We expect the
number of consoles owned by each household owning a console to grow, from 1.35
in the 32/64-bit cycle and 1.38 during the 128-bit cycle to around 1.5 in the current
generation. One key driver for multiple console ownership is the increasing
segmentation and specialization within the console market. Specifically, we believe
that many families owning a Wii will also purchase either a PS3 or Xbox 360 to
satisfy different gamers within the household—Wii for young (and old) gamers and
PS3 or Xbox 360 for those gamers in between. We also believe the percentage of
PS3 owners who will purchase an Xbox 360, and vice versa, will ultimately depend
upon the number of exclusive games for each platform. As we believe that the
economics of game development will make it more difficult for publishers to offer
exclusives to either Microsoft or Sony, we do not anticipate many third party
exclusive titles over the next few years. At the same time, first party (Sony and
Microsoft) development capability has diminished over the past few years, and we do
not anticipate many “killer app” exclusives for either console, other than games like
Gears of War 3 from Microsoft and God of War 3 and Gran Turismo 5 from Sony.
We speculate that competition for market share will drive console prices lower
over the next few years. At launch, Microsoft priced the fully equipped Xbox 360 at
$399.99, and Sony priced its console at $599.99. Sony has been slow to price the
PS3 competitively, with the core console SKU priced at $399.99 as of this writing.
We expect the price point to come down to $299.99 as soon as manufacturing
efficiencies permit, but think that a cut to this likely will not occur until 2010. It is
unclear whether Microsoft intends to cut the price of the Xbox 360 before this holiday
(we don’t expect a cut). As we expect the PS3 to remain priced at least $50 higher
than the Xbox 360, Sony must convince consumers that the premium is justified. By
2011, we expect the price points of all three consoles to fall below the $200 level,
making them truly mass-market consumer products.
Nintendo positioned the Wii as a cheaper alternative to the Xbox 360 and PS3,
competing with a strong lineup of proprietary content and a compelling control
scheme. The Wii remains at its launch price of $249.99, including the Wii Sports
game. The relatively low launch price immediately allowed Nintendo to achieve
mass appeal, and the Wii captured early market share over its more expensive rivals.
Because the specs for the Wii are based upon commodity components, the Wii has
consistently generated profits for Nintendo. We expect a price cut for the Wii to
$199.99 later this year, and expect Nintendo to keep the console priced $50 – 100
below its rivals at least until the introduction of a high-definition version is launched.

Figure 25—Console Unit Sales U.S. and Europe (2004 – 2011E)
U . S . H ard w are U n its (m il) 2004 2005 2006 2007 2008 2009E 20010E 20011E
P l ayS tatio n 0.7 0.0 0.0 - - - - -
N 64 - - - - - - - -
P l ayS tatio n 2 4.6 5.5 4.7 4.0 2.5 1.3 0.7 -
PS3 - - 0.7 2.6 3.5 4.3 4.8 5.5
G am eC u b e 2.3 1.7 0.8 0.2 0.0 - - -
W ii - - 1.1 6.3 10.2 9.5 8.0 7.0
Xbox 4.0 2.2 0.4 - - - - -
X b o x 360 - 0.6 3.9 4.6 4.7 4.6 4.3 4.0
Al l O th er 0.5 - - - - - - -
T o tal H o m e C o n so le 12.1 10.1 11.6 17.6 21.0 19.7 17.8 16.5
G ro w th (% ) -18% -17% 15% 52% 19% -6% -10% -7%
G B Ad v an ce/S P 7.1 4.3 3.2 1.1 0.0 - - -

D S /D S i 1.2 2.6 5.3 8.5 10.0 8.0 7.5 7.0
PSP - 3.6 3.0 3.8 3.8 4.5 3.3 3.2
Al l O th er 0.1 0.1 0.1 - - - - -
T o tal P o rtab le 8.4 10.6 11.7 13.4 13.8 12.5 10.8 10.2
G ro w th (% ) 8% 26% 10% 15% 3% -9% -14% -6%
T o tal H ard w are 20.5 20.7 23.2 31.1 34.8 32.2 28.6 26.7
G ro w th (% ) -9% 1% 12% 34% 12% -7% -11% -7%
E u ro p e H ard w are U n its (m il) 2004 2005 2006 2007 2008 2009E 20010E 20011E
P l ayS tatio n 0.7 0.4 0.2 0.1 0.1 - - -
N64 - - - - - - - -
P l ayS tatio n 2 5.8 6.7 4.4 3.8 2.8 1.4 1.0 0.5
PS3 - - - 2.8 3.5 4.5 5.0 5.5
G am eC u b e 1.6 1.1 0.4 0.1 - - - -
W ii - - 1.0 4.8 8.3 8.0 8.0 7.0
Xbox 2.7 1.6 0.2 - - - - -
X b o x 360 - 0.3 3.1 1.9 3.0 2.5 2.5 2.5
Al l O th er - - - - - - - -
T o tal H o m e C o n so le 10.8 10.1 9.3 13.5 17.7 16.4 16.5 15.5
G ro w th (% ) -9% -6% -8% 45% 31% -7% 1% -6%
G B Ad v an ce/S P 5.6 3.5 2.5 1.7 0.1 - - -

D S /D S i - 2.0 4.2 8.7 11.2 8.0 7.0 6.5
PSP - 2.0 2.7 3.1 3.8 4.5 3.0 3.0
Al l O th er 0.3 0.4 0.2 - - - - -
T o tal P o rtab le 5.9 7.9 9.6 13.5 15.1 12.5 10.0 9.5
G ro w th (% ) 7% 34% 22% 41% 12% -17% -20% -5%
T o tal H ard w are 16.7 18.0 18.9 27.0 32.8 28.9 26.5 25.0
G ro w th (% ) -4% 8% 5% 43% 21% -12% -8% -6%
U . S . an d E u ro p e S ales 37.2 38.7 42.1 58.1 67.6 61.1 55.1 51.7

G ro w th (% ) -7% 4% 9% 38% 16% -10% -10% -6%

Figure 26—Console Unit Sales Japan and Worldwide (2004 – 2011E)
Japan Hardware Units (mil) 2004 2005 2006 2007 2008 2009E 20010E 20011E
PlayStation - - - - - - - -
N64 - - - - - - - -
PlayStation2 3.0 2.1 1.4 0.8 0.5 - - -
PS3 - - 0.4 1.2 1.0 1.4 1.2 1.0
GameCube 1.0 0.6 0.1 0.0 - - - -
Wii - - 0.8 3.7 2.9 2.6 2.0 1.5
Xbox 0.2 0.1 - - - - - -
Xbox 360 - 0.1 0.2 0.3 0.3 0.2 0.2 0.2
All Other - - - - - - - -
Total Home Console 4.2 2.9 2.9 6.0 4.7 4.2 3.4 2.7
Growth (%) 0% -31% -1% 108% -22% -10% -19% -21%
GB Advance/SP 2.8 1.4 0.4 0.1 - - - -

DS/DSi 0.8 3.2 8.2 7.3 3.8 3.5 3.0 2.5
PSP 1.5 2.2 1.8 3.1 3.7 3.4 3.0 2.5
All Other - - - - - - - -
Total Portable 5.1 6.8 10.4 10.5 7.5 6.9 6.0 5.0
Growth (%) 17% 35% 52% 1% -29% -8% -13% -17%
Total Hardware 9.3 9.7 13.2 16.5 12.1 11.1 9.4 7.7
Growth (%) 9% 5% 36% 24% -26% -9% -15% -18%
Worldwide Hardware Units (mil) 2004 2005 2006 2007 2008 2009E 20010E 20011E
PlayStation 1.4 0.4 0.2 0.1 0.1 - - -
N64 - - - - - - - -
PlayStation2 13.4 14.3 10.5 8.6 5.8 2.7 1.7 0.5
PS3 - - 1.1 6.6 8.0 10.2 11.0 12.0
GameCube 4.9 3.4 1.2 0.3 0.0 - - -
Wii - - 2.9 14.8 21.4 20.1 18.0 15.5
Xbox 6.9 3.9 0.6 - - - - -
Xbox 360 - 1.0 7.2 6.8 8.1 7.3 7.0 6.7
All Other 0.5 - - - - - - -
Total Home Console 27.1 23.1 23.7 37.1 43.4 40.3 37.7 34.7
Growth (%) -12% -15% 3% 56% 17% -7% -6% -8%
GB Advance/SP 15.5 9.2 6.1 2.9 0.1 - - -

DS/DSi 2.0 7.8 17.7 24.5 24.9 19.5 17.5 16.0
PSP 1.5 7.9 7.5 10.0 11.3 12.4 9.3 8.7
All Other 0.4 0.5 0.3 - - - - -
Total Portable 19.4 25.3 31.6 37.4 36.4 31.9 26.8 24.7
Growth (%) 10% 31% 25% 18% -3% -12% -16% -8%
Total Hardware 46.5 48.4 55.4 74.5 79.7 72.2 64.5 59.4
Growth (%) -4% 4% 14% 35% 7% -9% -11% -8%

Figure 27—Console Dollar Sales U.S. and Europe (2004 – 2011E)
U.S. Hardware Sales ($mil) 2004 2005 2006 2007 2008 2009E 20010E 20011E
PlayStation 36 2 1 - - - - -
N64 - - - - - - - -
PlayStation2 726 823 628 519 327 129 55 -
PS3 - - 396 1,286 1,482 1,501 1,195 1,095
GameCube 228 163 73 18 1 - - -
Wii - - 269 1,558 2,550 2,176 1,432 903
Xbox 612 344 68 - - - - -
Xbox 360 - 231 1,512 1,737 1,421 1,145 856 596
All Other 20 - - - - - - -
Total Home Console $1,622 $1,565 $2,947 $5,118 $5,781 $4,950 $3,538 $2,594
Growth (%) -27% -4% 88% 74% 13% -14% -29% -27%
GB Advance/SP 599 329 251 88 1 - - -

DS/DSi 182 356 684 1,113 1,306 1,192 893 693
PSP - 911 685 722 717 671 426 317
All Other 13 13 13 - - - - -
Total Portable $794 $1,609 $1,631 $1,923 $2,024 $1,863 $1,318 $1,010
Growth (%) 10% 103% 1% 18% 5% -8% -29% -23%
Total Hardware $2,416 $3,174 $4,578 $7,041 $7,806 $6,813 $4,856 $3,603
Growth (%) -18% 31% 44% 54% 11% -13% -29% -26%
Europe Hardware Sales ($mil) 2004 2005 2006 2007 2008 2009E 20010E 20011E
PlayStation 34 20 10 5 5 - - -
N64 - - - - - - - -
PlayStation2 1,154 1,199 656 490 361 139 49 25
PS3 - - - 1,960 1,922 1,796 1,495 1,095
GameCube 158 109 32 7 - - - -
Wii - - 340 1,344 2,482 1,992 1,592 1,043
Xbox 456 238 30 - - - - -
Xbox 360 - 120 1,237 720 987 623 498 373
All Other - - - - - - - -
Growth (%) -27% -6% 37% 96% 27% -21% -20% -30%
GB Advance/SP 476 263 175 85 4 - - -

DS/DSi - 270 542 1,122 1,445 1,192 833 644
PSP - 558 564 617 718 671 357 297
All Other 48 48 20 - - - - -
Total Portable $524 $1,138 $1,301 $1,824 $2,167 $1,863 $1,190 $941
Growth (%) -16% 117% 14% 40% 19% -14% -36% -21%
Total Hardware $2,327 $2,824 $3,605 $6,350 $7,923 $6,411 $4,824 $3,475
Growth (%) -24% 21% 28% 76% 25% -19% -25% -28%
U.S. and Europe Sales $4,743 $5,999 $8,183 $13,391 $15,729 $13,224 $9,680 $7,078
Growth (%) -21% 26% 36% 64% 17% -16% -27% -27%

Figure 28—Console Dollar Sales Japan and Worldwide (2004 – 2011E)
Japan Hardware Sales ($mil) 2004 2005 2006 2007 2008 2009E 20010E 20011E
PlayStation - - - - - - - -
N64 - - - - - - - -
PlayStation2 585 317 140 40 23 - - -
PS3 - - 243 706 491 559 359 199
GameCube 119 59 6 1 - - - -
Wii - - 247 990 662 517 298 149
Xbox 36 15 - - - - - -
Xbox 360 - 31 68 94 105 55 45 35
All Other - - - - - - - -
Total Home Console $740 $423 $703 $1,830 $1,280 $1,131 $702 $383
Growth (%) -14% -43% 66% 160% -30% -12% -38% -45%
GB Advance/SP 277 125 25 3 - - - -

DS/DSi 112 413 1,058 797 337 242 177 123
PSP 449 531 372 587 550 439 297 198
All Other - - - - - - - -
Total Portable $837 $1,068 $1,456 $1,387 $887 $680 $474 $320
Growth (%) 128% 28% 36% -5% -36% -23% -30% -32%
Total Hardware $1,577 $1,491 $2,159 $3,218 $2,167 $1,811 $1,176 $703
Growth (%) 29% -5% 45% 49% -33% -16% -35% -40%
Worldwide Hardware Sales ($mil) 2004 2005 2006 2007 2008 2009E 20010E 20011E
PlayStation 70 22 10 5 5 - - -
N64 - - - - - - - -
PlayStation2 2,465 2,340 1,424 1,049 711 267 104 25
PS3 - - 639 3,951 3,894 3,855 3,049 2,388
GameCube 505 332 110 25 1 - - -
Wii - - 856 3,892 5,694 4,685 3,322 2,095
Xbox 1,104 598 98 - - - - -
Xbox 360 - 383 2,817 2,552 2,513 1,823 1,398 1,004
All Other 20 - - - - - - -
Growth (%) -25% -12% 62% 93% 12% -17% -26% -30%
GB Advance/SP 1,353 717 451 175 5 - - -

DS/DSi 294 1,039 2,284 3,033 3,088 2,626 1,903 1,459
PSP 449 2,000 1,621 1,926 1,986 1,780 1,080 811
All Other 60 60 32 - - - - -
Total Portable $2,155 $3,815 $4,388 $5,134 $5,078 $4,405 $2,982 $2,270
Growth (%) 26% 77% 15% 17% -1% -13% -32% -24%
Total Hardware $6,320 $7,489 $10,342 $16,609 $17,896 $15,035 $10,856 $7,781
Growth (%) -13% 18% 38% 61% 8% -16% -28% -28%

PERSONAL COMPUTER VIDEO GAMES
We do not include sales of PC hardware or peripherals in our industry hardware
definition, as most PC owners own the machines for other purposes. However, we do
include PC software sales in our software industry numbers, as these represent a
significant slice of the software market. Software produced for the PC will run on
compatible computer equipped with the minimum system requirements. Currently,
the overwhelming majority of PC games are made for Windows-based PCs, while
relatively few are sold for the Mac or Linux-based PC systems. According to the NPD
group, in 2008, over 93% of all PC software sold was for Windows-based computer
systems.
We estimate that PC game sales totaled $700 million in North America in 2008, down
14% from the prior year. Worldwide, we estimate that PC game sales totaled $2.43
billion in 2008, down around 13% over 2007. PC software sales have trended
downward for 13 years, roughly coinciding with the increasing popularity of home
consoles. Figure 29 illustrates actual and estimated PC game sales by major
geographic market for the 2004 – 20011 period.
Figure 29—PC Entertainment Software Sales (2004 – 2011E)
Japan North America Europe Worldwide
4,000
3,409
3,247
3,144
3,000 2,799
2,429 2,483
2,380
2,258
($ mil)
1,969 1,984
2,000 1,860
1,696
1,458 1,500 1,438 1,350
1,111
953 979
1,000 818
701 678 658 638
330 310 305 285 270 305 285 270
-
2004 2005 2006 2007 2008 2009E 20010E 20011E
Demand for PC software is driven by three trends: (1) gains from rising home PC
penetration; (2) gains from an increasing percentage of PC owners who play games;
and (3) losses from the shift in PC gamers toward console games as console
penetration increases. IDC reports that home PC penetration rates increased from
39% in 1996 to almost 51% in 2000 and we believe that this number exceeded 80%
in 2008. Home PC penetration is undoubtedly growing due to, among other things,
the continued reduction of PC prices and, more important for the game industry, the
lowering of costs associated with graphics cards, high-end monitors, and sound
systems. We estimate that the average price of a fully loaded desktop computer has
fallen 70%, to below $500, over the past seven years. As better technology at lower
cost is available to a greater number of PC owners, an increasing number of high-
quality games has lured more PC owners into the gaming community. A 1998 survey

by IDC indicated that 76% of all PC households have someone who uses the
computer to play games.
Recent declines in PC game demand resulted from a slowing of the rate of growth in
PC penetration, accompanied by the significant increase in the penetration rate of
128-bit and current generation consoles. As more households add consoles to their
mix of consumer electronic products, we expect a continued migration of gamers
from the home office to the living room, where the furniture is typically more
comfortable and the television monitor is typically larger. Last generation consoles
were powered by a 733 MHz microprocessor, slower than the typical home PC, while
two of the current generation consoles have 3.2 GHz microprocessors. PC software
publishers have always designed games to work with the “commodity standard”
microprocessor. Prior to 2003, PC games were designed to run with 733 MHz
microprocessors, which meant that the PC gaming experience was quite similar to
the console gaming experience. Beginning in 2004, PC games were designed to
run with 1.5 GHz or faster PCs, making them unfit for consumers with slower PCs.
We believe that the introduction of consoles faster than the commodity standard PC
placed further pressure on PC software sales.
One other factor impacting PC software sales is the recent growth of online gaming.
There are several MMOGs that have attracted players to the subscription model
(subscription rates are not currently captured in our models), so it is possible that the
overall spending by PC gamers was higher in 2008 than it was in 2005.

SOFTWARE ECONOMICS
This section of our report analyzes the two main components that determine gross
margin for publishers, video game pricing and video game production costs.
RETAIL PRICING TRENDS
Video game software is sold in the U.S. market at prices between $5 and $70 per
game, with higher price points for specialty bundles that include controllers (such as
Guitar Hero and Rock Band). Most new games made for current generation consoles
are priced in the $40 – 60 range, with 2009 releases pricing around $49.99 – 59.99,
with higher price points for “collectors’ editions”. PC games on the CD-ROM format
are inexpensive to manufacture, and tend to have the lowest price points. Games
sold on DVD (PS2 and Xbox 360) or proprietary formats similar to DVD (Wii and
PS3) are slightly more expensive to create and purchase. Nintendo sells games
using flash memory for the DS, with a slightly higher manufacturing cost. Sony’s
PSP uses a proprietary UMD format, with manufacturing costs similar to DVD costs.
Figure 30 illustrates the average retail U.S. prices between 2000 – 2011 for software
sold on various hardware platforms.
Figure 30—Average U.S. Retail Software Price by Platform
$70
$60
PlayStation
GB Advance/SP
$50
DS
PSP
$40 PlayStation2/PS2
$/Game
Xbox
$30 GameCube
PS3
Xbox 360
$20
Wii
Weighted ASP
$10
$0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010E 2011E
In the past, average selling prices (ASPs) for console games trended down over the
first four years following console launch. Through 2005, launch prices for new titles
held steady at the $49.99 price point for AAA titles, $39.99 for most casual titles, and
$29.99 for most budget titles, with the number of new titles introduced each year
holding steady at around 850 SKUs. In 2008, most front-line titles for the current
generation were priced at $59.99. The driver of ASP increases in the current cycle
has been the proliferation of newer games priced at $60 or above, with slower
discounting in the months following a game’s launch and a dramatic increase in
music-themed game bundles and Nintendo peripheral bundles. Because of the rapid
ramp in Wii sales during the current cycle, publishers who backed the PS3 or Xbox
360 have been slow to recoup their development costs within the first several months
following a game’s launch, keeping game pricing high for longer than in the past in

order to maximize revenues. The average life of a game has been lengthened to
over a year, with price cuts occurring infrequently unless the game is selling poorly.
As an example, in the last cycle, a game like Madden NFL Football might debut in
August at $49.99, drop in price after the holidays to $39.99, drop to $29.99 following
the Super Bowl, and drop again to $19.99 the following June. In the current cycle,
pricing for a game like Call of Duty 4 remained at $59.99 for more than a year after
the game’s fall 2007 launch. As of this writing (more than 18 months after launch),
the game remains priced at $39.99.
Average selling prices are important, as all games serve as close substitutes for
other games. Thus, if a consumer purchases a console, the publishers should care if
the consumer buys two or three old titles for a relatively low price or two or three new
titles for full price. The ASP of the prior generation console (32-/64-bit) game
declined from $47 in 1997 to $33 in 2000. The ASP for PS2 software in 2000 was
$49.14 per game, consistent with the PlayStation One’s average price during its
launch phase, and pricing increased following the launches of the GameCube and
Xbox a year later. The ASP for last generation console games dropped from $49.14
in 2000 to $30.02 in 2006 as a proliferation of older “greatest hits” titles attracted
consumer attention at $20 price points.
As expected, we have seen dramatic price increases for current generation software
since launch, with most games launching at a $59.99 price point ($49.99 for Wii
games), and handheld and portable games launching at $29.99 – 39.99. ASPs for
PS3 games were $56.73 in 2008, while Xbox 360 and Wii games were $56.68 and
$47.82, respectively. The ASP for all console and handheld games in 2008 was
$40.87, up a full $9 over the ASP in 2000.
It is important to note that in the last cycle, the typical “half-life” of a title was only
three months, so 75% of all units were typically sold within the title’s first six months.
In the current cycle, it is difficult to project the sales profile of new releases, with
many “steady sellers” on all three consoles well past the six-month mark.
We expect premium games for the current console cycle to maintain pricing for
a majority of units, keeping the ASP high. We continue to expect a decline in the
number of games produced each year, due to the economics of game development.
We think that discounting will be slower than in the past, and ASPs could remain at
2008 levels. We note that ASPs in 2007 and 2008 were up 14% and 10%,
respectively, largely due to contribution from high-priced music-themed bundles like
Guitar Hero and Rock Band. As growth for the music category inevitably slows, we
expect ASPs to moderate around the $38 – 40 level for a few years.
The average price of PC games has declined slightly over the last twelve years, from
an average of $28 in 1995 to an average of around $24 in 2008. Average prices
bottomed in 2000, at $21.72, and prices began an upward trend over the next five
years before flattening out. We believe the overall erosion in PC prices was due to
competition from superior software products available for the consoles at the high
end, and competition from downloadable games and handheld games at the low end.
We believe that the rebound in average prices is attributable to a lower number of
budget title games now available for PCs. We note that these figures do not include
casual game downloads from the Internet, or Internet based casual game
subscriptions, both of which have likely hurt sales of lower priced budget titles. We
believe that as console hardware prices continue to decline, a larger number of
budget titles will be offered on consoles, and the console gamer demographic will
increasingly reflect a demographic with less disposable income and a greater

appetite for budget games. As we expect to few high-quality premium PC games in
2009, we expect to see PC game average selling prices stabilize at $24/unit.
We believe that ASPs will decrease only slightly over time, in contrast to
dramatic declines in the past. We think that the line on Figure 30 that best
illustrates this point is “weighted ASP all”. This line reflects the average selling price
for all games, whether produced for the PC, legacy consoles, handhelds, portables,
legacy generation consoles or current generation consoles. Between 2000 and
2006, the weighted ASP all has fluctuated between $31.11 and $28.55, averaging
$29.89. We saw a dramatic increase in 2008, to $39.22, as game sales were
dominated by high priced bundles for the music themed games. Going forward, we
expect to see a modest decline in the mix of music themed games, driving the
weighted modestly lower. Factors that could affect this price are the mix of premium
titles, especially on the PC side, and a more rapid rate of decline for older title
pricing.
We strongly believe that weighted average selling prices of all games is the most
accurate barometer of retail pricing trends, and note the trend has been toward price
increases, rather than toward price declines. In our view, all video games (regardless
of platform) are close substitutes for all other video games. Further, as was
discussed more fully in our industry report six years ago (see Myth #6—Average
Selling Prices Always Decline Over Time), we believe that as the current consoles
required significant increases in development spending, a portion of the higher costs
must be passed through to consumers in the form of higher ASPs.
There are only three drivers for a reduction in retail pricing, in our view: a decline in
the economics of software production (the “supply” side); increasing competition; or
erosion in consumer demand at current price points (the “demand” side). We do not
believe that any of the three drivers are present or will arise over the next few years,
for the following reasons.
On the supply side, we see no signs that software economics are improving
dramatically for the publishers. In the PSOne cycle, Sony’s first-party titles were
among the best sellers, and it was the dominant software publisher. The company
was also in a position to discount its manufacturer’s software royalty at will in order to
induce third-party publishers to write software for its PSOne. As Sony chose to cut
pricing on software during the PSOne cycle, other publishers felt compelled to follow
suit. In the current cycle, Sony is one of many publishers, with a market share
smaller than three of the four largest U.S. and European publishers. Sony has
adopted the “razor and razor blades” business model, historically selling PSOnes
and PS2s at a very low margin in order to profit immensely from software royalties
paid by third parties. We see no indication that Sony is willing to discount the royalty,
except in cases where a game has achieved “greatest hits” status (more than
400,000 units sold), or where an exclusive on a Sony platform is offered (such as
was the case for Grand Theft Auto: San Andreas).
We also see no sign that research and development costs are coming down.
Current generation video games cost dramatically more than last generation titles to
produce, given more intense graphics and much more demanding specs for the
consoles. Over the first few years of the current cycle, we saw publishers spending
more and more in development, with each trying to build the “perfect” game. Of
course, during the last cycle, retail prices came down by $10 per unit a mere 10
months into the cycle. We note that the average PSOne game cost somewhere
around $750,000 to produce. Spread over 250,000 units, the R&D cost was only

$3/unit. In the last cycle, the average game cost was around $2.8 million (increasing
to $4 – 5 million in 2004 and 2005). Spread over the same 250,000 units, the R&D
cost is $11/unit. In the current generation, games cost an average of $10 million to
produce, meaning that the cost for a 250,000-unit seller will be a staggering $40 per
unit. At this level of development cost, it is highly likely that publishers will opt to
pass on games with marginal prospects. In order to insulate publishers against the
risks of poor sales, the obvious solution was to raise the retail price of current
generation games.
Also on the supply side, we see ever-increasing license fees for the rights to a
familiar figure or brand. We understand that the first Tony Hawk game cost publisher
Activision a mere 50¢ in license fees per unit. We expect that the Activision’s cost of
the Spider-Man 3 license was several times that figure (an estimated $3/unit), and
believe that the average motion picture license in the current generation could
approach 15 – 20% of sales. This means that a $60 retail game that wholesales for
$48 will command a royalty of between $7.20 and $9.60 per unit.
On the competitive front, we also see no indication of pricing pressure. Most
games do not compete head-to-head. For example, while PS3 titles Modern Warfare
2 and WWE Smackdown vs. Raw 2010 are expected on retail shelves the same
week, there was no reason to believe that a consumer with $120 wouldn’t purchase
both games. If one or the other were discounted, we believe it unlikely that the
consumer would expect that both should be discounted. It is true that some games,
notably sports and racing titles, do compete head-to-head. Because of this, we saw
early discounting of both NBA Live 2009 and its direct competitor NBA 2K9.
We expect the average publisher cost of a video game for current generation games
to be approximately $19 – 33 per unit, consisting of $12 manufacturing and royalty,
$5 – 12 R&D, and $2 – 9 in license fees (the latter two figures will vary based upon
the number of units produced). A $59.99 retail title will generally wholesale for $48,
resulting in a $15 – 29 (expected value of $22) per unit gross margin to the publisher.
If the publisher were to discount the game to $49.99, the wholesale price would drop
to $40, and the gross margin would drop to $10 – 23 per unit (expected value of
$16.50). We think it highly unlikely that unit sales of such a lower priced game would
increase by the 33% necessary to compensate for the reduced margin.
On the demand side, we also see no evidence of pricing pressure. We estimate
that the average PSOne game had a rated playing time of 10 hours. This means that
if a player was perfect, and never made an error, the game could be completed in 10
hours. Mere mortals typically take as much as four times as long to complete
games, so the maximum time a PSOne game could be enjoyed was 40 hours. We
estimate that the average PS2 game has a rated playing time of 40 hours, or 160
hours of maximum enjoyment. We note that Grand Theft Auto III, the third best-
selling video game of all time, has a rated playing time of 75 hours, and its successor
(and #2 best-selling game of all time), Grand Theft Auto: Vice City has a rated
playing time of 100 hours. GTA San Andreas (the #1 all-time best seller) is even
longer than Vice City, and we have as yet to hear of anyone who felt cheated for
plunking down $50 for one of these games. The most recent installment in the
series, Grand Theft Auto IV, was apparently so long that few people were able to
finish the game, limiting demand for Xbox Live downloadable content.
Another factor that should support retail pricing near current levels is the wide
availability of trade-in credits. GameStop, and to a lesser extent, Hollywood Video
(GameCrazy) and Blockbuster, all allow customers to trade in used games for store

credit toward the purchase of a new game. The trade-in supports retail pricing in two
ways: first, it increases demand by making new games more affordable (e.g., three
trade-ins plus $20 instead of $60 cash); and second, it makes the risk of a bad
purchase more affordable (the newly purchased game can be exchanged shortly
after it is purchased, usually for more than 50% of the price paid).
In addition, the interactive entertainment experience is greater than ever before. The
graphics and sound quality of current generation games are an order of magnitude
better than in the prior cycle. Finally, we note that the $40 PSOne game of 1997
would cost approximately $50 in 2008 dollars, according to the federal Bureau of
Labor Statistics. In 2005, with the introduction of the Xbox 360 and its HD graphics,
we saw consumers embrace the $59.99 price point without complaint.
A fourth factor is pressure at retail—we don’t think that publishers will be as
susceptible to retail pressure to discount in the future. We expect fewer SKUs
as game development costs rise, and note that retail shelf space has been
increasing due to dramatic declines in other packaged entertainment sales
(especially for music CDs). Of course, retailers have ordered fewer units than in the
past, and publishers have become more reliant upon reorders of popular games to
drive revenues.
For 2009, we have modeled an overall average retail price decline in the U.S. of
$0.96 per unit for video game software. In Europe, we have modeled a $2.54 per
unit decline for video game software, primarily due to a stronger dollar.
PRODUCTION COSTS
There are many participants in the video game value chain – hardware
manufacturers, licensed content providers, developers, publishers, and retailers –
each contributing some added value to the creation and sale of a video game. The
amount of compensation that each of these participants receives varies greatly from
game to game and impacts the cost of goods sold for these games. The gross
margin earned on a particular game by a publisher is a direct function of which
players are involved and their level of involvement. For instance, producing
Transformers for the PC, PS2, PS3, Xbox 360, Wii, PSP and DS requires widely
differing payouts for the various players involved in the creation of each of these
games, and the payouts are likely quite a bit higher than payouts on a game such as
Need for Speed. The result is that the publisher of the former, Activision, has a very
different gross margin on each game, and in most cases, the margin will be lower
than the margin earned by Electronic Arts on Need for Speed. Although many
variables affect which participant gets what share of a game’s revenues, we believe
that three most leveraging variables are (1) game platform, (2) content source, and
(3) level of developer involvement. Following is a more detailed explanation of how
these major variables affect the economics of a game as well as a brief description of
some of the other drivers that factor into determining the production costs for a
game.
Game Platform
A game’s platform is the single biggest variable in determining the ultimate
margin a publisher receives for a game. Games developed for dedicated consoles
(e.g., PS2, PS3, PSP, Wii, DS and Xbox 360) require the approval of the console
manufacturer before they are produced and sold. The hardware manufacturer is thus
able to control the number of titles produced for the platform, ensure minimum quality
standards, and most important, collect the manufacturer’s royalty on the production

of the game. The three console manufacturers (Sony, Nintendo, and Microsoft)
actually oversee manufacture of the game software to ensure control over the
process. Publishers compensate the console companies through a per-game royalty
and manufacturing payment. Production costs vary slightly among console
manufacturers, with direct costs of around $1 per DVD, and a $8 – 9 per game net
royalty charged for a premium-priced DVD title (the average royalty plus
manufacturing charge is typically around 25% of the wholesale price of the game,
with some price breaks for volume sales). All platform manufacturers offer tiered
rates based on a title’s intended retail price, thus allowing budget titles priced at
$9.99 to be profitable. We estimate that the console manufacturers charge
approximately $12 per unit to produce a current generation console game
(production costs plus manufacturer’s royalty) and approximately $6 – 8.50 per unit
for DS and PSP games. We expect the 25% all-in cost to hold throughout the
current cycle. There are no manufacturer royalty payments for PC software, and the
per title cost of creating a CD-ROM is approximately $2 including the box art.
Distribution costs and reserves for price protection impact the cost of sales by
between 0 – 10% of sales, depending upon the game. The cost of sales as a
percentage of revenues for the typical console game runs at around 30 – 35% ($13
average cost, including reserve, divided by an expected $42 average wholesale price
for a current generation game). The average for the typical handheld game is
between 35 – 45% ($10 average cost, including reserve, divided by $29 average
wholesale price for DS and PSP games). Because manufacturing royalties are paid
at the time of manufacture and reserves are taken after a game is sold to the retailer,
the provision for reserves impacts gross margin without a corresponding benefit on
the royalty side.
Content Source
The next most leveraging driver in determining the margin on video game
software is the source of the game’s content. If a game is based on content
licensed from an external party, (e.g., sports leagues, movies, television franchises,
book, comic book or toy characters), then the game’s publisher will typically pay a
royalty of approximately 5 – 20% of gross sales (usually between $3 – 10 per unit) to
the content owner. Often, these license arrangements carry a minimum guarantee to
the licensor, whereby the licensee promises to pay a fixed dollar amount regardless
of the ultimate number of units sold. These guarantees can be quite high, with an
estimated $15 – 20 million guarantee for each Pixar title and an estimated $40 – 50
million annual guarantee for the NFL and Major League Baseball licenses.
Games that are original concepts owned by the publisher generate higher margins
because they require no royalty payments. For example, one of Electronic Arts’ most
profitable franchises is its wholly owned Sims series, which requires no third-party
royalties. Over the past five years, licensed content has become increasingly
common as publishers turned to established franchises and brands to lower the risk
in their product portfolios. This began toward the end of the last cycle, as the
industry was well within the “mass market” phase of the console cycle. However, the
emphasis on licensed content did not translate to blockbuster sales. Only 10 of the
30 best selling brands in 2008 were based on some form of licensed content (down
from 20 in 2004), while 18 of the remaining 20 were sequels to proven brands
introduced in prior years. Among last year’s top sellers derived from another medium:
Pokemon, Star Wars, WWE, Tom Clancy and LEGO. This year, we expect top
sellers to include games based upon Avatar, Harry Potter, and Transformers.
Included in the top 30 were several popular games based upon licensed sports

content, including Madden NFL Football, NCAA Football, FIFA and Tiger Woods
Golf. Games based on established television, movie, or print content are becoming
increasingly common in the U.S. markets as well as overseas.
It is important to note that 19 of the top 30 brands (and all of the top 6) were original
brands owned by the major publishers, including Guitar Hero, Wii Fit, Grand Theft
Auto, Tom Clancy, Mario, Need for Speed, Call of Duty and The Sims. It is clear that
publishers understand the operating leverage potential from owned intellectual
property, and the centerpiece of most corporate strategies is the creation of new
owned I/P.
Development Costs
The third key variable adding to the cost of a video game is the cost of
development, paid either through internal staff compensation expense or
through royalties to third-party developers. Development costs for a video game
can vary widely based on the platform and scope of the project. Games built for the
DS only cost around $500,000 to create, while a game built for the Xbox 360 or PS3
may cost as much as $20 million to create. We expect the average for current
generation games to settle at around $10 million apiece over time, compared to an
average development cost for legacy console games of $2.5 – 4 million. Sequels
built on a pre-existing “engine” (the artificial intelligence that determines how the
game’s characters will interact) generally cost less to develop than newly created
games, and we expect development costs for current generation games to decline as
engines are utilized well into the cycle. As a rule of thumb, we estimate most game
development costs are budgeted at 10 – 20% of a video game’s expected revenues,
but the actual percentage depends upon the ultimate success of the underlying
game. Whether a game is developed internally or externally will frequently affect how
the game’s costs are classified on a publisher’s income statement and how the
revenues are shared.
Because a game’s development occurs prior to revenue recognition, a publisher can
entirely expense the cost of building a game before any revenues are received (this
method of accounting is practiced by Electronic Arts). Publishers can also track
specific game development costs, capitalize these costs on the balance sheet, and
later amortize the costs as the games are sold (this method is practiced by all other
major U.S. and European publishers). Games built internally are much more likely to
be expensed rather than capitalized because external developer payments are much
easier to track to a particular game. As a general rule, publishers capitalize software
development if the development expenditure is incurred in one period and revenues
from the developed game are expected to be realized in a different period. As the
time for development has expanded with the added complexity of the current
generation consoles, more game development costs have been capitalized than ever
before. Once capitalized, development costs are amortized under the “units-of-
production” method, in which the publisher estimates total unit sales for a particular
title, and amortizes a portion of the capitalized development as each unit is sold. For
example, a game with $5 million of capitalized development costs that is expected to
sell one million units would bear amortization of $5 per unit as the units are sold.
Many publishers include amortization of software development in the cost of goods
sold line, while others separately state amortization as an expense below the gross
profit line.
Even more confusing is the treatment of royalties paid to external developers. Often,
external developers are paid upfront fees for the development of the game, and a

per-unit royalty for units in excess of a threshold amount. Thus, it is possible for
publishers to minimize development costs by allowing the external developers to
share in the risks and rewards inherent in any title. If the game is a success, the
developer receives a windfall; if not, the developer receives only the fixed payment.
These arrangements have an impact on gross margins, as almost all of these
expenditures are included in the cost of goods sold.
Despite its impact on the gross margin, classifying external development costs as
either “cost of goods sold” or as “research and development” has no impact on the
ultimate profitability of a game. In contrast, the revenue-sharing arrangement with an
external developer for a particular game may have a significant impact on the game’s
profitability. Games built by external developers frequently provide incentives that
include additional royalty payments if a game’s sales meet a certain threshold level.
Extremely successful games built by external developers are generally not as
profitable as similarly successful games built by internal studios. The benefit to a
publisher of using external developers is typically lower overhead costs and
frequently lower overall costs. In addition, external developers are typically less
constrained by corporate culture, and are therefore less constrained creatively.
Similar to the leverage opportunity with licensed vs. owned intellectual property, the
publishers have recognized the opportunity to improve operating margins by
migrating toward internal development, and the use of external developers has
declined over the past several years.
Other Costs
There are other less leveraging costs that factor into the economics of producing
video games. Two other costs that frequently lower a publisher’s gross margin are
the use of third-party distributors and allowance for returns and price discounts. Most
publishers handle the bulk of distribution themselves, but in some territories
(primarily international) and with some smaller customers, publishers turn to third-
party distributors to warehouse and place their titles on retailer shelves. Third-party
distribution typically costs between 7 – 15% of a game’s wholesale price (around $3
– 4 per unit) but usually affects only a small percentage of major publishers’ games.
One highly variable factor influencing costs is the allowance for price protection that
publishers must provide to retailers. In the video game industry, publishers take the
bulk of price risk on the games that they create. Retailers often expect that a game
will sell for a predetermined price, and are invoiced at this price. If the game does not
sell for the predetermined price, the publisher must provide a credit to the retailer for
the difference between the sale price and the predetermined price for all units
remaining in the retailer’s inventory. Industry-wide, we estimate that publishers
maintain a reserve of 20% of receivables, or approximately 14% of shipped quarterly
revenues (wholesale price) as price protection for their games. It is important to note
that price protection doesn’t always involve games that aren’t selling well; rather,
planned price reductions also carry price protection, for the simple reason that
publishers are interested in keeping the channel well-stocked, and must protect
retailers when retail prices are cut on older games. Additions to and charges against
the price protection reserve are closely guarded secrets among publishers, and we
estimate that actual charges for price protection and returns range from 7 – 10% of
annual revenues. These numbers can vary widely depending on the specific titles
shipped and the publisher’s success in maintaining premium pricing.
Figure 31 illustrates the impact of these cost variables on a publisher’s gross margin
for a hypothetical game produced on the major hardware platforms (excluding third-
party distribution and price protection costs).

PC-CD ROM games typically produce the highest gross margin while DS games
produce the lowest margins. PC games are also less likely to carry any licensed
content fees, as more PC games are based on original content than console games.
Despite these advantages, PC games rarely achieve the margins indicated in our
side-by-side comparison. PC software tends to be distributed through a larger
number of small specialty retailers (versus mass-market super stores), resulting in
lower inventory turnover and higher product returns. The market for PC games also
tends to be more hit-driven than the market for console games, resulting in a few
mega-hits and many busts. As a result, PC games are either extremely profitable
because of their favorable margins or are marked down to just above development
costs. On the other hand, average console games are far more likely to turn a profit
than the average PC game. The highly volatile nature of the PC game market has
driven almost all publishers to focus on the console market as their primary revenue
platform.
Figure 31—Sample Gross Margin Calculation
Current Gen Next Gen DS PSP Downloadable

PC CD-ROM Console DVD Console DVD Game Card UMD Content (Xbox Live)
Retail Price $49.99 $39.99 $59.99 $34.99 $39.99 $9.99
Retailer Take $10.00 $8.00 $12.00 $7.00 $8.00 $3.00

Wholesale Price to Publisher $39.99 $31.99 $47.99 $27.99 $31.99 $6.99
Cost of Goods Sold

Manufacturing/Packaging $2.00 $2.00 $2.00 $3.00 $2.00 $0.00
Hardware Royalty Fee $0.00 $6.00 $10.00 $4.00 $5.00 $0.00
Licensed Content Royalties $0 - 8.00 $0 - 6.00 $0 - 9.50 $0 - 6.00 $0 - 6.00 $0 - 1.50
Development Costs $1 - 7.00 $1 - 5.00 $1 - 10.00 $1 - 3.00 $1 - 4.00 $1 - 3.50
Total COGS
Low $3.00 $9.00 $13.00 $8.00 $8.00 $1.00
High $17.00 $19.00 $31.50 $16.00 $17.00 $5.00
Average $10.00 $14.00 $22.25 $12.00 $12.50 $3.00
Publisher Gross Proft Margin*

High 92% 72% 73% 71% 75% 86%
Low 57% 41% 34% 43% 47% 28%
Average 75% 56% 54% 57% 61% 57%
*Does not include possible external distributor costs ($3/title) or price protection for returns (7%-10%).
Third-Party Distributor $0 - $4.00 $0 - $4.00 $0 - $4.00 $0 - $4.00 $0 - $4.00 $0

SOFTWARE GENRES
Video games fit into broad categories or ‘genres’, classified by their general
subject matter and style of game play. The NPD Group, a firm that tracks retail
sales of video games, defines 12 genres: strategy, role-playing, sports, extreme
sports, action, adventure, racing, shooter, fighting, simulation, family and children’s
(which includes the music genre). These genres are generally recognized throughout
the industry as primary game genres, although many sub-categories within these
definitions also exist. In addition, many games simply cannot be described by one
genre and it is becoming more common to build games that combine elements of
many different genres, (e.g., fighting/role-playing-games, driving/shooting games,
and strategy-simulation games). For purposes of our analysis, we have collapsed
the 12 categories into eight, combining the strategy and role-playing genres, the
children’s and family entertainment genres, and the action and adventure genres.
Figure 32—U.S. Video Game Software Market by Genre
2001 2002 2003 2004 2005 2006 2007 2008

STRATEGY/RPG 24% 18% 17% 17% 16% 20% 10% 13%
SPORTS 14% 13% 14% 15% 15% 16% 12% 15%
EXTREME SPORTS 7% 4% 3% 2% 2% 1% 1% 1%
ACTION 19% 26% 27% 30% 31% 25% 20% 21%
RACING 10% 13% 9% 7% 10% 9% 6% 7%
SHOOTER 10% 9% 11% 13% 11% 12% 14% 12%
FIGHTING 5% 5% 6% 5% 4% 4% 4% 5%
SIMULATIONS 2% 2% 2% 1% 1% 1% 1% 0%
FAMILY/ CHILDREN 9% 8% 9% 9% 8% 9% 22% 25%
ALL OTHER 1% 2% 3% 2% 2% 2% 1% 1%
TOTAL 100% 100% 100% 100% 100% 100% 100% 100%
Source: The NPD Group/Retail Track, Wedbush Morgan Securities estimates.
Despite the subjective nature of classifying games by content and game play, we
believe that an analysis of historical trends in gaming genres will lead to useful and
interesting conclusions. Demand for games in any particular genre tends to be
relatively stable from year to year, but over a multi-year period, definite trends will
emerge. Although the overall size of the market for entertainment software has
grown substantially and best-selling titles vary tremendously from year to year,
demand for certain game genres has remained stable over time, with others showing
higher demand and yet others showing lower demand. For example, the
strategy/role-playing-game (RPG) genre was the fastest growing genre from 1997 –
2000, and showed the greatest decline from 2000 – 2005. We believe that the
increased popularity of strategy/RPG games was largely due to the rapid increase in
the quality of these games during the 32/64-bit console cycle, and other games
caught up in quality during the 128-bit cycle. As we forecasted seven years ago,
growth rates for several genres reverted to the mean during the last console cycle.
Games with a shooter component (the action and shooter genres) experienced a
large market share increase, from 26% in 2000 to 33% of total sales in 2008. This
trend was magnified in 2004, when such high profile action/shooter games such as

Halo 2, Doom 3, and Grand Theft Auto: San Andreas were released, with the genre
capturing 43% market share. The family/children’s genre grew the fastest over the
last decade, due to the introduction of the impossibly popular Guitar Hero and Rock
Band games, and we look for a slight decline in market share for this genre in 2009
and beyond.
The following is a more detailed description of these game genres and our evaluation
of future trends. Each genre’s share of the U.S. interactive software market in 2008 is
included in brackets after the genre name.
Strategy/RPG (13%)
Strategy/Role Playing Games are those in which players’ characters are placed in
realistic situations and typically follow a pre-determined storyline. As the storyline
progresses, the chosen character is typically required to manage resources (e.g.,
money, weapons, armies) to be utilized at some point during the game. The
emphasis of a Strategy/RPG game is to manage the character’s actions and build
necessary skills in an effort to complete all given tasks. Because of their size and
sheer volume of game play (deep story line and intricate artwork), RPGs are often
the most expensive games to develop. RPGs can also take a very long time to
develop – typically as long as four years to finish and as much as $30 – 50 million.
RPGs are tremendously important to the success of a hardware system, particularly
in the Japanese market. We believe that a key success factor in Sony’s PlayStation
triumph over Nintendo was the decision by since-merged Square (Final Fantasy
series) and Enix (Dragon Quest series) to support Sony rather than Nintendo. Some
of the biggest games of all time are RPGs. Square-Enix is now selling the twelfth
sequel to its Final Fantasy franchise and has sold more than 45 million copies of the
franchise worldwide since its debut in Japan in 1987. The thirteenth and fourteenth
editions of Final Fantasy are coming out this year and next, and the latter is exclusive
to the PS3. Other examples of Strategy/RPG games that are popular in the U.S.
include Elder Scrolls, Fallout, Fable, Civilization, World of Warcraft, Diablo,
Xenosaga and Baldur’s Gate.
Figure 33—U.S. Top Video Game Software - Strategy/Role Playing Games
2008 STRATEGY/RPG
Rank Title Publisher Platform Sales ($ mil)

1 FABLE II Microsoft 360 $ 64
2 FALLOUT 3 Bethesda Softworks 360 $ 55
3 W ORLD OF W ARCRAFT: W RATH OF Activision PC $ 54
4 SPORE Electronic Arts PC $ 32
5 ANIMAL CROSSING: CITY FOLK Nintendo W II $ 30
6 CRISIS CORE: FINAL FANTASY VII Square Enix PSP $ 26
7 POKEMON DIAMOND VERSION Nintendo NDS $ 22
8 FALLOUT 3 Bethesda Softworks PS3 $ 22
9 LEGEND OF ZELDA: TW ILIGHT PRIN Nintendo W II $ 21
10 IMAGINE: BABYZ Ubisoft NDS $ 20
Genre Total $ 1,530

The Strategy/RPG game genre has experienced a modest decline in popularity over
the last five years, with large sales increases in the late 1990s followed smaller
declines in this decade. In the first years following the PS2 launch, RPGs benefited
from better graphics and more data storage capability, as faster processors in
consoles and PCs allowed for more visually stunning games. The DVD format has
allowed for more data in the games, resulting in better graphics, movies, and story
telling, attracting hardcore gamers. Additionally, with increasingly improved fighting
and shooting aspects, the RPG genre captured market share from the “fighting” and
“shooting” genres late last decade, only to give back market share to these genres
over the past four years. We expect the Strategy/RPG genre to maintain a high-teen
market share over the next five years, as game graphics are dramatically better on
current generation consoles.
Sports (15%)
The Sports category is consistently one of the most popular genres in gaming. Sports
games have existed since the earliest days of consoles, and include games that are
primarily adaptations or simulations of real-world sporting activities. Successful
sports games are valuable franchises for a publisher because the games have
excellent potential for recurring revenues. Each year, a publisher can produce a new
sequel to a popular sports game, (e.g., Madden NFL), because professional rosters
and teams change significantly from year to year. A sequel does not require a
complete overhaul of the game every year; rather, the publisher can just add new
players, stadiums, and rule changes, thus minimizing development costs. Over the
past two years, sports games have suffered some market share losses as consumer
spending migrated to the music genre. In 2009, we expect sports games to gain
some share, as the music genre loses a bit of share, and as Electronic Arts focuses
its efforts on the Wii audience.

Figure 34—U.S. Top Video Game Software - Sports/Extreme Sports
2008 SPORTS

1 FIT W / BALANCE BOARD Nintendo W II $ 407
2 MADDEN NFL 09 Electronic Arts 360 $ 102
3 MADDEN NFL 09 Electronic Arts PS3 $ 63
4 MARIO AND SONIC: OLYMPIC GAM E Sega W II $ 48
5 MADDEN NFL 09 Electronic Arts PS2 $ 43
6 MARIO AND SONIC: OLYMPIC GAM E Sega NDS $ 41
7 NCAA FOOTBALL 09 Electronic Arts 360 $ 38
8 MARIO SUPER SLUGGERS Nintendo W II $ 30
9 MADDEN NFL 09 Electronic Arts W II $ 29
10 NBA 2K9 Take-Two Interactive 360 $ 25
Genre Total $ 1,764
2008 EXTREME SPORTS

1 SHAUN W HITE SNOW BOARDING: R Ubisoft W II $ 22
2 SHAUN W HITE SNOW BOARDING Ubisoft 360 $ 14
3 SKATE Electronic Arts 360 $ 9
4 SHAUN W HITE SNOW BOARDING Ubisoft PS3 $ 7
5 SKATE IT Electronic Arts W II $ 6
6 SKATE Electronic Arts PS3 $ 4
7 TONY HAW K'S PROVING GROUND Activision PS2 $ 3
8 SHAUN W HITE SNOW BOARDING Ubisoft PSP $ 3
9 SHAUN W HITE SNOW BOARDING Ubisoft PS2 $ 3
10 TONY HAW K'S PROVING GROUND Activision 360 $ 2
Genre Total $ 92
Because of predictable demand for the genre, a deep and high-quality library of
sports titles will generally launch with a new console. We believe that one of the main
reasons Sega’s Dreamcast platform failed was due to Electronic Arts’ decision not to
produce any of its extremely popular sports games for that platform. Microsoft
recognized the importance of the sports genre to the success of the Xbox, securing
Electronic Arts as a third-party publisher that supported its Xbox Live service. Some
of the best-selling video games are sports franchises, including Madden NFL, NBA
Live/NBA 2K, and FIFA Soccer. We expect the sports category to grow in line with
the overall industry. The importance of sports to EA was reinforced in 2004, when
the company signed a highly publicized exclusive arrangement with the NFL, adding
this license to its other exclusives (NASCAR and FIFA Soccer). Competitor Take-
Two responded by signing its own semi-exclusive arrangement with Major League
Baseball.

Extreme Sports (1%)
We have broken out the extreme sports category from the overall sports genre, as
we believe that extreme sports appeal to a slightly different (and smaller) audience
than conventional sports games in the current console cycle. Only a small fraction of
the size of the sports genre in 2008, we expect extreme sports sales to gain some
share of overall software sales over the next several years, particularly as games like
Shaun White Snowboarding and Tony Hawk Ride gain in popularity. An extreme
sports game typically involves a single player trying to perform tricks or race through
a course while sustaining minimal damage. There has been some crossover
between the sports and extreme sports lines, with games such as NBA Street, FIFA
Street and NFL Street including features of both genres.
Action/Adventure (21%)
Action/adventure games are those in which players select a character to control
throughout a mission consisting of various shooting, fighting, and sometimes puzzle
solving aspects. The difference between an action/adventure game and a
strategy/role-playing-game is the former’s emphasis on game play versus the latter’s
emphasis on character development. Fast and fun game play is the focus of the
action/adventure genre while the strategy/RPG genre stresses decision-making and
the game’s storyline. Included within the NPD definition of action/adventure games is
the platform/scrolling character genre (such as Super Mario Bros.), as well as classic
action games (such as Spider-Man) and classic adventure games (such as Resident
Evil). Action/adventure games are designed to have short learning curves so that
players can pick up a game controller and play immediately. This category declined
slightly in 2007 – 2008, with 21% of total sales, but has remained the largest single
genre over the last decade, with music themed games selling fewer units at far
higher average prices. We expect the Action/Adventure genre to maintain market
share in the 20 – 25% range over the next five years.
Shooter (12%)
Another highly descriptive genre title, shooters are simply games in which a
character travels through various settings, shooting other characters or objects.
Shooters typically come in three varieties, shooters shown looking down the barrel of
a gun (first-person shooters), character controlled shooters (third-person shooters),
and vehicle shooters. First-person shooters allow the player to “see” his surroundings
through the eyes of his character while third-person shooters provide the player with
a view of his character in the character’s surroundings. Vehicle shooters usually
provide a third-person perspective of the vehicle so that the player can see his
vehicle reacting to the controls.
The shooter genre has maintained its popularity over the past few years,
notwithstanding the increased hybridization of Strategy/RPG games that now include
a shooter element and that threatened to capture market share from the shooter
genre. In addition, conventional wisdom dictates that as the mass-market audience
grows in size relative to the hardcore audience, the significance of this genre shrinks
– mass-market gamers have historically not played these games to the same extent
as hardcore gamers. We reject conventional wisdom, and note that although the
genre has historically been popular among a narrow audience – males aged 15 – 30
– we expect the demographic to expand further during the current console cycle.
Popular shooter games include Call of Duty, Gears of War and Halo. In 2009, we

expect this genre to gain share, as several shooters are expected during the holiday
season.
Figure 35—U.S. Top Video Game Software - Action/Shooter
2008 ACTION

1 GRAND THEFT AUTO IV Take-Two Interactive 360 $ 185
2 GRAND THEFT AUTO IV Take-Two Interactive PS3 $ 105
3 METAL GEAR SOLID 4: GUN OF THE Konam i PS3 $ 66
4 NEW SUPER MARIO BROS Nintendo NDS $ 57
5 SUPER MARIO GALAXY Nintendo W II $ 56
6 STAR W ARS: THE FORCE UNLEASH LucasArts 360 $ 47
7 LITTLE BIG PLANET Sony PS3 $ 36
8 LINK'S CROSSBOW TRAINING W / Z Nintendo W II $ 32
9 STAR W ARS: THE FORCE UNLEASH LucasArts W II $ 28
10 NINJA GAIDEN II Microsoft 360 $ 28
Genre Total $ 2,421
2008 SHOOTER
Rank Title Publisher Platform ($ mils.)

1 CALL OF DUTY: W ORLD AT W AR Activision 360 $ 145
2 GEARS OF W AR 2 Microsoft 360 $ 113
3 CALL OF DUTY: W ORLD AT W AR Activision PS3 $ 65
4 LEFT 4 DEAD Electronic Arts 360 $ 61
5 TOM CLANCY'S RAINBOW SIX: VEGA Ubisoft 360 $ 57
6 CALL OF DUTY 4: MODERN W ARFAR Activision 360 $ 55
7 ARMY OF TW O Electronic Arts 360 $ 46
8 HALO 3 Microsoft 360 $ 43
9 CALL OF DUTY 4: MODERN W ARFAR Activision 360 $ 40
10 CALL OF DUTY 4: MODERN W ARFAR Activision PS3 $ 33
Genre Total $ 1,446
Racing (7%)
Racing games place the player in the driver’s seat of some sort of vehicle (e.g., car,
motorcycle, jet ski, or boat), racing against the clock and/or competitors in an
enclosed or defined setting. The racing genre has been around since the earliest
video games, and is usually one of the easiest games to produce. Game play is
extremely important in this genre; how the vehicles ‘handle’ in the virtual world
determines the level of enjoyment, and players tend to continue to play enjoyable
games. Even with enhanced game play, the nature of the racing genre tends to
cause gamers to lose interest in racing games more quickly than other genres. Some
of the most popular racing games include Gran Turismo, Need for Speed, Burnout,
NASCAR, Forza and Midnight Club. We expect the racing genre to maintain its
current market share over the next several years. In late 2004 and early 2005, there
were an unprecedented number of “big” racing games released, including Gran

Turismo 4, Burnout 3, Need for Speed Underground 2, Street Racing Syndicate,
Midnight Club III: DUB Edition and Juiced, with several sequels later in 2005, driving
the category (pun intended) to a record market share. This year, there is renewed
competition, with new intellectual property Blur competing with a redesigned Need for
Speed Shift, as well as console exclusives Forza 3 and Gran Turismo 5. We
therefore expect the category to capture market share closer to 9% this year.
Figure 36—U.S. Top Video Game Software - Racing
2008 R A C IN G
R ank T itle Publisher Platform Sales ($ m il)

1 M AR IO KAR T W / W H EEL N intendo W II $ 248
2 M AR IO KAR T D S N intendo NDS $ 57
3 BU R N O U T PAR AD ISE Electronic Arts 360 $ 19
4 G R AN T U R ISM O 5: PR O LO G U E Sony PS3 $ 19
5 N EED FO R SPEED : U N D ER C O VER Electronic Arts 360 $ 18
6 M ID N IG H T C LU B: LO S AN G ELES T ake-T wo Interactive 360 $ 17
7 BU R N O U T PAR AD ISE Electronic Arts PS3 $ 14
8 N EED FO R SPEED : U N D ER C O VER Electronic Arts PS3 $ 13
9 M ID N IG H T C LU B: LO S AN G ELES T ake-T wo Interactive PS3 $ 13
10 G R ID C odem asters 360 $ 8
G enre T otal $ 785
Fighting (5%)
Fighting games involve characters that fight hand-to-hand, usually in a one-on-one
situation. NPD includes professional wrestling games under this genre, which has
given the sagging popularity of this genre a boost. Fighting games tend to be most
popular with young males ages 10 to 14. Popular Fighting games include the WWE,
Tekken, Mortal Kombat, Dead or Alive and the new UFC game. With the continued
popularity of professional wrestling and the advent of UFC and the competing MMA
from Electronic Arts, we expect the Fighting genre to maintain market share in the 5
– 7% range.
Simulation (less than 1%)
Simulation games attempt to re-create a realistic situation in a virtual world (note that
this category does not include one of the most popular sim games – The Sims – as it
is classified as Strategy/RPG). Situations usually involve control of various vehicles
such as planes, helicopters, and submarines. The most popular simulation games
are designed for the PC. These games are not very time-intensive and usually
attract an older audience. We expect this genre to continue to remain relatively small
over the next several years.

Figure 37—U.S. Top Video Game Software - Fighting/Simulations
2008 FIGHTING

1 SUPER SMASH BROS: BRAW L Nintendo W II $ 193
2 MORTAL KOMBAT VS DC UNIVERS E Midway Gam es 360 $ 30
3 SOUL CALIBUR IV Nam co Bandai Gam e s 360 $ 27
4 MORTAL KOMBAT VS DC UNIVERS E Midway Gam es PS3 $ 25
5 SOUL CALIBUR IV Nam co Bandai Gam e s PS3 $ 18
6 W W E SMACKDOW N VS. RAW 2009 THQ PS2 $ 18
7 NARUTO: ULTIMATE NINJA 3 Nam co Bandai Gam e s PS2 $ 16
9 W W E SMACKDOW N VS. RAW 2009 THQ 360 $ 13
Genre Total $ 552
2008 SIMULATIONS

1 ACE COMBAT 6: FIRES OF LIBERATI Nam co Bandai Gam es 360 $ 9
2 BLAZING ANGELS: SQUADRONS OF Ubisoft W II $ 4
3 MS FLIGHT SIMULATOR X DELUXE Microsoft PC $ 4
4 ACE COMBAT 5: UNSUNG Nam co Bandai Gam es P S2 $ 3
5 W W II ACES Destineer Studios W II $ 2
6 ACE COMBAT 6: FIRES OF LIBERATI Nam co Bandai Gam es 360 $ 2
7 BLAZING ANGELS 2: SECRET MISSI O Ubisoft 360 $ 2
8 BLAZING ANGELS 2: SECRET MISSI O Ubisoft PS3 $ 2
9 MS FLIGHT SIMULATOR X Microsoft PC $ 1
10 REBEL RAIDERS: OPERATION NIGH T XS Gam es PS2 $ 1
Genre Total $ 45
Family Entertainment/Children (25%)

The Family Entertainment genre includes interactive versions of puzzle, board,
dancing, music and trivia based games suitable for people of all ages, as well as
games based upon popular children’s characters. Throughout this decade, many
publishers have licensed cartoon or book content aimed at children and have
developed the content into popular games such as Harry Potter, SpongeBob, The
Incredibles (note that NPD characterizes Harry Potter and Little Big Planet as
Action/Adventure games while SpongeBob falls under the Family/Children’s game).
Casino and puzzle games such as Hoyle Casino and Tetris, round out this genre.
The growth in this genre came primarily from music themed games Rock Band and
Guitar Hero, requiring players to follow a rock music soundtrack while playing an
interactive guitar, drums or microphone. The Children’s category has probably
maintained around a 9% share over the last two years, with the music category
driving all of the growth in making the category dominant. We expect music themed
games to lose some market share over the next few years, as unit sales grow
modestly, but at lower price points with the mix shift from bundles to software.

Other (1%)
Some of the more popular games that we include in the “Other” category include
arcade games, such as the Pac-Man series, learning games, and some exer-games.
This category also includes a small number of games that are not classified in any
genre, usually because the publisher does not include a description of the game and
the game play is not obvious to the data-gathering company. With the success of
Jillian Michaels Fitness Ultimatum and EA Sports Active, and new games like Daisy
Fuentes Pilates on the horizon, we expect this category to grow somewhat over the
next few years.
Figure 38—U.S. Top Video Game Software – Family/Children/Other
2008 F A M IL Y / C H IL D R E N
R ank T itle P u b lis h e r P la t fo r m S a le s ($ m il)

1 PLAY W / R EM O TE N in te n d o W II $ 261
2 R O C K B A N D S P E C IA L E D B U N D L E E le c tro n ic A rts W II $ 140
3 R O C K B A N D S P E C IA L E D B U N D L E E le c tro n ic A rts 360 $ 132
4 R O C K B A N D S P E C IA L E D B U N D L E E le c tro n ic A rts PS2 $ 129
5 G U IT A R H E R O III L E G E N D S O F R O C A c tiv is io n W II $ 126
6 G U IT A R H E R O W O R L D T O U R W /B A N A c tiv is io n W II $ 125
7 G U IT A R H E R O W O R L D T O U R W /B A N A c tiv is io n 360 $ 71
8 G U IT A R H E R O III L E G E N D S O F R O C A c tiv is io n 360 $ 71
9 G U IT A R H E R O III L E G E N D S O F R O C A c tiv is io n PS2 $ 68
10 R O C K B A N D 2 S P E C IA L E D B U N D L E E le c tro n ic A rts 360 $ 63
G e n re T o ta l $ 2 ,9 3 9
2008 O THER
R ank T it le P u b lis h e r P la t f o r m S a le s ( $ m il)

1 P E R S O N A L T R A IN E R : C O O K IN G N in te n d o NDS $ 9
2 A C T IO N /A D V E N T U R E /F A M IL Y B U N D L O th e r NDS $ 5
3 A C T IO N /A D V E N T U R E B U N D L E O th e r PS2 $ 5
4 N A M C O M U S E U M 5 0 T H A N N IV N am co Bandai G am es PS2 $ 4
5 NAM CO M USEUM N am co Bandai G am es NDS $ 4
6 V A L U E G A M E B U N D L E 1 9 .9 9 O th e r W II $ 4
7 M Y S P A N IS H C O A C H U b is o ft NDS $ 4
8 N AM C O M U SEU M BATTLE C O LLEC T N am co Bandai G am es PSP $ 3
9 V A L U E G A M E B U N D L E 1 4 .9 9 O th e r NDS $ 3
10 M Y W ORD COACH U b is o ft NDS $ 3
G e n r e T o ta l $ 124

CONTENT OVERVIEW
Notwithstanding the specific game genre definitions used by the NPD group,
we think that it is important to focus on content in a manner useful to
investors. Several factors determine overall interactive entertainment software
sales. We believe that the primary drivers of software unit volume are (1) the number
of consoles sold each year, (2) the installed base of consoles sold in prior periods,
and (3) the “tie” ratios of software sales to hardware purchases. Overall software
sales are a function of price multiplied by volume, so increases in price per unit will
drive sales growth. As discussed in a prior section, front line pricing has increased in
the current generation, primarily due to higher starting price points and the
introduction of peripheral bundles. We expect software pricing to hold relatively
steady over the next few years, with front line games remaining at $59.99 and
peripherals and premium editions increasing in number, offsetting the inevitable
sales decline for high priced music bundles.
Approximately 33 million current generation home consoles were sold in the U.S. and
Europe in 2008, up 44% from the prior year due to the increased Wii production and
a price cut for the Xbox 360; we estimate the installed base in those two regions as
of this writing to be approximately 77 million consoles. As the current generation
installed base grows, we expect continued growth in software sales. We note that
“tie” ratios slightly exceeded the historic 3.5 – 4 units annually for each current
generation console in the first two years following launch (averaging 3.84 units in
2008) and we expect tie ratios to decline to below 3.3 units in 2009. We think that
the dominance of the Wii in the current cycle may skew tie ratios more seasonally
than in past cycles, as a greater number of Wii owners are more casual players than
has historically been the case this early in the cycle.
As is the case with motion pictures, it is always difficult to determine which titles will
be sure-fire “hits,” which will be moderately successful, and which will be “bombs”.
This problem is exacerbated by the constant shift in consumer hardware purchase
patterns among handhelds, portables, old consoles at discount prices, and new
consoles at relatively high prices. There are as many theories as there are forecasts
for the successful video game formula, and in this report, we offer yet another thesis.
In our view, content is the primary determinant in the consumer decision to purchase
a video game, as well as a driver in the selection of consoles. By “content”, we mean
a combination of the game’s brand, game play, genre, target demographic, and
“buzz” (e.g., online and magazine reviews, word-of-mouth, etc.). We offer a brief
summary of these factors below.
BRAND
A large number of titles produced by U.S. and European publishers have brand
identity. By “brand”, we do not mean the publisher’s name (e.g., Activision or
Electronic Arts), although we acknowledge that the success of similar games sold by
a particular publisher can create name recognition for other games sold by the same
publisher (as has been the case with Rockstar titles). Rather, we use the term
“brand” to refer to the main character or main title of a particular game. For example,
we would classify Electronic Arts’ Madden Football as a brand (also known as a
franchise).

There are several ways for publishers to brand their content. The most sure-fire way
to create a new brand is through licensing. Thus, brands such as Harry Potter, Lord
of the Rings, Transformers, WWE, Cars, Shrek, Spider-Man, and The Simpsons can
be licensed from the creators of the intellectual property, and will provide the licensee
immediate recognition with consumers. Through licensing, the publisher can be
confident that consumers will feel comfortable in making a game purchase, and
therefore more willing to incur the risk of developing the particular title.
Another way to create a brand is by using a celebrity endorser. For example, the
Tony Hawk, Madden, Tom Clancy, and Tiger Woods brands all have name
recognition that is sufficient to give their respective publishers the confidence to take
development risk. This approach has been very successful in the development of
sports and extreme sports games, and we expect the trend to continue.
Still another way to create a brand is through the successful sequels of original
content. Mario, Zelda, Halo, Tomb Raider, Grand Theft Auto, Need for Speed,
Mortal Kombat, and Call of Duty are all examples of brands developed by publishers
that are successful sequels launched in the current console cycle.
In the past, the most successful branding strategy was practiced by Electronic
Arts. In the last cycle, the company focused on delivering approximately 40 brands
to market each year that either were sequels or had the potential to become sequels.
Over the past decade, Electronic Arts licensed the rights to Harry Potter and Lord of
the Rings, established the Tiger Woods Golf brand, created the SSX snowboarding,
Def Jam, Need for Speed and Medal of Honor brands, and purchased the Sims,
Battlefield and Burnout brands. The company has recently developed a set of
Hasbro-licensed brands, and has spent game development dollars on franchise
brands that it believes will provide it with revenue streams for years to come,
including Dead Space and Dante’s Inferno.
Emulating this strategy, the U.S. industry’s other big player, Activision,
licensed rights to or created new titles that have sequel potential. During the
last cycle, Activision used the significant cash flow generated from its Tony Hawk
brand to launch the extremely successful Spider-Man brand. It then reinvested in
creating new wholly owned brands True Crime, Call of Duty and Gun. Two of these
brands were disappointments, highlighting the risk inherent in creating a brand from
the ground up. However, Call of Duty (and its Modern Warfare spin-off) provided the
capital necessary to purchase the Guitar Hero brand, and the success of these
brands led indirectly to a combination with Vivendi Games, owner of the World of
Warcraft, Starcraft and Diablo brands.
Other publishers have tried to create brands with sequel potential, with mixed
results. THQ had the most difficult time, with modest success from Saint’s Row, a
wholly owned intellectual property, and offset by poor performance from sequels to
the Juiced and Stuntman brands (purchased from less fortunate competitors). Take-
Two, on the other hand, has produced mixed, but generally positive results with its
branding strategy, producing a string of unsuccessful games based upon licensed
strategy, but producing generally successful brands from internally developed
intellectual property. The company has been able to leverage the huge success of
its flagship Grand Theft Auto brand into smaller successes with brands like
Civilization, BioShock and Midnight Club, and its new management (installed in
2007) appears to be succeeding in changing the company’s strategy.
Perhaps the most successful upstart among the publishers is Ubisoft, which
has established an entire line of casual brands, with surprising success. The

company’s Petz, My Coach and Imagine brands generated €325 million in sales in
2008 from virtually zero just three years prior, accounting for approximately 30% of
Ubisoft revenues. While Ubisoft’s casual business is susceptible to challenge from
better capitalized competitors (notably, Electronic Arts), management has reinvested
its profits from these brands in wholly owned intellectual property such as Assassin’s
Creed and Rayman.
GAME PLAY
All publishers strive to make high quality games that are fun to play. A bad game with
good brand recognition is still a bad game, and poor reviews and word-of-mouth can
kill a game’s sales potential (the exception to this rule was Vivendi Games’ 50 Cent,
a million unit seller with lower ratings than its title). A large portion of the amount
spent to develop a game is dedicated to getting the right look and feel, although
games produced for the handheld platforms can look comparable to console games
with lower overall software development costs due to the small screen size. With the
proliferation of big-screen televisions and surround-sound home entertainment
systems, a console game with poor graphics or poor sound quality is likely to be a
poor seller.
As we noted in our industry report published seven years ago (Content is King), there
is a high correlation between a game’s average rating by third-party reviewers and its
unit sales. Most games are rated on a 100-point scale, with the average rating
hovering around 65. Games rated 80 or higher tend to dominate the best-seller lists,
and games rated below 60 are seldom on the best-seller list for more than a few
weeks. Each time a publisher releases a sequel to a successful brand, industry
pundits quickly note the third-party ratings. A rating of less than 85 for an
established franchise brand such as Madden, WWE, Need for Speed or Tony Hawk
generally starts the rumor mill spinning about the pending demise of the brand, and
in some cases (notably with Tony Hawk), declining ratings can lead to a redesign of
the game from the ground up.
There is some variability among ratings from different sources, leading to speculation
as to whether ratings can be “bought”. While we do not believe this to be the case,
we have noted that many reviewers are biased in favor of or against certain games,
with review scores easy to predict in advance. For example, most RPG games
receive very high scores because most reviewers have an affinity for the genre, while
most movie-based games have difficulty receiving scores above 80 because most
reviewers find the games predictable. We have also seen reviewers exhibit a
tendency to rate sequels more harshly than originals, although there are exceptions
for games such as Halo 2 and Halo 3 (“the best game ever”) and Grand Theft Auto:
San Andreas and GTA IV (“the best game ever”, notwithstanding the same term
having been applied just a few months before to Halo 3). Similarly, most children’s
games are rarely taken seriously by reviewers, even though there may be a large
market for them. There are exceptions, but on balance, we think that review scores
can provide a useful statistic to consider in determining the likely success of a game.
GENRE
Publishers have historically developed competencies and competitive advantages
within specific software genres and gamers tend to stick to familiar genres when
purchasing software. Several companies have earned well-established reputations
for their competency in producing and marketing games targeted at specific genres
such as Electronic Arts (sports games), THQ (children’s games), Activision (music
and superhero games), and Take-Two (mature-themed games).

Figure 39—Percentage of U.S. Publishing Sales by Genre (2008)
ATVI ERTS COOL MWY NTDOY TTWO THQI UBI

STRATEGY/RPG 7% 12% 60% 1% 11% 8% 11% 20%
SPORTS 3% 32% 16% 6% 23% 22% 2% 2%
EXTREME SPORTS 1% 1% 0% 0% 0% 0% 0% 8%
ACTION 11% 4% 4% 2% 13% 53% 38% 19%
RACING 2% 7% 1% 1% 16% 7% 15% 1%
SHOOTER 24% 13% 2% 15% 0% 2% 4% 27%
FIGHTING 0% 0% 0% 51% 10% 0% 23% 1%
SIMULATIONS 0% 0% 0% 0% 0% 0% 0% 2%
FAMILY/CHILDREN 52% 31% 16% 23% 26% 8% 6% 18%
ALL OTHER 0% 0% 1% 1% 0% 0% 0% 3%
TOTAL 100% 100% 100% 100% 100% 100% 100% 100%
We believe that the NPD genres, although generally descriptive of each particular
game’s focus, are not suitably descriptive of the potential audience for the game. For
example, NPD classifies THQ’s WWE brand as a fighting game, comparing the
brand to other fighting games such as Midway’s Mortal Kombat and Sega’s Virtua
Fighter. In our view, the typical customer for the WWE brand is a fan of the real-life
World Wrestling Entertainment, and has a lot more in common with fans of NASCAR
than with fans of fighting. WWE video game customers purchase the game for the
same reasons that NFL fans purchase Madden Football; they like to control a
simulated game in which their heroes compete on the small screen. Customers of
the Mortal Kombat and Virtua Fighter series are looking for an altogether different
gaming experience.
We believe that investors are better served by having the various genres simplified
into fewer and more general categories as follows:
KIDDIE CONTENT: This category includes games targeted at children under the
age of 12. The category would include Pokemon, Hannah Montana, Mario Brothers,
Shrek, Scooby-Doo, Harry Potter, Pixar titles, SpongeBob and other internally
developed and licensed brands targeted at children. Though it is true that many
brands such as Mario are enjoyed by a much wider demographic, in our view these
brands generate the bulk of their sales by providing family-friendly content that is
always safe for play by children. The typical game in this category is built upon the
platform/scrolling character model, in which the character traverses a landscape and
overcomes various obstacles placed in its way. The object of most kiddie games is
to move to ever-higher levels, and the games are typically designed to allow a 10-
year old to progress to the end. Because of the relatively simple content, these
games are easily developed for the handheld platforms, which are disproportionately
owned by small children. Some popular kiddie content has been developed for the
current generation consoles, including Crash Bandicoot. To date, blockbuster titles
such as Harry Potter, Mario Galaxy, LEGO and The Legend of Zelda have all been
bona fide hits on the current generation consoles. Games included in this category
are almost always “E” rated. We believe that the relevant question to ask in
determining whether a particular game is a kiddie game is “would grandma buy it for
junior as a birthday present?”

SPORTS: This category is better defined by what is NOT included. It does not
include extreme sports, nor does it include “edgy” over-the-top sports titles such as
Midway’s Blitz: The League or Ready to Rumble Boxing. The category can generally
be defined as including family-friendly team and individual sports, including most of
the EA Sports and 2K Sports titles. The target audience is truly “everyone”, hence
the “E” rating on the label. It is important to draw a distinction between “E”-rated
sports games and other “E”-rated content—unlike the “Kiddie” games described
above, which are targeted at small children, the “E”-rated sports games are truly
aimed at the whole family, and we believe that the typical consumer includes parents
as well as children. The object of sports category games is to win the race, score
more points than your opponent, or win the boxing match.
EXTREME SPORTS: Activision can lay claim to inventing this category with its Tony
Hawk brand, and is hopeful of taking the brand to the next level with its peripheral-
based game, Tony Hawk Ride, planned for release later this year. Extreme Sports
games are targeted at early teens, although a large percentage of sales is
attributable to consumers outside the target audience. These games are “edgy”, and
provide an out-of-control gaming experience in which the player is always on the
verge of crashing. Content is very important, and almost all U.S. publishers offer a
game in this category (e.g., Midway with Blitz: The League, Activision with Tony
Hawk, Electronic Arts with SSX and its Street games, THQ with MX vs. ATV and
Take-Two with Amped). We also include THQ’s WWE franchise in this category, as
we believe that the outrageous nature of the wrestling experience is analogous to
other extreme sports entries. The winners in this category provide excellent content,
maximum control over game play, and sound branding. These games differ
somewhat from the typical sports games, insofar as the object of extreme sports
games is to avoid injury to the central character while scoring the most points,
winning the race, and so on. The extreme sports category also differs from the typical
“T”-rated shooter or fighting games in that the object of those games is to injure the
other character, while the object of extreme sports games is to avoid injury to the
player’s character. Depending upon the content, extreme sports games can be
labeled “E” or “T”, but the focus is clearly on mid-teens. Acclaim had a disastrous
experience in trying to raise the bar with its “M”-rated BMX XXX game released in
late 2002. The game was a poor seller, with fewer than 200,000 units sold across
three platforms. We believe that the inclusion of sexual innuendo and adult humor
alienated the core late teen male audience and limited opportunities for purchases by
parents as a gift, perhaps contributing to Acclaim’s ultimate bankruptcy.
EDGY CONTENT: This category includes almost all shooter and fighting games, as
well as several crossover-category role-playing, action, and racing games. The
games that best describe the category are Take-Two’s Grand Theft Auto games, in
which the central character is a criminal sent on various missions. In order to
complete the increasingly difficult missions, the character is required to steal cars
and money, kill other characters, and avoid the police. Each game is part racing, part
shooter, and part role-playing. We also include most shooter games, such as Halo,
Doom, Gears of War, Resistance, Resident Evil, and Wolfenstein in this category
and note that one thing these games have in common is that all were blockbusters.
On the fighting front, we believe the edgy category includes games in which the
object is to kill the opponent in a gory manner, and we therefore include Midway’s
Mortal Kombat in the category. There are other titles, like Saint’s Row, and Left 4
Dead that very comfortably fit the “edgy” definition.

ALL OTHER: It’s easy to lump all of the remaining genres together and leave it at
that. This category includes non-edgy action games, such as Activision’s recent
Bond game, role-playing games such as EA’s Mass Effect series, strategy games
such as The Sims and Final Fantasy, and puzzle games such as THQ’s Tetris
Worlds. These games are aimed at a broader demographic than are kiddie games.
TARGET DEMOGRAPHIC
In order to support the more than the expected 100 million consoles in the
worldwide installed base at the end of 2009, everyone should be considered a
potential customer. We believe that in the past, many publishers overlooked certain
groups in their quest to grow market share. With the success of the Wii, the
publishers’ focus has shifted dramatically in favor of more casual games.
Electronic Arts has consistently focused on the entire family in almost all of its
product offerings. In developing games, the company looks for brands that are
susceptible to sequels. This strategy has served the company well, as most of its
games appeal to at least 50% of potential game buyers. In targeting the broadest
audience possible, Electronic Arts has tended to focus on the middle demographic
(the early teen boy customer) and work its way outward in order to broaden the
appeal of its games from there. As a result, only a few of Electronic Arts’ offerings fit
within the Kiddie category (most notably the Harry Potter brand), and only a few fit
within the Edgy category (Dead Space and the Dante’s Inferno).
Activision, THQ, and to an extent Take-Two have emulated Electronic Arts’ strategy
of developing brands susceptible to sequels. Each company has taken a different
path, with Activision exploiting its strengths in music and superhero games, THQ
focused on the Kiddie category, and Take-Two squarely focused on the Edgy
category. Although Electronic Arts, Activision and THQ all are intent upon
developing brands that allow sequels, each was late in the Edgy category, following
the success of Take-Two with its Grand Theft Auto brand. Electronic Arts launched
Def Jam Vendetta, Black and The Godfather a couple of years ago, and has
introduced one or two new M-rated titles annually since. THQ introduced its “M”-
rated Saint’s Row in 2006, and followed with a sequel in 2008 and this year’s Red
Faction: Guerrilla, evidence that both companies recognize the opportunity in this
category that they have all but overlooked in the past. Activision has had the most
success of the three, with its Call of Duty and Modern Warfare brands among the
best selling M-rated games ever. Ubisoft, no stranger to M-rated games with its Tom
Clancy series, launched Assassin’s Creed as a new brand in 2007, and this year’s
sequel is expected to be one of the top performers.

Figure 40—Percentage of U.S. Console Software Genre Sales by ESRB Rating (2008)
EC E E10+ T M
(EARLY CHILD) (EVERYONE) (EVERYONE 10+) (TEEN) (MATURE) TOTAL
STRATEGY/RPG 0% 36% 13% 33% 18% 100%
SPORTS 0% 93% 3% 4% 0% 100%
EXTREME SPORTS 0% 11% 51% 37% 0% 100%
ACTION 0% 24% 20% 24% 32% 100%
RACING 0% 72% 14% 15% 0% 100%
SHOOTER 0% 0% 3% 19% 77% 100%
FIGHTING 0% 0% 1% 96% 3% 100%
SIMULATIONS 0% 18% 14% 68% 0% 100%
FAMILY/CHILDREN 0% 36% 8% 56% 0% 100%
ALL OTHER 0% 77% 16% 5% 2% 100%
In our opinion, target demographic is significant for two reasons: first, the largest
(and growing) group of consumers, consisting of males ages 16 and older, is
interested in edgy content. Over 70% of primary current generation console users fit
this demographic and we expect this market share to expand as the PS3 and Xbox
360 further penetrate the console installed base. Because of the expense of the PS3
and Xbox 360, early adopters were squarely within the sights of the edgy content
producers. As such, there were not a large number of “E”-rated games for the PS3
or Xbox 360 for the first few years, with most “E”-rated content released on the lower
priced (and more mass market friendly) Wii. We think that many consumers have a
tendency to shop for games by ESRB rating, and much as the “G”-rated motion
picture is an anathema to teens, we believe that the “E”-rated video game can cause
a similar aversion to early adopters of the PS3 and Xbox 360. Second, the success
of the Wii has caused a mismatch in content created by the publishers, with the early
focus of most publishers on the Xbox 360 and PS3, causing all (but Ubisoft) to
overlook the more family friendly Wii audience.
Figure 41—Percentage of U.S. Console Software Publisher Sales by Ratings (2008)
EC E E10+ T M
(EARLY CHILD) (EVERYONE) (EVERYONE 10+) (TEEN) (MATURE) TOTAL
ACTIVISION 0% 5% 12% 61% 22% 100%
ELECTRONIC ARTS 0% 39% 8% 44% 9% 100%
MAJESCO ENTERTAINMENT 0% 93% 3% 1% 2% 100%
MIDWAY GAMES 0% 28% 1% 47% 24% 100%
NINTENDO 0% 86% 1% 13% 0% 100%
TAKE 2 INTERACTIVE 0% 29% 8% 8% 54% 100%
THQ 0% 53% 3% 32% 12% 100%
UBISOFT 0% 35% 14% 19% 32% 100%

The proof of this concept is the music category, which has been phenomenally
successful on all platforms, with games intended for everyone (notwithstanding their
T ratings, for lyrics). We think it is notable that in focusing on the hard core,
Electronic Arts and THQ lost their way in the face of the Wii’s early success. Those
companies misjudged the market, and are just now beginning to recover from their
early mistakes. In contrast, Take-Two chose to release a relatively low cost title,
Carnival Games, that has so far sold almost 3 million units on the Wii. Ubisoft made
a calculated decision to exploit the Wii audience with its casual lineup, with generally
successful results.
We see a trend in growth rates of interactive entertainment software sales when
segmented by ESRB rating. Over the last seven years, the “E” category has
declined in popularity, with the “T” and “M” ratings capturing market share. When
combined, “T” and “M” have grown consistently each of the last eight years, peaking
at 51% of overall game sales in 2008 while “E” has struggled to maintain market
share. We expect the edgy category to maintain its market share this year, with a
number of expected “M”-rated titles scheduled for release on current generation
consoles.
With sports titles (almost all “E” rated) taken out, the contrast in growth rates is even
more striking. The “T” and “M” categories grew from a combined 29% of console
dollar sales in 1999 to a combined 51% of sales in 2008, while non-sports “E” games
have declined from the stable 50% range to last year’s 33% (combined wit E10+).
Figure 42 supports our thesis that demand for “edgy” content is on the rise.
Figure 42—Percentage of Total U.S. Console Software Sales by Rating
CONSOLE RATINGS
TOTAL
2001 2002 2003 2004 2005 2006 2007 2008
NOT SPECIFIED 0% 0% 0% 0% 0% 0% 0% 0%
EC (EARLY CHILDHOOD) 0% 0% 0% 0% 0% 0% 0% 0%
E (EVERYONE) 66% 53% 53% 51% 46% 41% 40% 39%
E10+ (EVERYONE 10+) 0% 0% 0% 0% 5% 13% 11% 10%
T (TEEN) 23% 29% 33% 28% 32% 29% 30% 32%
M (MATURE) 10% 18% 14% 21% 17% 17% 19% 19%
TOTAL 100% 100% 100% 100% 100% 100% 100% 100%
CONSOLE RATINGS
SPORTS SEPARATED
2001 2002 2003 2004 2005 2006 2007 2008
NOT SPECIFIED 0% 0% 0% 0% 0% 0% 0% 0%
EC (EARLY CHILDHOOD) 0% 0% 0% 0% 0% 0% 0% 0%
E (EVERYONE) 50% 36% 39% 35% 34% 25% 28% 24%
E10+ (EVERYONE 10+) 0% 0% 0% 0% 1% 12% 10% 9%
T (TEEN) 23% 25% 30% 25% 30% 26% 29% 32%
M (MATURE) 10% 18% 14% 21% 16% 16% 19% 19%
S (SPORTS) 16% 21% 17% 19% 19% 20% 15% 16%
TOTAL 100% 100% 100% 100% 100% 100% 100% 100%

“BUZZ”
We think that a game’s rating and word-of-mouth are almost as important as
brand and game play in the consumer’s purchase decision. This “buzz” can
carry a game beyond the ordinary hype surrounding its release, and will position the
publisher to create a successful sequel the following year. Consumers can determine
a game’s rating from a variety of sources, including websites and magazines, and
most consumers will ask others’ opinions before plunking down $60 for a game.
Publishers, who tend to promote their games aggressively, create much of the
“buzz.” The larger publishers advertise on television, and all publishers advertise in
print and online. In addition, publishers send copies of games to research analysts
(full disclosure—we seldom purchase games from the companies that we cover, and
Activision, EA, THQ, Sony, Nintendo, and Microsoft have been especially generous
with product), the press, and anyone else who can influence purchase decisions.
We believe that the most influential “buzz”-creating group consists of employees at
specialty retailer GameStop. GameStop hires hardcore gamers, and customers are
quite comfortable asking their employees about a particular game’s rating and game
play. A second source of influence is dedicated gaming magazines, with a combined
circulation of over 3 million subscribers. Ratings in these magazines can determine
the success or failure of a game. Perhaps even more influential are online ratings,
led by IGN/GameSpy, with over 25 million monthly visitors, and GameSpot, with over
15 million visitors. There are two popular websites that aggregate game ratings,
metacritic.com and gamerankings.com.
It is important to note that a large percentage of games receiving positive “buzz” fall
within the Edgy category. It is common to find four or five of the most popular games
on www.GameSpot.com at any given time to be “M”-rated edgy games.
CONCLUSION
We expect sales of interactive entertainment software to increase at an annual
growth rate of 8.8% over the next three years. Statistically, it is unlikely that each
genre will grow at exactly that rate. We expect the kiddie, and other categories to
grow as slowly as under 5% annually, the sports genre to grow in line, and the edgy
and extreme sports categories to grow as much as 15% annually, with much riding
on the success of Tony Hawk (pun intended).
We think that each of the five categories we have listed above currently account for
between 5% and 25% of overall video game sales. We expect the following growth
rates:
Kiddie 5%
Sports 10%
Extreme Sports 15%
Edgy 15%
Other 5%
Our bias is obvious: we expect today’s 18 – 30 year olds to drive interactive software
sales growth for the next several years. As the boys behind this group grow into
young men, they will become bored with kiddie and family-oriented content and will
look for more edgy content. We expect strong growth of the edgy category as
younger children age and emulate their older brothers.

SOFTWARE GROWTH FORECAST
Our outlook for sales of interactive entertainment software is very positive
over the next three years, with industry growth of 29%. The installed base of
current generation consoles is expected to reach 100 million units in the U.S. and
Europe by year-end, and we expect annual console sales of over 30 million annually
for the next several years. Last generation software sales have ceased to make an
impact on overall sales growth, with contribution of less than 4% in 2009, and with
sales of current generation and handheld/portable software more than making up for
the decline. Figure 43 illustrates historical and forecasted sales of interactive
entertainment software worldwide.
Figure 43—Worldwide Interactive Entertainment Software Sales (2004 – 2011E)
35,000
30,000
25,000
($millions)
20,000
15,000
10,000
5,000
-
2004 2005 2006 2007 2008 2009E 20010E 20011E
We forecast the worldwide interactive entertainment software market to grow at a

7.8% CAGR from 2008 to 2011, with slower growth in Japan offset by higher growth
in the rest of the world.
We expect U.S. and European software sales – the addressable markets for U.S.
and European publishers – to grow at an 8.8% CAGR over 2008 – 2011. We expect
the U.S. publishers to focus on the console, handheld and European markets over
the next three years, as we believe that these will provide the most upside, with
some investment in Asian online gaming.
In order to accomplish these growth rates, we believe that the industry must
achieve higher console hardware penetration rates than in the past and must
manage the inevitable decline in overall software “tie ratios”. Our forecast
assumes strong contribution from sales of software for the current generation
consoles (e.g., Xbox 360, PS3 and Wii), representing approximately 65% of total
worldwide game software sales in 2009. We assume that the tie ratios for the current
generation consoles will be slightly above 3.25 units per console in 2009, and that
future declines will be relatively minor. At the same time, we expect handheld and
portable software to maintain market share of 20 – 22% of the overall market. We

think that these assumptions are conservative, and think that there is potential for
upside, but our estimates presume that many households will have both a current
generation console and at least one handheld/portable device, and may make
purchases for each during this time. Going forward, we expect many households to
purchase more than one console, pressuring tie ratios, but expanding the market for
software even further.
As discussed in the Hardware Platform section, we expect the combined U.S. and
European current generation console installed base to end up in 2009 at a combined
100 million home console units. By year-end 2009, we expect the installed base of
over 100 million PS3, Xbox 360 and Wii console owners and 105 million DS and PSP
owners to continue buying software. We believe that strong demographic
fundamentals, additional functionality, increased market segmentation, and much
higher marketing spending will increase console penetration rates in this cycle in
every major geographic segment. We believe these same drivers will also allow
overall software “tie ratios” throughout the industry to remain at around 3.0 annually.
A “tie ratio” is defined as the number of software units sold per hardware unit. All tie
ratios are measured over a specific time period, e.g., the first three months of a
system launch, the first year, or the life of a hardware platform. Over the “life-of-
platform” for the current generation consoles, we expect tie ratios to hit record levels,
as we expect these consoles to have a longer life than in past cycles. The “life-of-
platform” tie ratio refers to all software units sold for a platform divided by all
hardware units sold for the platform during the platform’s entire lifecycle (usually six
to seven years for most consoles, but likely closer to 10 years for the current cycle).
Historical tie ratios for the 32-/64-bit console cycle and 128-bit console cycles
averaged approximately 11 units of software for each console. We expect a
significant increase in tie ratios during the current cycle, given the large number of
peripheral-based games currently under development, and the expected longer
overall life of the average console.
As a result of higher penetration rates and stable tie ratios, software sales are
expected to exceed those of the last console cycle. The charts in Figures 44 – 47
illustrate our worldwide forecast for software sales, as well as sales by geographic
and platform segments.

Figure 44—Software Unit Sales U.S. and Europe (2004 – 2011E)
U .S . S o ftw are U n its (m il) 2004 2005 2 006 20 07 200 8 200 9E 20010 E 200 11E
P layS ta tio n 7.9 2 .1 0.4 0.1 0.1 - - -
N 64 0.0 0 .0 - - - - - -
D ream ca st 0.1 0 .0 0.0 - - - - -
P layS ta tio n 2 8 4.1 76.2 73.5 56.1 40.0 18.0 4 .7 -
PS3 - - 1.3 12.6 27.2 40.3 53 .5 67.6
G am eC u b e 2 6.2 21.7 17.2 6.1 0.6 - - -
W ii - - 3.0 32.0 70.3 85.9 105 .4 1 20.9
Xbox 4 2.4 37.3 22.2 7.3 2.1 - - -
X b o x 360 - 2 .6 20.8 40.7 48.3 57.8 68 .1 76.8
All O th er - - - 0.1 0.4 - - -
T o tal H o m e C o n so le 160 .7 139 .9 138.4 154.9 1 89.0 201.9 231 .8 2 65.3
G ro w th (% ) 8% -13% -1% 12 % 22% 7% 15% 14%
G am eB o y/C o lo r 0.6 0 .1 0.0 - - - - -

G B Ad v an ce /S P 4 0.3 32.5 25.1 13.5 2.8 0.7 - -
DS 1.4 8 .2 23.4 46.1 59.0 70.2 80 .7 88.9
PSP - 9 .8 14.3 18.0 17.7 18.8 22 .1 24.9
All O th er 0.1 0 .1 - - 0.1 - - -
T o tal P o rtab le 4 2.3 50.6 62.9 77.6 79.5 89.7 102 .8 1 13.8
G ro w th (% ) 13% 19% 2 4% 23 % 3% 1 3% 15% 11%
T o tal C o n so le 203 .0 190 .5 201.3 232.5 2 68.5 291.6 334 .6 3 79.1

G ro w th (% ) 9% -6% 6% 16 % 16% 9% 15% 13%
P C U n it S a les 4 7.0 38.0 39.8 35.0 29.1 28.3 27 .4 26.6

G ro w th (% ) -11% -19% 5% -12 % -17% -3% -3% -3%
T o tal S o ftw a re 250 .0 228 .5 241.1 267.5 2 97.7 319.9 362 .0 4 05.7
G ro w th (% ) 4% -9% 5% 11 % 11% 7% 13% 12%
E u ro p e S o ftw are U n its (m il) 2004 2005 2 006 20 07 200 8 200 9E 20010 E 200 11E
P layS ta tio n 6.0 3 .0 2.0 1.0 0.5 - - -
N 64 0.4 0 .3 0.2 - - - - -
D ream ca st - - - - - - - -
P layS ta tio n 2 7 8.1 77.8 77.8 54.0 38.8 17.5 4 .7 -
PS3 - - - 10.9 25.2 39.4 53 .3 67.3
G am eC u b e 1 2.0 10.9 8.9 2.9 0.3 - - -
W ii - - 2.5 24.0 56.7 70.3 91 .1 1 07.0
Xbox 2 2.8 21.0 12.2 4.1 1.2 0.3 - -
X b o x 360 - 1 .5 17.6 23.5 28.7 33.7 39 .8 45.4
All O th er - - - - - - - -
T o tal H o m e C o n so le 119 .2 114 .6 121.2 120.2 1 51.5 161.2 188 .9 2 19.7
G ro w th (% ) 17% -4% 6% -1 % 26% 6% 17% 16%
G am eB o y/C o lo r 0.5 0 .3 0.2 - - - - -

G B Ad v an ce /S P 2 6.2 22.5 18.5 9.6 2.0 0.5 - -
DS - 4 .5 14.5 38.1 55.5 67.2 77 .0 84.5
PSP - 5 .0 10.1 13.3 13.9 16.1 19 .1 21.7
All O th er - - - - - - - -
T o tal P o rtab le 2 6.7 32.3 43.3 61.0 71.5 83.8 96 .1 1 06.3
G ro w th (% ) 24% 21% 3 4% 41 % 17% 1 7% 15% 11%
T o tal C o n so le 145 .9 146 .9 164.5 181.2 2 23.0 245.0 285 .0 3 26.0

G ro w th (% ) 18% 1% 1 2% 10 % 23% 1 0% 16% 14%
P C U n it S a les 6 3.5 62.0 60.0 57.5 54.0 60.0 57 .5 54.0

G ro w th (% ) -5% -2% -3% -4 % -6% 1 1% -4% -6%
T o tal S o ftw a re 209 .4 208 .9 224.5 238.7 2 77.0 305.0 342 .5 3 80.0
G ro w th (% ) 10% 0% 7% 6% 16% 1 0% 12% 11%
U .S . a n d E u ro p e S ales 459 .4 437 .4 465.6 506.3 5 74.7 624.9 704 .6 7 85.7

G ro w th (% ) 7% -5% 6% 9% 14% 9% 13% 12%

Figure 45—Software Unit Sales Japan and Worldwide (2004 – 2011E)
Japan Softw are (m il) 2004 2005 2006 2007 2008 2009E 20010E 20011E
PlayStation 5.0 3.0 1.5 0.5 - - - -
N64 0.7 0.5 0.3 0.3 - - - -
Dream cast - - - - - - - -
PlayStation2 53.0 45.5 39.0 24.0 12.0 6.0 3.0 1.0
PS3 - - 1.4 6.2 10.0 13.0 17.0 20.0
G am eCube 8.5 3.0 0.4 7.0 2.0 - - -
W ii - - 3.5 14.9 15.5 18.0 20.0 22.0
Xbox 1.2 0.9 0.5 0.2 0.1 - - -
Xbox 360 - 0.3 1.2 1.8 3.2 4.0 4.0 4.0
All O ther - - - - - - - -
Total Hom e Console 68.4 53.2 47.8 54.9 42.8 41.0 44.0 47.0
G row th (% ) 5% -22% -10% 15% -22% -4% 7% 7%
G am eBoy/Color - - - - - - - -
G B Advance/SP 17.1 7.3 2.6 0.4 0.3 - - -
DS 1.1 21.5 49.8 39.9 31.9 30.0 28.0 26.0
PSP 3.0 7.5 11.0 17.0 24.0 30.0 35.0 38.0
All O ther - - - - - - - -
Total Portable 21.2 36.3 63.3 57.2 56.2 60.0 63.0 64.0
G row th (% ) 25% 71% 74% -10% -2% 7% 5% 2%
Total Console 89.6 89.5 111.2 112.2 99.0 101.0 107.0 111.0
G row th (% ) 10% 0% 24% 1% -12% 2% 6% 4%
PC Unit Sales 7.8 7.6 7.4 7.3 7.2 7.4 7.3 7.2
G row th (% ) -3% -3% -3% -1% -1% 3% -1% -1%
Total Softw are 97.4 97.1 118.6 119.5 106.2 108.4 114.3 118.2
G row th (% ) 8% 0% 22% 1% -11% 2% 5% 3%
W orldw ide Softw are (m il) 2004 2005 2006 2007 2008 2009E 20010E 20011E
PlayStation 18.9 8.1 3.9 1.6 0.6 - - -
N64 1.1 0.8 0.5 0.3 - - - -
Dream cast 0.1 0.0 0.0 - - - - -
PlayStation2 215.2 199.5 190.3 134.1 90.8 41.5 12.4 1.0
PS3 - - 2.7 29.6 62.4 92.7 123.8 155.0
G am eCube 46.7 35.5 26.5 15.9 2.9 - - -
W ii - - 9.0 70.9 142.6 174.2 216.5 249.9
Xbox 66.4 59.3 34.9 11.5 3.4 0.3 - -
Xbox 360 - 4.4 39.6 66.0 80.3 95.4 111.9 126.2
All O ther - - - 0.1 0.4 - - -
Total Hom e Console 348.3 307.7 307.5 330.1 383.3 404.1 464.7 532.0
G row th (% ) 10% -12% 0% 7% 16% 5% 15% 14%
G am eBoy/Color 1.1 0.4 0.2 - - - - -

G B Advance/SP 83.6 62.3 46.2 23.4 5.0 1.2 - -
DS 2.5 34.2 87.7 124.1 146.4 167.4 185.8 199.5
PSP 3.0 22.3 35.4 48.3 55.6 64.9 76.2 84.6
All O ther 0.1 0.1 - - 0.1 - - -
Total Portable 90.3 119.2 169.5 195.8 207.2 233.5 262.0 284.1
G row th (% ) 19% 32% 42% 16% 6% 13% 12% 8%
Total Console 438.6 426.9 476.9 525.9 590.5 637.6 726.6 816.1
G row th (% ) 12% -3% 12% 10% 12% 8% 14% 12%
PC Unit Sales 118.3 107.6 107.2 99.8 90.3 95.7 92.2 87.8
G row th (% ) -7% -9% 0% -7% -10% 6% -4% -5%
Total Softw are 556.8 534.5 584.1 625.7 680.8 733.3 818.9 903.9
G row th (% ) 7% -4% 9% 7% 9% 8% 12% 10%

Figure 46—Software Dollar Sales U.S. and Europe (2004 – 2011E)
U .S . S oftw are ($m il) 2004 2005 2006 2007 2008 2009E 20010E 20011E
P layS tation 100 20 5 2 1 - - -
N 64 0 0 - - - - - -
D ream cast 0 0 0 - - - - -
P layS tatio n 2 2,817 2,530 2,304 1,767 1,218 414 94 -
PS3 - - 75 750 1,543 2,135 2,782 3,448
G am eC ub e 839 664 482 140 10 - - -
W ii - - 145 1,502 3,363 3,864 4,533 4,956
Xbox 1,485 1,282 604 137 24 - - -
X b o x 360 - 146 1,148 2,368 2,739 3,005 3,441 3,764
All O ther - - - 1 2 - - -
T otal H om e C onso le $5,243 $4,642 $4,762 $6,667 $8,899 $9,418 $10,851 $12,168
G ro w th (% ) 7% -11% 3% 40% 33% 6% 15% 12%
G am eB oy/C olo r 7 1 0 - - - - -
G B Adv ance/S P 949 744 519 249 38 7 - -
DS 47 258 671 1,248 1,571 1,684 1,816 1,867
PSP - 420 501 507 462 452 486 498
All O ther 2 1 - - 1 - - -
T otal P ortable $1,004 $1,424 $1,692 $2,004 $2,072 $2,142 $2,303 $2,366
G ro w th (% ) 11% 42% 19% 18% 3% 3% 7% 3%
T otal C o nso le $6,246 $6,066 $6,454 $8,670 $10,971 $11,560 $13,153 $14,534
G ro w th (% ) 8% -3% 6% 34% 27% 5% 14% 10%
P C $ S ales $1,111 $953 $979 $818 $701 $678 $658 $638

G ro w th (% ) -9% -14% 3% -16% -14% -3% -3% -3%
T otal So ftw are $7,357 $7,019 $7,433 $9,488 $11,672 $12,239 $13,811 $15,172
G ro w th (% ) 5% -5% 6% 28% 23% 5% 13% 10%
E urop e S oftw are ($m il) 2004 2005 2006 2007 2008 2009E 20010E 20011E
P layS tation 90 30 16 15 9 - - -
N 64 4 1 0 - - - - -
D ream cast - - - - - - - -
P layS tatio n 2 3,122 2,879 2,490 1,754 1,203 447 104 -
PS3 - - - 738 1,464 2,129 2,772 3,367
G am eC ub e 456 370 267 72 6 - - -
W ii - - 130 1,392 2,950 3,304 4,099 4,602
Xbox 911 801 366 89 12 - - -
X b o x 360 - 105 1,188 1,599 1,753 1,817 2,067 2,268
All O ther - - - - - - - -
T otal H om e C onso le $4,583 $4,187 $4,457 $5,658 $7,396 $7,697 $9,043 $10,237
G ro w th (% ) 25% -9% 6% 27% 31% 4% 17% 13%
G am eB oy/C olo r 9 3 2 - - - - -
G B Adv ance/S P 701 573 423 230 28 8 - -
DS - 157 471 1,333 1,666 1,680 1,849 1,944
PSP - 245 404 466 390 386 430 456
All O ther - - - - - - - -
T otal P ortable $710 $978 $1,300 $2,029 $2,084 $2,074 $2,279 $2,401
G ro w th (% ) 22% 38% 33% 56% 3% 0% 10% 5%
T otal C o nso le $5,293 $5,165 $5,757 $7,687 $9,480 $9,771 $11,321 $12,638
G ro w th (% ) 24% -2% 11% 34% 23% 3% 16% 12%
P C $ S ales $1,969 $1,984 $1,860 $1,696 $1,458 $1,500 $1,438 $1,350

G ro w th (% ) 6% 1% -6% -9% -14% 3% -4% -6%
T otal So ftw are $7,262 $7,149 $7,617 $9,384 $10,938 $11,271 $12,759 $13,988
G ro w th (% ) 19% -2% 7% 23% 17% 3% 13% 10%
U .S . an d E urop e S ales $14,619 $14,168 $15,051 $18,872 $22,611 $23,510 $26,570 $29,160
G ro w th (% ) 11% -3% 6% 25% 20% 4% 13% 10%

Figure 47—Software Dollar Sales Japan and Worldwide (2004 – 2011E)
Japan Softw are ($m il) 2004 2005 2006 2007 2008 2009E 20010E 20011E
PlayStation 78 39 20 7 - - - -
N 64 15 6 3 3 - - - -
D ream cast - - - - - - - -
PlayStation2 2,067 1,593 1,287 744 348 150 57 17
PS3 - - 84 360 540 650 782 860
G am eC ub e 383 113 15 140 32 - - -
W ii - - 175 717 713 792 840 880
Xbox 47 32 14 4 1 - - -
Xbox 360 - 18 66 90 144 172 164 156
All O ther - - - - - - - -
T otal H om e C onsole $2,589 $1,800 $1,663 $2,064 $1,778 $1,764 $1,843 $1,913
G row th (% ) -1% -30% -8% 24% -14% -1% 4% 4%
G am eB oy/C olor - - - - - - - -
G B Advance/SP 479 183 54 6 4 - - -
DS 42 710 1,543 1,157 861 750 672 572
PSP 135 315 440 646 864 1,020 1,120 1,140
All O ther - - - - - - - -
T otal Portable $656 $1,208 $2,036 $1,809 $1,729 $1,770 $1,792 $1,712
G row th (% ) 29% 84% 69% -11% -4% 2% 1% -4%
T otal Console $3,245 $3,008 $3,699 $3,873 $3,507 $3,534 $3,635 $3,625
G row th (% ) 4% -7% 23% 5% -9% 1% 3% 0%
PC $ Sales $330 $310 $305 $285 $270 $305 $285 $270

G row th (% ) -4% -6% -2% -7% -5% 13% -7% -5%
T otal Softw are $3,575 $3,318 $4,004 $4,158 $3,777 $3,839 $3,920 $3,895
G row th (% ) 3% -7% 21% 4% -9% 2% 2% -1%
W orldw ide Softw are ($m il) 2004 2005 2006 2007 2008 2009E 20010E 20011E
PlayStation 268 89 40 23 10 - - -
N 64 20 7 3 3 - - - -
D ream cast 0 0 0 - - - - -
PlayStation2 8,006 7,002 6,080 4,265 2,769 1,011 255 17
PS3 - - 159 1,848 3,546 4,914 6,336 7,675
G am eC ub e 1,677 1,148 763 352 48 - - -
W ii - - 450 3,611 7,026 7,961 9,472 10,438
Xbox 2,443 2,114 984 230 37 - - -
Xbox 360 - 269 2,402 4,057 4,636 4,994 5,673 6,188
All O ther - - - 1 2 - - -
T otal H om e C onsole $12,415 $10,629 $10,882 $14,388 $18,073 $18,879 $21,736 $24,318
G row th (% ) 11% -14% 2% 32% 26% 4% 15% 12%
G am e B oy/C olor 16 4 2 - - - - -
G B Advance/SP 2,129 1,500 996 485 70 15 - -
DS 89 1,125 2,685 3,738 4,098 4,114 4,337 4,384
PSP 135 980 1,345 1,618 1,716 1,858 2,036 2,094
All O ther 2 1 - - 1 - - -
T otal Portable $2,370 $3,610 $5,029 $5,842 $5,885 $5,986 $6,374 $6,478
G row th (% ) 19% 52% 39% 16% 1% 2% 6% 2%
T otal Console $14,784 $14,239 $15,911 $20,230 $23,958 $24,865 $28,110 $30,797
G row th (% ) 12% -4% 12% 27% 18% 4% 13% 10%
1.56 1.39 1.29
PC $ Sales $3,409 $3,247 $3,144 $2,799 $2,429 $2,483 $2,380 $2,258
G row th (% ) -1% -5% -3% -11% -13% 2% -4% -5%
T otal Softw are $18,194 $17,486 $19,055 $23,030 $26,388 $27,349 $30,490 $33,055
G row th (% ) 10% -4% 9% 21% 15% 4% 11% 8%

SECTION 2: INVESTING IN SOFTWARE PUBLISHERS

INVESTING IN SOFTWARE PUBLISHERS
With the economic downturn, the historical gains in share prices for the major
publishers were all but wiped out. The average forward multiple for a video game
publisher has historically been 25 – 50% higher than the overall market multiple,
reflecting the superior growth prospects for the industry and the tremendous earnings
leverage generated by massive early investments in R&D. However, as of this
writing, most of the public video game publishers trade at or below the market
multiple, reflecting investor concern about the health of the industry.
We believe that the interactive entertainment industry offers secular dynamics
that will provide extended and sustainable growth. Several publishers stand
poised to capitalize on this growth, providing investors with an opportunity to
participate. In this section, we analyze historical returns for the industry, and
compare and contrast the publishers in order to provide insight into how their
different strategies and assets produce different risk and return profiles.
In prior console cycles, U.S. investors in this industry were offered few domestic
investment alternatives. Given rapid growth and industry consolidation during the last
console cycle, we believe that the industry now offers investors fewer viable choices,
while at the same time limiting risk. Figure 48 lists the key publicly traded
entertainment software publishers.
Figure 48—Key U.S. Publicly-Traded Interactive Entertainment Software Publishers
Share Market CY 2008 2008 U.S.

Price Capitalization Revenues Market
Ticker 5/20/2009 ($ mils) ($ mils) Share
Activision Blizzard ATVI $ 11.41 $ 15,874 $ 4,370 17%

Electronic Arts ERTS $ 22.08 $ 7,110 $ 4,396 20%
Majesco Entertainment COOL $ 1.33 $ 37 $ 64 1%
Midway Games MWYGQ $ 0.07 $ 6 $ 220 1%
Nintendo 7974.JP ¥25,720.0 ¥3,292,000 ¥1,892,000 17%
Take-Two Interactive Software TTWO $ 9.35 $ 720 $ 1,538 6%
THQ THQI $ 5.96 $ 407 $ 845 4%
Ubisoft UBI.FP € 15.08 € 1,493 € 1,070 5%
Year for COOL & TTWO = Nov-Oct

Source: Company reports, Bloomberg, and Wedbush Morgan Securities estimates.
The universe of publicly traded entertainment software publishers includes

companies with market capitalizations ranging from under $50 million to over $30
billion. The industry offers two large-cap companies (Nintendo and Activision
Blizzard), one mid-cap company (Electronic Arts), three small-cap companies (Take-
Two, THQ and Ubisoft), and two micro-cap companies (Atari and Majesco) to
consider as investment opportunities. Over the last three years, five micro cap
companies (Acclaim, Bam!, Interplay, Midway and 3DO) declared bankruptcy or
ceased operations.

INDUSTRY PRICE PERFORMANCE
Investing in a portfolio of entertainment software publishers over the last ten
years has not been a profitable venture, primarily due to the bankruptcies of
five companies and the precipitous decline in value of Atari. An index of U.S.
and European entertainment software publishers (Activision, Acclaim, Atari, BAM!,
Electronic Arts, Interplay, Midway, Take-Two, 3DO, THQ and Ubisoft) over the past
ten years produced a negative 3.2% compound annual return, compared to positive
returns for the broader market indices. There have been clear winners, with
Activision investors realizing returns of 29% over the last ten years, with more
modest returns for Ubisoft, EA and Take-Two investors in the mid-to-high single
digits. There were also clear losers, with THQ investors losing approximately 4%
per year over the last ten years and Majesco losing over 90% of its value in its first
two years as a public company. Publishers Acclaim, BAM!, Interplay, Midway and
3DO all went out of business over the last six years. Investors who sought quality
substantially outperformed the market indices. The index of the six largest
publishers (Activision, Electronic Arts, Nintendo, Take-Two, THQ and Ubisoft)
generated a CAGR of 8.5% over the last ten years, crushing negative returns
for the broader market. In our view, the rewards of investing in video game
publisher stocks far outweigh the risks. Investing in a portfolio of high quality
entertainment software publishers over the years has proven a profitable venture.
HISTORICAL INDUSTRY RETURNS

Share prices of U.S. entertainment publishers increased roughly in tandem with the
top-line growth of these companies during the past two console cycles. Revenues
within the entertainment software industry grew at a 20% CAGR during the 1991-
2002 period. Similarly, the share-price returns of U.S. and European publishers
during this period grew at a 20% CAGR. We note that share prices grew quite rapidly
during the 16-bit cycle, and somewhat more slowly during the 32-/64-bit cycle. This
result was largely driven by the success of Electronic Arts during the 16-bit cycle and
the underperformance of several small firms during the 32/64-bit cycle. In contrast,
the average share price declined by a 28% CAGR during the first two full years of the
128-bit cycle, but rebounded significantly over the next four years. The industry was
not immune to the broader market downturn, with share prices declining faster than
the overall market. We believe that this presents an opportunity, as we expect a
reversion to the mean sometime in the next few years. Figure 49 illustrates the
share price appreciation for the U.S. and European publishers over the last two
console cycles. We include the universe of U.S. and European publishers (plus
Nintendo) in this index (Acclaim, Activision, Atari, BAM!, Electronic Arts, Interplay,
Majesco, Midway, Nintendo Take-Two, THQ, 3DO and Ubisoft).

Figure 49—Industry Stock Performance (1999 – 2009)
Stock Price
as of close
Company 1/4/1999 Other Date 5/20/2009 CAGR %
Acclaim Entertainment $ 11.44 $ - -100%
Activision Blizzard $ 0.91 $ 11.41 29%
Atari $ 237.50 $ 1.68 -39%
BAM! $ 8.00 11/14/2001 $ - -100%
Electronic Arts $ 12.63 $ 22.08 6%
Interplay $ 1.75 $ 0.06 -28%
Nintendo ¥10,710 ¥25,720 11%
Majesco Entertainement $ 12.50 1/26/2005 $ 1.33 -41%
Midway Games 10.94 $ 0.07 -40%
Take-Two Interactive Software 5.75 $ 9.35 5%
3DO $ 35.00 $ - -100%
THQ $ 8.69 $ 5.96 -4%
Ubisoft Entertainment € 7.18 € 15.08 8%
Source: Bloomberg, Baseline, Wedbush Morgan Securities estimates. Includes dividends for Nintendo.

REVENUE SIZE AND GROWTH
The publicly traded publishers vary tremendously in terms of size. The largest public
firm in the industry, Nintendo, generated revenues of over $18 billion in 2008, while
the smallest, Majesco, recorded sales of only $64 million.
Total revenue for each U.S. publisher includes both publishing and distribution
revenues. Only three publishers – Electronic Arts, Activision, and Take-Two –
currently derive any significant portion of their total revenues from distribution.
Because publishing revenues generally grow faster and deliver higher margins than
distribution revenues, we believe that investors value publishing revenues more.
Figures 50 and 51 illustrate publishing and total revenues for the eight companies in
our coverage universe.
Figure 50—Publishing Revenues 2005 – 2008 ($ millions)
2005 2006 2007 2008

Activision Blizzard 1,159 1,035 2,201 3,230
Electronic Arts 2,613 2,937 2,663 3,363
Majesco Entertainment 60 67 51 64
Midway Games 150 166 157 220
Nintendo ¥217,000 ¥338,600 ¥547,800 ¥700,100
Take-Two Interactive Software 856 753 691 1,230
THQ 830 1,003 1,016 845
Ubisoft Entertainment € 598 € 597 € 873 € 996

Source: Company reports and Wedbush Morgan Securities estimates.
Figure 51—Total Revenues 2005 – 2008 ($ millions)
2005 2006 2007 2008

Activision Blizzard 1,484 1,387 2,608 4,370
Electronic Arts 2,863 3,119 3,151 4,479
Majesco Entertainment 60 67 51 64
Midway Games 150 166 157 220
Nintendo ¥508,300 ¥809,500 ¥1,570,000 ¥1,892,000
Take-Two Interactive Software 1,203 1,038 982 1,538
THQ 830 1,003 1,016 845
Ubisoft Entertainment € 622 € 627 € 909 € 1,070


We forecast publishing revenues for the five largest companies to grow slightly faster
than our forecasted industry CAGR (8.8%) over the next three years, as we expect
each to expand its international market share over this period (in Ubisoft’s case, we
expect growth in the U.S.). We expect distribution revenues for the top three
publishers to be flat to down over this period. Although it is highly likely that market
share for some publishers will change dramatically during the next console cycle, we
have little specific product visibility after 2009. However, we believe that the industry
will continue to experience contraction or consolidation, and our long-term forecasts
for some of these publishers assume that some of them will slightly outperform the
industry average. Accordingly, our revenue models assume that some will gain
market share in 2010 and beyond.

COMPANY STRATEGIES
Software publishers employ a variety of strategies to differentiate themselves from
one another and to gain competitive advantages. In this section, we analyze the
publishers along seven key strategic lines:
(1) Platform focus
(2) Internal versus external development
(3) Third-party distribution
(4) Geographic sales dispersion
(5) Online (including microtransactions and in-game advertising)
(6) Intellectual property ownership
(7) Game genre focus
PLATFORM FOCUS
Deciding how best to allocate development resources is an important decision for
publishers. In some cases, publishing games on every platform is a good idea (such
as when a mass-market title like Madden NFL Football or Transformers is published).
Other times, it makes more sense to limit development to those platforms that have
the right target demographic for a particular game. For example, some games that
are clearly aimed at the kiddie audience (such as Sonic the Hedgehog games) may
be profitable if published only on the DS and Wii. Different game platforms require
varying development costs, time to market, and marketing budgets, and generate
different gross margins.
The first decision a publisher faces is whether to produce console, handheld or PC
software. Although generally ignored by sell-side analysts, the PC software market is
still quite large, and expected to generate sales of over $2 billion annually for the
next several years. While software sales for the DS, Xbox 360, PS3 and Wii each
exceeded PC software sales in 2008, the significant size of the PC software market
(a combined $2.2 billion in U.S. and European 2008 sales) makes this option an
immediately attractive one. Unfortunately, the PC software market is also the most
highly competitive and highly saturated, and we expect the overall market to shrink
slightly over the next three years. Games sold for the PC platform produce below
average unit and dollar sales, and generally carry ASPs well below most console
games, with few PC titles achieving bona fide “hit” status.
PC gamers also tend to be more demanding customers than console gamers, most
likely due to a much older and affluent demographic profile. Because of this,
successful PC games often require development budgets and development periods
similar to current generation console games. We estimate that the average new
property takes over two years to develop for the PC, similar to the current generation
consoles. High development costs and a hit-driven market combine to produce a
difficult competitive environment, and few publishers can generate sustainable profits
with a PC focus. In our view, publishers (like Blizzard) that approach the PC platform
cautiously and stick to developing games within proven PC genres and with a history
of success (like Starcraft) will be the most successful. Over the long term, we expect
PC software sales to decline, especially as the specs for the current generation
consoles are similar to those of the most powerful PCs, and we believe that

publishers will devote development dollars primarily to the faster-growing console
market.
Most publishers take a diversified approach to platform development, concerned that
committing a disproportionate amount of development budgets to a particular
platform is risky. The economics of game development in the last cycle often dictated
that games were developed for the PS2 first, as that platform had the largest
installed base. This changed in the current console cycle, as publishers initially
developed for the PS3 and Xbox 360, discounting the potential of the Wii. When it
became clear that the Wii was the clear winner, it became obvious that ignoring this
platform was a big mistake. Development for the Wii added a layer of complexity
due to its different architecture. While Wii development carries generally lower
development cost, making a bet on the platform less risky, games for the console
had to be built from scratch, as they could not easily be ported from the other two
consoles. Console games for the PS3 and Xbox 360 take from 24 – 36 months to
develop and bring to market and cost an average of $10 million each, with many
costing twice that amount. Therefore, at launch, publishers were forced to forecast
the future market climate at least two years in advance before they decided which
games to publish on which platforms. Committing funds and resources to a slow-
growth platform can be costly; similarly, publishing a game for a hot platform can turn
a mediocre title into a winner (as evidenced by Take-Two’s Carnival Games for the
Wii). The Dreamcast platform provides a good example. Publishers such as Acclaim
and Midway suffered in 2000 when the Dreamcast platform failed to sell enough
hardware to make software releases for this platform profitable. Publishers must also
attempt to gauge likely future competition on a particular platform, favoring a
diversified strategy. In general, most publishers match their platform development to
their expected platform market share, i.e., the largest number of games is produced
for the largest expected platform. Although profitable publishing opportunities can
exist on relatively small platforms if the competitive landscape is favorable, we
expect publishers to employ this strategy cautiously.
Choices about platform focus in the current cycle are a moving target. Many
games produced for the Xbox 360 have been ported to the PS3, but it is not clear
whether this was the most efficient method. Because the PS3 has a seven-core
processor and the Xbox 360 has a three-core processor, development for the PS3 is
somewhat more complicated than for the Xbox 360. This has worked to Microsoft’s
advantage, as early in the cycle, publishers chose to develop all games for the 360
because of the relative ease of development; conversely, in the future, it could work
against Microsoft, should publishers choose to develop first for the more complex
device, anticipating an easier time porting to the competitor’s device.

Figure 52—Covered Companies Publisher Sales Mix by Platform
CY 2005 ATVI ERTS COOL MW Y NINT THQI TTW O UBI

Personal Computer 16% 16% 5% 3% 0% 9% 17% 19%
GBA 7% 3% 48% 2% 38% 23% 1% 12%
DS 3% 3% 1% 0% 24% 3% 0% 2%
PSP 5% 9% 5% 1% 0% 2% 17% 5%
PlayStation 2 37% 46% 19% 55% 0% 42% 37% 33%
Xbox 19% 16% 22% 35% 0% 14% 24% 23%
GameCube 7% 5% 0% 4% 38% 7% 1% 4%
Xbox 360 6% 3% 0% 0% 0% 0% 3% 2%
Total 100% 100% 100% 100% 100% 100% 100% 100%

GBA 5% 2% 33% 6% 18% 14% 2% 6%
DS 5% 3% 26% 6% 54% 11% 0% 6%
PSP 4% 10% 3% 9% 0% 7% 16% 8%
PlayStation 2 42% 36% 20% 47% 0% 31% 32% 16%
Xbox 6% 8% 18% 10% 0% 3% 6% 3%
GameCube 3% 3% 0% 7% 21% 5% 0% 1%
Xbox 360 20% 17% 0% 2% 0% 15% 25% 31%
PS3 3% 2% 0% 0% 0% 0% 1% 0%
W ii 3% 1% 0% 7% 7% 2% 0% 11%
Total 100% 100% 100% 100% 100% 100% 100% 100%

GBA 1% 0% 6% 1% 6% 5% 0% 2%
DS 6% 8% 57% 8% 42% 20% 2% 23%
PSP 4% 8% 2% 2% 0% 8% 8% 5%
PlayStation 2 32% 24% 9% 8% 0% 26% 24% 8%
Xbox 0% 1% 2% 1% 0% 0% 1% 0%
GameCube 0% 0% 0% 1% 4% 1% 0% 0%
Xbox 360 30% 19% 1% 30% 0% 14% 33% 24%
PS3 11% 13% 0% 18% 0% 7% 10% 17%
W ii 10% 10% 22% 10% 48% 7% 9% 12%
Total 100% 100% 100% 100% 100% 100% 100% 100%

GBA 0% 0% 0% 0% 1% 1% 0% 0%
DS 9% 8% 62% 7% 25% 24% 4% 30%
PSP 1% 6% 1% 1% 0% 7% 6% 2%
PlayStation 2 15% 10% 1% 6% 0% 14% 9% 2%
Xbox 0% 0% 0% 0% 0% 0% 0% 0%
GameCube 0% 0% 0% 0% 0% 0% 0% 0%
Xbox 360 19% 24% 0% 31% 0% 14% 35% 23%
PS3 12% 23% 0% 29% 0% 13% 31% 22%
W ii 20% 13% 35% 25% 74% 18% 10% 14%
Total 100% 100% 100% 100% 100% 100% 100% 100%
Year for COOL & TTWO = Nov-Oct; ex. CY2005 and CY2006 Year for TTWO = Feb-Jan

DEVELOPMENT ASSETS
Publishers create games using either full-time employee developers or by
hiring an external developer. The number of internal development personnel can
greatly impact a publisher’s cost structure. Maintaining a large internal development
team raises the publisher’s fixed overhead costs, but gives the publisher the
opportunity to increase operating margin should sales exceed forecasts. Utilizing
external developers typically shifts some of the commercial product risk to the
developer as developers frequently trade some near-term compensation for royalty
payments on highly successful titles.
There is no rule for the appropriate mix of internal and external development. Most
publishers approach development opportunistically, hiring those developers who are
truly exceptional (“own the best and hire the rest”). Highly talented developers are
rare and can mean the difference between good games and great games; publishers
have tended to move quickly to hire truly talented developers. However, we believe
that development has become more of a commodity than ever before, and we do not
endorse internal development capability if the reason for an acquisition is to give the
publisher greater control. Several publishers have shown that external developers
can be used effectively to produce excellent games on schedule without adding
these costs to their income statement and increasing operating leverage. Good
examples of top-notch development talent, wisely acquired by publishers include
Electronic Arts’ purchase of Maxis (SimCity and The Sims), Activision’s purchase of
Neversoft Entertainment (Tony Hawk’s Pro Skater) and Infinity Ward (Call of Duty
and Modern Warfare), Take-Two’s purchase of Angel Studios (Midnight Club), Visual
Concepts (2K Sports games), Irrational (Bioshock) and Firaxis (Civilization), and
THQ’s purchase of Volition (Saint’s Row and Red Faction).
Several publishers have fallen on hard times over the last few years, largely
due to their cost structure growing faster than their revenue base. At Electronic
Arts and THQ, one of the biggest factors depressing earnings was the decision to
bring development in-house, and both companies completed restructurings earlier
this year involving the closure of studios and layoffs of development personnel.
One trade-off that should be considered when determining the benefit of a shift
in favor of internal development is the likelihood of “groupthink”. We believe
that internal studios are often more creatively constrained than are external studios,
due to a combination of corporate hierarchy, comparisons to past internally
developed products, and constant scrutiny by management. Additionally, over
dependence upon internal personnel can serve to limit the flow of “new” ideas, solely
by virtue of limiting the potential number of creative people consulted. We believe
that over the past year, declining game quality at several U.S. and European
publishers is attributable to over dependence upon internal creative talent.
Six years ago, we noted that the companies with the highest percentage of internal
development personnel and highest operating leverage were 3DO and Midway
Games. 3DO declared bankruptcy in 2003, and Midway declared bankruptcy earlier
this year. Another highly leveraged publisher, Acclaim (with over 60% internal
development talent), declared bankruptcy in 2004. Still another, Eidos, was acquired
for a fire sale price earlier this year. As noted above, THQ and Electronic Arts fell on
hard times, largely due to overhead that was growing faster than revenues. We
estimate that Take-Two and Activision each have approximately 75% of development
performed in house. Both companies have acquired external studios in the past two

years, and appear to be moving even more development in house over the next few
years.
DEVELOPMENT SYNERGIES
One of the foreseen consequences of current generation console launches
was the dramatic increase in the cost of game development. Each of the last
three console transitions involved significant advances in hardware technology, with
correspondingly significant advances in the quality of software produced for the new
consoles. We think that the success of past console cycle transitions was determined
more by advances in software development than by advances in hardware
technology. The terms 8-bit, 16-bit, etc., refer to the amount of information processed
by the console during each microprocessor cycle. The total amount of information
processed is therefore a function of both the “bits” and the “cycles”. When
microprocessors routinely doubled in power every 18 months during the 1980s and
1990s, the amount of information that could be processed in a finite period of time
also routinely doubled. When Sony replaced its PSOne (which processed 32 bits of
information per cycle at 33 megahertz cycle speed) with the PS2 (which processed
128 bits of information per cycle at 295 MHz), it increased the amount of information
seen each second by almost 40 fold. This allowed for significant improvements in
graphic design, with more fluid motion capture and a greater number of characters
on screen performing more detailed maneuvers. To the extent that software
developers were able to take advantage of this processing speed, games were
longer, more complex, more visually stunning, and generally more interesting.
Unfortunately, providing greater information carries a greater cost, both in
terms of time and money. The average PSOne game took a team of 10 – 12
developers approximately nine months to complete. If we assume fixed costs of
$100,000 per game plus variable costs of $100,000 per year per developer (including
office expense, systems support, taxes, benefits, etc.), the typical PSOne game cost
publishers approximately $900,000 to produce. The average PS2 game took a team
of 15 – 24 developers approximately 20 months to complete. If we assume no
changes to fixed or variable costs, it’s easy to understand the estimated average cost
of $3 – 4 million per PS2 game.
The Xbox 360 and the PS3 CPUs are 4 – 10x faster than those in their
predecessors, with RAM that is 8 – 16x greater than legacy console memory. This
means that current generation software has the potential to carry around 60 times
the amount of information contained in legacy software. Middleware and
development tools can significantly reduce the cost of creating games containing this
exponential increase in information, but we estimate that at least a two- to four-fold
increase in manpower or time is required to complete a current generation game.
Current generation games frequently require the efforts of 50 – 70 person
development teams, and cost between $10 – 15 million to produce. Increasingly,
substantial investments in common development tools and processes allow for
“learning curve” benefits, with subsequent games using the same game engine as a
predecessor costing as much as 20% less to produce. The average current
generation console game takes at least two full years to complete (with some efforts
taking three to four years), compared with the average 20-month completion time for
legacy generation games.
As we pointed out in our industry report five years ago (The Definition of Insanity),
most of the large publishers lamented overspending on PS2, Xbox, and GameCube
software development and abandoning the large PSOne installed base too early

when the last cycle launched. In the first three quarters of calendar 2000, Electronic
Arts had a net loss of $73 million, while Activision and THQ eked out profits of $7
million and $5 million, respectively. The latter two companies capitalize software
development, while EA expenses its development; on an apples-to-apples basis, all
three companies lost a significant amount in the months leading up to the last
console launch. Profits suffered in 2006 – 2008, as the publishers who made bets on
the Xbox 360 and PS3 (EA, THQ, and to some extent, Take-Two) had rocky results,
while the publishers with an emphasis on the Wii (Activision with its Guitar Hero
brand and Ubisoft with its Imagine and Petz brands) thrived.
The greatest potential synergy is likely to come from porting games from one
console to another. At present, games can be ported from the Xbox 360 to the PS3
at a relatively low cost, perhaps $3 million. Should Nintendo launch the Wii Plus
(HD) over the next few years, we will expect to see games ported from the Xbox 360
to the other two consoles, driving average development costs lower. Should porting
synergies materialize, we expect SKU counts to increase, and selection to broaden,
driving current generation hardware adoption rates higher.
THIRD-PARTY DISTRIBUTION
Every major publisher owns distribution assets sufficient to place the majority of its
products on U.S. store shelves. We estimate that Nintendo and the U.S. and
European publishers distribute between 90% and 95% of their published software
using their own internal resources. Many of these publishers also own international
distribution assets, particularly in Europe, that are used to place their own software
products with retailers. Some publishers also pursue a strategy of using these
internally owned distribution assets to distribute product for other publishers. Some
publishers such as Activision and Electronic Arts acquired their international
distribution assets primarily to distribute their own products, but now also distribute
some third-party software. In the case of Activision and Take-Two, some publishers
also distribute hardware.
Third-party distribution is a low-margin, low-risk line of business that we expect to
decline during the current console cycle. The amount of software distributed by
publishers using internal resources grew significantly over the past two console
cycles as publishers expanded their operations to capture this link in the software
value chain. We expect this trend to continue and to limit the growth rate for third-
party distribution businesses in the future. However, as a greater number of games
appear on retail shelves, particularly with the large boxes for the music themed
games and several new peripheral bundles, we believe that distribution assets could
provide some margin expansion as underrepresented independent publishers seek
distribution for their products.
We believe that publishers should only pursue third-party distribution revenues when
they maintain some form of competitive advantage or unique market position.
Distribution is highly competitive, and with low margins and low growth rates, we
believe that publishers should place a priority on growing publishing assets. We
believe that most U.S. and European publishers have shed their marginal distribution
assets and now only own value-added or strategic distribution assets, though we
continue to believe that Take-Two’s U.S. distribution business is non-strategic.
GEOGRAPHIC DISPERSION OF REVENUES
As we noted earlier in our discussion of geographic markets, we believe that the
addressable market for U.S. and European publishers includes the North American

and European markets. The Japanese and other Asian markets are very difficult for
U.S. companies to penetrate because of differences in consumer preferences and
challenging distribution and retail networks. Going forward, we expect some further
penetration of Asian online markets by U.S. and European publishers, though (with
the exception of Activision Blizzard), we do not expect significant penetration over
the next two years. EA intends to penetrate Asian markets with its free-to-play
games, but we think that the company will likely generate only modest revenues over
the near term.
We believe that approximately 70 – 85% of all U.S. software has the same appeal to
European consumers as to U.S. consumers. Some products, such as U.S.-based
sports games (e.g., football and baseball) and games based on U.S.-specific pop
culture or media trends (e.g., children’s cartoons and some music themed games),
simply do not carry the same appeal with European consumers. Other products,
such as soccer games or racing games, generally perform better in Europe than in
the U.S. We estimate that U.S. publishers with established distribution channels in
Europe should expect to earn 45 – 50% of total revenues from this region by 2011.
While some U.S. publishers have already achieved this level of international reach,
we note that several U.S. publishers still have ample room to grow in this area.
Figure 53 illustrates domestic versus international revenues for U.S. and European
publishers in our coverage universe.
Figure 53—Domestic vs. International Revenues
2007 2008
North North
America International America International
Activision Blizzard 58% 42% 54% 46%
Electronic Arts 51% 49% 58% 42%
Majesco Entertainment 86% 14% 91% 9%
Midway Games 62% 38% 65% 35%
Nintendo 31% 69% 39% 61%
Take-Two Interactive Software 75% 25% 65% 35%
THQ 50% 50% 52% 48%
Ubisoft Entertainment 41% 59% 39% 61%

ONLINE STRATEGIES
When it merged with VU Games, Activision jumped past the rest of the publicly
traded publishers to become the most successful online game publisher. There are
many Chinese companies involved with online gaming, and many are enjoying great
success, but among the packaged goods video game publishers, only Activision
Blizzard has managed to generate significant profits from its online endeavors.
Electronic Arts is perhaps the next farthest along among U.S. and European
publishers in adopting an online gaming strategy with its several online efforts
(Warhammer Online, pogo.com, a Star Wars MMO, and several free-to-play games

in development), but the company has experienced significant growing pains. EA has
had mixed results in the past, developing several online games aimed at a massively
multiplayer audience with its Ultima Online and Sims Online games, but neither ever
achieved the level of success most expected. To date, Electronic Arts has not been
profitable in online gaming, as the size of its audience has been smaller than
generally expected. As we discussed in our industry report six years ago (see Myth
#8—Online Gaming is the Next Great Thing), we believed that this market would take
several years to develop and mature. So far, the other major U.S. and European
publishers have been modest in their approaches to online gaming, with most
incorporating multiplayer features into PC and console games. Among Western
publishers, only Activision Blizzard has managed to generate immense success with
its World of Warcraft.
All of the large U.S. and European publishers are looking for ways to add revenue
streams through in-game advertising and microtransactions. For several years,
Activision led the charge in developing a rate card for in-game ads, but since its
merger with VU Games, we have not heard much about the in-game advertising
opportunity. Electronic Arts has been working hard to deliver microtransactions to
customers with its free-to-play games, but we remain skeptical that its choice of
Western content (FIFA Online, NBA Street and Battlefield Heroes) will resonate with
Asian audiences. The other Western publishers appear to have adopted a “wait and
see” approach, and we expect that many will selectively exploit whatever
opportunities arise in the future.
INTELLECTUAL PROPERTY STRATEGIES

Content source is a key driver in determining the margin on video game software
sales. A game’s content can be based upon an original concept (or sequel to an
original concept), or may be based upon a concept owned by a third party. In most
cases, third party intellectual property (“IP”) will have value only if the IP has been
developed and used in another medium, such as film, television, comic books, toys
or literary works. Games also may be based on “real-life” content, such as sports
leagues or prominent celebrities.
A typical video game is burdened by both fixed and variable costs. On the fixed side,
costs usually consist solely of development costs for the game (typically $10 million
or more for a PC game, $10 – 20 million for current generation console games, and
$300,000 to $1 million for a handheld game). Variable costs include the
manufacturer’s royalty (typically 20 – 25% of gross sales for console and handheld
games, zero for PC games), manufacturing costs ($1 – 2 per unit), distribution costs
(zero to 15% for large publishers), royalties for licensed content (5 – 20% of gross
sales, depending upon the license), royalties paid to third-party developers (typically
20 – 30% offset by any advance for R&D), and vendor allowances and other
marketing support (zero to 10% of gross sales). The highest margin game in a
perfect world is a PC sequel based upon original content that is internally developed,
requires no license fee, and requires little marketing support. In such a case, the
gross margin could approach 90%. We believe that Electronic Arts’ The Sims games
generate gross margins that approach 90%. The lowest margin game will be
externally developed, based upon licensed content, and published on a console, with
margins below 30%. We believe that most EA Partners games (including Rock
Band) provide examples of low-margin games, primarily due to the revenue sharing
arrangement with the third party developer.

It follows then, that when content is original, margins can be quite high, because the
games produced require no royalty payments. However, the risk associated with
original content is quite high, as publishers are burdened with the expense of brand
building. Although the margins generated from original properties can cushion some
of the brand-building burden, publishers have tended to take the more conservative
route over the past few years, and have increased reliance upon proven brands,
especially as the “mass market” phase of the console cycle emerges. Of the 30 top-
selling games in 2008, eight were licensed and 21 were sequels (only Wii Fit was a
new intellectual property), and we expect similar figures in 2009. Notably, high
profile new intellectual properties such as Dead Space, Mirror’s Edge, Shaun White,
Left 4 Dead, Spore and Wii Music failed to break through, with some likely to be
abandoned. The following paragraphs detail the intellectual property strategies of
the eight publishers we cover.
Activision Blizzard
Activision Blizzard’s major licensed properties include Marvel properties (Spider-
Man, X-Men, Marvel Ultimate Alliance), DreamWorks properties (Madagascar,
Shrek, Shark Tale, Over the Hedge, Bee Movie, Kung Fu Panda and Monsters vs.
Aliens), and several one-off licenses, including Tony Hawk, Doom, Wolfenstein,
World Series of Poker, Lemony Snickets, and Cabela’s. Over the last decade, the
company’s publishing sales mix has fluctuated between 50% and 80% derived from
licensed content, but in 2002, the company began to focus on increasing the
percentage generated from owned IP, and it developed three new brands: True
Crime, Call of Duty and Gun. Only one of these brands was a huge success, but the
company re-focused in late 2005, when Call of Duty sold quite well, and True Crime
and Gun were disappointments. Activision cut its losses with the two disappointing
brands, and cemented its future in 2006 by purchasing the Guitar Hero brand. Its
merger with VU Games cemented Activision’s diversification into owned IP, when it
gained control of the Blizzard stable of franchises, including Warcraft, Starcraft,
Diablo and World of Warcraft. The company derives over two thirds of its revenues
from owned IP, and we expect this percentage to grow in the future.
Activision’s licenses are relatively long term, with its license for Spider-Man locked up
through 2017, and its license for Shrek subject to a renewal option. It has Tony
Hawk under long-term license to lend his name to video games for another five
years. While Activision does not disclose the terms of its licensing arrangements, we
believe that its Spider-Man license carries a royalty rate of 12 – 15%, its Shrek
license a rate of 15%, and most of its other licenses below a 10% rate. Its Doom
license is rumored to carry a higher rate, but given that Doom IP owner id Software is
also the developer of the content, we believe that Activision is able to earn at least a
40% gross margin on the PC game, and earn above a 30% margin on the console
version. Because of the balance between licensed and owned IP, Activision is able
to generate overall publishing gross margins in excess of 60%. We do not believe
that any of Activision’s licenses represent more than 5% of total revenues.
Electronic Arts
Electronic Arts is heavily dependent upon licensed content (with approximately 60%
of revenues derived from third party IP), but much of its licensed content is
differentiated through superior game development and marketing. Its sports
franchises are all included as licensed content, and the company generally can be
counted on to capture 60% or more in market share within each genre. Its licenses
with the NFL, NBA and other sports leagues are likely to be renewable indefinitely,

and we see little risk to the company’s sports licenses overall. Because of its size
and superior execution, Electronic Arts typically is granted a “first look” from IP
owners, and in the past, it successfully exploited both the Harry Potter and Lord of
the Rings licenses. While the company does not disclose the terms of its licensing
arrangements, we believe that it pays royalties at an average rate of approximately
12%, with a range of between 5 – 20%. The higher end properties likely command
royalties at the full 20% rate, while sports licenses on average probably command
lower overall royalties. We note that in 2004, the company signed exclusive licenses
with the NFL and its players, rumored to be significantly higher than its licenses in
the past (we estimate an annual guarantee of $35 million). However, due to the
exclusive terms of its license, we believe that the company will be able to generate
profits over time.
Because of its ability to scale R&D expense due to the large number of units sold per
game, we believe that Electronic Arts is able to generate margins in excess of 55%
on most of its licensed content. EA has relinquished licenses for the James Bond (to
Activision) and Lord of the Rings franchises over the last two years, but we do not
believe that Electronic Arts is at risk to lose any meaningful licenses over the next
few years. Given the shift by its competitors to owned intellectual property, we
believe that EA is well positioned to win any licenses it chooses. We do not believe
that any of Electronic Arts’ licenses represent more than 10% of total revenues.
The company also has several high profile brands that are wholly owned. Among
these are The Sims, Burnout, Dead Space, Need for Speed, Medal of Honor, Army
of Two, Spore, Mass Effect, Dragon Age, Mercenaries and The Saboteur. Each of
these brands is likely to provide significant sequel potential over the next five years.
Majesco Entertainment
Majesco has a relatively brief history as a publisher, with only a handful of games
published to date, generally with disappointing results. Its first few games were
based upon original content (BloodRayne, Psychonauts, and Advent Rising) and it
released several more based upon third party IP (Jaws, Aeon Flux, and Taxi Driver).
Because of disappointing sales of its first few releases, it cancelled its other new
games, and decided to focus the company’s efforts on more modest budget and
value titles. Its Game Boy Advance Video products (since discontinued) were all
licensed, and its gadget business (also discontinued) was substantially dependent
upon third party licenses, and both delivered results substantially below expectations.
We believe that the company does not intend to grow its internal development
capability, and we do not expect it to develop original IP over the next several years.
Instead, Majesco is focused on gaining rights to DS and Wii titles that have been
overlooked by its larger competitors. It has had tremendous success with this
strategy, and has established two brands, Cooking Mama and Jillian Michaels
Fitness Ultimatum in just over two years, with more likely on the horizon.
Midway Games
Midway recently declared bankruptcy, we think it is an interesting case study on what
can go wrong in terms of focus. Over the past decade, the company had been intent
upon exploiting its deep stable of arcade IP, with its big sellers during the last cycle
consisting of Mortal Kombat, Spy Hunter, and Gauntlet. We estimate that less than
30% of Midway revenues come from third party IP, but note that it licensed the
publishing rights to Unreal Tournament in 2006. It enjoyed success with licensed
property NBA Ballers, a “street” version of NBA basketball with the unique twist of
gambling with the NBA star to win his prized possessions. It also released the highly

successful Blitz: The League, a story-driven football game with no professional
sports license. Due to its reliance on owned IP, Midway positioned itself to generate
healthy gross margins of 60% or more on most of its games, but the company could
not generate sufficient sales to cover its sizeable overhead, and it generated losses
year after year.
Nintendo
Nintendo is laser focused on developing owned intellectual property, and 100% of its
first party publishing revenues are derived from owned IP. The company is different
from the other publishers we cover insofar as it is also a hardware manufacturer, and
its software strategy is intended to provide differentiated content that will support its
proprietary hardware. Thus, Nintendo first party games are available only on its DS
and Wii consoles, providing an incentive to consumers to purchase those platforms
instead of competitive platforms offered by Sony and Microsoft.
Take-Two Interactive
Take-Two’s content, until 2006, consisted almost exclusively of owned IP. In 2005,
the company purchased a development studio from Sega, allowing it to produce and
publish branded sports games. The company has a fledgling sports business, with
its NBA game performing very well, its hockey game likely breaking even, and its
baseball games likely losing money. The baseball losses are the result of an
onerous contract with Major League Baseball (through 2012) that all but ensures that
Take-Two cannot generate a profit from these games. We expect licensed products
to make around 30% of publishing revenues in FY:09. Take-Two owns the rights to
the Civilization franchise, and owns Firaxis, its developer. The company also
acquired Irrational Software, and obtained the rights to the highly successful
BioShock. Because of the incredible margins earned on its flagship Grand Theft
Auto franchise, we expect Take-Two to generate publishing gross margins of around
55 – 60% over the next three fiscal years, but think that the company’s relatively high
fixed cost structure and its baseball license guarantee could limit its profitability. We
do not expect any of Take-Two’s licensed properties to represent more than 15% of
total revenues over the next few years.
THQ
THQ has historically been somewhat more dependent upon licensed content than its
competitors. Part of this dependence was intentional; the company has grown the
video game market for products based upon the WWE license and has successfully
exploited the Nickelodeon license (SpongeBob, Jimmy Neutron, Rugrats, Rocket
Power, Fairly OddParents, Danny Phantom, everGirl, The Wild Thornberrys and
Avatar) over the last five years. THQ has also executed well in building a market for
Nickelodeon property Tak and the Power of JuJu under an innovative “game first”
arrangement wherein the company produced the Tak game five years prior to the
debut of the Nickelodeon cartoon show. The company has had even greater success
with its Disney/Pixar license, producing multi-million unit sellers including Finding
Nemo, The Incredibles, Cars, Ratatouille, WALL-E and Up. Other licenses include
Polar Express, Monster House, Barnyard, Bratz, Scooby Doo, and The Punisher.
We estimate that THQ incurs royalties on its licensed content ranging from 5 – 20%,
with its Nickelodeon and Disney/Pixar licenses likely at the high end of the range.
Because of the large number of units sold under these licenses, we estimate that
THQ generated gross margins in excess of 60% on most of its licensed properties.
The Nickelodeon master license (essentially all properties other than Tak) runs
through 2010, and the company’s license with Pixar covers one additional property,

expected in 2011. Its WWE license was also renewed in 2004 for several more
years, although the license is the subject of litigation (we expect the litigation to be
resolved amicably, with a likely increase in the royalty rate, but a renewal of the
overall license). We estimate that the combined Nickelodeon licenses represent
approximately 15% of total revenues. We estimate that the Disney/Pixar license will
account for approximately 18% of revenues this year. We estimate that the WWE
license represented approximately 20% of revenues last year, and expect it to
represent approximately 20% of revenues going forward. The company’s newest
license, based on the Ultimate Fighting Championship league, is off to a spectacular
start, and could represent as much as 15% of revenues this year. We do not expect
any of THQ’s other licensed properties to represent more than 10% of total revenues
over the next few years.
The company has had generally poor results from its efforts to develop owned IP,
with properties Juiced, Full Spectrum Warrior and Destroy All Humans each having
disappointing sequels. It also had fair to poor results with The Outfit, Company of
Heroes, Stuntman, Frontlines Fuel of War and S.T.A.L.K.E.R., with at least two of
these brands likely to be abandoned. Its Saint’s Row brand has fared better than the
others, with solid sales of the original and a sequel, and the company revived its Red
Faction brand this year, with generally positive reviews. In order to succeed going
forward, we expect the company to focus on one or two new brands each year, and
its recent restructuring supports this level of activity.
Ubisoft
Ubisoft has an impressive lineup of owned IP, having purchased the licenses for the
Tom Clancy series of games. The company produces five Tom Clancy games
(Splinter Cell, Rainbow 6, Ghost Recon, EndWar and H.A.W.X) and likely plans
further brand extensions. In addition, Ubisoft owns the Rayman, Driver, Far Cry,
Petz and Imagine properties, and has rights to Prince of Persia, Brothers in Arms,
Teenage Mutant Ninja Turtles, Open Season, Surf’s Up and Star Trek games. This
generation, Ubisoft had phenomenal success with wholly-owned Assassin’s Creed,
and it is preparing a sequel to its Wii brand, Red Steel. Every few years, Ubisoft
releases a large scale game based upon a licensed property, with King Kong in 2005
and Avatar expected later this year.
Ubisoft’s strategy is to develop and control an ever increasing mix of owned IP, with
a smattering of licensed content to enable it to broaden its exposure to the Wii and
DS platforms. It’s overall blended license rate is probably less than 5% of sales,
giving the company the greatest operating leverage in the industry, should it be able
to successfully grow revenues over the next three years.

CONTENT COMPARISON
The most successful publishers in the past have been those who built diverse
libraries of branded games, producing sequels and recurring revenue streams.
With steady, sequel-driven revenues, publishers have better visibility into their future
performance, leading to better planning and investment. Less volatile revenue and
earnings models have tended to engender more confidence from Wall Street and
higher public valuations. In this section, we identify the most lucrative entertainment
software brands and the publishers profiting from them.
For purposes of the following discussion, we examine U.S. retail sell-through figures
provided by the NPD Group. We compare the reported sell-through figures for each
brand to reported overall U.S. retail sell-through for each publisher, in order to
extrapolate the contribution of each brand to the publisher’s overall success.
Although NPD reports sell through (i.e., sales to consumers) rather than sell in (i.e.,
wholesale sales) and reports on a retail dollar basis rather than actual amounts
realized by the publishers, we believe that this “apples to apples” comparison is
useful in determining publisher dependence on individual brands.
BRAND BUILDING
The publishers with the greatest success in creating and nurturing high-quality
branded entertainment software are Nintendo, Activision and Electronic Arts.
Nintendo is unquestionably the most successful creator of entertainment software
over the past 20 years and captured the number one position in U.S. sales among
software publishers each year until 2001. Many of the brands that Nintendo
introduced in the 1980s and early 1990s for the NES and SNES consoles are still
dominant brands today such as Mario, Zelda, and Donkey Kong. Similarly, Electronic
Arts has built a portfolio of recurring revenue streams by growing its library of
established brands. Electronic Arts now dominates the sports genre and its hit
football, soccer, basketball, and golf games (among many others) are best sellers
year after year. Electronic Arts also has expanded beyond the sports game genre
and built successful brands in many other genres, including the real-time-strategy
genre (Command & Conquer and Battlefield), strategy/RPG genre (The Sims),
extreme sports (Skate), kiddie (Harry Potter) and the driving genre (Burnout and
Need For Speed). Activision’s results are far more concentrated, with its top two
brands (Guitar Hero and Call of Duty) responsible for over 70% of its domestic sales.
According to NPD, in 2008, Electronic Arts captured the highest market share for
entertainment software sales in the U.S., with its 20.3% market share slightly ahead
of second place Activision’s 16.7% share, with Nintendo in third place with 16.6%
market share.
TOP BRANDS OF 2008
A look at the top-selling brands of 2008 (Figure 54) provides a proxy for which
publishers currently own mega-hit content. We note that Electronic Arts published
eight of the top 30 brands, with four from Nintendo, three each from Activision and
Ubisoft, two each from LucasArts, Microsoft and Konami, and one apiece from six
other publishers. Most strikingly, Sony had no top 30 brands for the third year in a
row.

Figure 54—Top Interactive Entertainment Software Brands (U.S. $ Sales 2006 – 2008)
Rank Sales ($ mil)

2008 2007 2006 Brand Primary Publisher 2008 2007 2006
1 1 8 Guitar Hero Activision Blizzard $ 992 $ 821 $ 154

2 2 2 Mario Brothers Nintendo $ 761 $ 472 $ 257
3 8 - Rock Band Electronic Arts $ 662 $ 181 $ -
4 5 5 Call Of Duty Activision Blizzard $ 446 $ 316 $ 169
5 - - Wii Fit Nintendo $ 407 - -
6 - 14 Grand Theft Auto Take-Two Interactive $ 361 $ 54 $ 94
7 4 1 Madden Football Electronic Arts $ 312 $ 321 $ 339
8 7 - Wii Play Nintendo $ 261 $ 204 -
9 - - LEGO LucasArts $ 224 - -
10 11 3 Star Wars LucasArts $ 180 $ 142 $ 227
11 27 25 Sonic Sega $ 163 $ 63 $ 64
12 - 16 Gears Of War Microsoft $ 146 $ 50 $ 92
13 9 7 The Sims Electronic Arts $ 143 $ 178 $ 158
14 13 6 Tom Clancy Ubisoft $ 130 $ 132 $ 165
15 6 9 Pokemon Nintendo $ 119 $ 237 $ 114
16 12 4 Need For Speed Electronic Arts $ 106 $ 132 $ 173
17 14 - Warcraft Activision Blizzard $ 104 $ 120 $ 32
18 15 13 WWE THQ $ 103 $ 114 $ 94
19 - - Fallout Bethesda Softworks $ 100 - -
20 19 11 NCAA Football Electronic Arts $ 94 $ 90 $ 110
21 18 22 Tiger Woods Electronic Arts $ 89 $ 91 $ 67
22 20 12 FIFA Electronic Arts $ 79 $ 76 $ 102
23 - - Imagine Ubisoft $ 78 $ 19 -
24 - 10 Final Fantasy Square Enix $ 78 $ 56 $ 113
25 21 23 Dance Dance Revolution Konami $ 78 $ 75 $ 66
26 - - Metal Gear Solid Konami $ 77 $ 7 $ 18
27 - - Fable Microsoft $ 77 $ 4 $ 12
28 26 20 NBA Live Electronic Arts $ 71 $ 65 $ 83
29 - - Mortal Kombat Midway Games $ 70 $ 21 $ 36
30 28 - Petz Ubisoft $ 70 $ 60 $ 33
Top 30 Brands as a % of Total U.S. Retail Sales 56% 43% 46%
TOP BRANDS BY COMPANY

The table in Figure 55 lists the top 10 brands for each publisher (U.S. sales) and the
percentage of total company sales that these ten brands generated for their
publishers and illustrates the depth of each publisher’s portfolio of “hit brands” and
dependence on these brands. We believe that brand depth is one the most important
indicators of a publisher’s future prospects. Strong software brands provide a
publisher with sequel titles for several years and a deep library of brands provides a
steady base of recurring revenues. We note that all but two of the top 30 brands is an
established brand with a history of producing successful titles prior to 2008. These
mega-hit brands are the result of growing and developing successful brands over

several years. Possessing a deep library of solid brands is the first step to producing
one of these mega-hit brands in the future.
Figure 55—Publisher Top Brands (U.S. $ Sales 2008)
CY 2008 ACTIVISION CY 2008 ELECTRONIC ARTS

Amount Amount
Rank Brand ($ mil) Rank Brand ($ mil)
1 Guitar Hero $ 992 1 Rock Band $ 662
2 Call Of Duty $ 446 2 Madden Football $ 312
3 Warcraft $ 104 3 The Sims $ 143
4 Spider-Man $ 42 4 Need For Speed $ 106
5 Cabela's $ 32 5 NCAA Football $ 94
6 Kung Fu Panda $ 32 6 Tiger Woods $ 89
7 James Bond $ 25 7 FIFA $ 79
8 Transformers $ 23 8 NBA Live $ 71
9 Crash Bandicoot $ 20 9 Left 4 Dead $ 67
10 Tony Hawk $ 17 10 Battlefield $ 57
Total Top 10 Brands $ 1,734 Total Top 10 Brands $ 1,680
%* 89% %* 71%
CY 2008 MAJESCO CY 2008 MIDWAY CY 2008 NINTENDO
Amount Amount Amount
Rank Brand ($ mil) Rank Brand ($ mil) Rank Brand ($ mil)
1 Cooking Mama $ 45 1 Mortal Kombat $ 70 1 Mario Brothers $ 761
2 Jillian Michaels $ 13 2 Game Party $ 30 2 Wii Fit $ 407
3 Cake Mania $ 3 3 Unreal $ 17 3 Wii Play $ 261
4 Left Brain Right Brain $ 3 4 TNA IMPACT! $ 9 4 Pokemon $ 119
5 Wonder World Amusement Park $ 2 5 Touchmaster $ 6 5 Zelda $ 67
6 Wild Earth $ 2 6 Blitz: The League $ 5 6 Animal Crossing $ 54
7 Furu Furu Park $ 2 7 NBA Ballers $ 4 7 Nintendogs $ 44
8 Nancy Drew $ 1 8 Blacksite: Area 51 $ 3 8 Wii Music $ 42
9 Jaws $ 1 9 Stranglehold $ 2 9 Brain Age $ 39
10 Pet Pals $ 1 10 Cruis'n $ 1 10 Kirby $ 26
Total Top 10 Brands $ 72 Total Top 10 Brands $ 147 Total Top 10 Brands $ 1,820
%* 88% %* 94% %* 94%

CY 2008 TAKE-TWO CY 2008 THQ CY 2008 UBISOFT
Amount Amount Amount
Rank Brand ($ mil) Rank Brand ($ mil) Rank Brand ($ mil)
1 Grand Theft Auto $ 361 1 WWE $ 103 1 Tom Clancy $ 130
2 NBA 2K $ 60 2 Saints Row $ 40 2 Imagine $ 78
3 Carnival Games $ 54 3 MX Vs ATV $ 33 3 Petz $ 70
4 MLB 2K $ 49 4 Wall-E $ 25 4 Shaun White Snowboarding $ 49
5 Midnight Club $ 49 5 SpongeBob SquarePants $ 25 5 Assassin's Creed $ 41
6 Civilization $ 37 6 Cars $ 20 6 Rayman $ 40
7 Bully $ 17 7 Frontlines: Fuel of War $ 17 7 Prince Of Persia $ 33
8 Elder Scrolls $ 14 8 Drawn To Life $ 17 8 Far Cry $ 25
9 NHL 2K $ 12 9 Paws & Claws Pet $ 14 9 Brothers In Arms $ 21
10 Top Spin $ 9 10 de Blob $ 11 10 My Coach $ 18
Total Top 10 Brands $ 662 Total Top 10 Brands $ 305 Total Top 10 Brands $ 505
%* 90% %* 69% %* 80%

*% of total company U.S. sell-through attributable to top ten brands
*% of total company U.S. sell-through attributable to top ten brands

As Figure 55 illustrates, Nintendo, Electronic Arts and Activision were the only
publishers with more than one brand that generated over $100 million in U.S.
retail sales during 2008. We chose a $100 million threshold because we believe
that this figure reflects potential lifetime sales of more than three million units,
indicating a bona fide “home run”. All of Electronic Arts’ top-10 brands generated

more than $57 million in 2008, demonstrating the company’s exceptional brand
library. Nintendo had ten brands generate more than $20 million apiece, with
Activision (nine), and Ubisoft (nine) right behind. Take-Two and THQ each had six
brands over the $20 million threshold, with Midway (two) and Majesco (one) rounding
out the rest. The $20 million level of U.S. retail sales, in our view, is a good proxy for
a worldwide million unit seller, reflecting a bona fide “hit” franchise that contributes
significantly to each company’s bottom line results.
Figure 55 also provides insight into the U.S. revenue concentration of the publishers.
We note that the two most diversified large publishers, EA and THQ, derived 71%
and 69% of 2008 U.S. sales, respectively, from their top 10 brands and only 28% and
23% from their top single brand, respectively. As much as this sounds balanced, we
note that both EA and THQ had miserable financial performance in 2008, with each
generating significant operating losses. The least diversified companies last year
were Activision and Nintendo, who not so coincidentally had the best financial
performance. Thus, diversification may not always be a good sign, particularly if the
average game in a company’s portfolio is unprofitable.
Over the past five years, we have seen a concerted effort from the U.S. and
European publishers to emulate Electronic Arts, recognizing that increased brand
diversification mitigates risk as we enter the console transition. Take-Two has added
a full line of sports titles to its portfolio, and has created or acquired several solid
intellectual properties in an effort to diversify away from its dependence upon the
Grand Theft Auto brand. We expect THQ to continue its diversification selectively,
and believe that Activision continue its strategy of annually introducing one new
wholly owned intellectual property (this year’s Blur) in order to grow margins late in
the current console cycle.

ACCOUNTING ISSUES
CAPITALIZED SOFTWARE DEVELOPMENT AND PREPAID
ROYALTIES
Under GAAP, companies are required to capitalize amounts paid for intellectual
property that relate to future periods. “Payments” consist of advances paid to third
parties for licenses, progress payments to third party developers, and amounts paid
as salaries and occupancy for internal developers prior to the release of the game
that is being developed. Because some licensing and development arrangements
represent efforts that may extend over several years, video game publishers are
required to capitalize amounts paid in one period when the underlying game is
expected to be delivered in a later period. There is little flexibility under the
accounting rules regarding the amounts to be capitalized, once a decision is made
that the game being developed is “feasible”. However, great flexibility is offered to
companies in determining the rate at which capitalized license and royalty fees are
amortized. In general, these amounts are amortized on a units-of-production basis,
whereby each company makes its best estimate of the number of units of a game
that will likely be produced. Should the estimate be lower than the actual units sold,
the game’s capitalized license fees will be amortized relatively rapidly; should the
estimate be greater, the license fees will be amortized relatively slowly.
As a general rule, many people are confused by the treatment of capitalized software
development and prepaid royalties. It appears to us that investors are frequently
confused/concerned about how various publishers treat software development costs,
and many investors believe that the companies are deferring recognition of expense
(and managing earnings) by making additions to the capitalized software or prepaid
license account. In particular, investors are confused about the "current asset"
account treatment of capitalized software and prepaid licenses, as amortization of
the current asset account should be expected to impact earnings over the next 12
months.
Under GAAP and SFAS No. 86, companies are required to make every effort to
match expense and revenue within the same period (meaning, for example, that if an
expense is incurred in the first quarter of the year that results in revenue in the third
quarter, the recognition of the expense should be deferred until the third quarter).
Most of the companies in the interactive entertainment software publishing business
follow SFAS No. 86, and have been capitalizing software development for several
years. Electronic Arts has chosen to expense software development when incurred,
creating the appearance of negative operating leverage when the expenses are
incurred, and positive operating leverage when the underlying games are released.
Electronic Arts has managed to convince its auditors that it cannot determine
whether a game is “viable” (requiring capitalization) until the game is released, and
therefore, the company has chosen to expense all software development (continuing
to capitalize prepaid royalties). We think that the recent decline in EA’s share price is
in large part attributable to the fact that the company continues to invest in
development without any underlying revenues, causing investors to believe that
growth has stalled.
The problem many investors perceive is a gradual and substantial increase in the
amounts capitalized. Midway, THQ and Take-Two have all built sizeable capitalized
software and prepaid royalty balances over the last few years. These balances are a

function of two factors: first, the number of games under development expected to
be released during the year; and second, the escalating development cost of the
typical game. In the current console cycle, it is clear that each publisher is interested
in capturing as much market share as possible. In addition, the launches of three
major console platforms, as well as the launches of the Nintendo DS and the Sony
PSP required the development of as many as eight versions of each new title,
contributing to the proliferation of games under development. The cost of
development has risen from an average of $100,000 (handheld) and $500,000
(console) in the PSOne cycle to an average of $350,000 (handheld) and $3 million
(console) in the PS2 cycle (our estimates), and current generation console games
typically cost as much as $10 million each to produce. Taken together, these factors
have contributed to a large increase in development costs for every publisher.
Activision has become more like EA throughout the current cycle. The company’s
capitalized software balance is at a record low as a percentage of its sales, as it has
adopted the conservative policy of deeming new games infeasible until launch. As a
result, development spending on games like Blur (a new racing game) have been
largely expensed rather than capitalized. We expect Activision to deliver far more
leverage than is typical from a company that capitalizes software development, due
to its conservative approach.
The timing of game development and release is yet another important factor. In the
PSOne cycle, game development seldom took more than a year, and often took as
little as three months. Thus, there were fewer occasions that created a mismatch in
timing between development spending and revenue recognition. In the PS2 cycle,
the major console games typically took 18 months or longer to develop. The bulk of
development spending therefore seldom occurred within the same year as games
were released, creating a need to capitalize to the current asset account. In the
current cycle, game development often takes as long as three years, resulting in
even larger growth of long-term capital accounts. In addition, the typical console
game has enjoyed an extension of its “shelf” life, due to tiered pricing for new
releases and catalog titles. Thus, games that used to sell 90% of total units within
six months of release now sustain reasonable sales levels for as long as a year.
We believe that growth in the capitalized software account balance is necessary for
companies choosing to participate in the current console cycle, notwithstanding that
many industry observers see it as a deferral of expense. Increases in prepaid
royalties are a function of company strategy, with companies that are more heavily
dependent upon licensed content (such as THQ) spending more to acquire key
licenses. In our view, spending on new products reflects management commitment
to growth, and we think that additions to the capitalized software and prepaid royalty
account balances reflect such commitment. We expect to see continued additions to
the capitalized software account balances at each publisher that capitalizes over the
next two years, as the publishers ramp up their capability to create current
generation games.
As we approach the middle of this console cycle, we believe that higher and higher
development spending will be the norm. First, developing games for multiple
platforms is likely to increase overall development spending. Second, most
publishers are concerned about conceding a competitive advantage to the others,
and each has incurred investment in development tools for the current generation
consoles. So long as the current console cycle creates growth in demand, we expect
to see net additions to capitalized software development costs. The pace of the
additions for current generation consoles will slow as the rate of growth of the

installed console base slows, but will be more than offset by significant development
spending for online games, microtransaction-based free-to-play games, and MMOs.
RESERVES
Another area of concern for investors is an account called “reserves for returns and
allowances”. This account is created by companies to protect against the financial
risk arising from either returns of games that under perform in the marketplace or
from planned price cuts for games that were released in prior periods. Because of
the negotiating leverage of video game retailers (such as Wal-Mart, Best Buy,
Target, and GameStop), the publishers must also protect against “requested” price
concessions for any game not selling well.
Each of the interactive entertainment software publishers maintains a reserve against
the potential for product returns and price protection. Historically, these reserves
have been managed by adding a sufficient amount to the reserve balance to create a
cushion, and drawing down against the reserve whenever price protection is granted.
We estimate that actual charges against reserves for most companies in the industry
average approximately 6 – 9% of sales, and we expect additions to reserves to be
sufficient to maintain a cushion. In other words, we believe that overall reserve
balances should grow in line with revenue growth, and that quarterly additions should
generally offset actual charges during the preceding quarter.
Unfortunately, the practice in the industry has been to compare the absolute dollar
amount of the reserve against the absolute dollar amount of gross accounts
receivable, creating a misleading “reserve ratio” that is analogous to the more typical
bad debt reserves maintained by manufacturers of other products. Investors are
often confused by this ratio, and any downward movement in the ratio typically
causes downward pressure on the publisher’s stock price. We believe that reserves
for allowances and returns are much more closely correlated to sales than they are
to receivables balances, for two reasons:
First, receivables balances in this sector are more volatile than in other sectors due
to the nature of interactive entertainment software publishing. Most publishers offer
relatively few products each quarter (an average of 10 – 15), and each shipment of
product will cause receivables to swell temporarily. This is in contrast to classic
manufacturing, where 1,000 widgets flow off the assembly line each day, and sales
are relatively constant from week to week. Thus, reserve ratios will fluctuate wildly
as the denominator (accounts receivable) fluctuates, even if the numerator (reserves)
remains constant.
Second, the reserve balance reflects the risk that a portion of sold product will be
returned or will be discounted through vendor concessions. Although highly
subjective, the underlying analysis of reserves should consider the quality of the
products sold, and whether they are being sold at expected levels and at full price.
Again, this relationship is more closely correlated to sales than it is to receivables. In
addition, reserves would be maintained even if all purchases were paid for in cash
(i.e., no accounts receivable balance), so it is clear that the reserve balance should
reflect the risk that a portion of the company's sales, and not receivables, will be
returned or offered price protection. Because sales occur throughout the quarter and
receivables are merely a snapshot in time, trying to gauge a relationship between
reserves and receivables will always be a moving target; measuring them against
sales more closely reflects the risk inherent in the sales.

Each company we cover appears to have sufficient reserves, with most maintaining
reserves of approximately 20% of peak quarter sales. In our view, reserves in
excess of 10% of peak quarter publishing revenues are excessive. We believe that
five of the companies we cover may have reserves in excess of what will be required
to provide price protection to customers, but believe that each of these companies
has maintained a conservative reserve balance in order to minimize the likelihood of
earnings shortfalls in subsequent periods attributable to games that under perform.
In summary, we believe that reserves should reflect the likelihood that a portion of
full-price sales will be returned or discounted. We think that although subjective, the
adequacy of a particular company’s reserve should be a function of the quality of its
products. This measure will apply regardless of the level of receivables, and we
caution investors against accepting a reserve “ratio” as proof of reserve adequacy.

UPSTARTS AND STARTUPS
The video game industry is likely to change considerably over the next five
years, with constantly evolving business models. In this section, we briefly
explore the strategies of several new companies we expect to change the
landscape. Among these are game delivery network OnLive, console manufacturer
Zeebo, casual gaming startup WebWars, and free-to-play startup Quick Hit.
OnLive
OnLive is the creation of Rearden Labs, founded by Internet pioneer Steve Perlman.
The company has created technology that compresses video games in such a way
as to limit latency when games are played online. The company intends to host
games that are purchased or rented by consumers on central servers, and to enable
its customers to play games on any television or PC, provided that there is a high
speed Internet connection nearby. While the business model is still under
development, we find the concept incredibly exciting, given that the OnLive offering
will not involve any physical purchase of a game disc or download. Thus, game
publishers will be protected against piracy, and consumers will not be in a position to
re-sell games for later sale in the used market.
Zeebo
Zeebo is a videogame console that launched in Brazil earlier this year. The console
allows consumers to purchase games through a 3G wireless connection, and is
expected to retail for around $249, or one-third the cost of a current generation
console. While games for the device are primarily last generation quality, Zeebo is
marketing to an audience that is just beginning to adopt last generation consoles,
and newer games from EA and id are offered on the system. It appears that this
concept will allow Zeebo to expand games to markets where taxes and political
considerations have blocked access in the past.
WebWars
WebWars offers browser-based online games for younger gamers, making the web
browser a fundamental component of the game. The WebWars approach offers
games in modular form, with each module serving as a building block for any other
game. The concept is simple and the execution appears brilliant, with the company’s
ad-supported model likely to generate significant revenues. Although its initial launch
will be in the West, it’s clear that there will be opportunities in Asia in the future.
Quick Hit
Quick Hit is a free-to-play football game supported by microtransaction revenue.
Unlike many of its competitors, the company’s approach is to sell real-world items
(energy drinks, footwear, jerseys) that are essential to real-world football players to
play at a professional level. There is opportunity for the game to attract sponsored
microtransactions, lowering the cost of play to the consumer. Like WebWars, Quick
Hit is browser-based, placing the player in the role of coach and allowing him to
make strategic choices. Players improve and advance with persistent game play.
The game is expected to launch in September.
We think that these four upstarts will make headlines in 2009, and have the potential
to make their investors a lot of money in the future.

SECTION 3: COMPANY PROFILES

COVERED PUBLICLY TRADED INTERACTIVE ENTERTAINMENT COMPANIES
Companies Under Coverage

Activision Blizzard (ATVI)
Electronic Arts (ERTS)
Majesco Entertainment (COOL)
Midway Games (MWY)
Nintendo (7974.JP / NTDOY.US)
Take-Two Interactive Software (TTWO)
THQ (THQI)
Ubisoft Entertainment (UBI.FP)
Retail Companies Under Coverage

Best Buy (BBY)
Blockbuster (BBI)
GameStop (GME)

Activision Blizzard (ATVI)
Price (as of close 6/22/09) 52-Week Range $8.14–19.28 ST / LT Debt $0 / 0

Shares Outstanding 1.3 billion Debt/Capital 0%
$12.33 Insider/Institutional 52% / 48% ROE NMF
Public Float 572 million Cash & Inv/Share $2.29
Rating Market Capitalization $16 billion Book Value /Share $8.42
STRONG BUY
FYE 2009A** CY 2009E** CY2010E**
12- Month Price Target EPS($)* ACTUAL CURRENT PREVIOUS CURRENT PREVIOUS
$16 Q1 $0.08 $0.08A $0.09E
Q2 0.12 0.07E 0.12E
Q3 0.07 0.11E 0.12E
Q4 0.31 0.41E 0.47E
Year** $0.58 $0.67E $0.80E
P/E Ratio N/A 18x 15x
Change N/A N/A 19%
FYE 2009A** CY 2009E** CY2010E**

Revenue ($ mil.) ACTUAL CURRENT PREVIOUS CURRENT PREVIOUS
Q1 $603 $724A $783E
Q2 654 785E 916E
Q3 770 870E 898E
Source: Nasdaq.com Q4 2,343 2,490E 2,653E
Year** $3,767 $4,869E $5,250E
Company Description Change N/A N/A 8%
Activision Blizzard, headquartered in **Pro forma ** Numbers may not add up due to rounding. **Activision changed FY to CY in
Santa Monica, California, develops, 2008, amounts shown are in calendar quarter format.
publishes, and distributes interactive
entertainment software for PCs, home
consoles, handheld devices, and the
Internet.
Activision’s Top 10 Selling Brands for 2008 (U.S. Retail Sales $)
C Y 2008 A C T IV IS IO N
Am ount
R ank B ra n d ( $ m il)
1 G u it a r H e r o $ 992
2 C a ll O f D u t y $ 446
3 W a rc ra ft $ 104
4 S p id e r - M a n $ 42
5 C a b e la 's $ 32
6 Kung Fu Panda $ 32
7 Jam es Bond $ 25
8 T ra n s fo rm e rs $ 23
9 C r a s h B a n d ic o o t $ 20
10 Tony H awk $ 17
T o ta l T o p 1 0 B ra n d s $ 1 ,7 3 4
Source: The NPD Group/Retail Track and Wedbush Morgan Securities.

COMPANY OVERVIEW
Activision Blizzard, based in Santa Monica, California and founded in 1979, was the first independent
developer and distributor of entertainment software. Today it is a leading video game software publisher for
Nintendo, Sony, and Microsoft video game consoles as well as for the PC. In addition to publishing, it
maintains distribution operations in Europe for third-party publishers of interactive entertainment software, its
own publishing operations, and manufacturers of interactive entertainment hardware. Key games include its
Marvel licensed Spider-Man and X-Men games, and its Call of Duty, Tony Hawk, and Guitar Hero games. In
July 2008, it merged with Vivendi’s game unit bringing the highly successful World of Warcraft online game
to the company. Vivendi owns approximately 52% of the Activision’s shares.
VALUATION
Activision’s core business remains strong, and the continued growth of Blizzard’s business give us great
confidence in our estimates. Blizzard has recently shifted service providers in China, driving a likely $0.03
increase in EPS this year and another $0.03 in EPS growth next year as a result. Blizzard is expected to
launch Starcraft 2 later this year, with two Starcraft 2 expansion packs launching next year. We expect to
see the Activision’s product mix shift, with owned intellectual property and lower cost licensed property
comprising a greater portion of publishing revenues next year.
We note that most of Activision’s major FY:10 games (Modern Warfare 2, Tony Hawk Ride and Blur)
showed very well at the E3 Expo. We believe Modern Warfare 2 will be the best selling game in 2009.
Maintaining our STRONG BUY rating, and our $16 price target, which reflects a forward multiple of 18x our
calendar 2010 adjusted EPS estimate of $0.76 plus $2.50/share in cash. Our price target reflects a discount
to the current forward multiple for the S&P 500 to reflects concerns about Activision’s revenue concentration
from its three flagship properties.
Risks to attainment of our share price target include changes to game release timing, greater than expected
deterioration of the average selling price (ASP) for game software, the effects of competition, options
investigation impact, and lower than expected consumer demand for video game hardware.

Activision Blizzard, Inc.
Income Statement ($ millions) Jun-08 Sep-08 Dec-08 2009** Mar-09 Jun-09 Sep-09 Dec-09 2009 Mar-10 Jun-10 Sep-10 Dec-10 2010
Fiscal Year End: March 31 1QA 2QA 3QA FY-A 1QA 2QE 3QE 4QE CY-E 1QE 2QE 3QE 4QE CY-E
Publishing $ 578.6 $ 443.0 $ 1,695.0 $ 2,716.5 $ 348.0 $ 462.7 $ 518.3 $ 1,914.4 $ 3,243.4 $ 386.2 $ 512.3 $ 483.5 $ 2,034.2 $ 3,416.2
Blizzard $ - $ 271.0 $ 477.0 $ 748.0 $ 291.0 $ 287.3 $ 316.7 $ 455.7 $ 1,350.6 $ 352.0 $ 363.5 $ 374.9 $ 498.4 $ 1,588.8
Distribution 75.6 56.0 171.0 302.6 85.0 35.0 35.0 120.0 275.0 45.0 40.0 40.0 120.0 245.0
Total Revenues 654.2 770.0 2,343.0 3,767.2 724.0 785.0 870.0 2,490.1 4,869.0 783.2 915.8 898.4 2,652.6 5,250.0
Product Costs 311.9 313.0 1,061.0 1,685.9 238.0 262.8 301.6 927.2 1,729.6 270.5 294.6 286.0 921.3 1,772.4
Royalties 68.2 39.0 169.0 276.2 108.0 98.4 97.0 300.4 603.8 99.5 115.0 112.5 310.0 637.0
Cost of Revenues 380.2 352.0 1,230.0 1,962.2 346.0 361.2 398.6 1,227.6 2,333.4 370.0 409.6 398.5 1,231.3 2,409.4
Michael Pachter (213) 688-4474

Gross Profits 274.0 418.0 1,113.0 1,805.0 378.0 423.8 471.4 1,262.4 2,535.6 413.2 506.2 499.9 1,421.3 2,840.6
Product Development 50.0 200.0 196.0 446.0 111.0 100.0 100.0 160.0 471.0 105.0 100.0 100.0 155.0 460.0
Sales & Marketing 86.5 142.0 240.0 468.5 78.0 113.4 113.1 293.9 598.4 86.2 137.4 125.8 278.5 627.8
General & Admin. 57.4 94.0 103.0 254.4 70.0 120.0 95.0 110.0 395.0 100.0 90.0 95.0 110.0 395.0
Other Amortization/Restructuring 0.0 176.0 233.0 409.0 94.0 65.0 65.0 70.0 294.0 0.0 0.0 0.0 0.0 0.0
Total Costs and Expenses 193.9 612.0 772.0 1,577.9 353.0 398.4 373.1 633.9 1,758.4 291.2 327.4 320.8 543.5 1,482.8
Income (loss) from operations 80.1 (194.0) 341.0 227.1 25.0 25.4 98.3 628.5 777.2 122.1 178.8 179.2 877.8 1,357.8
Interest income (expense), net 10.9 24.0 18.0 52.9 10.0 19.0 19.0 19.0 67.0 19.0 19.0 19.0 19.0 76.0
Income (loss) before income tax provision 91.1 (170.0) 359.0 280.1 35.0 44.4 117.3 647.5 844.2 141.1 197.8 198.2 896.8 1,433.8
Income tax provision (benefit) 32.1 (62.0) 118.0 88.1 18.0 15.1 39.9 220.2 293.1 48.0 67.2 67.4 304.9 487.5
Net income (loss) 59.0 (108.0) 241.0 192.0 17.0 29.3 77.4 427.4 551.1 93.1 130.5 130.8 591.9 946.3
Shares, Basic 592.6 1,271.0 1,326.0 1,063.2 1,308.0 1,290.0 1,280.0 1,270.0 1,287.0 1,270.0 1,270.0 1,270.0 1,270.0 1,270.0
Shares, Diluted 647.0 1,384.0 1,390.0 1,140.3 1,359.0 1,340.0 1,330.0 1,320.0 1,337.3 1,320.0 1,320.0 1,320.0 1,320.0 1,320.0
EPS Basic (Adjusted GAAP) $ 0.10 $ (0.08) $ 0.18 $ 0.18 $ 0.01 $ 0.02 $ 0.06 $ 0.34 $ 0.43 $ 0.07 $ 0.10 $ 0.10 $ 0.47 $ 0.75
EPS Diluted (Adjusted GAAP) $ 0.09 $ (0.08) $ 0.17 $ 0.17 $ 0.01 $ 0.02 $ 0.06 $ 0.32 $ 0.41 $ 0.07 $ 0.10 $ 0.10 $ 0.45 $ 0.72
EPS Basic (pro forma) $ 0.12 $ 0.07 $ 0.32 $ 0.50 $ 0.08 $ 0.07 $ 0.11 $ 0.43 $ 0.69 $ 0.09 $ 0.12 $ 0.12 $ 0.49 $ 0.83
EPS Diluted (pro forma) $ 0.12 $ 0.07 $ 0.31 $ 0.48 $ 0.08 $ 0.07 $ 0.11 $ 0.41 $ 0.67 $ 0.09 $ 0.12 $ 0.12 $ 0.47 $ 0.80
Percentage Analysis
% of Sales
Gross Margin 42% 54% 48% 48% 52% 54% 54% 51% 52% 53% 55% 56% 54% 54%
Product Development 8% 26% 8% 12% 15% 13% 11% 6% 10% 13% 11% 11% 6% 9%
Sales & Marketing 13% 18% 10% 12% 11% 14% 13% 12% 12% 11% 15% 14% 11% 12%
General & Admin. 9% 12% 4% 7% 10% 15% 11% 4% 8% 13% 10% 11% 4% 8%
Royalties 10% 5% 7% 7% 15% 13% 11% 12% 12% 13% 13% 13% 12% 12%
Operating Profit 12% -25% 15% 6% 3% 3% 11% 25% 16% 16% 20% 20% 33% 26%
Net Income 9% -14% 10% 5% 2% 4% 9% 17% 11% 12% 14% 15% 22% 18%
Y/Y % Change
Revenue 32% 142% 58% 20% 20% 13% 6% 8% 17% 3% 7% 8%
Gross Margin 64% 271% 55% 50% 55% 13% 13% 9% 19% 6% 13% 12%
Product Development 52% 505% 57% 40% 100% -50% -18% -5% 0% 0% -3% -2%
Sales & Marketing 26% 174% 100% 16% 31% -20% 22% 10% 21% 11% -5% 5%
General & Admin. 60% 151% 45% 37% 109% 1% 7% 43% -25% 0% 0% 0%
Royalties -38% -26% 2% 42% 44% 149% 78% -8% 17% 16% 3% 6%
Operating Profit 166% nm -16% -54% -68% nm 84% 388% 605% 82% 40% 75%
Net Income 112% -15573% -11% -62% -50% nm 77% 448% 346% 69% 38% 72%
*Pro forma for FY:09 and thereafter **FY09 contains only 3 Qtrs Reflects 2-for-1 stock split 9/08
Company report and Wedbush Morgan Securities estimates
Interactive Entertainment Industry Report 161

Electronic Arts (ERTS)
Price (as of close 6/22/09)

52-Week Range $14.24–$50.17 ST / LT Debt $0 / 0
$19.97 Shares Outstanding 325 million Debt/Capital 0%
Insider/Institutional 5% / 92% ROE N/A
Rating
BUY Market Capitalization $6 billion Book Value/Share $9.73
12- Month Price Target

FYE MAR 2009A 2010E 2011E
$27 EPS($)* ACTUAL CURRENT PREVIOUS CURRENT PREVIOUS
Q1 Jun $(0.42) $(0.12)E $(0.05)E
Q2 Sep (0.06) 0.28E 0.29E
Q3 Dec 0.56 1.03E 1.05E
Q4 Mar (0.37) (0.20)E 0.06E
Year** $(0.30) $1.00E $1.35E
Change N/A N/A 35%
FYE MAR 2009A 2010E 2011E

Q1 Jun $609 $779E $892E
Q2 Sep 1,126 1,244E 1,277E
Source: Nasdaq.com Q3 Dec 1,742 1,670E 1,736E
Q4 Mar 609 657E 795E
Company Description Year** $4,086 $4,350E $4,700E
Electronic Arts, headquartered in Change 2% 6% 8%
Redwood City, California, develops, *Pro forma.
publishes, and distributes interactive
entertainment software for personal ** Numbers may not add up due to rounding.
computers, home consoles, handheld
devices, and the Internet.
Electronic Arts’ Top 10 Selling Brands for 2008 (U.S. Retail Sales $)
C Y 2008 E L E C T R O N IC A R T S
Am ount
1 R ock Band $ 662
2 M a d d e n F o o t b a ll $ 312
3 T h e S im s $ 143
4 N eed For Speed $ 106
5 N C A A F o o t b a ll $ 94
6 T ig e r W o o d s $ 89
7 F IF A $ 79
8 N B A L iv e $ 71
9 L e ft 4 D e a d $ 67
10 B a t t le f ie ld $ 57
T o ta l T o p 1 0 B ra n d s $ 1 ,6 8 0
Source: The NPD Group/Retail Track and Wedbush Morgan Securities

COMPANY OVERVIEW
Electronic Arts, based in Redwood City, California, is one of the largest independent developer and
publisher of interactive entertainment software in the world. EA games are segmented into three major
brands, EA Games, EA Sports, and EA Play. Top titles under the EA Games label include Battlefield, Need
For Speed, Medal of Honor, and Harry Potter. The EA Sports division is the industry leader with top-selling
sports games including Madden NFL, NCAA Football, NBA Live, FIFA Soccer, and Tiger Woods PGA Tour.
EA Play brands include The Sims and its Hasbro and other casual games. Electronic Arts also develops
online subscription games such as Warhammer and Pogo as well as games for mobile devices/phones.
VALUATION
Despite recent weak performance, we continue to like the EA story. We have been wrong about this stock
for close to five years, overestimating management’s ability to manage the company’s cost structure. This
time, we are again placing our faith in management’s ability to cut costs (the definition of insanity), but this
time, we genuinely expect a different outcome. In contrast to prior false starts, EA management has actually
cut costs and reduced both headcount and projects. We think that the Q4 results reflect management’s
commitment to cost cutting, and believe that the company is sincere in its expressed desire to grow profits
substantially over the next few years.
EA’s first half lineup is loaded, with Harry Potter, Tiger Woods, EA Sports Active and Fight Night up against
easy Q1 comps, and with FIFA and Need for Speed up against easy Q2 comps. We think that the
company’s lineup will allow it to handily beat consensus expectations the first half of the year, and expect EA
shares to continue to appreciate over the near term. We are particularly impressed with the potential for EA
Sports Active and for Tiger Woods, and think that both could be blockbusters on the Wii.
Maintaining BUY, and our $27 price target, reflecting a multiple of 15x our adjusted FY:11 EPS estimate of
$1.29/share, plus $8/share in cash. Our target is below the low end of the company’s historical range,
reflecting market contraction and recent poor execution.
deterioration of the average selling price (ASP) for game software, the effects of competition (both from
other video game publishers and from other forms of entertainment), and slower than expected consumer
demand for video game hardware.

Electronic Arts
Pro Forma Income Statement
Income Statement Jun-08 Sep-08 Dec-08 Mar-09 2009 Jun-09 Sep-09 Dec-09 Mar-10 2010 Jun-10 Sep-10 Dec-10 Mar-11 2011
Fiscal Year End: March 31 1QA 2QA 3QA 4QA FY-A 1QE 2QE 3QE 4QE FY-E 1QE 2QE 3QE 4QE FY-E
Net Revenues (non GAAP) 609.0 1,126.0 1,742.0 609.0 4,086.0 778.8 1,243.9 1,670.3 657.0 4,350.0 891.6 1,277.4 1,736.0 795.0 4,700.0
Cost of Goods Sold 292.0 553.0 921.0 307.0 2,073.0 355.6 549.4 597.4 313.0 1,815.4 408.4 565.6 676.0 293.9 1,943.8
Gross Profit 317.0 573.0 821.0 302.0 2,013.0 423.2 694.5 1,072.9 344.0 2,534.6 483.2 711.8 1,060.1 501.2 2,756.2
Research & Devel. 322.0 337.0 271.0 295.0 1,225.0 285.0 285.0 325.0 275.0 1,170.0 295.0 290.0 310.0 300.0 1,195.0
Sales & Marketing 123.0 192.0 245.0 111.0 671.0 127.4 218.9 212.1 93.5 652.0 137.7 212.2 220.7 106.3 676.8
General & Admin. 74.0 79.0 71.0 61.0 285.0 70.0 70.0 75.0 70.0 285.0 81.0 82.0 61.0 75.0 299.0
Restructuring and Other Charges
164 Interactive Entertainment Industry Report

Amortization of Intangibles
Total Operating Expenses 519.0 608.0 587.0 467.0 2,181.0 482.4 573.9 612.1 438.5 2,107.0 513.7 584.2 591.7 481.3 2,170.8
Operating Income (loss) (202.0) (35.0) 234.0 (165.0) (168.0) (59.2) 120.6 460.8 (94.6) 427.6 (30.5) 127.6 468.4 19.9 585.4
Interest Income 15.0 7.0 14.0 8.0 44.0 6.0 6.0 6.0 6.0 24.0 6.0 6.0 7.0 7.0 26.0
Income before Taxes (187.0) (28.0) 248.0 (157.0) (124.0) (53.2) 126.6 466.8 (88.6) 451.6 (24.5) 133.6 475.4 26.9 611.4
Income Taxes (52.0) (8.0) 69.0 (37.0) (28.0) (14.9) 35.4 130.7 (24.8) 126.4 (6.9) 37.4 133.1 7.5 171.2
Income b/f minority interest (135.0) (20.0) 179.0 (120.0) (96.0) (38.3) 91.1 336.1 (63.8) 325.1 (17.6) 96.2 342.3 19.3 440.2
Minority Interest - - - - - - - - - - - - - - -
Net Income (135.0) (20.0) 179.0 (120.0) (96.0) (38.3) 91.1 336.1 (63.8) 325.1 (17.6) 96.2 342.3 19.3 440.2
Shares, Basic 318.0 319.0 321.0 322.0 320.0 323.0 323.0 323.0 323.0 323.0 323.5 324.0 324.5 325.0 324.3
Shares, Diluted 326.0 325.0 322.0 322.0 321.0 324.0 324.0 325.0 326.0 324.8 326.5 327.0 327.5 328.0 327.3
EPS (Basic pro forma) (0.42) (0.06) 0.56 (0.37) (0.30) (0.12) 0.28 1.04 (0.20) 1.01 (0.05) 0.30 1.05 0.06 1.36
EPS (Diluted pro forma) (0.41) (0.06) 0.56 (0.37) (0.30) (0.12) 0.28 1.03 (0.20) 1.00 (0.05) 0.29 1.05 0.06 1.35
Percentage Analysis
% of Sales
Gross Margin 52% 51% 47% 50% 49% 54% 56% 64% 52% 58% 54% 56% 61% 63% 59%
Research & Devel. 53% 30% 16% 48% 30% 37% 23% 19% 42% 27% 33% 23% 18% 38% 25%
Sales & Marketing 20% 17% 14% 18% 16% 16% 18% 13% 14% 15% 15% 17% 13% 13% 14%
General & Admin. 12% 7% 4% 10% 7% 9% 6% 4% 11% 7% 9% 6% 4% 9% 6%
Operating Profit -33% -3% 13% -27% -4% -8% 10% 28% -14% 10% -3% 10% 27% 2% 12%
Net Income -22% -2% 10% -20% -2% -5% 7% 20% -10% 7% -2% 8% 20% 2% 9%
Y/Y % Change
Total Revenue 41% 20% 0% -34% 2% 28% 10% -4% 8% 6% 14% 3% 4% 21% 8%
Gross Margin 17% 4% -14% -35% -10% 34% 21% 31% 14% 26% 14% 2% -1% 46% 9%
Research & Devel. 38% 42% -10% 4% 16% -11% -15% 20% -7% -4% 4% 2% -5% 9% 2%
Sales & Marketing 58% 21% 18% -10% 18% 4% 14% -13% -16% -3% 8% -3% 4% 14% 4%
General & Admin. 17% 7% -15% -23% -5% -5% -11% 6% 15% 0% 16% 17% -19% 7% 5%
Operating Profit 96% -144% -36% 588% -153% -71% -444% 97% -43% -355% -49% 6% 2% -121% 37%
Net Income 96% -123% -38% -491% -128% -72% -556% 88% -47% -439% -54% 6% 2% -130% 35%
Company reports and Wedbush Morgan Securities estimates

Majesco Entertainment (COOL)

52-Week Range $0.36–2.18 ST / LT Debt $0 / 0
Insider/Institutional 43% / 19% ROE 13%
Rating Public Float 22 million Cash & Inv/Share $0.35
BUY Market Capitalization $54 million Book Value/Share $0.40
12- Month Price Target FYE OCT 2008A 2009E 2010E

$2.50 EPS($) ACTUAL CURRENT PREVIOUS CURRENT PREVIOUS
Q1 Jan $0.07 $0.13A $0.12E
Q2 Apr (0.01) 0.01A 0.00E
Q3 Jul 0.01 (0.01)E 0.04E
Q4 Oct (0.04) 0.03E 0.05E
Year** $0.02 $0.15E $0.21E
P/E Ratio 94x 12x 9x
Change N/A 650% 40%
FYE OCT 2008A 2009E 2010E

Q1 Jan $19 $33A $29E
Source: Nasdaq.com Q2 Apr 13 21A 16E
Q3 Jul 14 14E 17E
Q4 Oct 18 19E 29E
Company Description Year** $64 $86E $90E
Majesco Entertainment, based in Change 25% 35% 5%
Edison, New Jersey, is a global ** Numbers may not add up due to rounding. **Pro forma.
developer, publisher and marketer of
interactive entertainment software and
accessories.
Majesco’s Top 10 Selling Brands for 2008 (U.S. Retail Sales $)
C Y 2008 M AJESC O
Am ount
1 C o o k in g M a m a $ 45
2 J illia n M ic h a e ls $ 13
3 C a k e M a n ia $ 3
4 L e f t B r a in R ig h t B r a in $ 3
5 W o n d e r W o r ld A m u s e m e n t P a r k $ 2
6 W ild E a r t h $ 2
7 F u ru F u ru P a rk $ 2
8 N a n c y D re w $ 1
9 Jaw s $ 1
10 P e t P a ls $ 1
T o ta l T o p 1 0 B ra n d s $ 72

COMPANY OVERVIEW
Majesco Entertainment, based in Edison, New Jersey, is a global developer, publisher and marketer of
interactive entertainment software and accessories. In addition to its own proprietary brands such as
BloodRayne, Majesco is a supplier of value-priced Nintendo GBA, DS, and Wii software, and accessories.
Majesco Sales Inc. was incorporated in 1986 in New Jersey. On December 5, 2003, Majesco Sales Inc.
completed a reverse merger with ConnectivCorp, then a publicly traded company with no active operations.
As a result of the merger, Majesco Sales Inc. became a wholly-owned subsidiary and the sole operating
business of the public company. On April 13, 2004, the public company changed its name from
"ConnectivCorp" to "Majesco Holdings Inc." On December 31, 2004, Majesco completed a 1-for-7 reverse
stock split. On January 26, 2005, Majesco completed a secondary offering of 6 million shares at
$12.50/share for $75 million, with about $46 million in company proceeds and the rest to selling
shareholders. On April 11, 2005, Majesco changed its name from Majesco Holdings Inc. to Majesco
Entertainment Company.
VALUATION
Majesco’s recent performance is solid. We continue to believe that Majesco can deliver sustainable profits,
as we have better revenue visibility with an ever stronger game lineup. Majesco has stabilized margins,
aggressively managed expenses, and delivered $0.16 in EPS over the last six quarters. The company’s
focused portfolio of casual titles continues to expand, and we expect it to add one hit title per year to its
current lineup of Cooking Mama and Jillian Michaels. We think there is some potential to expand the Mama
brand.
It is difficult to measure the impact of any potential capital raise. We believe that the company has sufficient
liquidity for its operations, and envision a sale of securities only in the event of an acquisition. We believe
investors should remain focused on Majesco’s continuing profitability. The company has delivered consistent
profits for six quarters, and appears positioned to do so for the foreseeable future.
Maintaining our BUY rating, and $2.50 price target, which reflects a forward P/E multiple of 12x our FY:10
EPS estimate of $0.21. The company appears to be in a position of sustainable profitability, and its liquidity
is much improved.
Risks to attainment of our share price target include negative changes in performance of the company’s
products, access to capital, balance sheet and cash liquidity risks, changes to game release timing, the
effects of competition, changing macroeconomic factors, and changes in consumer demand for video game
hardware.

Majesco Entertainment
Income Statement ($ millions) Jan-08 Apr-08 Jul-08 Oct-08 2008 Jan-09 Apr-09 Jul-09 Oct-09 2009 Jan-10 Apr-10 Jul-10 Oct-10 2010
Fiscal Year End: October 31 1QA 2QA 3QA 4QA FY-A 1QA 2QA 3QE 4QE FY-E 1QE 2QE 3QE 4QE FY-E
Total Revenues 18.7 12.8 14.5 18.0 63.9 32.8 20.5 14.2 18.5 86.0 28.8 15.9 16.5 28.9 90.0
Product Costs 7.9 5.8 5.8 9.3 28.9 11.8 7.8 6.2 6.3 32.2 11.4 6.6 6.4 12.0 36.3
Software Dev & License Costs 3.2 2.6 2.5 3.7 11.9 9.1 6.0 3.0 3.9 22.0 5.9 2.3 2.3 6.7 17.1
Cost of Revenues 11.2 8.3 8.3 13.0 40.8 21.0 13.8 9.2 10.2 54.2 17.2 8.8 8.7 18.6 53.3

Gross Profits 7.5 4.4 6.2 5.0 23.1 11.9 6.7 5.0 8.2 31.8 11.6 7.0 7.8 10.2 36.6

Product Development 0.9 0.7 0.8 0.9 3.3 1.3 1.0 0.8 0.9 4.0 1.1 1.2 1.3 1.2 4.8
Sales & Marketing 2.3 1.9 2.3 2.1 8.6 4.1 3.2 2.2 3.8 13.3 4.0 3.0 3.0 4.5 14.5
General & Admin. 2.1 2.0 2.7 2.7 9.5 2.1 2.0 2.2 2.5 8.8 2.6 2.5 2.1 2.8 10.0
Depreciation and Amortization 0.1 0.1 0.1 0.1 0.3 0.1 0.1 0.1 0.1 0.3 0.1 0.1 0.1 0.1 0.4
Restructuring and Other (0.8) (0.1) (0.4) (1.4) (2.7) (0.4) 2.0 0.0 0.0 1.5 0.0 0.0 0.0 0.0 0.0
Total Costs and Expenses 4.6 4.6 5.5 4.3 19.1 7.2 8.2 5.3 7.3 7.8 7.8 6.8 6.5 8.6 0.0
Income (loss) from operations 2.9 (0.2) 0.6 0.6 4.0 4.7 (1.5) (0.3) 0.9 3.8 3.8 0.2 1.3 1.6 6.9
Interest income (expense), net (0.2) (0.1) (0.1) (0.2) (0.6) (0.5) (0.2) (0.1) (0.1) (0.9) (0.1) (0.1) (0.1) (0.1) (0.4)
Other income (expense), net 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Income (loss) before income tax provision 2.7 (0.3) 0.5 0.4 3.4 4.3 (1.7) (0.4) 0.8 3.0 3.7 0.1 1.2 1.5 6.5
Income tax provision (benefit) 0.0 0.0 0.0 0.0 0.0 0.1 0.0 0.0 0.0 0.1 0.0 0.0 0.0 0.0 0.0
Net income (loss) 2.7 (0.3) 0.5 0.4 3.4 4.2 (1.7) (0.4) 0.8 2.9 3.7 0.1 1.2 1.5 6.5
Preferred Stock Dividend 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Shares, Basic 27.4 27.4 27.4 26.9 27.3 27.0 28.5 29.5 30.0 28.7 30.1 30.4 30.7 31.0 30.5
Shares, Diluted 27.4 27.4 27.5 28.0 27.6 27.9 28.9 29.9 30.4 29.3 30.5 30.8 31.1 31.4 31.0
EPS Basic (GAAP) $ 0.10 $ (0.01) $ 0.02 $ 0.01 $ 0.12 $ 0.15 $ (0.06) $ (0.01) $ 0.03 $ 0.10 $ 0.12 $ 0.00 $ 0.04 $ 0.05 $ 0.21
EPS Diluted (GAAP) $ 0.10 $ (0.01) $ 0.02 $ 0.01 $ 0.12 $ 0.15 $ (0.06) $ (0.01) $ 0.03 $ 0.10 $ 0.12 $ 0.00 $ 0.04 $ 0.05 $ 0.21
EPS Basic (pro forma) $ 0.07 $ (0.01) $ 0.01 $ (0.04) $ 0.02 $ 0.14 $ 0.01 $ (0.01) $ 0.03 $ 0.15 $ 0.12 $ 0.00 $ 0.04 $ 0.05 $ 0.21
EPS Diluted (pro forma) $ 0.07 $ (0.01) $ 0.01 $ (0.04) $ 0.02 $ 0.13 $ 0.01 $ (0.01) $ 0.03 $ 0.15 $ 0.12 $ 0.00 $ 0.04 $ 0.05 $ 0.21
Percentage Analysis
% of Sales
Gross Margin 40% 35% 43% 28% 36% 36% 33% 35% 45% 37% 40% 44% 47% 35% 41%
Product Development 5% 6% 6% 5% 5% 4% 5% 6% 5% 5% 4% 8% 8% 4% 5%
Sales & Marketing 12% 15% 16% 12% 14% 13% 16% 16% 21% 15% 14% 19% 18% 16% 16%
General & Admin. 11% 16% 19% 15% 15% 6% 10% 16% 14% 10% 9% 16% 13% 10% 11%
Depreciation and Amortization 0% 1% 0% 0% 0% 0% 0% 1% 1% 0% 0% 1% 1% 0% 0%
Operating Profit 16% -1% 4% 4% 6% 14% -7% -2% 5% 4% 13% 2% 8% 6% 8%
Net Income 14% -2% 4% 2% 5% 13% -8% -3% 4% 3% 13% 1% 7% 5% 7%
Y/Y % Change
Revenue 29% -12% 44% 51% 25% 76% 61% -2% 3% 35% -12% -23% 16% 56% 5%
Gross Margin 67% -27% 108% 35% 34% 58% 52% -19% 65% 38% -2% 5% 56% 24% 15%
Product Development 48% 30% 51% 42% 43% 44% 40% -1% 2% 20% -15% 21% 63% 33% 21%
Sales & Marketing 33% 1% 11% 23% 16% 79% 67% -3% 77% 54% -3% -6% 36% 18% 9%
General & Admin. -7% -5% 64% 16% 14% -1% -2% -20% -7% -8% 24% 27% -5% 12% 14%
Depreciation and Amortization 5% -20% -21% -60% -33% -10% -20% 69% 28% 13% 45% 45% 0% 0% 18%
Operating Profit nm nm nm nm nm 62% nm -149% 43% -4% -19% nm nm 75% 81%
Net Income nm nm nm nm nm 54% nm -179% 112% -14% -11% nm nm 84% 128%

Midway Games (MWYGQ)

52-Week Range $0.03–$4.20 ST / LT Debt (mil) $225 / 0
Rating Public Float 13 million Cash & Inv/Share $0.26
HOLD Market Capitalization $6 million Book Value/Share $(1.70)
12- Month Price Target FYE DEC 2007A 2008A 2009E

N/A EPS($)* ACTUAL ACTUAL PREVIOUS CURRENT PREVIOUS
Q1 Mar $(0.22) $(0.37)A $(0.32)E
Q2 Jun (0.16) (0.38)A (0.21)E
Q3 Sep (0.37) (0.83)A (0.13)E
Q4 Dec (0.35) (0.50)A 0.17E
Year** $(1.09) $(2.08)A $(0.50)E
P/E Ratio NA NA NA
Change NA NA NA
FYE DEC 2007A 2008A 2009E

Revenue ($ mil.) ACTUAL ACTUAL PREVIOUS CURRENT PREVIOUS
Q1 Mar $11 $30A $27E
Q2 Jun 32 23A 28E
Source: Nasdaq.com Q3 Sep 37 51A 48E
Q4 Dec 78 115A 97E
Year** $157 $220A $200E
Company Description Change -5% 40% -9%
Midway, headquartered in Chicago,
Illinois, publishes interactive *Excludes preferred stock accretion.
entertainment software primarily for
** Numbers may not add up due to rounding.
video game consoles.
Midway’s Top 10 Selling Brands for 2008 (U.S. Retail Sales $)
C Y 2008 M ID W A Y
Am ount
1 M o rta l K o m b a t $ 70
2 G a m e P a rty $ 30
3 U n re a l $ 17
4 T N A IM P A C T ! $ 9
5 T o u c h m a s te r $ 6
6 B lit z : T h e L e a g u e $ 5
7 N B A B a lle r s $ 4
8 B la c k s it e : A r e a 5 1 $ 3
9 S t r a n g le h o ld $ 2
10 C r u is 'n $ 1

COMPANY OVERVIEW
Midway Games, based in Chicago, Illinois, has been a pure-play, interactive entertainment company since
1998 when it was spun-off from WMS Industries. In June 2001 Midway exited the coin-operated arcade
games business to focus entirely on developing and publishing titles for Nintendo, Sony, and Microsoft video
game consoles. Midway key games include Mortal Kombat, SpyHunter, Slugfest, Blitz, NHL Hitz, Gauntlet,
and Defender. Sumner Redstone had owned approximately 88% of Midway until late 2008 when he sold his
entire position.
Because of this, $150 million of Midway notes were now callable by its holders. On February 12, 2009,
Midway filed for Chapter 11 bankruptcy protection due to an acceleration of payment due on its $150 million
convertible notes. In June, Warner Bros. Entertainment made an offer for most of Midway’s assets for $33
million, with completion subject to court approval.
VALUATION
Midway’s value remains uncertain. It has had success with key games (notably Mortal Kombat), though it
has not been able to consistently produce profitable games. We were hopeful that the company will perform
better in 2009 than in 2008, but the departure of Sumner Redstone’s and National Amusements’ support for
the company in December was too much of a challenge for its already fragile balance sheet. Midway cash
position will limit its ability to continue its investment in game development, and presents significant
challenges to its operations.
With continued restructurings and uncertainties due to its bankruptcy filing, Midway’s path to profitability
remains steep; and without better visibility into a return to profitability, we are maintaining our HOLD rating.
We expect the company to liquidate as it completes its bankruptcy.
Risks to the company include changes to investment position of Midway’s shares by the company’s control
shareholder, game release timing, greater than expected deterioration of the average selling price (ASP) for
game software, debt level, changing macroeconomic factors, the effects of competition, and bankruptcy
resolution.

Midway Games Inc.
Income Statement ($ millions) Mar-07 Jun-07 Sep-07 Dec-07 2007 Mar-08 Jun-08 Sep-08 Dec-08 2008 Mar-09 Jun-09 Sep-09 Dec-09 2009
Fiscal Year End: Dec 31* 1QA 2QA 3QA 4QA FY-A 1QA 2QA 3QA 4QA FY-A 1QE 2QE 3QE 4QE FY-E
Revenue:
Total Revenue 11.1 31.8 36.7 77.6 157.2 29.9 23.4 51.4 114.8 219.6 26.9 28.1 48.2 96.8 200.0
Product Costs and Distribution 6.6 11.1 13.5 25.3 56.4 14.2 11.6 20.6 41.0 87.4 7.6 7.1 13.8 22.3 50.8
Royalties and Product Development 2.7 9.7 24.2 53.8 90.4 17.4 13.2 49.8 37.7 118.1 18.0 11.0 15.0 20.0 64.0
Total Cost of Sales 9.3 20.8 37.7 79.0 146.8 31.6 24.9 70.4 78.7 205.5 25.6 18.1 28.8 42.3 114.8
Gross Profit (loss) 1.8 11.0 (0.9) (1.5) 10.4 (1.7) (1.4) (19.0) 36.2 14.0 1.3 10.0 19.4 54.5 85.2
Research and development expense 7.6 6.4 6.2 5.1 25.4 6.7 6.1 9.2 10.8 32.9 5.0 5.0 5.0 5.0 20.0
Selling expense 6.2 8.8 14.2 13.8 43.0 8.6 10.0 15.3 18.4 52.3 7.5 6.2 8.7 16.5 38.8
Administrative expense 5.7 5.2 5.0 5.3 21.2 6.8 5.0 5.2 11.1 28.0 6.0 6.0 5.0 5.0 22.0
Restructuring expense (0.8) 0.0 0.0 0.0 (0.8) 0.0 0.0 11.7 2.6 14.3 0.0 0.0 0.0 0.0 0.0

Total Operating Expenses 18.8 20.4 25.4 24.2 97.6 22.1 21.1 41.4 42.9 127.5 18.5 17.2 18.7 26.5 80.8
Operating income (loss) (17.0) (9.4) (26.3) (25.7) (78.4) (23.8) (22.6) (60.4) (6.8) (113.5) (17.2) (7.1) 0.7 28.0 4.4
Interest income and other expense, net (2.3) (4.5) (6.8) (8.4) (22.0) (9.4) (11.8) (15.3) (39.3) (75.8) (12.0) (12.0) (12.0) (12.0) (48.0)
Income (loss) before tax (19.3) (13.9) (33.1) (34.1) (100.3) (33.2) (34.3) (75.7) (46.0) (189.3) (29.2) (19.1) (11.3) 16.0 (43.6)
Credit (provision) for income taxes (0.6) (0.4) (0.4) 2.1 0.8 (0.8) (0.5) (0.3) (0.2) (1.7) (0.5) (0.5) (0.5) (0.5) (2.0)
Net Income (loss) (19.8) (14.3) (33.5) (31.9) (99.6) (34.0) (34.8) (75.9) (46.2) (191.0) (29.7) (19.6) (11.8) 15.5 (45.6)
Cum. Dividend on Pref. Stock 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Shares, Basic 91.0 91.1 91.2 91.4 91.2 91.4 91.6 91.6 91.6 91.6 91.7 91.8 91.9 92.0 91.9
Shares, Diluted 92.6 92.6 92.6 92.6 92.3 92.6 92.7 93.2 93.3 93.0 93.4 93.5 93.6 93.7 93.6
EPS Basic (GAAP) $ (0.22) $ (0.16) $ (0.37) $ (0.35) $ (1.09) $ (0.37) $ (0.38) $ (0.83) $ (0.50) $ (2.08) $ (0.32) $ (0.21) $ (0.13) $ 0.17 $ (0.50)
EPS Diluted (GAAP) $ (0.21) $ (0.15) $ (0.36) $ (0.34) $ (1.08) $ (0.37) $ (0.38) $ (0.81) $ (0.50) $ (2.05) $ (0.32) $ (0.21) $ (0.13) $ 0.17 $ (0.49)
Percentage Analysis
% of Sales
Gross Profit (loss) 16% 35% -3% -2% 7% -6% -6% -37% 32% 6% 5% 36% 40% 56% 43%
Research and development expense 69% 20% 17% 7% 16% 22% 26% 18% 9% 15% 19% 18% 10% 5% 10%
Selling expense 56% 28% 39% 18% 27% 29% 43% 30% 16% 24% 28% 22% 18% 17% 19%
Administrative expense 52% 16% 14% 7% 14% 23% 22% 10% 10% 13% 22% 21% 10% 5% 11%
Operating income (loss) -153% -30% -72% -33% -50% -80% -96% -118% -6% -52% -64% -25% 1% 29% 2%
Net Income (loss) -179% -45% -91% -41% -63% -113% -149% -148% -40% -87% -110% -70% -24% 16% -23%
Y/Y % Change
Revenue -28% 23% 34% -20% -5% 170% -26% 40% 48% 40% -10% 20% -6% -16% -9%
Research and development expense -29% -40% -13% -40% -31% -12% -5% 48% 112% 30% -26% -18% -46% -54% -39%
Selling expense -4% -32% 76% -12% 0% 39% 13% 8% 33% 22% -13% -38% -43% -11% -26%
Administrative expense 7% -5% -3% -1% 0% 18% -3% 4% 109% 32% -11% 19% -3% -55% -22%
Operating income (loss) nm nm nm -7285% nm nm nm nm nm nm nm nm nm nm nm
Net Income (loss) 0% 0% 8% -67% nm -1492% nm nm nm nm nm nm nm nm nm

Nintendo (7974.JP / NTDOY.US)
¥25,740 52-Week Range ¥22,000-36,800 ST / LT Debt $0 / 0
Shares Outstanding 128 million Debt/Capital 0%
Rating Insider/Institutional 40% / 25% ROE 23%
Public Float 85 million Cash & Inv/Share ¥10,236
BUY Market Capitalization ¥3,295 billion Book Value/Share ¥9,805

FYE MAR 2009A 2010E 2011E
¥43,000 EPS(¥)** ACTUAL CURRENT PREVIOUS CURRENT PREVIOUS
Q1 Jun ¥839 ¥427E ¥698E
Q2 Sep 294 454E 810E
7
¥58,300 Q3 Dec 529 1,375E 1,387E
6 ¥53,300 Q4 Mar 521 437E 420E
5 ¥48,300 Year** ¥2,182 ¥2,693E ¥3,315E
4 ¥43,300 P/E Ratio 12x 10x 8x
3
¥38,300 Change 8% 23% 23%
¥33,300
2
¥28,300
1 ¥23,300 FYE MAR 2009A 2010E 2011E
0 ¥18,300
REV (¥ bil) ACTUAL CURRENT PREVIOUS CURRENT PREVIOUS
J J A S O N D J F M A M J
Source: Thomson
Q1 Jun ¥423 ¥350E ¥364E
Q2 Sep 414 368E 381E
Company Description Q3 Dec 700 770E 662E
Q4 Mar 302 312E 234E
Nintendo, based in Kyoto, Japan, is a
Year** ¥1,839 ¥1,800E ¥1,639E
leading manufacturer of video game
Change 10% -2% -9%
consoles and publisher of video game
software. ** Numbers may not add up due to rounding.
Nintendo’s Top 10 Selling Brands for 2008 (U.S. Retail Sales $)
C Y 2008 N IN T E N D O
Am ount
1 M a r io B r o t h e r s $ 761
2 W ii F it $ 407
3 W ii P la y $ 261
4 Pokem on $ 119
5 Z e ld a $ 67
6 A n im a l C r o s s in g $ 54
7 N in t e n d o g s $ 44
8 W ii M u s ic $ 42
9 B r a in A g e $ 39
10 K ir b y $ 26
T o ta l T o p 1 0 B ra n d s $ 1 ,8 2 0

COMPANY OVERVIEW
Nintendo, based in Kyoto, Japan, is a leading manufacturer of video game consoles and publisher of video
game software. The company’s hardware include the Wii (sold over 50 million units to date) and the DS
(sold over 102 million units to date) and its software include blockbuster franchises such as Super Mario
Bros., Pokemon, and Legend of Zelda.
VALUATION
Notwithstanding variances in earnings due to volatile F/X, Nintendo’s recent operating performance has
been solid, and we expect its outstanding performance to continue in FY:10. The lone weak spot for the
company remains Japan. We expect 5% software sales growth in the U.S. and European markets in 2009,
but expect the Japanese market to grow only 2%. The company should be able to dramatically grow
earnings in FY:10 as its mix of sales shifts in favor of high margin software. We have modeled slightly down
revenues, with hardware contributing less and software contributing more than in FY:09, triggering a
material increase in gross margin, relatively flat operating profit, and significant earnings growth (due to
expected lack of foreign exchange losses).
Maintaining BUY, and our ¥43,000 price target, which reflects a forward P/E multiple of 13x our FY:10
adjusted EPS estimate of ¥2,600, plus an estimated ¥9,000/share in cash. We value Nintendo at a multiple
at the low end of its historical range in light of market multiple contraction.
deterioration of the average selling price (ASP) for game software and hardware, the effects of competition,
changing macroeconomic factors, unexpected changes in foreign exchange rates, and slower than expected
consumer demand for video game hardware and software.

Nintendo Co., Ltd.
Income Statement (billion yen) Jun-08 Sep-08 Dec-08 Mar-09 2009 Jun-09 Sep-09 Dec-09 Mar-10 2010 Jun-10 Sep-10 Dec-10 Mar-11 2011
Fiscal Year End: March 31 1QA 2QA 3QA 4QA FY-A 1QE 2QE 3QE 4QE FY-E 1QE 2QE 3QE 4QE FY-E
Hardware ¥262.2 ¥253.3 ¥450.7 ¥193.6 ¥1,159.7 ¥210.0 ¥212.0 ¥416.4 ¥151.5 ¥989.9 ¥195.5 ¥189.5 ¥341.9 ¥119.0 ¥845.9
Publishing 160.4 159.5 247.6 108.1 675.6 139.3 155.7 351.7 160.0 806.7 167.5 190.6 317.6 114.3 790.0
Other 0.7 0.7 1.2 0.6 3.3 0.5 0.5 2.0 0.5 3.5 0.5 0.5 2.0 0.5 3.5
Total Revenues 423.4 413.5 699.5 302.3 1,838.6 349.8 368.2 770.1 312.0 1,800.1 363.5 380.6 661.5 233.8 1,639.4

Cost of Revenues 243.7 226.1 381.5 193.7 1,045.0 196.7 206.4 417.5 165.6 986.2 178.9 177.7 314.9 107.7 779.2

Gross Profits 179.7 187.4 318.0 108.6 793.6 153.1 161.8 352.6 146.4 813.9 184.6 203.0 346.6 126.1 860.3
SG&A 60.5 54.4 68.9 54.6 238.4 67.0 70.0 80.3 69.0 286.3 50.0 45.0 70.0 50.0 215.0
Restructuring and Other 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Total Costs and Expenses 60.5 54.4 68.9 54.6 238.4 67.0 70.0 80.3 69.0 286.3 50.0 45.0 70.0 50.0 215.0
Income (loss) from operations 119.2 133.0 249.1 53.9 555.3 86.1 91.8 272.3 77.4 527.6 134.6 158.0 276.6 76.1 645.3
Other income (expense), net 57.7 (72.6) (134.0) 42.3 (106.6) 2.0 2.0 12.0 13.0 29.0 10.0 10.0 11.0 11.0 42.0
Extraordinary revenue (expense) 3.6 (1.7) (7.9) 5.5 (0.6) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Income (loss) before income tax provision 180.5 58.7 107.2 101.7 448.1 88.1 93.8 284.3 90.4 556.6 144.6 168.0 287.6 87.1 687.3
Income tax provision (benefit) 73.1 21.2 39.5 35.3 169.1 33.5 35.6 108.0 34.3 211.5 55.0 63.8 109.3 33.1 261.2
Minority Interest 0.1 (0.1) 0.0 (0.1) (0.1) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Net income (loss) 107.3 37.6 67.7 66.6 279.1 54.6 58.2 176.3 56.0 345.1 89.7 104.1 178.3 54.0 426.1
Shares, Basic 127.9 127.9 127.9 127.9 127.9 128.0 128.1 128.2 128.3 128.1 128.4 128.5 128.6 128.7 128.5
Shares, Diluted 127.9 127.9 127.9 127.9 127.9 128.0 128.1 128.2 128.3 128.1 128.4 128.5 128.6 128.7 128.5
EPS Basic ¥839 ¥294 ¥529 ¥521 ¥2,182 ¥427 ¥454 ¥1,375 ¥437 ¥2,693 ¥698 ¥810 ¥1,387 ¥420 ¥3,315
EPS Diluted ¥839 ¥294 ¥529 ¥521 ¥2,182 ¥427 ¥454 ¥1,375 ¥437 ¥2,693 ¥698 ¥810 ¥1,387 ¥420 ¥3,315
Percentage Analysis
% of Sales
Gross Margin 42% 45% 45% 36% 43% 44% 44% 46% 47% 45% 51% 53% 52% 54% 52%
SG&A 14% 13% 10% 18% 13% 19% 19% 10% 22% 16% 14% 12% 11% 21% 13%
Operating Profit 28% 32% 36% 18% 30% 25% 25% 35% 25% 29% 37% 42% 42% 33% 39%
Other / Extraordinary Income (Expense) 14% -18% -20% 16% -6% 1% 1% 2% 4% 2% 3% 3% 2% 5% 3%
Net Income 25% 9% 10% 22% 15% 16% 16% 23% 18% 19% 25% 27% 27% 23% 26%
Y/Y % Change
Revenue 24% 17% 13% -15% 10% -17% -11% 10% 3% -2% 4% 3% -14% -25% -9%
Gross Margin 29% 31% 17% -25% 13% -15% -14% 11% 35% 3% 21% 25% -2% -14% 6%
SG&A 25% 22% 2% 4% 12% 11% 29% 17% 26% 20% -25% -36% -13% -28% -25%
Operating Profit 32% 35% 21% -42% 14% -28% -31% 9% 44% -5% 56% 72% 2% -2% 22%
Other / Extraordinary Income (Expense) 148% 590% -1473% -52% 200% 3% -3% -8% 27% -27% 500% 500% 92% 85% 145%
Net Income 34% -28% -46% nm 8% -49% 55% 160% -16% 24% 64% 79% 1% -4% 23%

Take-Two Interactive Software (TTWO)
$8.73 52-Week Range $5.56–$26.88 ST / LT Debt (mil) $0 / 70
Rating Insider/Institutional 6% / 91% ROE 21%
BUY Market Capitalization $672 million Book Value/Share $7.20

FYE OCT 2008A 2009E 2010E
$11 EPS($)* ACTUAL CURRENT PREVIOUS CURRENT PREVIOUS
Q1 Jan $(0.41) $(0.52)A $(0.16)E
Q2 Apr 1.52 (0.04)A (0.06)E
Q3 Jul 0.93 (0.55)E 0.45E
Q4 Oct 0.02 1.18E 1.85E
Year** $2.08 $0.10E $2.10E
P/E Ratio 4x 87x 4x
Change N/A -95% 2000%
FYE OCT 2008A 2009E 2010E

Q1 Jan $240 $257A $282E
Source: Nasdaq.com Q2 Apr 540 230A 259E
Q3 Jul 434 155E 339E
Company Description Q4 Oct 323 484E 670E
Take-Two, headquartered in New York Year** $1,538 $1,125E $1,550E
City, develops, publishes, and Change 57% -27% 38%
distributes interactive entertainment
software for PCs, home consoles, and
handheld devices.
Take-Two’s Top 10 Selling Brands for 2008 (U.S. Retail Sales $)
C Y 2008 T A K E -T W O
Am ount
1 G ra n d T h e ft A u to $ 361
2 N BA 2K $ 60
3 C a r n iv a l G a m e s $ 54
4 M LB 2K $ 49
5 M id n ig h t C lu b $ 49
6 C iv iliz a t io n $ 37
7 B u lly $ 17
8 E ld e r S c r o lls $ 14
9 N H L 2K $ 12
10 T o p S p in $ 9

COMPANY OVERVIEW
Take-Two Interactive Software, based in New York City, is a leading developer and publisher of games for
Nintendo, Sony, and Microsoft video game consoles as well as for the PC. Take-Two publishes its products
under its Rockstar Games and 2K (Games, Sports, and Play) labels. Take-Two games include the top three
selling games for the PS2, Grand Theft Auto 3, Grand Theft Auto: Vice City, and Grand Theft Auto: San
Andreas. Other key games include Max Payne, Midnight Club, and BioShock. Take-Two also owns a third-
party distribution business, Jack of All Games, which distributes its software as well as third-party software,
hardware and accessories to retail outlets in the United States.
VALUATION
As we look forward to FY:10, we see an impressive lineup, with the two shifted games, reorders of this fall’s
BioShock 2, the release of Max Payne 3, and a likely installment of Grand Theft Auto. We are increasingly
confident in our FY:10 estimate, and expect to see consensus estimates for the out year steadily increase
over the next several months.
We note that the last Grand Theft Auto came out 13 months ago, and if the company chooses to use the
same game engine from the prior version, it could allow 30 months of game development and still release
the next installment within its 2010 fiscal year. Should we be right, we think that consensus estimates will
rise to above the $2.00 level, and we expect Take-Two shares to appreciate dramatically.
Maintaining our BUY and our $11 price target, which is based on a forward multiple of 12x estimated
sustainable EPS of $0.80 (fully-taxed) plus $1.50/share in net cash. This multiple is at the low end of Take-
Two’s historical range, and reflects the company earnings volatility and market contraction.
Risks to attainment of our share price target include performance of the company’s games, levels of
competition, changing macroeconomic factors, changes in consumer demand for video game hardware, and
the ability of the company to attract merger partners.

Take-Two Interactive Software Inc.
Income Statement ($ millions) Jan-08 Apr-08 Jul-08 Oct-08 2008 Jan-09 Apr-09 Jul-09 Oct-09 2009 Jan-10 Apr-10 Jul-10 Oct-10 2010
Fiscal Year End: October 31 1QA 2QA 3QA 4QA FY-A 1QA 2QA 3QE 4QE FY-E 1QE 2QE 3QE 4QE FY-E
Publishing $ 122.6 $ 483.4 $ 381.8 $ 242.6 $ 1,230.4 $ 148.9 $ 174.6 $ 115.0 $ 408.5 $ 847.0 $ 181.9 $ 208.7 $ 289.1 $ 620.3 $ 1,300.0
Distribution 117.8 56.4 52.1 80.9 307.1 107.9 55.1 40.0 75.0 278.0 100.0 50.0 50.0 50.0 250.0
Net Sales 240.4 539.8 433.8 323.4 1,537.5 256.8 229.7 155.0 483.5 1,125.0 281.9 258.7 339.1 670.3 1,550.0
Product costs 148.2 185.0 154.4 146.4 633.9 149.9 109.0 72.6 185.1 516.6 132.3 105.4 136.9 229.5 604.1
Royalties & Licenses 15.1 75.5 59.6 35.1 185.3 27.7 24.6 19.0 53.0 124.2 37.0 36.0 37.0 97.0 207.0
Software development costs 22.7 57.7 45.7 43.3 169.4 23.3 28.0 25.0 45.0 121.3 30.0 32.0 35.0 75.0 172.0
Total Cost of Sales 186.0 318.2 259.7 224.8 988.7 200.9 161.6 116.6 283.1 762.2 199.3 173.4 208.9 401.5 983.1
Gross Profits 54.4 221.6 174.2 98.7 548.9 55.9 68.1 38.4 200.4 362.8 82.6 85.3 130.2 268.8 566.9
Operating Expenses:

Research and development costs 15.8 14.8 17.2 16.1 63.9 20.9 14.8 15.0 16.5 67.2 18.0 18.0 19.0 19.0 74.0
Selling and marketing 33.7 45.9 42.9 44.8 167.4 40.8 31.0 32.0 50.0 153.8 35.0 36.0 40.0 67.0 178.0
General and administrative 31.4 49.2 47.1 44.5 172.2 39.7 31.4 32.0 40.0 143.2 40.0 32.7 33.9 39.0 145.6
Depreciation and amortization 6.4 7.5 6.2 5.6 25.8 5.1 4.8 5.0 5.0 19.9 6.5 6.5 7.0 7.0 27.0
Stock options and others 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Restructuring and other non recurring charges 0.2 0.9 1.8 1.6 4.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Total Operating Expenses 87.5 118.4 115.1 112.7 433.7 106.6 82.0 84.0 111.5 384.1 99.5 93.2 99.9 132.0 424.6
Income (loss) from operations (33.1) 103.2 59.0 (14.0) 115.1 (50.7) (13.9) (45.6) 88.9 (21.2) (16.9) (7.9) 30.3 136.8 142.3
Interest expense (income), net 0.2 0.8 (0.9) 2.8 3.0 (2.3) 1.5 1.0 0.5 0.6 1.0 1.0 1.0 1.0 4.0
Income (loss) before equity in loss of affiliate and

income taxes (33.2) 102.3 59.9 (16.8) 112.2 (48.3) (15.3) (46.6) 88.4 (21.9) (17.9) (8.9) 29.3 135.8 138.3
Equity in loss of affiliate and other 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Income (loss) before income taxes (33.2) 102.3 59.9 (16.8) 112.2 (48.3) (15.3) (46.6) 88.4 (21.9) (17.9) (8.9) 29.3 135.8 138.3
Provision (benefit) for income taxes 4.8 4.1 8.1 (1.9) 15.0 2.1 (5.3) 2.0 2.0 0.8 2.0 3.5 2.0 6.3 13.8
Net income (loss) before extraordinary item (38.0) 98.3 51.8 (15.0) 97.1 (50.4) (10.1) (48.6) 86.4 (22.7) (19.9) (12.4) 27.3 129.5 124.5
Net income (loss) (38.0) 98.3 51.8 (15.0) 97.1 (50.4) (10.1) (48.6) 86.4 (22.7) (19.9) (12.4) 27.3 129.5 124.5
Shares, Basic 73.1 75.1 75.9 76.0 75.0 76.1 76.6 77.0 77.5 76.8 77.5 77.5 77.9 78.4 77.8
Shares, diluted 75.0 76.0 77.0 76.9 75.9 76.9 77.0 77.4 77.8 77.3 77.8 77.8 78.3 78.3 78.0
EPS Basic (GAAP) $ (0.52) $ 1.31 $ 0.68 $ (0.20) $ 1.29 $ (0.66) $ (0.13) $ (0.63) $ 1.12 $ (0.30) $ (0.26) $ (0.16) $ 0.35 $ 1.65 $ 1.60
EPS Diluted (GAAP) $ (0.51) $ 1.29 $ 0.67 $ (0.19) $ 1.28 $ (0.66) $ (0.13) $ (0.63) $ 1.11 $ (0.29) $ (0.26) $ (0.16) $ 0.35 $ 1.65 $ 1.60
EPS Basic (pro forma) $ (0.41) $ 1.54 $ 0.94 $ 0.01 $ 2.09 $ (0.52) $ (0.04) $ (0.55) $ 1.19 $ 0.09 $ (0.16) $ (0.06) $ 0.45 $ 1.85 $ 2.10
EPS Diluted (pro forma) $ (0.40) $ 1.52 $ 0.93 $ 0.02 $ 2.08 $ (0.52) $ (0.04) $ (0.55) $ 1.18 $ 0.10 $ (0.16) $ (0.06) $ 0.45 $ 1.85 $ 2.10
Percentage Analysis
% of Sales
Gross Margin 23% 41% 40% 31% 36% 22% 30% 25% 41% 32% 29% 33% 38% 40% 37%
Research & Development 7% 3% 4% 5% 4% 8% 6% 10% 3% 6% 6% 7% 6% 3% 5%
Selling and marketing 14% 9% 10% 14% 11% 16% 14% 21% 10% 14% 12% 14% 12% 10% 11%
General and administrative 13% 9% 11% 14% 11% 15% 14% 21% 8% 13% 14% 13% 10% 6% 9%
Operating Profit -14% 19% 14% -4% 7% -20% -6% -29% 18% -2% -6% -3% 9% 20% 9%
Net Income -16% 18% 12% -5% 6% -20% -4% -31% 18% -2% -7% -5% 8% 19% 8%
Y/Y % Change
Revenue -13% 163% 110% 11% 57% 7% -57% -64% 49% -27% 10% 13% 119% 39% 38%
Gross Margin -26% 383% 357% 10% 122% 3% -69% -78% 103% -34% 48% 25% 239% 34% 56%
Research & Development 12% 24% 54% 44% 32% 32% 0% -13% 3% 5% -14% 22% 27% 15% 10%
Selling and marketing -4% 63% 22% 39% 28% 21% -32% -25% 11% -8% -14% 16% 25% 34% 16%
General and administrative -3% 22% 36% 27% 21% 27% -36% -32% -10% -17% 1% 4% 6% -3% 2%
Operating Profit nm nm nm -546% nm nm -113% -177% nm -118% nm nm nm 54% nm
Net Income 0% 0% 0% 0% nm 0% 0% 0% 0% -123% 0% 0% 0% 0% nm
Company report and Wedbush Morgan Securities estimates restated for stock options

THQ (THQI)
52-Week Range $2.23 – 21.98 ST / LT Debt $24 / 0 million

Price (as of close 6/22/09) Shares Outstanding 68 million Debt/Capital 5%
$6.85 Public Float 66 million Cash & Inv/Share $2.58
Market Capitalization $466 million Book Value/Share $4.49
Rating
BUY FYE MAR 2009A 2010E** 2011E**
EPS($)* ACTUAL CURRENT PREVIOUS CURRENT PREVIOUS
12- Month Price Target Q1 Jun $(0.38) $(0.08)E $(0.04)E
$9 Q2 Sep
Q3 Dec
(0.46)
(0.14)
(0.27)E
0.76E
(0.18)E
0.77E
Q4 Mar (0.54) (0.12)E (0.06)E
Year** $(1.52) $0.30E $0.50E
Change N/A N/A N/A
FYE MAR 2009A 2010E** 2011E**

Q1 Jun $121 $175E $176E
Q2 Sep 152 111E 139E
Q3 Dec 386 387E 423E
Q4 Mar 154 147E 162E
Year** $813 $820E $900E
Source: Nasdaq.com Change -23% 1% 10%
Company Description
THQ, headquartered in Agoura Hills, ** Numbers may not add up due to rounding. **Pro forma.
California, develops, publishes, and
distributes interactive entertainment
software for home consoles, handheld
devices, PCs, and the Internet.
THQ’s Top 10 Selling Brands for 2008 (U.S. Retail Sales $)
C Y 2008 THQ
Am ount
1 W W E $ 103
2 S a in t s R o w $ 40
3 MX Vs ATV $ 33
4 W a ll- E $ 25
5 S p o n g e B o b S q u a re P a n ts $ 25
6 C a rs $ 20
7 F r o n t lin e s : F u e l o f W a r $ 17
8 D r a w n T o L if e $ 17
9 P a w s & C la w s P e t $ 14
10 d e B lo b $ 11

COMPANY OVERVIEW
THQ, based in Agoura Hills, California, is a leading developer and publisher of games for Nintendo, Sony,
and Microsoft video game consoles as well as for the PC. Most of THQ’s games are geared toward mass-
market audiences and include recognizable product lines including World Wrestling Entertainment (WWE),
Nickelodeon (SpongeBob SquarePants), and Disney/Pixar (Cars and The Incredibles) games.
VALUATION
THQ has largely completed its restructuring, with considerable reductions in headcount, consolidation of
facilities, reductions in the planned number of titles, and overall lower spending. Its strategic plan is focusing
on fewer titles, with emphasis on fighting games, children’s games, family games and online games. The
restructuring involved the cancellation of several titles and a reduction in annual product development and
corporate spending by approximately $220 million. Recent releases have performed very strongly, with UFC
2009 Undisputed selling over 2 million units, exceeding our estimates, and Red Faction Guerilla received
review scores averaging 87%.
We are maintaining our BUY rating, and $9 price target, which reflects an enterprise value multiple of 10x
our FY:10 free cash flow estimate of $0.70 per share, plus an estimated $2/share in cash. We are using a
free cash flow multiple for THQ because we think that consensus EPS estimates do not adequately reflect
the company’s performance.
deterioration of the average selling price (ASP) for game software, the effects of competition (both from
other publishers as well as from other forms of entertainment), slower than expected consumer demand for
video game hardware, and lower demand for its games.

THQ Incorporated
Income Statement ($ millions) Jun-08 Sep-08 Dec-08 Mar-09 2009* Jun-09 Sep-09 Dec-09 Mar-10 2010* Jun-10 Sep-10 Dec-10 Mar-11 2011*
Fiscal Year End: December 31 1QA 2QA 3QA 4QA FY-A 1QE 2QE 3QE 4QE FY-E 1QE 2QE 3QE 4QE FY-E
Net Sales $121.1 $151.6 $385.6 $154.3 $812.6 $175.3 $110.8 $387.1 $146.9 $820.1 $176.4 $138.5 $423.3 $161.8 $900.0
Cost of Sales 56.1 72.7 150.8 58.3 337.9 60.7 37.9 119.6 51.9 270.0 61.4 47.8 133.0 56.9 299.1
Gross Margin 65.0 79.0 234.8 96.0 474.7 114.7 72.9 267.5 95.0 550.1 115.0 90.7 290.2 105.0 600.9
Royalties and Amortization 33.2 53.5 137.7 78.4 302.7 47.0 39.0 105.0 40.0 231.0 50.0 49.0 109.0 46.0 254.0

Product Development 33.5 23.2 23.6 23.7 104.0 22.0 22.0 26.0 22.0 92.0 24.0 24.0 28.0 24.0 100.0

Sales & Marketing 29.1 43.1 67.9 20.1 160.2 38.0 20.7 50.0 30.0 138.7 33.5 25.2 59.3 30.0 147.9
Payment to venture partner 1.5 0.9 13.4 4.0 19.7 2.0 2.0 12.0 3.0 19.0 2.0 2.0 12.0 3.0 19.0
General & Administrative 16.1 17.0 22.0 16.9 72.0 13.0 14.0 15.0 14.0 56.0 15.0 15.0 17.0 15.0 62.0
In-process R&D & Other Charges 3.5 - 158.5 45.4 207.4 10.0 - - - 10.0 - - - - -
Operating Expenses 116.9 137.7 423.1 188.3 866.0 132.0 97.7 208.0 109.0 546.7 124.5 115.2 225.3 118.0 582.9
Operating Profit (51.9) (58.7) (188.4) (92.3) (391.3) (17.3) (24.8) 59.5 (14.0) 3.4 (9.5) (24.5) 65.0 (13.0) 18.0
Interest Income & other 4.5 (2.4) 1.9 (1.5) 2.5 1.0 1.0 1.0 1.0 4.0 2.0 2.0 2.0 2.0 8.0
Income before Taxes (47.4) (61.1) (186.3) (93.7) (388.5) (16.3) (23.8) 60.5 (13.0) 7.4 (7.5) (22.5) 67.0 (11.0) 26.0
Income Taxes (14.3) 57.9 (5.8) 8.4 46.2 (1.6) (2.4) 15.1 (1.3) 9.8 (2.3) (6.7) 20.1 (3.3) 7.8
Net Income (33.1) (119.0) (180.5) (102.0) (434.7) (14.7) (21.4) 45.4 (11.7) (2.4) (5.3) (15.7) 46.9 (7.7) 18.2
Shares, Basic 66.6 66.8 67.0 67.1 66.9 67.2 67.3 67.8 68.3 67.7 68.4 68.5 69.0 69.5 68.9
Shares, Diluted 68.3 68.3 68.3 68.3 68.3 68.4 68.5 69.0 69.5 68.9 69.6 69.7 70.2 70.7 70.1
EPS Basic (GAAP) $(0.50) $(1.78) $(2.69) $(1.52) $(6.50) $(0.22) $(0.32) $0.67 $(0.17) $(0.04) $(0.08) $(0.23) $0.68 $(0.11) $0.26
EPS Diluted (GAAP) $(0.48) $(1.74) $(2.64) $(1.49) $(6.36) $(0.22) $(0.31) $0.66 $(0.17) $(0.04) $(0.08) $(0.23) $0.67 $(0.11) $0.26
EPS Basic (pro forma) $(0.38) $(0.46) $(0.14) $(0.54) $(1.52) $(0.08) $(0.27) $0.77 $(0.12) $0.30 $(0.04) $(0.18) $0.78 $(0.06) $0.50
EPS Diluted (pro forma) $(0.36) $(0.42) $(0.09) $(0.51) $(1.38) $(0.08) $(0.26) $0.76 $(0.12) $0.30 $(0.04) $(0.18) $0.77 $(0.06) $0.50
Percentage Analysis
% of Sales
Gross Margin 54% 52% 61% 62% 58% 65% 66% 69% 65% 67% 65% 65% 69% 65% 67%
Royalties 27% 35% 36% 51% 37% 27% 35% 27% 27% 28% 28% 35% 26% 28% 28%
Product Development 28% 15% 6% 15% 13% 13% 20% 7% 15% 11% 14% 17% 7% 15% 11%
Selling & Marketing 24% 28% 18% 13% 20% 22% 19% 13% 20% 17% 19% 18% 14% 19% 16%
Payment to venture partner 1% 1% 3% 3% 2% 1% 2% 3% 2% 2% 1% 1% 3% 2% 2%
General & Administrative 13% 11% 6% 11% 9% 7% 13% 4% 10% 7% 9% 11% 4% 9% 7%
Operating Profit -43% -39% -49% -60% -48.2% -10% -22% 15% -10% 0.4% -5% -18% 15% -8% 2.0%
Net Income -27% -78% -47% -66% -53% -8% -19% 12% -8% 0% -3% -11% 11% -5% 2%
Y/Y % Change
Revenue 16% -34% -24% -29% -23% 45% -27% 0% -5% 1% 1% 25% 9% 10% 10%
Gross Margin 7% -44% -30% -25% -29% 76% -8% 14% -1% 16% 0% 24% 9% 10% 9%
Royalties 26% -12% -22% -3% -12% 41% -27% -24% -49% -24% 6% 26% 4% 15% 10%
Product Development 36% -19% -43% -31% -19% -34% -5% 10% -7% -12% 9% 9% 8% 9% 9%
Selling & Marketing 27% -9% 4% -50% -9% 31% -52% -26% 50% -13% -12% 21% 19% 0% 7%
Payment to venture partner 62% -21% -30% 41% -18% 37% 122% -10% -24% -4% 0% 0% 0% 0% 0%
General & Admininstrative -16% -4% 42% -4% 3% -19% -18% -32% -17% -22% 15% 7% 13% 7% 11%
Operating Profit nm nm -1292% nm nm nm nm nm nm nm nm nm 9% nm 428%
Net Income nm nm -1264% nm nm nm nm nm nm nm nm nm 3% nm nm
*Pro forma

Ubisoft Entertainment (UBI.FP)
52-Week Range €9.66 – 35.50 ST / LT Debt €62 / €23 million

€16.49 Public Float 44 million Cash & Inv/Share €2.47
Market Capitalization €2 billion Book Value/Share €7.83
Rating
BUY FYE MAR 2009A 2010E 2011E
EPS(€)** ACTUAL CURRENT PREVIOUS CURRENT PREVIOUS
12- Month Price Target 1H – Sep €0.24 €(0.19)E €(0.10)E
€21 2H – Mar 0.47 1.09E 1.14E
Year* €0.71 €0.91E €1.05E
Change -38% 28% 15%
$33
FYE MAR 2009A 2010E 2011E
10
$28 Revenue (€ mil.) ACTUAL CURRENT PREVIOUS CURRENT PREVIOUS
8
$23
Q1 Jun €169 €98E €128E
6
Q2 Sep 175 140E 160E
$18
4 Q3 Dec 508 647E 670E
2 $13 Q4 Mar 20 315E 343E
Year* €1,058 €1,200E €1,300E
0 $8
J J A S O N D J F M A M
Change 14% 13% 8%
Source: Thomson
Company Description ** Numbers may not add up due to rounding.

Ubisoft Entertainment, based in
Montreuil-sous-Bois, France, is a
leading worldwide developer,
publisher, and distributor of interactive
entertainment products.
Ubisoft’s Top 10 Selling Brands for 2008 (U.S. Retail Sales $)

C Y 2008 U B IS O F T
Am ount
1 T o m C la n c y $ 130
2 I m a g in e $ 78
3 P e tz $ 70
4 S h a u n W h it e S n o w b o a r d in g $ 49
5 A s s a s s in 's C r e e d $ 41
6 R a ym a n $ 40
7 P r in c e O f P e r s ia $ 33
8 F a r C ry $ 25
9 B ro th e rs In A rm s $ 21
10 M y C oach $ 18

COMPANY OVERVIEW
Ubisoft Entertainment, based in Montreuil-sous-Bois, France, is a leading developer, publisher, and

distributor of interactive entertainment products. Through a combination of organic growth and acquisitions,
the company has grown significantly over the past several years to its current position as a top tier global
video game publisher. Ubisoft has a deep and varied portfolio of strong selling video game franchises and
brands. These include Rayman, Tom Clancy’s Rainbow Six/Splinter Cell/Ghost Recon, Prince of Persia, The
Settlers, Assassin’s Creed, and Far Cry.
VALUATION
Our thesis on Ubisoft has been that the company is well-positioned to deliver meaningful upside to revenue
and earnings in FY:10. In our view, the FY:10 lineup, consisting of Assassin’s Creed 2, Ghost Recon 4,
Splinter Cell Conviction, Avatar, Red Steel 2, I Am Alive, R.U.S.E. and several recurring franchises, has the
potential to generate €250 – 400 million in revenue growth when compared to the FY:08 lineup. That year,
the company had Assassin’s Creed, Ghost Recon, and several family and licensed titles, and managed to
deliver €928 million in revenue and a 14.3% operating profit (before stock options expense). In our view,
Ubisoft’s FY:10 lineup has the potential to generate between €1.2 – 1.33 billion in revenue.
We note that most of its major FY:10 games (Assassin’s Creed 2, Splinter Cell Conviction, and Avatar)
showed very well at the E3 Expo, and have the potential to exceed our estimates though we believe the
back end loaded revenue profile may limit upside to guidance.
We are maintaining our BUY rating, and our €21 price target, which reflects a forward P/E multiple of 18.5x
our FY:11 adjusted EPS estimate of €1.02 plus €2/share in cash. Ubisoft shares have historically traded at a
forward multiple of 24 – 30x, and our target reflects a premium of 20% to the S&P 500 multiple, well below
its historical 25 – 50% premium to reflect recent industry weakness.
deterioration of the average selling price (ASP) for game software, the effects of competition, foreign
exchange changes, and lower than expected consumer demand for video game hardware.

Ubisoft Entertainment
Income Statement (euros millions) Jun-08 Sep-08 Dec-08 Mar-09 6-Months 2009 Jun-09 Sep-09 Dec-09 Mar-10 6-Months 2010 Jun-10 Sep-10 Dec-10 Mar-11 6-Months 2011
Fiscal Year End: March 31 1QA 2QA 3QA 4QA 1H09A 2H09A FY-A 1QE 2QE 3QE 4QE 1H10E 2H10E FY-E 1QE 2QE 3QE 4QE 1H11E 2H11E FY-E
Total Revenues 169.0 175.5 507.8 205.6 344.5 713.4 1,057.9 98.1 140.3 646.9 314.8 238.4 961.6 1,200.0 127.5 160.1 669.8 342.6 287.6 1,012.4 1,300.0
Cost of Revenues 142.9 275.5 418.4 94.6 341.8 436.4 110.8 359.0 469.8
Gross Profits 201.6 437.9 639.5 143.7 619.8 763.5 176.8 653.3 830.1
Product Development 60.7 185.6 246.3 80.0 250.0 330.0 90.0 260.0 350.0
Sales & Marketing 107.9 96.3 204.2 60.0 155.0 215.0 65.0 164.0 229.0
G&A 0.0 60.2 60.2 25.0 45.0 70.0 30.0 50.0 80.0
Depreciation and Amortization 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Restructuring and Other 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Total Costs and Expenses 168.6 342.2 510.8 165.0 450.0 615.0 185.0 474.0 659.0

Operating income (w/o stock comp) 33.0 95.7 128.7 (21.3) 169.8 148.5 (8.2) 179.3 171.1
Stock comp expense 8.1 8.8 16.9 8.0 9.0 17.0 8.0 9.0 17.0
Operating income 24.9 87.0 111.9 (29.3) 160.8 131.5 (16.2) 170.3 154.1
Interest income (expense), net 1.7 (0.8) 0.9 2.0 2.0 4.0 2.0 2.0 4.0
Other income (expense), net 10.2 (14.4) (4.2) 0.0 0.0 0.0 0.0 0.0 0.0
Income (loss) before income tax provision 36.8 71.8 108.6 (27.3) 162.8 135.5 (14.2) 172.3 158.1
Income tax provision (benefit) 12.7 27.1 39.8 (9.5) 57.0 47.4 (5.0) 60.3 55.3
Net income (loss) 24.1 44.7 68.8 (17.7) 105.8 88.1 (9.2) 112.0 102.8
Shares, Basic 93.4 94.4 93.9 95.4 96.4 95.9 95.4 96.4 95.9
Shares, Diluted 99.2 96.0 97.2 96.5 97.0 96.8 97.5 98.0 97.8
EPS Basic (GAAP) € 0.26 € 0.47 € 0.73 (€ 0.19) € 1.10 € 0.92 (€ 0.10) € 1.16 € 1.07
EPS Diluted (GAAP) € 0.24 € 0.47 € 0.71 (€ 0.18) € 1.09 € 0.91 (€ 0.09) € 1.14 € 1.05
EPS Basic (w/o stock comp) € 0.32 € 0.54 € 0.86 (€ 0.13) € 1.16 € 1.04 (€ 0.04) € 1.23 € 1.20
EPS Diluted (w/o stock comp) € 0.30 € 0.53 € 0.83 (€ 0.13) € 1.16 € 1.03 (€ 0.04) € 1.21 € 1.17
Percentage Analysis
% of Sales
Gross Margin 58.5% 61.4% 60.5% 60.3% 64.5% 63.6% 61.5% 64.5% 63.9%
Product Development 18% 26% 23% 34% 26% 28% 31% 26% 27%
Sales & Marketing 31% 14% 19% 25% 16% 18% 23% 16% 18%
G&A 0% 8% 6% 10% 5% 6% 10% 5% 6%
Depreciation and Amortization 0% 0% 0% 0% 0% 0% 0% 0% 0%
Operating Income (w/o stock option) 9.6% 13.4% 12.2% -8.9% 17.7% 12.4% -2.8% 17.7% 13.2%
Net Income 7% 6% 7% -7% 11% 7% -3% 11% 8%
Y/Y % Change
Revenue 26% 38% 13% -5% 32% 7% 14% -42% -20% 27% 53% -31% 35% 13% 14% 4% 9% 21% 21% 5% 8%
Gross Margin 20% -2% 4% -29% 42% 19% 23% 5% 9%
Product Development -25% 1% -7% 32% 35% 34% 13% 4% 6%
Sales & Marketing 40% -32% -7% -44% 61% 5% 8% 6% 7%
Operating Income (w/o stock option) 261% -23% -3% -165% 77% 15% nm 6% 15%
Net Income -21% -44% -37% -174% 136% 28% nm 6% 17%

Best Buy (BBY)
52-Week Range $16.42 – 48.99 ST / LT Debt $1.0 B / $1.1 B

Market Capitalization $14 billion Book Value/Share $12.92
Rating
HOLD FYE FEB 2009A 2010E 2011E
12- Month Price Target Q1 May 0.43 $0.42A $0.50E
$40 Q2 Aug 0.48 0.46E 0.55E
Q3 Nov 0.35 0.43E 0.49E
Q4 Feb 1.61 1.69E 1.87E
Year** $2.87 $3.00E $3.40E
Change -8.0% 4.5% 13.6%
FYE FEB 2009A 2010E 2011E

Q1 May 8,990 $10,095A $10,611E
Q2 Aug 9,801 10,990E 11,697E
Q3 Nov 11,500 11,649E 12,682E
Q4 Feb 14,724 15,422E 16,965E
Year** $45,015 48,155E 51,955E
Change 12.5% 7.0% 7.9%
Source: Nasdaq.com *Excludes non-recurring charges.
Company Description ** Numbers may not add up due to rounding.

Best Buy is a specialty retailer of
consumer electronics, home office
products, entertainment software,
appliances, and related services
primarily in the United States, Canada,
and China.

COMPANY OVERVIEW
Best Buy is a specialty retailer of consumer electronics, home office products, entertainment software,
appliances and related services under multiple brand names throughout the world. These include:
-923 U.S. Best Buy stores in 49 states, the District of Columbia and Puerto Rico that averaged
approximately 39,700 retail square feet.
-19 Pacific Sales stores in California that averaged approximately 34,000 retail square feet.
-12 Magnolia Audio Video stores in California, Oregon and Washington that averaged approximately 11,600
retail square feet..
-Nine Best Buy Mobile stand-alone stores in New York and North Carolina that averaged approximately
1,400 retail square feet.
-Seven Geek Squad stand-alone stores in California, Colorado, Georgia, Minnesota and Texas that
averaged approximately 2,000 retail square feet.
-121 Future Shop stores throughout all of Canada's provinces and 51 Canada Best Buy stores in seven
provinces: Alberta, British Columbia, Manitoba, Nova Scotia, Ontario, Quebec and Saskatchewan.
-160 Five Star stores in seven of China's 34 provinces and one China Best Buy store in Shanghai
VALUATION
We continue to believe that Best Buy’s earnings leverage is under-appreciated by the Street. The company
not only continues to gain market share, but is controlling costs extremely well. SG&A spend is expected to
be roughly flat with last year, despite a major integration of Best Buy Europe and continued store expansion.
Even on a disappointing comp number, gross margins in the company’s core domestic business expanded
70 bps vs. last year and pro forma EPS was roughly flat with a year ago. In other words, while facing
formidable internal and external challenges, the company has managed to earn roughly the same amount of
money as it did during better times.
Maintaining our HOLD rating and $40 price target. Our price target reflects a P/E multiple of just under 12.0x
our FY 2011 (calendar 2010) EPS estimate of $3.40, slightly lower than the company’s historical 13 – 15x
multiple to account for market contraction.
Risks to attainment of our share price target include changes to the macroeconomic outlook, variability in
new product release timing, the effects of competition from other consumer electronic and big-box retailers
and changes in consumer demand for consumer electronics.

Best Buy
Income Statement ($ millions) 2008 May-08 Aug-08 Nov-08 Feb-09 2009 May-09 Aug-09 Nov-09 Feb-10 2010 2011
Fiscal Year End: February 28 FY-A Q1A Q2A Q3A Q4A FY-A Q1A Q2E Q3E Q4E FY-E FY-E
BBY Domestic revenue 33,328 7,453 8,133 8,196 11,288 35,070 7,525 8,231 8,373 11,812 35,941 38,566
BBY International revenue 6,695 1,537 1,668 3,304 3,436 9,945 2,570 2,759 3,276 3,610 12,214 13,388
Total revenue 40,023 8,990 9,801 11,500 14,724 45,015 10,095 10,990 11,649 15,422 48,155 51,955
BBY Domestic COGS 25,170 5,633 6,107 6,197 8,513 26,450 5,637 6,156 6,331 8,932 27,055 29,010
BBY International COGS 5,308 1,224 1,313 2,442 2,588 7,566 1,901 2,047 2,424 2,693 9,065 9,927
Total cost of revenue 30,478 6,857 7,420 8,639 11,101 34,016 7,538 8,203 8,755 11,624 36,120 38,937
Gross profit 9,545 2,133 2,381 2,861 3,623 10,999 2,557 2,787 2,894 3,797 12,035 13,018
Consolidated gross margin 23.8% 23.7% 24.3% 24.9% 24.6% 24.4% 25.3% 25.4% 24.8% 24.6% 25.0% 25.1%
Domestic SG&A 6,163 1,544 1,711 1,714 1,750 6,719 1,560 1,740 1,743 1,801 6,844 7,275
International SG&A 1,224 312 331 873 749 2,265 649 709 832 812 3,002 3,282
Total selling, general & admin 7,387 1,856 2,042 2,587 2,499 8,984 2,209 2,449 2,575 2,613 9,846 10,557
Consolidated SG&A margin 18.5% 20.6% 20.8% 22.5% 17.0% 20.0% 21.9% 22.3% 22.1% 16.9% 20.4% 20.3%
BBY Domestic op income, adj 1,995 277 315 283 1,025 1,901 328 335 300 1,079 2,042 2,281
BBY International op income, adj 163 0 24 (9) 99 114 20 3 20 105 147 179
Total operating income 2,158 277 339 274 1,124 2,015 348 338 319 1,184 2,189 2,460
Consoldiated operating margin 5.4% 3.1% 3.5% 2.4% 7.6% 4.5% 3.4% 3.1% 2.7% 7.7% 4.5% 4.7%
Investment impairment, restructuring (111) (144) (255) (52) (25) (77)

Net interest expense (income) (67) (8) 12 38 17 59 14 16 25 8 63 56
Earnings bef tax and min. interests 2,225 285 327 125 963 1,701 282 297 294 1,176 2,049 2,404
Provision for income taxes 815 106 122 68 378 674 126 113 112 437 788 923
Minority interests (3) (11) (17) (31) 0 (3) (3) (17) (23) (31)
Equity in earnings (loss) of affiliates 6 2 8 (3) (3) 3 3 0 12
Net Income - pro forma 1,411 179 202 52 570 1,004 153 178 182 724 1,238 1,462
Basic Shares 440.0 411.4 412.1 412.9 413.6 412.5 415.2 416.2 416.7 417.2 416.3 418.2
Diluted Shares 452.5 423.4 423.3 422.6 423.2 423.1 425.7 426.7 427.5 428.0 427.0 429.5
Basic EPS (GAAP) 3.21 0.44 0.49 0.13 1.38 2.43 0.37 0.43 0.44 1.74 2.97 3.50
Diluted EPS (GAAP) 3.12 0.42 0.48 0.13 1.35 2.38 0.36 0.42 0.43 1.69 2.90 3.40
Diluted EPS (pro forma) 3.12 0.43 0.48 0.35 1.61 2.87 0.42 0.46 0.43 1.69 3.00 3.40
Comps FY 2008 May-08 Aug-08 Nov-08 Feb-09 FY 2009 May-09 Aug-09 Nov-09 Feb-10 FY 2010 FY 2011
Domestic comps 1.9% 3.5% 5.3% -6.3% -4.8% -1.3% -4.9% -5.0% -1.0% 1.5% -1.9% 2.7%
International comps 9.0% 4.7% -1.0% 0.3% -5.3% -0.9% -13.9% -7.0% -3.0% 2.5% -3.1% 2.9%
Total comp-store sales 2.9% 3.7% 4.2% -5.3% -4.9% -1.0% -6.2% -5.3% -1.6% 1.7% -2.1% 2.7%
Income Statement Ratios FY 2008 May-08 Aug-08 Nov-08 Feb-09 FY 2009 May-09 Aug-09 Nov-09 Feb-10 FY 2010 FY 2011
BBY Domestic
Gross margin 24.5% 24.4% 24.9% 24.4% 24.6% 24.6% 25.1% 25.2% 24.4% 24.4% 24.7% 24.8%
SG&A margin 18.5% 20.7% 21.0% 20.9% 15.5% 19.2% 20.7% 21.1% 20.8% 15.3% 19.0% 18.9%
Operating margin 6.0% 3.7% 3.9% 3.5% 9.1% 5.4% 4.4% 4.1% 3.6% 9.1% 5.7% 5.9%
BBY International
Gross margin 20.7% 20.4% 21.3% 26.1% 24.7% 23.9% 26.0% 25.8% 26.0% 25.4% 25.8% 25.9%
SG&A margin 18.3% 20.3% 19.8% 26.4% 21.8% 22.8% 25.3% 25.7% 25.4% 22.5% 24.6% 24.5%
Operating margin 2.4% 0.0% 1.5% -0.3% 2.9% 1.1% 0.8% 0.1% 0.6% 2.9% 1.2% 1.3%
CONSOLIDATED
Gross margin 23.8% 23.7% 24.3% 24.9% 24.6% 24.4% 25.3% 25.4% 24.8% 24.6% 25.0% 25.1%
SG&A margin 18.5% 20.6% 20.8% 22.5% 17.0% 20.0% 21.9% 22.3% 22.1% 16.9% 20.4% 20.3%
Operating margin 5.4% 3.1% 3.5% 2.4% 7.6% 4.5% 3.4% 3.1% 2.7% 7.7% 4.5% 4.7%
Net margin 3.5% 2.0% 2.1% 0.5% 3.9% 2.2% 1.5% 1.6% 1.6% 4.7% 2.6% 2.8%
Tax Rate 36.6% 37.2% 37.3% 54.4% 39.2% 39.6% 44.7% 38.0% 38.0% 37.2% 38.5% 38.4%

Blockbuster (BBI)
52-Week Range $0.13 – 3.19 ST / LT Debt (mil) $881 / 0

Market Capitalization $167 million Book Value/Share $1.12
Rating
STRONG BUY FYE DEC 2008A 2009E 2010E
12- Month Price Target $0.20 $0.12A $0.07E
Q1 Mar
$2.50 Q2 Jun (0.20) (0.07)E 0.02E
Q3 Sep (0.08) (0.02)E 0.00E
Q4 Dec 0.40 0.24E 0.27E
Year** $0.35 $0.28E $0.35E
P/E Ratio 2x 3x 2x
Change N/A -20% 25%
FYE DEC 2008A 2009E 2010E

Q1 Mar $1,394 $1,122A $1,167E
Q2 Jun 1,305 1,131E 1,096E
Q3 Sep 1,205 1,123E 1,076E
Q4 Dec 1,385 1,372E 1,288E
Year** $5,288 $4,748E $4,627E
Change -5% -10% -3%
*Excludes non-recurring charges.
Source: Nasdaq.com
Company Description
Blockbuster, based in Dallas, Texas, is
the largest specialty retailer of rentable
home videocassettes (VHS), DVDs
and video games in the world.

COMPANY OVERVIEW
Blockbuster, headquartered in Dallas, Texas, is the largest specialty retailer of rentable DVDs and video
games in the world. The company has approximately 7,000 company operated and franchised stores in 28
countries. Blockbuster’s customer transaction database contains more than 51 million U.S. and Canadian
household member accounts. International revenue accounts for about 20% of total revenues. Its Total
Access online rental and Game Rush store within a store video game specialty retailer concept have proven
to be growth drivers for the company.
VALUATION
Investment in Blockbuster requires two acts of faith: first, investors must believe that this management team
has sufficient control over the company’s cost structure to deliver on its promises to generate over $300
million of EBITDA annually and to repay debt aggressively; and second, investors must believe that the
rental industry is not in a death spiral that will cause Blockbuster’s revenues to decline at a rate that cannot
be saved by aggressive cost cutting. We are confident that the first act of faith is well-placed; we are less
confident about the second, given the precipitous decline in same store sales during the first quarter, but we
agree that the theatrical release schedule was sufficiently strong to drive improving comps in the middle part
of the year.
We believe Blockbuster’s valuation is compelling. At an enterprise value of 3x EBITDA, the company is

trading at less than half its historical valuation. We understand that investors may remain skeptical so long
as comps are negative.
Maintaining STRONG BUY, and our 12-month price target of $2.50, which reflects an EV/EBITDA multiple of
4x our 2009 EBITDA estimate of $320 million. This multiple is less than half of Blockbuster’s historical
multiple, reflecting recent market contraction, credit concerns and execution risks.
Risks to attainment of our share price target include changes to movie release timing, the effects of
competition (both from other video rental companies and other forms of entertainment), greater than
expected weakness in consumer demand for video rentals, online subscriber attrition, and debt repayment
risk.

Blockbuster Inc.
Income Statement ($ millions) Mar-08 Jun-08 Sep-08 Dec-08 2008 Mar-09 Jun-09 Sep-09 Dec-09 2009 Mar-10 Jun-10 Sep-10 Dec-10 2010
Fiscal Year End: December 31 Q1A Q2A Q3A Q4A FY-A Q1A Q2E Q3E Q4E FY-E Q1E Q2E Q3E Q4E FY-E
Rental revenues 1,076.3 972.3 899.9 917.3 3,865.8 860.7 785.7 779.8 847.4 3,273.5 844.9 765.3 757.0 798.1 3,165.3
Merchandise revenues 309.8 323.8 297.9 457.9 1,389.4 255.5 339.1 337.4 515.1 1,447.2 315.7 325.8 313.8 484.0 1,439.3
Other 8.0 8.4 6.8 9.5 32.7 6.0 6.0 6.0 9.0 27.0 6.0 5.0 5.0 6.0 22.0
Total revenue 1,394.1 1,304.5 1,204.6 1,384.7 5,287.9 1,122.2 1,130.8 1,123.2 1,371.5 4,747.7 1,166.6 1,096.1 1,075.8 1,288.1 4,626.6
Cost of rental revenues 410.5 397.5 329.3 329.7 1,467.0 314.2 288.4 288.3 311.6 1,202.5 312.5 288.8 287.0 296.9 1,185.2
Cost of merchandise sold 241.9 251.8 232.0 372.7 1,098.4 217.3 253.9 252.5 381.5 1,105.2 232.9 240.3 230.2 351.2 1,054.7
Cost of sales 652.4 649.3 561.3 702.4 2,565.4 531.5 542.3 540.8 693.1 2,307.7 545.5 529.1 517.2 648.1 2,239.9
Gross profit 741.7 655.2 643.3 682.3 2,722.5 590.7 588.5 582.4 678.4 2,440.0 621.1 567.0 558.6 640.0 2,386.7
Selling, General & Admin expenses 596.9 599.6 573.2 519.2 2,288.9 488.4 515.4 501.8 518.4 2,024.0 515.5 489.2 479.8 480.4 1,964.9
Share-based comp 4.2 5.6 2.9 5.0 17.7 5.0 3.0 3.0 6.0 17.0 5.0 4.0 4.0 5.0 18.0
Advertising 30.5 31.9 32.4 27.2 122.0 12.4 24.9 23.6 28.8 89.7 25.7 24.1 23.7 28.3 101.8
Depreciation 39.9 37.9 37.1 37.3 152.2 34.8 33.0 30.0 30.0 127.8 27.0 27.0 25.0 25.0 104.0

Amortization 0.0 0.0 0.0 435.0 435.0 0.0 2.0 3.0 2.0 7.0 0.0 0.0 0.0 0.0 0.0
Operating Income 70.2 (19.8) (2.3) (341.4) (293.3) 50.1 10.2 21.0 93.2 174.6 48.0 22.6 26.1 101.3 198.0
Interest expenses (income) 18.1 17.9 17.4 17.2 70.6 17.2 21.1 22.8 30.8 92.0 22.5 16.0 19.1 27.5 85.1
Other expenses (income) (0.1) 0.0 (5.8) (9.5) (15.4) (0.4) 0.0 0.0 (2.3) (2.7) 0.0 0.0 0.0 0.0 0.0
Total non-operating (income)/expense18.0 17.9 11.6 7.7 55.2 16.8 21.1 22.8 28.5 89.3 22.5 16.0 19.1 27.5 85.1
Pretax Income 52.2 (37.7) (13.9) (349.1) (348.5) 33.3 (10.9) (1.8) 64.7 85.2 25.5 6.6 7.0 73.8 112.9
Provision for income taxes 6.8 4.2 3.9 10.7 25.6 5.6 2.0 2.0 11.9 21.5 10.0 3.0 7.0 13.8 33.8
Preferred div and other (2.8) (2.8) (2.8) (2.9) (11.3) (2.8) (2.8) (2.8) (2.8) (11.2) (2.8) (2.8) (2.8) (2.8) (11.2)
Net Income 42.6 (44.7) (20.6) (362.7) (385.4) 24.9 (15.7) (6.6) 49.9 52.5 12.7 0.8 (2.8) 57.2 68.0
Nonrecurring/noncash adjustments (2.8) (5.8) (5.0) (440.2) (453.8) (2.8) (2.8) (2.8) (2.8) (11.2) (2.8) (2.8) (2.8) (2.8) (11.2)
Net Income (pro forma) 45.4 (38.9) (15.6) 77.5 68.4 27.7 (12.9) (3.8) 52.7 63.7 15.5 3.6 0.0 60.0 79.2
Basic Shares 191.4 191.9 192.1 192.1 191.8 192.7 193.2 193.7 194.2 193.5 194.7 195.2 195.7 196.2 195.5
Diluted Shares 221.5 222.0 222.5 192.1 193.0 222.8 223.3 223.8 224.3 223.6 224.8 225.3 225.8 226.3 225.6
Basic EPS (GAAP) 0.22 (0.23) (0.11) (1.89) (2.01) 0.13 (0.08) (0.03) 0.26 0.27 0.07 0.00 (0.01) 0.29 0.35
Diluted EPS (GAAP) 0.19 (0.20) (0.09) (1.89) (2.00) 0.11 (0.07) (0.03) 0.22 0.23 0.06 0.00 (0.01) 0.25 0.30
Basic EPS (pro forma) 0.24 (0.20) (0.08) 0.40 0.36 0.14 (0.07) (0.02) 0.27 0.33 0.08 0.02 0.00 0.31 0.41
Diluted EPS (pro forma) 0.20 (0.18) (0.07) 0.40 0.35 0.12 (0.06) (0.02) 0.24 0.28 0.07 0.02 0.00 0.27 0.35
EBITDA
EBITDA (unadjusted) 110.10 18.10 34.80 (304.10) (141.10) 85.10 45.25 54.01 125.20 309.56 75.02 49.65 51.12 126.25 302.04
Adjustments 4.40 9.00 5.40 3.60 22.40 13.30 3.00 3.00 6.00 25.30 5.00 4.00 4.00 5.00 18.00
Adjusted EBITDA 114.50 27.10 40.20 (300.50) (118.70) 98.40 48.25 57.01 131.20 334.86 80.02 53.65 55.12 131.25 320.04
Income Statement Ratios

Gross margin 53.2% 50.2% 53.4% 49.3% 51.5% 52.6% 52.0% 51.9% 49.5% 51.4% 53.2% 51.7% 51.9% 49.7% 51.6%
SG&A 42.8% 46.0% 47.6% 37.5% 43.3% 43.5% 45.6% 44.7% 37.8% 42.6% 44.2% 44.6% 44.6% 37.3% 42.5%
Advertising 2.2% 2.4% 2.7% 2.0% 2.3% 1.1% 2.2% 2.1% 2.1% 1.9% 2.2% 2.2% 2.2% 2.2% 2.2%
Operating margin 5.0% -1.5% -0.2% -24.7% -5.5% 4.5% 0.9% 1.9% 6.8% 3.7% 4.1% 2.1% 2.4% 7.9% 4.3%
Net margin 3.1% -3.4% -1.7% -26.2% -7.3% 2.2% -1.4% -0.6% 3.6% 1.1% 1.1% 0.1% -0.3% 4.4% 1.5%
Tax Rate 13.0% -11.1% -28.1% -3.1% -7.3% 16.8% -18.4% -109.0% 20.0% 25.3% 39.1% 45.5% 99.9% 20.0% 29.9%
Year-over-Year Changes
Comps 1.4% 9.0% 1.9% 3.7% 3.9% -9.6% -8.5% -2.0% 4.5% -3.9% 10.5% 2.5% 0.8% -1.0% 3.2%
Store unit growth -5.9% -3.3% -4.2% -5.4% -5.4% -5.9% -6.3% -6.5% -6.1% -6.1% -6.0% -5.6% -5.3% -5.4% -5.4%
Net Sales -5.4% 3.3% -2.7% -11.6% -4.6% -19.5% -13.3% -6.8% -1.0% -10.2% 4.0% -3.1% -4.2% -6.1% -2.6%
Gross Profit -2.7% 3.1% -3.7% -14.4% -4.9% -20.4% -10.2% -9.5% -0.6% -10.4% 5.2% -3.7% -4.1% -5.7% -2.2%
SG&A -7.7% -2.7% -3.9% -18.1% -8.2% -18.2% -14.0% -12.5% -0.2% -11.6% 5.5% -5.1% -4.4% -7.3% -2.9%
Operating Income -481.5% -78.3% -60.3% -552.8% 629.6% -28.6% -151.7% -1013.7% -127.3% -159.5% -4.2% 121.1% 24.3% 8.6% 13.5%
Net Income -192.3% -66.4% -58.7% 89.0% -141.5% -39.0% -66.9% -75.4% -32.0% -6.9% -43.9% -127.9% -100.2% 13.8% 24.3%
Source: Company reports and Wedbush Morgan Securities estimates

GameStop (GME)
Price (as of close 6/22/09) 52-Week Range $16.91 – 48.53 ST / LT Debt (mil) $0 / 496
$21.96 Insider/Institutional 7% / 90% ROE 22%
Rating Market Capitalization $4 billion Book Value/Share $14.42
BUY
FYE JAN 2008A 2009E 2010E
12- Month Price Target EPS($)* ACTUAL CURRENT PREVIOUS CURRENT PREVIOUS
$29 Q1 Apr
Q2 Jul
$0.38
0.34
$0.43A
0.34E
$0.50E
0.49E
Q3 Oct 0.34 0.48E 0.54E
Q4 Jan 1.34 1.68E 1.77E
Year** $2.40 $2.93E $3.30E
P/E Ratio 9x 8x 7x
Change 33% 22% 13%
FYE JAN 2008A 2009E 2010E

Q1 Apr $1,814 $1,981A $2,070E
Q2 Jul 1,804 1,816E 1,920E
Q3 Oct 1,696 1,899E 1,961E
Q4 Jan 3,492 3,705E 3,835E
Source: Nasdaq.com Year** $8,806 $9,400E $9,786E
Change 24% 7% 4%
Company Description *Excludes non-cash charges for amortization of goodwill and intangibles, restructuring,
GameStop, based in Grapevine, TX, is and non-recurring charges.
the largest video game and PC
entertainment software specialty retailer ** Numbers may not add up due to rounding.
in the world, with more than 6,200
stores.

COMPANY OVERVIEW
GameStop, based in Grapevine, Texas, is the largest video game and PC entertainment software specialty
retailer in the United States with over 6,000 stores. GameStop also operates an e-commerce web site under
the name www.gamestop.com/www.ebgames.com and publishes Game Informer, one of the industry’s most
popular video game magazines in the U.S. with a subscriber base of over three million.
In October 2005, GameStop completed its acquisition of Electronics Boutique for $1.7 billion in cash and
stock. Prior to the merger, Electronics Boutique was the second largest specialty retailers of video game and
PC entertainment software, with over 2,200 stores worldwide.
VALUATION
We find GameStop a compelling investment at these levels. We do not think that the end is near, and think
that the company is in a good position to grow its used business by compressing the time between new
game releases and when it is willing to offer trade-in credits for used games. By so doing, GameStop can
drive used game pricing higher, and will drive its gross profits correspondingly higher.
In our view, GameStop can grow earnings through used game growth. With higher pricing comes
disproportionate growth, higher gross profits, and higher EPS. We think that the used business can grow at
a 20% rate for several more years.
Maintaining BUY, and our $29 price target, which reflects a multiple of 8.7x our FY:10 EPS estimate of
$3.30. This multiple is a 30% discount to the S&P 500 forward multiple, reflecting slowing comp growth,
recent market multiple contraction, and a higher likelihood of digital distribution.
Risks to attainment of our share price target include changes to game release timing, the effects of
competition, limited supply of video game products, and slower than expected consumer demand for video
game hardware and software.

GameStop Corp.
Income Statement ($ millions) Apr-08 Jul-08 Oct-08 Jan-09 2008 Apr-09 Jul-09 Oct-09 Jan-10 2009 Apr-10 Jul-10 Oct-10 Jan-11 2010
Fiscal Year End: January 31 Q1A Q2A Q3A Q4A FY-A Q1A Q2E Q3E Q4E FY-E Q1E Q2E Q3E Q4E FY-E
Total revenue 1,813.6 1,804.4 1,695.7 3,492.1 8,805.9 1,980.8 1,815.6 1,899.4 3,704.5 9,400.3 2,069.9 1,920.2 1,961.0 3,834.5 9,785.6
Cost of sales 1,340.2 1,320.3 1,222.3 2,652.9 6,535.8 1,438.6 1,306.2 1,365.4 2,751.2 6,861.5 1,503.9 1,374.2 1,405.8 2,843.6 7,127.5
Gross profit 473.4 484.1 473.4 839.2 2,270.1 542.1 509.4 534.0 953.3 2,538.8 566.0 546.0 555.2 990.9 2,658.1
Selling, General & Admin expenses 316.9 339.4 326.9 426.3 1,409.6 367.8 361.3 349.5 452.0 1,530.6 382.9 364.8 358.9 467.8 1,574.4
Depreciation & Amortization 34.8 36.3 35.8 38.1 145.0 37.8 39.0 39.0 39.0 154.8 39.0 39.0 39.0 39.0 156.0
Stock-based comp 11.8 8.3 8.8 7.0 35.9 8.0 8.3 9.4 10.4 36.1 8.5 8.3 9.3 9.8 35.9
Restructuring & Other Charges 16.6 (12.0) 4.6 0.0 0.0

Operating Income 109.9 100.1 85.3 379.8 675.1 128.5 100.8 136.1 451.9 817.2 135.6 133.8 148.0 474.3 891.8

Interest expenses (income) 8.5 9.2 8.8 12.3 38.8 11.7 10.5 10.4 10.5 43.0 5.0 5.9 5.1 5.9 21.8
Other expenses (income) 2.3 0.0 0.0 0.0 2.3 2.9 0.0 0.0 0.0 2.9 0.0 0.0 0.0 0.0 0.0
Total non-operating (income)/expense 10.8 9.2 8.8 12.3 41.2 14.5 10.5 10.4 10.5 45.9 5.0 5.9 5.1 5.9 21.8
Pretax Income 99.1 90.9 76.5 367.5 634.0 113.9 90.3 125.7 441.5 771.3 130.7 128.0 142.9 468.4 869.9
Provision for income taxes 37.0 33.7 29.9 135.2 235.7 43.5 32.5 45.2 158.9 280.2 47.0 46.1 51.5 168.6 313.2
Net Income 62.1 57.2 46.7 232.3 398.3 70.4 57.8 80.4 282.5 491.2 83.6 81.9 91.5 299.8 556.8
Nonrecurring expense/(income), after tax (2.3) 0.0 (10.5) 8.2 (4.6) (1.8) 0.0 0.0 0.0 (1.8) 0.0 0.0 0.0 0.0 0.0
Net Income (pro forma) 64.4 57.2 57.1 224.2 402.9 72.2 57.8 80.4 282.5 493.0 83.6 81.9 91.5 299.8 556.8
Basic Shares 161.8 163.4 163.7 163.8 163.2 164.5 164.6 164.8 165.0 164.7 165.1 165.2 165.4 165.6 165.3
Diluted Shares 167.4 168.1 168.0 167.2 167.7 168.0 168.1 168.3 168.5 168.2 168.6 168.7 168.9 169.1 168.8
Basic EPS (GAAP) 0.38 0.35 0.29 1.42 2.44 0.43 0.35 0.49 1.71 2.98 0.51 0.50 0.55 1.81 3.37
Diluted EPS (GAAP) 0.37 0.34 0.28 1.39 2.38 0.42 0.34 0.48 1.68 2.92 0.50 0.49 0.54 1.77 3.30
Basic EPS (pro forma) 0.40 0.35 0.35 1.37 2.47 0.44 0.35 0.49 1.71 2.99 0.51 0.50 0.55 1.81 3.37
Diluted EPS (pro forma) 0.38 0.34 0.34 1.34 2.40 0.43 0.34 0.48 1.68 2.93 0.50 0.49 0.54 1.77 3.30
Income Statement Ratios

Gross margin 26.1% 26.8% 27.9% 24.0% 25.8% 27.4% 28.1% 28.1% 25.7% 27.0% 27.3% 28.4% 28.3% 25.8% 27.2%
SG&A 17.5% 18.8% 19.3% 12.2% 16.0% 18.6% 19.9% 18.4% 12.2% 16.3% 18.5% 19.0% 18.3% 12.2% 16.1%
Depreciation&Amortization 1.9% 2.0% 2.1% 1.1% 1.6% 1.9% 2.1% 2.1% 1.1% 1.6% 1.9% 2.0% 2.0% 1.0% 1.6%
Stock-based comp 0.6% 0.5% 0.5% 0.2% 0.4% 0.4% 0.5% 0.5% 0.3% 0.4% 0.4% 0.4% 0.5% 0.3% 0.4%
Operating margin 6.1% 5.5% 5.0% 10.9% 7.7% 6.5% 5.6% 7.2% 12.2% 8.7% 6.6% 7.0% 7.5% 12.4% 9.1%
Net margin 3.4% 3.2% 2.8% 6.7% 4.5% 3.6% 3.2% 4.2% 7.6% 5.2% 4.0% 4.3% 4.7% 7.8% 5.7%
Tax Rate 37.3% 37.1% 39.0% 36.8% 37.2% 38.2% 36.0% 36.0% 36.0% 36.3% 36.0% 36.0% 36.0% 36.0% 36.0%
Year-over-Year Changes
Comps 27.1% 20.0% -1.8% 9.6% 12.3% -1.5% -9.0% 2.8% 2.5% -0.5% 0.5% 1.5% -1.0% -0.5% 0.0%
Store unit growth 13.2% 12.2% 12.2% 17.9% 17.9% 14.5% 14.4% 12.4% 4.7% 4.7% 5.3% 5.2% 5.5% 5.4% 5.4%
Net Sales 41.8% 34.8% 5.2% 21.9% 24.1% 9.2% 0.6% 12.0% 6.1% 6.7% 4.5% 5.8% 3.2% 3.5% 4.1%
Cost of goods sold 44.1% 35.2% 2.6% 21.6% 23.8% 7.3% -1.1% 11.7% 3.7% 5.0% 4.5% 5.2% 3.0% 3.4% 3.9%
Gross Profit 35.7% 34.0% 12.8% 22.7% 25.2% 14.5% 5.2% 12.8% 13.6% 11.8% 4.4% 7.2% 4.0% 3.9% 4.7%
SG&A 26.7% 24.9% 15.8% 21.5% 22.0% 16.1% 6.4% 6.9% 6.0% 8.6% 4.1% 1.0% 2.7% 3.5% 2.9%
Depreciation&Amortization 12.2% 13.0% 6.1% 14.0% 11.3% 8.6% 7.4% 9.0% 2.4% 6.8% 3.1% 0.0% 0.0% 0.0% 0.8%
Operating Income 81.3% 97.2% -11.9% 29.6% 34.6% 16.9% 0.7% 59.5% 19.0% 21.1% 5.6% 32.8% 8.8% 5.0% 9.1%
Net Income 122.7% 147.4% 5.1% 18.1% 36.0% 12.1% 1.1% 40.8% 26.0% 22.4% 15.8% 41.7% 13.7% 6.1% 12.9%
Diluted EPS 114.6% 142.5% 4.1% 17.9% 33.7% 11.7% 1.1% 40.5% 25.1% 22.0% 15.3% 41.2% 13.3% 5.7% 12.5%
Diluted Shares Outstanding 3.8% 2.0% 1.0% 0.2% 1.7% 0.4% 0.0% 0.2% 0.7% 0.3% 0.4% 0.4% 0.4% 0.4% 0.4%
Source: Company reports and Wedbush Morgan Securities estimates

OTHER RELATED INTERACTIVE ENTERTAINMENT COMPANIES
Publicly Traded Related Companies

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Gameloft (GFT.FP)
Giant Interactive Group (GA)
Glu Mobile (GLUU)
GRAVITY (GRVY)
Konami (KNM)
Mad Catz Interactive (MCZ)
Microsoft (MSFT)
NAMCO BANDAI Holdings (7832.JP)
NCsoft (036570.KS)
Netease.com (NTES)
Perfect World (PWRD)
Playlogic Entertainment (PLGC)
Sega Sammy (SGAMY)
Shanda Interactive Entertainment (SNDA)
SONY (SNE)
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SQUARE ENIX (9684.JP)
Tecmo Koei Holdings (3635.JP)
The9 Limited (NCTY)
Time Warner (TWX)
Vivendi (VIV.FP)
Walt Disney (DIS)
Webzen (WZEN)

Capcom (9697.JP)
52-Week Range ¥1,491–2,090 Revenues FY:09 (Mar) ¥92 billion

¥1,753 Shares Outstanding 67 million
Market Capitalization ¥117 billion
Rating
Not Rated
N/A Company Description
Capcom Co., Ltd., based in Osaka, Japan, is a leading global publisher,
developer, and manufacturer of home and arcade video games. Its top
games include Street Fighter, Onimusha, Devil May Cry, and Resident Evil.
Capcom shares trade primarily on the Tokyo Stock Exchange.
Source: QUICK Corp.

Two-Year Price Chart
Gameloft (GFT.FP)
Price (as of close 6/22/09) 52-Week Range €1.26–3.80 Revenues FY:08 (Dec) €110 million
€2.77 Shares Outstanding 71 million
Market Capitalization €197 million
Rating
Not Rated
N/A
Company Description
Gameloft, founded in 1999, is a leading international publisher and
developer of video games for mobile phones. Ubisoft Entertainment owns
approximately 10% of Gameloft. Gameloft shares trade primarily on the
Euronext Stock exchange.
Source: Yahoo!

Giant Interactive Group (GA)

$8.00 52-Week Range $5.00–$13.97 Revenues FY:08 (Dec) $233 million
Shares Outstanding 226 million
Rating
Market Capitalization $2 billion
Not Rated
N/A
Company Description
Giant, based in Shanghai, China, is one of China's leading online game
developers and operators, focusing on MMORPG games for personal
computers. Its online games include ZT Online, a online role-playing game;
ZT Online PTP, a pay-to-play game based on the ZT Online free-to-play
game; and Giant Online, a military-themed MMO game. Giant shares trade
primarily on the NYSE.
Source: Nasdaq.com
One-Year Price Chart
Glu Mobile (GLUU)
Price (as of close 6/22/09) 52-Week Range $0.22–$5.16 Revenues FY:08 (Dec) $90 million
$1.13 Shares Outstanding 30 million
Rating Market Capitalization $33 million
Not Rated
Company Description
N/A
Glu, based in San Mateo, California, is a leading global publisher of mobile
games. Founded in 2001, its games includes original titles Super K.O.
Boxing!, Stranded and the Ancient Empires franchise, and titles based on
major brands from Atari, Harrah's, Hasbro, Microsoft, PlayFirst, PopCap
Games, SEGA and Sony.
Source: Nasdaq.com

GRAVITY (GRVY)
$1.10
52-Week Range $0.36–$1.99 Revenues FY:08 (Dec) $33 million
Rating Shares Outstanding 28 million
Not Rated Market Capitalization $31 million
N/A
Company Description
GRAVITY Co. Ltd., based in Seoul, Korea, develops and distributes online
games in Korea and other Asian countries. Its key product is the MMORG
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Source: Nasdaq.com characters-related products. GRAVITY shares trade primarily in the U.S.
One-Year Price Chart with American Depositary Shares (each representing 0.25 ordinary share).
Konami (KNM)
Price (as of close 6/22/09) 52-Week Range $12.77–$35.60 Revenues FY:09 (Mar) $3 billion
Rating Market Capitalization $3 billion
Not Rated
N/A
Company Description
Konami, based in Tokyo, Japan, produces video game software for home
consoles, game machines for amusement arcades and other entertainment
venues and other amusement-related products, and operation of health
and fitness club facilities. Key video game franchises include Metal Gear
Solid, Castlevania, Silent Hill, Frogger, Yu-Gi-Oh!, and Dance Dance
Revolution. Konami shares trade primarily on the Tokyo Stock Exchange
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Source: Nasdaq.com

Mad Catz Interactive (MCZ)

52-Week Range $0.15–$0.80 Revenues FY:08 (Mar) $88 million
$0.31
Rating Market Capitalization $17 million
Not Rated
N/A
Company Description
Mad Catz Interactive, based in San Diego, CA, engages in the design,
manufacture, marketing, and distribution of accessories for video game
platforms, personal computers, and audio devices. Its products include
control pads, steering wheels, joysticks, memory cards, video cables, light
guns, flight sticks, dance pads, microphones, car adapters, carry cases,
mice, keyboards, and headsets.
Source: Nasdaq.com
Microsoft (MSFT)

52-Week Range $14.87–$28.92 Revenues FY:08 (Jun) $60 billion
$23.28 Shares Outstanding 9 billion
Not Rated
N/A
Company Description
Microsoft, based in Redmond, WA, develops, manufactures, licenses, and
support its software products (operating systems, server applications,
business applications, software development tools). The company also
produces the Xbox and Xbox 360 video game console and software. It’s
leading game software franchises include Halo and Age of Empires.
Microsoft’s Home and Entertainment division which includes the Xbox
business accounts for approximately 10% of total revenues.
Source: Nasdaq.com

NAMCO BANDAI Holdings (7832.JP)

52-Week Range ¥817 - 1,080 Revenues FY:08 (Mar) ¥426 billion
¥1,020 Shares Outstanding 250 million
Rating Market Capitalization ¥250 billion
Not Rated
N/A
Company Description
NAMCO BANDAI Holdings, based in Tokyo, Japan, was formed in
September 2005 from the merger of two major Japanese toy and video
game companies. Key brands include Tekken, Soul Calibur, Pac-Man,
Mobile Suit Gundam, Digimon, Dragon Ball Z, and .hack series. NAMCO
BANDAI shares trade primarily on the Tokyo Stock Exchange.
Source: QUICK Corp.

NCsoft (036570.KS)

22,900–
174,000KRW 52-Week Range 201,500KRW Revenues FY:08 (Dec) 347 billion
Shares Outstanding 21 million KRW
Rating
Not Rated Market Capitalization
$3,654 billion
KRW
N/A
Company Description
NCsoft, based in Seoul, Korea, is the leading Korean online game
company with branches in North America, Japan, China, and Taiwan. The
Source: KOREA EXCHANGE company's key title Lineage, a massively multiplayer online role-playing
One-Month Price Chart game (MMORPG), has over three million subscribers in Asia. Other titles
include City of Heroes, Lineage II, and Guild Wars. NCsoft shares trade
primarily on the Korea Exchange.

Netease.com (NTES)

Rating
Not Rated Market Capitalization $4 billion

N/A
Company Description
Netease.com, based in Beijing, China, operates an interactive online and
wireless community in China. It provides Chinese language content and
services, including content, community and communication, and
commerce, through its online games, wireless services, and Internet portal.
In June 2009, Netease.com became the operator of World of Warcraft in
Source: Nasdaq.com China. Netease.com shares trade primarily in the U.S. with American
One-Year Price Chart Depositary Shares (each representing 100 ordinary share).
Perfect World (PWRD)

52-Week Range $8.78-$30.00 Revenues FY:08 (Dec) $211 million
$28.93
Rating Market Capitalization $1.4 billion
Not Rated
N/A
Company Description
Perfect World Co., Ltd. is a leading online game developer and operator
based in China. Perfect World primarily develops online games includes
Perfect World, Legend of Martial Arts, Zhu Xian, Chi Bi, Pocketpet Journey
West and Battle of the Immortals. Perfect World shares trade primarily in
the U.S. with American Depositary Shares (each representing 5 ordinary
share).
Source: Nasdaq.com

Playlogic Entertainment (PLGC)

$0.95 52-Week Range $0.10–$1.16 Revenues FY:09 (Mar) $9 million
Rating
Market Capitalization $44 million
Not Rated
N/A
Company Description
Playlogic Entertainment, based in New York and Amsterdam, is an
independent publisher of entertainment software for consoles, PCs,
handhelds, mobile devices, and other digital media. Playlogic publishes
various genres of games developed throughout the world and also has an
in-house production facility.
Source: Nasdaq.com
Sega Sammy (SGAMY)

52-Week Range $2.00–$3.15 Revenues FY:07 (Mar) $6 billion
$3.05
Shares Outstanding 1.1 billion
Not Rated
N/A
Company Description
Sega Sammy Holdings, based in Tokyo, Japan, is the holding company for
SEGA and Sammy. SEGA is a leading maker of video games, with key
brands including Sonic the Hedgehog, Phantasy Star, and Virtua Fighter,
while Sammy is Japan's top pachinko game machines maker. Sega
Sammy shares trade primarily on the Tokyo Stock Exchange with American
Depositary Shares (each representing 0.25 ordinary share) in the U.S.
Source: Nasdaq.com

Shanda Interactive Entertainment (SNDA)

52-Week Range $19.75–$65.00 Revenues FY:08 (Dec) $522 million
Not Rated
N/A
Company Description
Shanda Interactive Entertainment Limited, based in Shanghai, China,
develops and operates online games and related businesses in China.
These games include The Legend of Mir II and The World of Legend.
Shanda shares trade primarily in the U.S. with American Depositary Shares
(each representing two ordinary share).
Source: Nasdaq.com
SONY (SNE)

$25.32 52-Week Range $15.64–$46.93 Revenues FY:08 (Mar) $79 billion
Rating
Not Rated
N/A
Company Description
Sony, based in Tokyo, Japan, develops, manufactures, and sell electronic
equipment, instruments, and devices. Its Game segment (approximately
10% of total revenues) provides entertainment hardware, including
PlayStation 2 and 3, and PSP, along with related software. Its key software
franchises include SOCOM, Jak, Ranchet and Clank, and Gran Turismo.
Sony shares trade primarily on the Tokyo Stock Exchange with American
Depositary Shares (each representing one commom share) in the U.S.
Source: Nasdaq.com

SouthPeak Interactive (SOPK)
$0.81 52-Week Range $0.55–$2.65 Revenues FY:08 (Jun) $40 million
Rating Shares Outstanding 41 million

N/A
Company Description
SouthPeak Interactive, based in Midlothian, Virginia, develops and
publishes interactive entertainment software for all current hardware
platforms. In October 2008, the company acquired video game developer
Gamecock Media Group.
Source: Nasdaq.com
SQUARE ENIX (9684.JP)

¥2,420 52-Week Range ¥1,497–2,925 Revenues FY:09 (Mar) ¥135 billion
Rating
Market Capitalization ¥278 billion
Not Rated
N/A
Company Description
SQUARE ENIX Co., Ltd. based in Tokyo, Japan, is a leading global game
company best known for its console role-playing game franchises, Final
Fantasy, Dragon Quest, and Kingdom Hearts series. In April 2009,
SQUARE acquired video game publisher Eidos plc. for approximately $150
million. SQUARE shares trade primarily on the Tokyo Stock Exchange.
Source: QUICK Corp.

Tecmo Koei Holdings (3635.JP)

52-Week Range ¥634–797 Revenues FY:10 (Mar) ¥43 billion
¥709 Shares Outstanding 90 million Estimated
Rating Market Capitalization ¥64 billion
Not Rated
N/A
Company Description
Tecmo Koei Holdings is a Japanese company formed in 2009 when Koei
merged with Tecmo. Tecmo, Ltd. is a leading Japanese video game
company best known for the Ninja Gaiden, Dead or Alive, and Monster
Rancher video game series. Koei is known for its Romance of the Three
Kingdoms and Dynasty Warriors games. Tecmo shares trade primarily on
the Tokyo Stock Exchange.
Source: QUICK Corp.
The9 Limited (NCTY)

Rating
Market Capitalization $285 million
Not Rated
N/A
Company Description
The9 Limited, based in Shanghai, China, is a leading online game operator
in China. The9 operates licensed MMORPGs, consisting of MU, and
Mystina Online. The9 was the Chinese operator of World of Warcraft until
June 2009. The9 Limited shares trade primarily in the U.S. with American
Depositary Shares (each representing one ordinary share).
Source: Nasdaq.com

Time Warner (TWX)

52-Week Range $17.81–$50.70 Revenues FY:08 (Dec) $47 billion
€17.36 Shares Outstanding 1.2 billion
Not Rated
N/A
Company Description
Time Warner, based in New York, is a leading media and entertainment
company, whose businesses include interactive services, filmed
entertainment, television networks and publishing. Time Warner companies
include AOL, Time Inc., HBO, Turner Broadcasting System and Warner
Bros. Entertainment. Warner Bros. Interactive Entertainment is the video
game group, and we esimate that this represents well less than 5% of Time
Source: Yahoo! Warner’s total revenues.
Vivendi (VIV.FP)
€17.36 52-Week Range €16.32–27.39 Revenues FY:08 (Dec) €25 billion
Rating Shares Outstanding 1.2 billion
Not Rated Market Capitalization €21 billion

N/A
Company Description
Vivendi SA, based in Paris, France is a French media conglomerate with
activities in music, television and film, publishing, telecommunications, and
video games. In July 2008, Vivendi merged its video game business with
Activision to create Activision Blizzard (whom it holds a 52% interest).
Vivendi’s video game business accounts for about 8% of its total revenues.
Source: Yahoo!
Vivendi’s shares trade primarily on the Euronext Stock exchange.

Walt Disney (DIS)

$22.66 52-Week Range $15.14–$34.85 Revenues FY:08 (Sep) $38 billion
Rating
Not Rated
N/A
Company Description
The Walt Disney Company, based in Burbank, CA, is a diversified global
entertainment company. The company’s video game group Disney
Interative Studios has historically leveraged its parent company’s vast
portfolio of intellectual properties but is now broadening into self developed
games. We esimate that Disney Interative Studios represents well less than
Source: Nasdaq.com
5% of Disney’s total revenues.
Webzen (WZEN)

Rating

N/A
Company Description
Webzen, based in Seoul, Korea, develops and distributes online games,
and other related services principally in the Republic of Korea and other
Asian countries. The company’s principal game product, MU, is an online
role playing game (MMORPG) and HUXLEY. Webzen shares trade
primarily on the Korea Exchange with American Depositary Shares (each
representing 0.3 commom share) in the U.S.
Source:Nasdaq.com

Diversified Entertainment Valuation Summary
(in millions except per share data)
As of close Earnings / Share Price / EPS Adj. EPS EV / Adj Inc Revenues
Price Price 52 Week Range Diluted Market Enterprise Out Yr. Out Yr. Out Yr. Out Yr. Out Yr.
Ticker FYE Rating Target 6/26/09 Low High Shares Cap Value N4Qe N4Qe N4Qe N4Qe N4Qe N4Qe N4Qe N4Qe N4Qe N4Qe
Video Game Publishers

Activision Blizzard* (MP) ATVI Dec Str Buy $16 $12.66 $8.14 $19.28 1,390 17,597 14,497 $0.67 $0.80 18.9x 15.8x $0.64 $0.77 16.3x 13.5x 4,869 5,250
Electronic Arts* (MP) ERTS Mar Buy $27 $20.90 $14.24 $50.17 322.0 6,730 4,230 $1.00 $1.35 20.9x 15.5x $0.94 $1.29 14.0x 10.2x 4,350 4,700

Majesco Entertainment (MP) COOL Mar Buy $2.50 $2.00 $0.36 $2.18 29.0 58 48 $0.14 $0.21 14.3x 9.5x $0.14 $0.21 11.8x 7.9x 77 90

Midway Games (MP) MWY Dec Hold n/a $0.05 $0.03 $4.20 92.6 5 206 $(0.50) $(0.10) n/m n/m $(0.20) $0.20 n/m 11.1x 200 225
Take Two Interactive* (MP) TTWO Oct Buy $11 $9.50 $5.56 $26.88 77.0 732 622 $0.41 $2.10 23.2x 4.5x $0.41 $2.10 19.7x 3.8x 1,179 1,550
THQ* (MP) THQI Mar Buy $9 $7.41 $2.23 $21.98 68.3 506 354 $0.30 $0.50 24.7x 14.8x $0.16 $0.36 32.4x 14.4x 820 900
Nintendo (MP) 7974.JP Mar Buy ¥43,000 ¥25,850 ¥22,000 ¥36,800 128.0 ¥3,309 ¥2,000 ¥2,693 ¥3,315 9.6x 7.8x ¥2,593 ¥3,215 6.0x 4.9x ¥1,800 ¥1,639
Ubisoft Entertainment (MP) UBI.FP Mar Buy € 21 € 16.58 € 9.66 € 35.50 99.0 € 1,641 € 1,569 € 0.74 € 0.91 22.4x 18.2x € 0.71 € 0.88 22.3x 18.0x 1,200 1,250
Entertainment Retailers
Best Buy (MP) BBY Feb Hold $40 $33.58 $16.42 $48.99 425.7 14,295 15,944 $3.00 $3.40 11.2x 9.9x $3.00 $3.40 12.5x 11.0x 48,155 51,955
Gamestop (MP) GME Jan Buy $29 $22.17 $16.91 $48.53 167.2 3,707 3,973 $3.00 $3.30 7.4x 6.7x $3.12 $3.42 7.6x 6.9x 9,489 9,786
RadioShack (MP) RSH Dec Hold $12 $13.74 $6.47 $19.90 125.2 1,720 1,547 $1.39 $1.40 9.9x 9.8x $1.39 $1.40 8.9x 8.8x 4,267 4,225
Netflix (MP) NFLX Dec Buy $48 $40.37 $17.90 $50.24 60.7 2,450 2,163 $1.83 $2.20 22.1x 18.4x $1.80 $2.17 19.8x 16.4x 1,782 2,031
Blockbuster (MP) BBI Dec Str Buy $2.50 $0.62 $0.13 $3.19 192.0 119 1,043 $0.23 $0.35 2.7x 1.8x $0.55 $0.67 9.9x 8.1x 4,792 4,627
Internet & Related Companies

PetMed Express (EW) PETS Mar Hold $14 $15.04 $12.15 $19.03 23.0 346 301 $1.01 $1.07 14.9x 14.1x $0.97 $1.03 13.5x 12.7x 240 252
Travelzoo (EW) TZOO Dec Hold $6 $12.19 $3.72 $11.38 16.3 199 183 $0.13 $0.22 93.8x 55.4x $0.09 $0.18 124.5x 62.3x 87 90
Price Price 52 Week Range Diluted Market Enterprise EPS P/E Adj. EBITDA EV / EBITDA
Movies and Entertainment FYE Rating Target 6/26/09 Low High Shares Cap Value (EV) FY 09 FY 10 FY 09 FY 10 FY 09 FY 10 FY 09 FY 10
Cinemark Holdings (CW) CNK Dec Hold $12 $10.83 $6.73 $16.30 109.6 1,187 2,565 $0.77 $0.88 14.1x 12.3x 409 431 6.3x 5.9x
DreamWorks Animation SKG (MP) DWA Dec Hold $27 $27.24 $17.32 $32.73 87.2 2,375 2,184 $1.64 $2.05 16.6x 13.3x 241 295 9.1x 7.4x
Marvel Entertainment (MP) MVL Dec Hold $35 $34.67 $22.82 $38.50 78.9 2,735 2,797 $1.38 $2.30 25.1x 15.1x 196 312 14.3x 9.0x
Regal Entertainment (CW) RGC Dec Hold $13 $12.90 $6.72 $20.27 154.1 1,988 3,801 $0.78 $0.94 16.5x 13.7x 576 619 6.6x 6.1x
Warner Music Group (CW) WMG Sept Hold $5.50 $6.17 $1.58 $9.05 154.5 953 2,517 $(0.35) $(0.27) n/m n/m 421 436 6.0x 5.8x
World Wrestling Entertainment (MP) WWE Dec Buy $13 $12.88 $8.76 $18.75 73.9 952 731 $0.64 $0.72 20.1x 17.9x 90 95 8.1x 7.7x
Entertainment: Toys
Hasbro (CW) HAS Dec Hold $25 $24.47 $21.14 $41.68 153.4 3,754 4,344 $1.96 $2.08 12.5x 11.8x 649 677 6.7x 6.4x
JAKKS Pacific (EW) JAKK Dec Buy $14 $13.40 $10.17 $27.12 28.5 382 334 $2.00 $2.25 6.7x 6.0x 90 102 3.7x 3.3x
LeapFrog Enterprises (EW) LF Dec Hold n/a $2.33 $0.80 $10.63 64.1 149 59 $(0.45) $0.20 n/m 11.7x (14) 24 nmf 2.5x
Mattel (CW) MAT Dec Hold $16 $15.94 $10.36 $21.99 359.9 5,737 6,232 $1.23 $1.43 13.0x 11.1x 801 939 7.8x 6.6x
RC2 Corp * (CW) RCRC Dec Hold $15 $13.31 $3.22 $27.09 17.5 233 281 $1.54 $1.50 8.6x 8.9x 63 61 4.5x 4.6x
*Pro forma
Source: Company reports and Wedbush Morgan Securities estimates (e), First Call for companies not rated.

Public Companies Mentioned in this Report (priced as of close 6/26/09)
COMPANY TICKER RATING PRICE PRICE TARGET

ACTIVISION BLIZZARD ATVI STRONG BUY $12.66 $16
BEST BUY BBY HOLD $33.58 $40
BLOCKBUSTER BBI STRONG BUY $0.62 $2.50
DREAMWORKS ANIMATION DWA HOLD $27.24 $27
ELECTRONIC ARTS ERTS BUY $20.90 $27
GAMESTOP GME BUY $22.17 $29
HASBRO HAS HOLD $24.47 $25
JAKKS PACIFIC JAKK BUY $13.40 $14
MAJESCO ENTERTAINMENT COOL BUY $2.00 $2.50
MARVEL ENTERTAINMENT MVL HOLD $34.67 $35
MIDWAY GAMES MWYGQ HOLD $0.05 N/A
NETFLIX NFLX BUY $40.37 $48
NINTENDO 7974.JP BUY ¥25,850 ¥43,000
TAKE TWO INTERACTIVE TTWO BUY $9.50 $11
THQ THQI BUY $7.41 $9
UBISOFT ENTERTAINMENT UBI.FP BUY €16.58 €21
WORLD WRESTLING ENTERTAINMENT WWE BUY $12.88 $13
ANALYST CERTIFICATION
I, Michael Pachter, certify that the views expressed in this report accurately reflect my personal opinion and that I
have not and will not, directly or indirectly, receive compensation or other payments in connection with my specific
recommendations or views contained in this report.
IMPORTANT DISCLOSURES
INVESTMENT RATINGS
STRONG BUY – The stock is expected to return at least 20% over the next 6-12 months.
BUY – The stock is expected to return at least 15% over the next 6-12 months.
HOLD – The stock is expected to return between -15% and +15% over the next 6-12 months.
SELL – The stock is expected to decline by at least 15% over the next 6-12 months.
DISTRIBUTION OF RATINGS (as of March 31, 2009)

BUY – 43% (2% of this rating category were investment banking clients within the last 12 months).
HOLD – 56% (3% of this rating category were investment banking clients within the last 12 months).
SELL – 1% (0% of this rating category were investment banking clients within the last 12 months).
The analysts responsible for preparing research reports do not receive compensation based on specific
investment banking activity. The analysts receive compensation that is based upon various factors including
WMS’ total revenues, a portion of which are generated by WMS’ investment banking activities.
WMS makes a market in the securities mentioned herein.
WMS changed its rating system from (BUY/ HOLD/SELL) to (STRONG BUY/BUY/HOLD/SELL) on January 5,
2006.
Additional information is available upon request by contacting Ellen Kang in the Research Department at (213)
688-4529, or by email to ellen.kang@wedbush.com, or the Business Conduct Department at (213) 688-8090.
OTHER DISCLOSURES

RESEARCH DEPT. * (213) 688-4505 * www.wedbush.com
INSTITUTIONAL TRADING Los Angeles (213) 688-4470 / (800) 421-0178 * INSTITUTIONAL SALES Los Angeles (800) 444-8076
CORPORATE HEADQUARTERS (213) 688-8000
The information herein is based on sources that we consider reliable, but its accuracy is not guaranteed. The information contained herein is
not a representation by this corporation, nor is any recommendation made herein based on any privileged information. This information is not
intended to be nor should it be relied upon as a complete record or analysis; neither is it an offer nor a solicitation of an offer to sell or buy any
security mentioned herein. This firm, Wedbush Morgan Securities, its officers, employees, and members of their families, or any one or more
of them, and its discretionary and advisory accounts, may have a position in any security discussed herein or in related securities and may
make, from time to time, purchases or sales thereof in the open market or otherwise. The information and expressions of opinion contained
herein are subject to change without further notice. The herein mentioned securities may be sold to or bought from customers on a principal
basis by this firm. Additional information with respect to the information contained herein may be obtained upon request.

EQUITY RESEARCH DEPARTMENT
(213) 688-4529
DIRECTOR OF RESEARCH
Mark D. Benson (213) 688-4435
INDUSTRIAL MATERIALS AND SERVICES TECHNOLOGY

Industrial Materials & Services Communications Equipment
Al Kaschalk....……..….……………………. (213) 688-4539 Rohit Chopra …………………...…………. (212) 668-9871
Christine Hersey....……..…...…………….. (213) 688-4311 Sanjit Singh …………………...…………... (212) 938-9922
Communications Technology
CONSUMER PRODUCTS AND SERVICES Matthew Robison………..……...…………. (415) 263-6659
Consumer Products Leo Choi ………………………………….… (415) 263-6669
Rommel T. Dionisio ………………..……… (213) 688-4418 Datacenter Technologies
Kurt M. Frederick, CPA …………………… (213) 688-4459 Kaushik Roy…...………………...…………. (415) 274-6873
Education Software: Enterprise Applications / SaaS
Ariel Sokol …………………..…………...... (212) 668-9874 Michael B. Nemeroff.……………..………. (212) 668-9876
Entertainment Retail David Giesecke…...…..…………………... (212) 938-9925
Michael Pachter …………………..……..... (213) 688-4474 Software: Data Warehouse / Analytics & Online
Edward Woo, CFA …………………….….. (213) 688-4382 Business Optimization
Chris White…………..….…………………. (213) 688-4423 J. Derrick Wood, CFA…………..…………. (415) 274-6822
Footwear & Apparel David Kaczorowski….……………………….(415) 274-6883
Jeff Mintz, CFA…………….…………….… (213) 688-4518 Internet: Infrastructure
David Epstein …………………...….……... (213) 688-6624 Kerry Rice, CPA …………………………… (213) 688-4538
Specialty Retail: Hardlines Next Generation Tech
Joan L. Storms, CFA ……………………… (213) 688-4537 Al Kaschalk....……..………....……………. (213) 688-4539
John Garrett…………………………...…… (213) 688-4523 Christine Hersey....……..…………………. (213) 688-4311
Semiconductors
Specialty Retail: Softlines
Patrick Wang…………………………...…. (212) 938-9938
Betty Chen …………………..…………...... (415) 273-7328
Michael Lucarelli..………………...…….…. (212) 938-9927
Connie Wong…….…………..…………..... (415) 273-7315
Telecommunications Software
Specialty Retail: Sporting Goods Scott P. Sutherland, CFA ……………..…. (213) 688-4522
Jeff Mintz, CFA …..……………….…..….… (213) 688-4518 Suhail Chandy …………………...……..…. (213) 688-4380
David Epstein …….……….…………..…… (213) 688-6624
Transaction Processors
Gil B. Luria....….…..………....……………. (213) 688-4501
ENTERTAINMENT AND MEDIA
Nick Setyan……....……..…………………. (213) 688-4519
Advertising & Broadcasting Wireless Equipment
James Dix, CFA………………….…..….… (213) 688-4315 Scott P. Sutherland, CFA ………….…….. (213) 688-4522
Entertainment: Software Suhail Chandy ……………...……….…….. (213) 688-4380
Michael Pachter …………………...…….… (213) 688-4474
Edward Woo, CFA ………….…………….. (213) 688-4382
LIFE SCIENCES
Chris White…………..….…………………. (213) 688-4423
Entertainment: Toys Biotechnology / Biopharmaceuticals
Chris White…………..………….…………. (213) 688-4423 Gregory R. Wade, Ph.D.………...……….. (415) 274-6863
Edward Woo, CFA …………………….….. (213) 688-4382 Jeremiah Shepard, Ph.D.………...……….. (415) 274-6862
Movies & Entertainment Richard Lau ..…………….………..………. (415) 274-6851
Chris White…………..…...………..…….... (213) 688-4423
Michael Pachter….….………….…………. (213) 688-4474 Kimberly Lee, D.O….……………..………. (415) 274-6842
Internet Advertising/Media Cardiovascular, Devices & Regenerative
Edward Woo, CFA…….…………….…..… (213) 688-4382 Duane Nash, MD JD MBA…...…..………. (415) 263-6650
Emerging Pharmaceuticals
Liana Moussatos, Ph.D.….........…………. (415) 263-6626
Life Sciences Tools & Diagnostics
Un K. Kwon-Casado, M.SC...…....………. (415) 263-6634
Specialty Pharmaceuticals
Patricia Bank …………………...…………. (415) 263-6646
EQUITY SALES EQUITY TRADING

Los Angeles (213) 688-4470 / (800) 444-8076 Los Angeles (213) 688-4470 / (800) 421-0178
San Francisco (415) 274-6800 San Francisco (415) 274-6811
New York (212) 668-9868 New York (212) 344-2382 / (800) 421-0178
Boston (617) 832-3700 Boston (617) 832-3700 / (800) 421-0178
CORPORATE HEADQUARTERS
1000 Wilshire Blvd., Los Angeles, CA 90017-2465
Tel: (213) 688-8000 www.wedbush.com

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LOS ANGELES | SAN FRANCISCO | NEW YORK | BOSTON | SEATTLE

Entertainment Software Publishing and Retail

Money for Nothing

Michael Pachter Edward Woo, CFA

It is important to acknowledge the contribution from media sites IndustryGamers.com, Edge-Online,

i Interactive Entertainment Industry Report Michael Pachter (213) 688-4474

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The interactive entertainment industry consists of several constituencies: the

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Total 100% Total 100%

Source: Wedbush Morgan Securities estimates.

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We estimate that interactive entertainment sales totaled $44 billion worldwide in

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Source: Wedbush Morgan Securities estimates.

22 Interactive Entertainment Industry Report Michael Pachter (213) 688-4474

Source: Wedbush Morgan Securities estimates.

HARDWARE AND SOFTWARE SALES SPLIT

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$16 2006 2007 2008

* Includes trade, book club, paperback, and other sales.

We expect interactive entertainment to be the fastest growing U.S. entertainment

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In addition to fundamental market drivers, we expect a broadening demographic is

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INCREASING YOUTH INCOME

28 Interactive Entertainment Industry Report Michael Pachter (213) 688-4474

Figure 6—Primary Video Gamer by Age and Gender

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Home Console Handheld Console PC Software Total

North America 76% 18% 6% 100%

Europe 68% 19% 13% 100%

Japan 47% 46% 7% 100%

Worldwide 69% 22% 9% 100%

Source: Wedbush Morgan Securities estimates.

30 Interactive Entertainment Industry Report Michael Pachter (213) 688-4474

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32 Interactive Entertainment Industry Report Michael Pachter (213) 688-4474

U.S. Life Cycle

Oct-85 8-bit Nintendo NES 36.3 Actual

Jan-89 16-bit Sega Genesis 18.5 Actual

May-95 32-bit Sega Saturn 1.4 Actual

Sep-99 128-bit Sega Dreamcast 4.1 Actual

Nov-05 Next-gen Microsoft Xbox 360 30.0 Projected