LARA CROFT BUYS THE GECKO

On September 10th, Eidos PLC, publisher of the Tomb Raider series, announced that it was purchasing Crystal Dynamics, a developer of Playstation games, for $47.5 million in cash.

Crystal Dynamics is best know for its Gex games, featuring an endearing gecko character. They have been well-reviewed, and close to 250,000 copies of the first game were shipped to retailers in the States alone. (This is pretty good for a Playstation title.)

But Crystal Dynamics has had its share of problems, recently; Legacy of Kain: Soul Reaver, originally slated to appear this summer, has been pushed back, to "sometime in the first quarter 99", and The Unholy War, originally slated to appear right about now, they now say will show up "before the holidays." But publication delays are not unusual in the field--in fact, they're the norm. And Gex 3 is still scheduled for 1st quarter 1999--and should do well.

It's impossible to know how Crystal Dynamics is doing financially, because it's privately owned.

As for Eidos?

You may know Eidos for Tomb Raider, but it's more than that--it claims to be the third largest electronic game publisher in the world.

Really? Up there with EA and GT Interactive?

Yes.

In 1996, London-based Eidos grossed a mere £3.7 million. In 1998 (its fiscal year ends in March), it grossed £137 million.

Whoah.

And in the last two years, it's grown from 60 employees to more than 500--and that's before the Crystal Dynamics takeover.

How has Eidos managed that?

The basic answer is: Never underestimate the power of a major hit. GT Interactive raised money and became a major publisher on the strength of Doom II's success--never mind that id developed Doom II, GT merely published it. Similarly, Tomb Raider has made it possible for Eidos to attract a lot of cash.

Welcome to the world of the 90s bull market. It may be coming to an end, but we're still seeing the effects. If you're hot, you can fund almost anything.

Maybe that's unfair. Eidos is actually profitable, to the tune of £16.5 million on turnover of £137 million last year. Plenty of companies in the field are operating in the red; Eidos looks good on this score. And it looks like Eidos will do well this year, too; in the quarter ending June 30th, it grossed £28.5 million, compared to £9.7 million for the same quarter last year. (And lost money for the quarter--but that's normal; most game companies book a lot of sales for the Christmas season, and do not so hot the rest of the year.)

But Eidos is growing like a teenager on steroids not so much because it has hot games--although the Tomb Raider franchise is doing just fine--but through acquisition, funded by the fact that it can attract money.

In 1995, it started on an acquisition spree. Eidos bought Core Design, the actual developers of Tomb Raider, as well as some smaller groups including Simis, a flight sim developer, and Big Red Software, which does racing games. They funded Pumpkin Studios, founded by Jim Bambra, who used to be head of R&D for MicroProse. They started their own development groups in San Francisco and London. They bought Glassworks, a post-production house that does high-end computer animation work--for the advertising and film industries as well as developers.

And they invested in a number of software studios that remain independent, including ION Storm (John Romero's new company), with whom they have a distribution deal. They also publish titles from Looking Glass and a number of other independent developers--including the PC version ofSquaresoft's Final Fantasy VII--but their deal was only for FFVII, not any future products, and since Square has recently announced a cross-distribution deal with Electronic Arts, they presumably won't be handling Square product in the future.

With its congeries of development arms and affiliated developers, Eidos pretty much covers all the bets: it's got developers for console action games, shooters, real-time strategy, sports, and computer RPGs. Though it still doesn't have the internal development muscle of an EA, or sublabels as well established as EA Sports, say, it is well on its way to being a major player. And it's got some forthcoming titles that have a good shot at being major hits: Tomb Raider III and Daikatana for two.

But unlike EA and GT Interactive, Eidos is not a major distributor. (A publisher is a company that pays to publish a game, and handles marketing; a distributor deals with retailers and gets the product on the shelves.) EA and GT both rely on their distribution network for an income stream that's a lot more stable than publishing, which is so hit-driven; they both distribute the products of many companies they do not publish. Eidos has no such fall-back.

Eidos does have three small non-game subsidiaries--Eidoscope, a web design shop; Glassworks, a special effects house; and Eidos Technologies, a video codec and technology firm. But together, they probably aren't big enough to carry the company if its game operations fail to keep producing hits.

Computer gaming, like the toy industry, is littered with companies that got big quick on the basis of one major hit, and then cratered. Without some other, more stable income stream, Eidos could be in trouble if it doesn't keep delivering hot products.

Like most companies that have gotten big quickly, Eidos is relying on growth by acquisition to persuade investors that it's going to continue growing strongly, thus attracting the cash to let it grow further.... This works fine, if you actually manage the companies you take over well and squeeze further profits out of them. It doesn't work so hot if you're relying on a bull market that comes to a screeching halt, exposing the frailties in your underlying management, or if too many bombs persuade the investment community that you've lost the magic touch.

Which is the case with Eidos?

Darned if I know. But a couple of things make me nervous.

First, any company that go from 60 employees to 500 in the space of two years is going to have problems. Your managers get spread awfully thin. You have problems integrating acquisitions. Your corporate culture doesn't get transmitted to new people. And inevitably, many of your people don't have sufficient experience in the field, and make dumb decisions out of sheer innocence.

Second, a year ago last August, Eidos's auditors, Coopers & Lybrand, a Big Six accounting firm, refused to certify Eidos's annual report, because Eidos wasn't in compliance with British standards for corporate governance. Eidos's shares dove on the news, although they've since recovered (and declined again).

There was never any implication of impropriety, but the fact that management wasn't on the ball enough to make sure its annual report was properly audited implies to me that Eidos is moving too quickly, growing too fast.

Of course, that was a full year ago--and Eidos hasn't made any big acquisitions since then, so maybe their management realized the need to digest what they'd gotten so far.

They haven't made any big acquisitions--until now.

And Crystal Dynamics is a big acquisition; it has more than 100 employees and five full development teams. That's quite large, for an independent developer. It drastically increases Eidos's presence in the States--which may be one big reason for the acquisition, of course.

Whether Eidos will be able to digest Crystal Dynamics, and get its games back on track, is an open question. And while Gex is a decent franchise, and five full development teams is a nice thing to pick up for a company trying to establish itself as one of the major players in the field, $47.5 million is also a lot of change. Remember that Eidos only made 16.5 million pounds last year (about $28 million, at current exchange rates). And the acquisition is a pure cash transaction.

100 people is also a lot of overhead to add; Crystal Dynamics has not exactly set the world on fire in recent years. Whether Eidos can squeeze that much value out of Crystal Dynamics is an open question.

One interesting feature of the announcement, though, is that Crystal Dynamic's president, Rob Dyer, will henceforth head up Eidos's American publishing operations. Maybe part of the reason for the Crystal Dynamics takeover is to acquire some managers to help bulk out Eidos's thin management layer. Or maybe this is the kind of sop that's typical in a takeover; you tell management at your takeover target that you'll integrate them into the firm, give them positions of power, so they won't resist the takeover. And then once you've taken control of the reins, you boot them out.

I wouldn't know.

But based on past experience of companies that have grown this quickly, I'd guess that Eidos will go through a rough patch within the next 18 months. It will wind up laying of people, and closing some of its subsidiaries. But it will probably survive; it has some good franchises. And even if the fact that it relies so much on publishing makes it vulnerable to the hit-or-miss nature of the game industry, the fact that it is a big publisher helps provide some security. A small company that has a bomb is out of business; a big company publishes enough titles in a year that some of them are likely to be hits. It can survive a number of bombs, as long as a few titles hit big. Eidos is big enough, now, to be hard to kill.

As for the industry as a whole--the Crystal Dynamics takeover is probably a good thing. The more major publishers we have, the more places independent developers can go to try to get funding for new titles. And that means more titles funded, and more willingness to take a risk on something innovative.

So what the hell--the Crystal Dynamics takeover may not merit three cheers, but maybe we can go for two. Two cheers for Lara Croft.

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