Activision Blizzard (ATVI)

Christmas 07, and we haven’t seen any new original IP. We’ve seen Guitar Hero brand extensions, and based on what I understand of Christmas 08 there’s not one coming this year either. Have you abandoned that strategy or do you have products in process, in other words something in your hip pocket, a rabbit to pull out of the hat to spike revenues yet again in 09 and 2010?

Thomas: Yeah you know it’s not a secret that introducing new intellectual properties in this industry is the riskiest thing you can do. But if you do it well then you can also reap high rewards. So as a result we are very selective in our development process of our new intellectual properties and I am not in favor of committing to one new IP a year because I want to make sure that we have all the flexibility we need to shut things down if they’re not tracking from the consumer testing perspective. As opposed to putting yourself on the hook and then force yourself to make compromises just so you get one out every year. So that’s not the strategy. What the strategy is is we look at new IP and we put it into development when it has global appeal, when we can exploit it across all platforms, when it has the potential to become an annualizable franchise, when we have proven development solutions in the genre in the next gen. And when the financial returns we can get are above the company average, which they have to be because it is also above average risk. So this is a pretty tall order for any project to deliver against, and as a result we are very selective. We’ve got the first one probably coming out, it’s going to be our entry into the racing genre. And we checked all the boxes there, and it took us awhile until we signed off and acquired Bizarre, which is the top developer in the racing genre, and was very successful over the years with Project Gotham Racing. So that product is in development and it’s doing extremely well. These guys are outstanding, I mean phenomenal. I’ve never seen such a high quality green light than the one they’ve delivered. So that is very encouraging, we have a couple of others in the pipeline, but again I don’t want to set any timing expectations because we are going to ship those when we think they are at the stage where they can deliver in excess of $100 million in revenue. Because anything short of that you can’t see the financial returns that make this venture interesting from a shareholder perspective.

Michael: But you are comfortable saying there are two or more owned intellectual properties that we should expect in the next two years?

Thomas: Yes absolutely, and let’s not forget by the way the combined companies portfolio will be owned, more than 75% of the revenue from the combined companies portfolio will be owned IP. So we will remain focused on growing those proven high operating margin franchises, because that’s by far the best return on investment that our shareholders can get and I think we’ve got coming up with this merger the strongest intellectual property portfolio, the strongest portfolio of development talent, and we are not going to be dependent on creating a lot of new IP to get to our margin objectives. We think that what we have we can get above 25%, and that’s from a shareholder perspective desirable because it poses significantly less risk that what is in the business plans of some of our competitors that have to bank on new IP success to a much greater extent.

Michael: Can we talk about integrating Activision, Vivendi both on a financial basis and an operating basis. When you talk about synergy you said 50-100 million, what should we expect in terms of head count from the two companies - What is head count now, what do you think head count will be after the combination? And then also can you talk on the operating side about how the Blizzard success of World of War Craft creates opportunities for other Activision owned intellectual properties, or perhaps migrate towards some kind of an online MMO space.

Thomas: Right now I think, and Geri correct me if I’m wrong, I think that the combined head count on a proforma basis is around seven thousand. In the short term that number will probably come down as we eliminate overlap in the sales force and the back office etc. But at the end of the day we’re going to grow, so after the initial I would expect that the headcount will probably grow as we pursue additional business opportunities. From a Blizzard perspective, they’ve been running the business very successfully over these years, maybe the most successful developer

out there. They have a very strong pipeline so this is not a merger where we are trying to go and fix anything at Blizzard, it’s quite opposite, Activision’s strategies are working, Blizzard’s strategies are working, so we are going to remain focused on executing those strategies. Blizzard has a strong pipeline that goes beyond Linch King and the expansion pact on World of Warcraft. As you know they’ve already talked about Starcraft, and this is probably a product in their pipeline that may not be fully appreciated by the community out there, but I think that is going to be a very very exciting product that is going to hit the market at some point. So, we look at the combination as not needing any significant surgery. Now of course when you look to the rest of the Vivendi games business they haven’t been as successful as Blizzard was on their console business and we are going to apply the same success criteria that we apply to our own franchises and to our own studios to their development pipeline, and there are a few proven properties in the pipeline, there are a few proven studios in their portfolio, so as a result we will emerge with the strongest portfolio in the industry, and the strongest development talent in the industry. And if we keep executing well we will continue to lead return on investment, which for Activision last year we generated I think 57% return on invested capital which is hard to find no matter which sector or which company you are in. So we are bullish about the prospects.

Michael: Does their investment and success in delivering a super high quality online experience, having call centers having servers that actually work glitch free does that present an opportunity for Activision to monetize something else Call of Duty online or ?

Thomas: Down the road there are many opportunities.  Now having said that the worse thing we can do right now is disrupt their existing pipeline. So we are not going to say stop what you are doing let’s go focus on Call Of Duty MMO.  So, that’s not what you should expect. It would be a mistake because their pipeline is very strong.

Now if we think about propositions such as how do we bring guitar hero to Asia that’s where we can benefit tremendously from their expertise.  As you know both Starcraft, World of Warcraft is very popular in internet cafes.  Blizzard has established great relationships with internet cafe providers in Korea. They’ve had the most success, I would even argue they are the only successful western publisher in Asia.  So benefiting from their expertise, not having to make all the mistakes they have already made from our perspective is going to be a big qualitative benefit. Now, can I put an EPS number on that? I don’t think so, but it’s definitely a directional positive that we are going to hopefully bring to fruition over the coming years.

Michael: Now that we are seeing Activision go from a roughly 1.5 billion revenue company a year ago to probably a 4 billion or higher revenue company a year from now – what kind of challenges do you face?  Now, how do you approve a project that you expect to generate 50 or 75 million in revenue.  Is it even worth bothering with a tiny little game that only sells 2 million units?

Thomas: Well you know, you probably know that I used to work for 15 years for a company that had more than 50 billion dollars in sales.  And what I learned that it is actually easier to grow if you are the market leader in an industry that rewards scale and the reasons for that is that you have a more concentrated retail environment. So to the extent that you have a stronger portfolio you are going to end up with better execution in retail.   Development costs continue to rise so you have to be well capitalized in order to afford continue making AAA games that can sell more than 5 million units like we’ve done and lastly creating new intellectual properties and creating new brands in the minds of consumers is not getting any easier or any cheaper either.   So I actually view the fact that we are now the market leader and we are now the number one company as a positive for our ability to keep the growth going.  We are also aware of course that last year’s success is next year’s base period and the good news is Activision has answered that challenge for 16 consecutive years so we have a good track record there and we also believe we still have significant opportunities to expand operating margins which is our prime focus area and we are right now at industry leading margins of 18 to 19 percent and by 2009 which is not that far away and pretty tangible we expect to exceed 25 percent.  So, if you look at all that you should be pretty encouraged that we are far from tapped out in terms of top and bottom line growth.

Michael: I’d like invite the audience to ask questions and I will repeat them. Any questions please?