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Copyright 2001

[ October 1st 2001 ]

Britain's computer-games developers and publishers were the toast of the leisure sector two years ago. They had a reputation as the world's finest in an industry that generates more annual profit than Hollywood movies.

After a sharp 18-month downturn, fuelled by a rash of profits warnings, 1.4 billion has been wiped off their value, taking the size of the sector to just 335m. And there was worse news last week as French-quoted Infogrames, the second-largest computer-games company in the world, reported a 75.8m loss, having made a 16.9m loss the previous year.

Across the channel, AIM-quoted Empire Interactive reported on Thursday a 1.63m loss in its interim results, an improvement on its 2.07m loss on the comparable period last year. Meanwhile, Sony said it was slashing 100 off its PlayStation 2 console. But shareholders toying with pulling the plug on their games investments might have a few lives to play with. The next few months will be crucial for a turnround that could put much of the value back into the shares.

Everything hinges on the success of new consoles due to be launched early next year. Nintendo is bringing out its GameCube, and Microsoft is making its debut in the games-hardware market with its Xbox. Sony has already brought out its PlayStation 2. Much rides on the success of the new consoles, as customers have been holding off from spending as they wait for the new technology, contributing to the sector's poor performance over the past two years.

Nick Gibson, a games analyst at Durlacher, says consoles come out every five years, so the fall in demand and the "year of profit warnings" follow a predictable trend. "Cyclical growth has been a characteristic of the games industry since its inception," he says. "The cycles have proven remarkably uniform in pattern. Periods of strong growth have tended to last four to five years, followed by flat or falling sales during a two-year transition period as new games platforms are introduced."

New games platforms drive the cycle. In the 1980s, the Sinclair ZX81 and Atari hosted classics such as Space Invaders and Pac-Man, and the technology has since become increasingly sophisticated. Where 10 years ago, cars in racing games were almost identical, it is now easy to recognise individual brands and models as well as the tracks and environment in which the game takes place. Those that never wanted to play games in their youth are finally able to relate to them as the technology makes them more accessible and broadens their appeal.

Gibson says the depths of the cycle this time round have been mild compared with previous years. "The last two growth periods occurred between 1989 and 1993, and between 1995 and 1999," he says. "The major players haven't been hit as much as they were in 1994-95, which really was a drop off the cliff - some companies were wiped off the map."

The industry is in the later stages of a two-year transition. It is moving out of the downward part of one console cycle and onto the incline of the next. The problem is the transition is not fast enough for Britain's software developers and publishers depending on a Christmas launch of Xbox. It has been delayed until next year.

December is the peak time for sales and many had factored revenues into their profit forecasts. It now seems strong year-on-year growth will really be felt only at the end of 2002, with a 15%-25% annual boost from then until 2005.

Mike McGarvey, chief executive of Eidos, which has fallen in value from 1.3 billion in December 1999 to 233m after two profit warnings, is exposed on only one game for the Xbox. "I think the implications of the slippage in revenue terms are not huge for us," he says. "It will not make much of a dent as we were only bargaining on some opportunistic revenue."

Investors are also concerned that the appetite for games involving violence may collapse after the terrorist attacks in America. Jane Cavanagh, chief executive of Sci, which fell from 111m at the beginning of last year to 13.38m, is an expert in bad-taste games. She developed Carmageddon, in which players get points for the number of pedestrians hit, and signed up Ronnie Biggs as an adviser for her Great Train Robbery game. She is developing a war game set in the Middle East.

"There has consistently been an appetite for these types of game," she says. "Conflict: Desert Storm is entertaining and based on fact - it in no way glorifies war. As far as violence goes, it is what boys want, and I don't think what is going on in America will stop people playing - it may even attract more interest."

Other firms whose market values have crashed are Rage, down from 211m to 17.4m; Argonaut, down from 90.4m to 26.6m; Empire, down from 52m to 27.3m; Warthog, down from 19m to 12.9m; and Bits Corp, down from 20.6m to 4.5m. Infogrames has shouldered the biggest loss - from 3.8 billion to 553.9m.

Many publishers have used this year and the last to write off as much of the bad news as possible, so they are in better shape for the upturn. Bruno Bonnell, Infogrames' founder and chief executive, has rapidly grown the business by acquisition and has spent the past year rationalising. "Yes, there has been a drop in value, which has surprised us all," he says. "But we are at the cusp of an upturn and it is true we have been careful in shedding loss-making units - if it was not expected to make a profit in the next year, we closed it." Bonnell has also written off his online and Wap mobile-phone divisions.

As the cycle begins again with a new set of consoles, only time will tell whether the sector will bounce back. The market is expanding as the age of gamers increases, upgrading their consoles with each cycle. "The increasing sophistication of game aesthetics is attracting new players," says Gibson. "The industry is at a pivotal point, and few would doubt that growth is a given."

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