Description

Atari is a developer, publisher, and distributor of video games for all major platforms, including PlayStation, PlayStation2, Xbox, GameCube, Gameboy Advance, PC, and others. The company develops games using internal and external development studios. The company is majority owned by Infogrames Entertainment S.A., a public French company. Atari maintains three publishing studios in Santa Monica, California; Beverly, Massachusetts; and Minneapolis, Minnesota. Key brands and franchises include Dragonball Z, Driver, Roller Coaster Tycoon, Neverwinter Nights, and The Matrix. Atari is 60% owned by its parent Infogrames (which is based in France). Infogrames and Atari also have a distribution relationship, where as Atari distributes games created in European studios in the USA and Canada, while Infogrames distributes Atari’s domestically produced games internationally.

Atari priced at $2.80/share is a value play if a few things unfold though out 2005. The new CEO Jim Caparro of ATARI effective as of Nov 29, 2004 has the potential to be very effective(served on Atari’s board of directors since Febuarry 2002). Mr. Caparro is a veteran in the DVD and music business; he has also previously recognized value by selling his business away to larger entertainment conglomerates (while at Warner Music served as President of Def Jam, sold this entity of Def Jam Music to Viacom). Mr. Caparro assumes the CEO position from Bruno Bonnell, who remains on as Chairman and Chief Creative Officer. Caparro is a media executive with nearly 30 years of experience at Warner Music, Universal Music, and Polygram. This appointment is a positive for Atari shareholders.

As the WSJ article states (site the Dec 29,2004 WSJ article, “Videogames Makers are Playing ‘Takeover 2005”), Consolidation in the video gaming industry has been occurring; recently (October 11, 2004) with MWY purchasing an individual production studio, ‘Inevitable Entertainment Inc.,’ for 300,000 shares, or $3m (at $10 per share). The investment banking multiples of the transactions were not published in the MWY press release. Mentioned in the article, “…..the world’s biggest game publisher, Electronic Arts Inc., stocked such predictions last week when it announced a deal to acquire nearly 20% of the shares in one of Europe’s biggest game publishers, Ubisoft entertainment SA, in a transaction with an estimated value of $85 million to $100 million.” Atari its self has been on an acquisition binge in the past 3-5 years , in the last 2 years acquiring an entity from Hasbro Interactive , and an independent studio named Shiny Entertainment (responsible for the production of The Matrix Games - On 5/2/02, Shiny Entertainment was purchased for $47 million via cash and debt. Though this purchase, ATARI has the exclusive rights to publish two more Matrix games; “the Matrix Reloaded” and “the Matrix Revolutions.”). Finally Infogrames recently sold/divested (Nov 2004) the Civilization Franchise to an undisclosed buyer for just over $20m USD.

The Video Game Industries USA based players are EA Sports, Activision, Take-Two Interactive Software, THQ, Midway, and Atari; so for the most part, at least domestically 6 companies dominate the industry. Of this list the first 4 listed could pay 20’s current year earnings for ATARI and still remain accretive based on their respective p/e multiples (each above 25x’s). ATAR currently sells for 75% of current year Sales, while all of its competitors trade for at least 2x’s current year sales, in some cases 3 - 4x’s.


ATAR’s genre is geared towards kids with games such as: Backyard Football 2002, Feddi Fish: the Case of the Haunted Schoolhouse, Pajama Sam, Spy Fox – Dry Cereal, Putt-Putt Saves the Zoo, TONKA Construction 2, and Monopoly Junior. (this is a great demographic to cater too !) These games, like the rest of Atari’s game portfolio are available (own self space at Wal-Mart, Best buy, Target, Game stop, Elbow, etc). All of the above games are also available at www.atariondemand.com – for $15 per month you can seamlessly download all of Atari’s (sans newest releases) PC based games. It works very well; I have been a customer for nearly 3 months now. I have also failed to see the competitors replicate this distribution system (I’ve checked all their websites, and none provide any downloadable service)…..… yet anyway.

“Atari on Demand” , as a web based distribution system can save Atari lots on distribution, marketing, and selling cost , furthermore possibly help on the transition cost to next generation of consoles. For Atari, a large % of their current game portfolio is format ready for the PC, this bodes well for the next generations Xbox game consoles, which I understand (from speaking with an EA sports programmer) that their 2006 console will be essentially WinXP operating system. There for, Atari has completed much of their transfer cost already, since much of their game portfolio is PC based.

Downside:

Weak F2005 game pipeline, no major blockbusters planned for 2005 at this point. Through by cutting their Year over Year R&D budget from $85 to $75 (which they plan to do) sales may deteriorate while EPS remains stable at $.25cents. With out his help (cutting back on R&D) ATAR would and even may still have problems hitting $.25cents in F2005.

Upside:

Atari is 1 of 6 of the major US players, of which participate in a currently consolidating industry (i.e. Dec 27 WSJ article). Also, MOBILE GAMING opportunity (see footnote #1), and ATARI is #1 recognized brand (not saying it’s the #1 strongest brand, but #1 recognized) .

INFO recently secured financing (see foot note #2 below final page) concreting that they probably wont be “forced” to sell ATAR (piece meal in market), so if INFO wants to auction it at this point they will be able to get a better price.

My sum of the parts of INFO’s asset Atari is conservatively north of $5 per share, while a buy out from a competitor (i.e.: any of the other 5 players) could fetch 46.25(25x’s a Atar’s eps of $.25) , and still be accretive to their respected multiples (except MWY, not applicable b/c no earnings in this current year). Recall a mediocre franchise like Civilization sold recently for over $20m.


Valuation:

Atari is currently a $360m Market cap with No debt. Atari is a profitable company that should earn between $.22 and $.25cents this fiscal year. Atari possess a substantial NOL ( > $250m).

Currently at $2.85, ATAR is trading at .75x’s current sales. Its peer’s atvi, erts, mwy - each are priced at 21x's, 28, and no earnings, and each on a sales basis at 2x’s, 4.9x’s, and 5.7x’s respectively.



Remaining Questions:
Can as suitor trust Bruno Bonnel (CEO of IFOE, recently stepped down from CEO post of ATAR to hand off to JIM, and recently resigned ATAR board member) not to be self dealing when selling the Atari asset?

If/when ATAR is auctioned; the Atari European Revenues would dissipate, unless the relationship remained intact with out Bruno running both entities, or would the current agreements stay intact? ( IFOE currently distributes USA Atar’s produced games throughout Europe and Asia; this adds roughly $15m annually to Atar’s profits. )

A few questions still unanswered… and quite a few variables in between these two companies I have not mentioned due to space requirements. i.e. this write up is light on accounting, valuation, and peer analysis discussion (want to keep at 2pages). These 3 points will hopefully be topics in the Q & A - following this write up.

Footnote #1:

I recently spoke to a company representative concerning their mobile opportunity; they are currently in a deal that is producing revenues (via distributing classic games such as Centipede, asteroids, breakout, and missile command. The mobile Brand is: “Atari Retro”. There current agreement that is producing revenues is to soon expire, then Atari in 2005, we believe Atari has plans to manage its own Mobile Games sales.

Foot note #2:

Additionally, Infogrames’ separate announcements that it had received bank financing for its business over the holidays, in addition to the unveiling of a new refinancing plan have also likely had a positive effect on ATAR shares. On October 29, Infogrames reiterated sales guidance for its second quarter, and more importantly, announced funding from its bankers for its business over Christmas. This likely helped ease some market concerns over the company’s finances. On November 24, Infogrames announced a refinancing plan for its July 2005 convertible bonds (117 million euros). This involves a bonus issue of warrants to its shareholders, giving them the right to buy new Infogrames shares while the proceeds will be used to repay the convertible bonds.

Catalyst

Catalyst:

Q3 and Q4 make up most of their earnings, so this current quarter (Xmas buying) is very important, for it is a cyclical industry. Also important is the current success of the Flashback console, and specially / critically the future success (not in current expectations) of the “Atari on demand”.

The next catalyst is Infogrames choosing to SELL its largest asset which is ATARI in an open market , of which we think the price would be $5 -$6 , using a sum of the parts valuation method , along with relative value. [Possibly Bruno (as a Frenchman) would be more content working/ living /focusing exclusively in his home country of France, thus selling the USA component of the business.]