E3 recap: Are sequels and WWII shooters enough?

Top industry stock picker reflects on what this year's E3 lineups suggest about the industry; tags hip-hop as the trend to watch.

This interview is rated "E" for Everyone, but it didn’t start out that way. Michael Pachter, senior vice president of research for investment banking and brokerage firm Wedbush Morgan Securities, has a reputation for strong opinions. But his reputation for accuracy is equally robust. Earlier this month, in a Forbes magazine feature, Special Report: Wall Street's Top Analysts, the magazine ranked Pachter as the number one earning's forecaster in the software category.

Among the companies Pachter covers are some game industry giants, including Activision, Acclaim, Electronics Boutique, Electronic Arts, Atari, Hollywood Entertainment, Midway Games, THQ, Take-Two Interactive, and GameStop.

We spoke to Pachter this week, just days after E3 had ended. The high and lows were still fresh in his mind.

GameSpot: Four days after the trumpet call that closes down E3, what do you recall most from the show?

Michael Pachter: Sequels, sequels, and more sequels. People just aren’t taking any risk on new intellectual property (IP). Obviously there are some new games but very few.

GS: Is that an advisable tack at this stage in the consoles' cycles?

MP: Apparently that’s what all the publishers seem to think.

GS: But from a financial perspective, does it make sense?

MP: The question is, how are consumers going to react? If consumers are fine with a bunch of Rambo 4s or Star Wars 6s at the movies, then fine. But I feel there’s a point where sequels wear off. I think you still need to introduce new content to get people excited. I’m afraid that the [software] companies are being a bit too conservative.

GS: Is is possible to point fingers?

MP: It’s hard to pin it on any one company. Everybody’s got to manage their balance sheets and their assets so they don’t take risks.

GS: But if you look at the movies as a guide, The Lord of the Rings 3 certainly did well at the box office.

MP: It’s a slam dunk, except it might have cost $180 million to do $300 million. We don’t know. You’re just making a bigger bet. So how did Matrix 3 do?

GS: It bombed.

MP: Right. My point is that sequels are no slam dunk either. You tend to spend more on the sequel. I think it takes some innovation. I’d like to see a blend, and I think we should just skew it towards sequels. I understand why these guys are being conservative, but I think what they don’t realize is that the Matrix 1, which wasn’t that expensive a movie, was a mass-market film, and it did pretty well.

GS: Are game companies approaching a mass-market audience intelligently?

MP: I think companies are defining the mass market as "stupid people who don’t have any taste" as opposed to "people who are every bit as hardcore as the core but don’t have as much money." I think that there’s a mix. There are people who just don’t care--who have waited to buy a console because they’re not that hardcore. And there are also a lot of people who care very much but don’t have the budget to buy a console until it gets down to $149. I think the companies are lumping all of the mass market in the former category, "people who don’t care," who will only get captured by Harry Potter, [even though] there’s a significant number of people in the latter category who want to play the next Grand Theft Auto with the best of them.

GS: The mass market isn’t clearly defined, is it?

MP: Right, we don’t know. And we have to defer to these companies that spend a lot of money on market research instead of the financial analyst. He’s just guessing. I’ll go with my gut.

GS: And….

MP: My gut tells me that 14-year-old boys are all the same, whether their parents make $50,000 or $500,000. And the $50,000 household with the dad who may not have a huge amount of disposable income and doesn’t have a PS 2 yet, well, he’s getting one this year, and he wants to play cool games.

GS: How do you read a company's booth?

MP: By lines. The number of people tells me more about the booth and whether it’s laid out right than anything.

GS: How does that translate into something that you can judge a company’s fortunes by?

MP: Remember what E3 is. It's industry people. I’m not sure how most of those young, punk kids got in there, but it’s industry people or people who care enough to lie and cheat and wangle their ways in. So it’s hardcore people. Lines equal popular, more hardcore gamers. It has nothing to do with mass market. Obviously, an intelligently designed booth will have fewer lines than a poorly designed booth. I mean, the Nintendo DS line was way over an hour long. I don’t know if you went over there or not, but I went in there, and there were like 20 of them on display.

GS: What if they put 40 on display?

MP: I don’t want to say that the lines are the "end all, be all," but they certainly allow us to gauge the level of interest among the hardcore consumers.

GS: You mentioned DS in your research note this morning. You said that you favored the prospects of the DS over the PSP.

MP: For the near-term.

GS: Can you explain?

MP: Near-term because the DS has the replacement angle. If you have two kids and one GBA SP, and you told them to share--you may actually buy a second one now, because the DS is different and better and is fully backward-compatible. You’ll buy a second one and hand down the first one. The GBA SP had that same feature over the GBA. So, I think the DS is going to sell a bunch of units. Remember, there’s a 22-million-installed base in the US for the GBA. I could see easily 10 percent of those people just upgrading.

GS: How long do the legs last?

MP: Well, that’s the thing. It’s not going to. Then it’s going to be a question of content, and I think that PSP is going to get a lot of ports. DS is going to take a lot of original content development. Now, I did have a publisher tell me that the DS is very easy to program for, so that’s good. But the real question is: Does original content drive sales, or do ports from old games drive sales? We’ll see what happens.

GS: Which product had more sizzle?

MP: I thought the DS was truly innovative, where the PSP is exactly what I thought it would be. The DS changes gameplay. It’s a whole new way of playing games, and that’s cool. I think the potential is incredible. And frankly, I think the DS takes the GBA audience from a range of 6-12 to an audience of 6-20, because it's going to allow for more-challenging gameplay. PSP doesn't even start until about 16 or 17 because of its price.

GS: As a financial analyst, what’s more important? A look at the balance sheet or hands-on with the games?

MP: Hands-on with the games is completely irrelevant with me, because there’s no way I could decide if a game’s going to be good or not just from looking at it. I would never ever look at my own taste and decide that’s what consumer tastes are going to be. For the life of me, I will never understand Tony Hawk. Nor will I understand WWE. And, frankly, I have Madden Football 2001, am perfectly happy with it, and don’t know why anybody would buy a version after that.

GS: Speaking of Madden... Is there any stopping EA? From a purely negative perspective, what typically ends the reign of a juggernaut in its prime?

MP: I think that the model is Disney…or McDonald's.

GS: Where did they become vulnerable?

MP: They failed to adapt to the times. They failed to pay attention to what their competitors where doing and [failed] to address competitive advantages that others had. And so what Disney did was it didn’t make R-rated moves. What McDonald's did was it stuck to its menu and didn’t offer salads and alternative choices. Wendy’s Value Menu just crushed McDonald's and took share. And all the other companies making R-rated movies just killed the Disney film division. And they both changed their minds way too late. They lost a huge competitive advantage.

EA is just like that with M-rated content. They keep saying, "We’ll do it, but we’re not going to do gratuitous sex or violence." I defy you to name a game that has gratuitous sex and violence. You can say Manhunt, and I can argue with you that it doesn’t have gratuitous violence. There’s a point to it. And Mortal Kombat? Come on? Does anybody really think tearing a guy’s head off makes any difference at all?

GS: So what’s behind EA's position?

MP: I don’t know what’s behind it. I don’t understand them. EA’s reality has EA’s view at the center--as the median, the mean of the world. And they’re not. They have an extreme view. Their extreme view happens to be skewed toward "We’re a family-friendly company," but it’s not mainstream. Mainstream is reflected by consumer culture. Look at television and film. And the fact is that there’s gratuitous sex and violence in every movie--and there is on television as well. The EA guys are behind the times.

GS: When do you predict that they will embrace M-rated product?

MP: July 2013? I don’t know.

GS: You don’t see it as an eventual part of their business model?

MP: They truly believe it’s inappropriate, and the fact is, when we look back on 2004--and when we combine PC games and console games--we are going to discover that mature-rated content makes up greater than 20 percent of total sales. That’s pretty easy to predict with Half-Life and Doom and Halo and Grand Theft Auto. So, EA has made a big concession saying, "We’ll make lighter M-rated games, but we’re not going to make the darker ones." Well, that’s some progress. But the fact is, people want to buy games where they blow up everything in sight. The EA guys seem to be branding gratuitous sex and violence as code for pornography. They consider it pornographic. Well, obviously the mainstream doesn’t, or 20 percent of sales wouldn’t be that type of content. I think it’s foolish of them to cede 20 percent of the market.

GS: So if EA doesn’t get it, in terms of tracking cultural trends, who does get it? Who gets it to a T?

MP: Probably Activision, because they have a balance. Take-Two gets that mature-rated content works, but they obviously can’t execute. Midway gets it, but Activision probably has the right balance. Activision doesn’t feel that if they put out a mature-rated title, like Doom, that’s it’s going to keep people from buying Shrek--that moms are going to picket the stores and say, "We can’t buy Shrek." [It] just never even occurs to them that people are going to brand them as the M-rated content company with Doom. And it doesn’t get any more violent than Doom. Where [EA CEO] Larry Probst says 30 percent of his developer workforce will walk off the job if he were to [publish] Grand Theft Auto, he’s just wrong.

GS: What’s the conventional wisdom say when looking at Microsoft’s decision to can its sports lineup? Is it that they can't compete with EA's sports lineup?

MP: It’s not just that no one can compete with EA. Microsoft [games] suck! I guess their tennis game was good--Top Spin. Microsoft should can all games that they developed and should have bought somebody who knows how to do it.

GS: Have they bought anyone in recent history that knows what they’re doing?

MP: The Rare guys were great developers for the N64, but they didn’t do anything for these guys. [Microsoft] made some really bad decisions. They should have bought EA. They screwed up.

GS: Where do you see the Xbox agenda taking Microsoft four years down the road?

MP: I still think that their ultimate goal is to move the Internet connection to underneath the television set, and I think that they’re going to continue on that track, but I don’t know that they’ll beat Sony to it. They’ll move enough people, but the problem with Microsoft is they’re a software company who is trying to dominate the Internet through ISPs or software. They decided to create a hardware solution to get there--to achieve their goals--and they don’ know how to make hardware. So they overspend. The Xbox is a wonderful box, but they just kind of forgot that you need content, and no one’s buying it. And they’re going to forget it again [in the next] cycle.

GS: Do you think that Sony needs to get on board the online bandwagon to retain its top ranking as a hardware manufacturer?

MP: Sony bought software capability because I think they learned the lesson from Betamax. If you don’t have software support, you can’t watch a box. I think that they bought Columbia Pictures because I think they’re heading towards this universal media box, whether it’s the PSP or the PSX or something else. I think that they want to own content because they recognize they’ll sell more hardware if they own content. Microsoft doesn’t understand that yet. The only way you can control and guarantee third-party support is to own it. Microsoft just never read that case in business school.

GS: Is Nintendo a contender? A player?

MP: They’re definitely a player.

GS: It’s not as if they’ve conceded all sectors or all genres, except for the kiddie genre?

MP: No, they’re just really good at the kiddie genre, and they made a tactical error creating a box that was cute…and didn't rely enough on third-party content. They highlighted [in their E3 press conference] that they’re trying to do third-party mature-rated content. We’ll see if they succeed.

GS: What’s it going to take to compete intelligently when the next-gen consoles are released. What will the winning tactics be?

MP: Last is first and first is last. Sit back and let Microsoft fail.

GS: Harsh words, Michael.

MP: I think Nintendo and Sony will spend all their time lining up third-party support for their launches, and if they launch a year or two later than Microsoft--with 200 titles each--and Microsoft still only has 30, Microsoft finishes third in a three-horse race.

GS: That seems very unlikely.

MP: What if [Sony and Nintendo are] backward-compatible? What if Microsoft is not backward-compatible? Then make it 1200 to 30. I think that Nintendo and Sony are going to sit back and wait. And, frankly, let’s say the PS 2 is down to $49 by then. I think Sony would be smart to build a box that has dual drive that plays both games, PS2 and PS3, even if they do a new processor. Microsoft may not figure that out until way too late.

GS: So what was the take-away from this year’s E3?

MP: I was underwhelmed by the game offerings. Aside from the Nintendo DS, the most innovative game I saw was Destroy All Humans, which is destined for failure. But it is a very clever to twist everything so that you’re actually an alien shooting people. It’ll never sell, because it's over-the-top violent. But good for them for trying.

GS: What does the industry have to do to make it another great year and to make E3 ’05 a spectacular event?

MP: I think the industry has to give us something new. And I don’t mean 'all content' new but a higher percentage of new things and a lower percentage of sequels. Did you count how many racing games there were? And how many Vietnam games there were? Come on? Military subversion? Racing games? Give me a break. Come up with something different!

GS: Did anyone impress?

MP: Did you go over to Playlogic? They had a game called Inuits. It’s an Eskimo game. Good for them!’ They’re trying something different. It was interesting. It’s not going to do well, but it’s nice to see developers pushing the envelope with something different. I just didn’t see enough of that. Games are getting to the point where you expect them to be visually stunning, but I was surprised how many ‘me too’ games [there were].

GS: What's your prediction for next year?

MP: Hip-hop. I’ll bet next year there are 50 hip-hop games.

GS: Which will be a good thing or a dumb thing?

MP: Don’t know. I think that Def Jam Vendetta was the first, so give EA credit for actually pioneering something different. And you can tell that San Andreas is going to be a hip-hop game, as is Midnight Club 3: DUB Edition. I must have seen four or five games with hip-hop soundtracks. Next year there’ll be 20.

GS: Back to your note on E3. You are pretty kind to all companies, Acclaim, Midway, and Atari included.

MP: A rising tide lifts all ships.

GS: Tell me about Acclaim.

MP: Acclaim could make it. I thought 100 Bullets was innovative. Interview with a Made Man is totally innovative--a mafia story told in retrospect, which is smart. And you determine the outcome. The Last Job is a heist caper, and it was smart. We haven’t seen a game like that. Good for them for trying. Why are they the ones? Why isn’t EA doing that?

GS: In the context of what E3 can do for a company, is being off the show floor, as Take-Two was, detrimental to their agenda?

MP: I think Take-Two has some [problems]. I wrote in my note that we were quite candid with them about what they’re doing wrong. I was mad at them, because there are 10 screenshots or more [of San Andreas] in Game Informer Magazine, and they only showed three at the investor presentation. What’s wrong with them? They can’t even show their investors the same [material] that they’re putting in a magazine. They’re playing everything so close to the vest. They should have had a TV commercial produced, and they should have shown it to investors. Are they afraid that their investors are going to call up their competitors and their ideas are going to be ripped off?

GS: I've heard people use words like ignorant, inexperienced, unsophisticated.

MP: Yes, yes, and yes.

GS: Does E3 still have significance to the industry?

MP: I think so. It’s a marketing opportunity, and some guys capitalized on it, and some guys did not. And I think it’s a marketing opportunity to retail, which is important. But at the end of the day, you can market the hell out of a game, like Turok, and get retailers to take 500,000 units--and then have them ship back 300,000 of them. It doesn’t make any difference--you’ve still got to get it right.

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