MCV

In April 2005, the games industry was gripped by a David-and-Goliath battle with Eidos as the prize. In the red corner stood Elevation Partners, the investment fund led by John Riccitiello, who had secured the backing of Eidos’s management for a takeover. Mike McGarvey and his team were unpopular with investors having presided over a sustained period of poor performance. They recommended the offer from Elevation, and expected to continue to run Eidos after the acquisition.

In the blue corner stood little SCi, led by Jane Cavanagh, Bill Ennis and Rob Murphy. SCi had gained a reputation for financial reliability and strong management. The company knew its way around the City (unlike Elevation which brought US sensibilities to the takeover battle and underestimated the ability of shareholders to ignore the will of senior executives.) Rumour has it that key investors were desperate to ensure that the management were not rewarded for their perceived failure to deliver value, and leapt on the opportunity to support a counter bid from SCi.

A strong reputation and clever negotiating paid off, and Jane Cavanagh, Bill Ennis and Rob Murphy found themselves in charge of an enlarged SCi, the heroes of Britsoft outsmarting the American invaders.

Now, less than three years later, that same team have been unceremoniously dumped. The reasons seem eerily familiar to anyone who remembers that bid battle. So what went wrong?

The first reason is definitely counter-intuitive, and is driven by the City’s need for predictability. In the first 12 months after the acquisition, SCi appeared to be performing extremely well. Tomb Raider Legend and Hitman Blood Money were released to great reviews and the company reported profits of approximately £23 million.

Unfortunately, they could not repeat the trick the following year. Without their key franchises, and with underwhelming performance from Championship Manager and Conflict Global Storm, the profit turned to a loss of £2.5 million in the year to June 2007.

This situation was not necessarily disastrous. Investors know that games run on a cycle of two years for development (unless you are Electronic Arts). Delivering a strong profit in 2008 might have been enough to keep investors happy. But the profit warning on 11th January seems to have been a step too far. The company warned that four titles, including Tomb Raider: Underworld, would be delayed to Q4. Losses for the 12 months are forecast rise to £19 million, and SCi stated that it will have a working capital shortfall that some analysts have estimated at up to £30 million. For shareholders aware of the chequered track record at Eidos, this was the final straw.

The reliance on Tomb Raider and Hitman was known and understood by shareholders. The real issue the investors saw was that management had failedto broaden the portfolio of games to deliver successive years of profit and predictability

Some of these operational issues may have stemmed from the difficulties in adapting from running a small SCi to a significantly-larger Eidos with global reach. SCi’s management team built their reputation running a lean publisher with no in-house development and tight financial controls. The entire staff was small enough for senior management to know everyone by name. The acquisition of Pivotal Games, developers of the Conflict series, took SCi’s employee count to over 100, but with Eidos, management suddenly had to deal with over 700 staff spread around the world, including large and critical teams in San Francisco (Crystal Dynamics) and IO (Copenhagen).

As if the operational issues were not challenging enough, senior management were continually distracted by bid speculation. As the graph above shows, SCi has been consistently touted as a potential target. A number of these potential deals were consummated. Serial investor Robert Tchenguiz took a 15% stake, while in December 2006, Warner took a 10% stake at a price of 502p, raising £45 million for the company. Combined with a placing of 3.5 million shares in April 2006 for £17.4 million, this means that SCi has raised £120 million from investors since April 2005.

In the past two years, the rumoured bidders for SCi have been legion. The shares peaked in October 2005 at 635p, on rumours that Midway was interested in acquiring SCi. The industrial logic was compelling (Midway was strong in first-person shooters and in the US, but lacked breadth of franchises and European reach; SCi was a complementary partner) but Midway lacked cash without the support of majority shareholder Sumner Redstone. When Redstone did not step forward, SCi announced that the bid talks had collapsed. Subsequently, rumours have centred on Ubisoft, EA, Vivendi, Time Warner, and most recently CDC Corporation, but the market was growing sceptical of these talks.

The share price started a steep decline and the announcement in early January that all bid conversations had terminated, combined with a profit warning, led to a 50% collapse. In less than a year, SCi’s share price had fallen 90%. As the Financial Times said, “As a rule of thumb, when only Northern Rock is below you in the list of the FTSE All-Share’s worst-performing stocks, something needs to be done.”

That something was a management change, and Phil Rogers is now in charge, with the extremely tough remit of saving one of Britsoft’s fallen idols.