When Japanese video game developer Square Enix unveiled its "friendly" offer to buy rival Tecmo last week, analysts and investors applauded. The two companies seemed a natural fit: Square Enix's Final Fantasy and Dragon Quest series had a huge following among diehards in Japan, while Tecmo's Ninja Gaiden and Dead or Alive fighting games were popular in the U.S. and Europe. To sweeten the deal, Square Enix President Yoichi Wada pledged to preserve the Tecmo brand. He gave Tecmo's management a week to think it over.
On Sept. 4, with a midnight deadline looming, Tecmo said no to Square Enix's takeover bid. A couple of hours later, Tecmo revealed why: The $110 million Tokyo company was exploring a possible merger with a different Japanese game maker, Koei. The two said they would form a joint committee to discuss a plan. Koei President Kenji Matsubara told reporters they would spend the next two months drawing up a detailed plan.
Marriage of Equals
A Tecmo-Koei merger would give them combined annual sales of $370 million, less than a third as much as Square Enix makes on its own. Analysts say it's too early to assess whether Tecmo and Koei can benefit from a merger. And some question whether they will be big enough to thrive in the $48 billion-a-year global gaming business. Square Enix's Wada was clearly hoping to apply his company's marketing and distribution muscle to Tecmo's library of hit games, which could boost sales volumes. "These days, you need a certain amount of scale," he says, adding that he's on the lookout for more prospective deals.
Tecmo didn't give a reason for going with Koei. But size appears to have been one issue: Rather than getting swallowed up, Tecmo may have wanted something closer to a marriage of equals. "Through a merger, we hope to grow by respecting each other's identities and creating an environment that will let employees fully show off their skills," Tecmo and Koei said in a statement. Square Enix's shares fell 1.9%, while Tecmo's rose 7.5% and Koei's edged up 0.3%.
The moves come as the industry's giants eye consolidation. In July, U.S.-based Activision (ATVI) merged with Blizzard, the gaming unit of French media group Vivendi, to form the the world's largest game maker. And sports-franchise specialist Electronic Arts (ERTS) and Grand Theft Auto creator Take-Two Interactive Software (TTWO) are in talks about a potential tie-up. Those deals appear to be as much about getting talented designers and programmers as they are about buying successful game franchises.
Industry executives say Japan's midsize game developers are prime takeover targets. Many of them have a strong record at home but limited exposure overseas. A suitor with a worldwide network—particularly in the U.S. and Europe—could take a niche Japanese developer stuck in a stagnant market and create a global mainstream franchise.
Exodus of Top Ranks
Tecmo has other issues to consider. Its senior ranks have been in upheaval recently. In June, Tomonobu Itagaki, who led the development of Ninja Gaiden and Dead or Alive and is one of Japan's most celebrated game designers, unexpectedly quit. He claimed that he was owed unpaid bonuses for his work and filed a lawsuit against the company. On Aug. 20, Tecmo President Yoshimi Yasuda also resigned, after apparently losing the board's support.
That has analysts wondering if Tecmo can repeat the success of the franchises that it had built its fortunes on. "It's a loss that Itagaki is no longer there," and not just because of his talents as a game designer, says Credit Suisse (CS) analyst Jay Defibaugh. Itagaki's name helped build anticipation for Tecmo's games. "Selling games is as much about building buzz as it is about coming up with a great game," says Defibaugh. Tecmo forecasts a 16.6% gain in operating profit to $20 million on an 18.7% rise in sales to $131 million this fiscal year through December.
Square Enix seemed ready for a prolonged fight. No sooner had Tecmo sided with Koei when Square Enix issued a statement demanding that Tecmo explain to shareholders how Koei's offer was better than Square Enix's. Square Enix had offered to pay 920 yen ($8.40) for each Tecmo share, a 30% premium at the time of the offer, making the takeover bid worth more than $200 million. But on Sept. 5, after receiving no word from Tecmo, Square Enix decided to withdraw its offer.