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The Global Interactive Entertainment Report (172 pages, 14 Megabytes)
Complementary Summary Presentations:
The Global Interactive Entertainment Report Summary Presentation (51 pages, no video embedded, 2 Megabytes)
In-Depth
Please see analyst certification and other important disclosures starting on page 165.
Page 1
Industry
Equity Research
Global
Brian Pitz Industry Overview June 21, 2005
+1 (1)212 761-4133 / Brian.Pitz@morganstanley.com
Mary Meeker
+1 (1)212 761-8042 / Mary.Meeker@morganstanley.com
The Global Interactive
Entertainment Report
• Strong secular growth should also help to mitigate industry cyclicality
We estimate the industry’s 5-year trough-to-peak revenue CAGR will be 10% globally,
as the next console cycles get underway, and that the industry leaders will grow
faster than the overall market, with the potential for upside to our assumptions. This
report follows our Electronic Arts and Activision initiations of coverage.
• Only segment of US consumer media with a significant acceleration in spending
Gaming continues to increase share of consumer dollars and time, particularly in comparison
to other offline media, such as broadcast TV, newspapers and books. Over the
next 5 years, we anticipate 10% compound global revenue growth (trough-to-peak),
though we expect the leaders in the space to grow in excess of this rate.
• New areas of growth may help smooth volatility of the business over time
We believe that the financial performance of the publishers should become less sensitive
to the hardware cycle over time, due to expanding gamer demographics and geographies,
increasing broadband penetration, rising usage of handheld/mobile devices,
secular online gaming shifts and the emergence of robust in-game advertising opportunities.
Publishers also continue to refine their operating and management philosophies,
in addition to reaping the benefits of economies of scale.
• MSFT’s push to dominate the next-generation console should benefit publishers
We believe that Microsoft has the most consistent and unified strategy going into the
next generation at this point, and the Xbox 360 could take significant share in the next
console cycle, at least in North America and Europe. We believe that strong competition
among the console makers should continue to benefit the industry as a whole and
the third-party publishers in particular, by providing more favorable royalty terms.
• We remain Overweight ERTS and ATVI, the industry leaders
We believe that owning shares of ERTS provides the best exposure to the secular media
growth opportunities of the industry. Activision, which is less than half the size of
Electronic Arts in terms of revenue, should have greater opportunities to expand its
market share and margins, if the company executes.
• We view US Interactive Entertainment (Video Game) industry as Attractive
With a new hardware product cycle about to start, we believe the stocks have started to
adjust for the cycle trough. The near term could still prove rocky, but we see strong
drivers for Interactive Entertainment to expand its share of a growing overall entertainment
industry pie. Leading publishers and companies with unified online strategies
should benefit disproportionately from the slow, steady emergence of onlineenabled
game play.
Interactive Entertainment
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 2
Table of Contents
Summary and Investment Conclusion ............................................................................................................................................3
Interactive Entertainment Global Market Sizing .............................................................................................................................9
Market Growth Driver #1: Gaining Consumer Dollars and Share of Time...................................................................................24
Market Growth Driver #2: Hardware Competition and Convergence...........................................................................................27
Market Growth Driver # 3: Emergence of Online Gaming Business Models ...............................................................................32
Interactive Entertainment Key Players and Market Share .............................................................................................................35
Competitive Landscape: It Is Really Electronic Arts vs. the Rest .................................................................................................56
Industry Background: Understanding the Business Models and the Cycle ...................................................................................62
Cost Drivers and Profitability.......................................................................................................................................................81
Historical Investment Cycle Perspective ......................................................................................................................................92
A History of Video Games .........................................................................................................................................................100
Public Company Profiles ............................................................................................................................................................114
Private Company Profiles...........................................................................................................................................................135
Internet & Consumer Software Universe....................................................................................................................................137
Global Interactive Entertainment Slides .....................................................................................................................................138
Roadmap to the Report
We start with a snapshot of where the industry is today in terms of size and market shares. Next, we focus on the current business
models for each segment within the industry and attempt to establish a projected market size, determined by what we believe
are the fundamental market growth drivers for the next 5-10 years. Following, we discuss the current market shares of
hardware manufacturers and software publishers globally. After establishing the top-line for the industry, we examine the cost
side of the equation for software publishers in a proprietary analysis, in order to discuss historical and projected operating margins
of the major players. Then, we look at how we arrived here, discussing some of the history and evolution of Interactive
Entertainment and its key players. Finally, we discuss stock price performance over time as related to the rest of our analysis.
A slide presentation summarizing this report follows on page 139.
Our reports on Electronic Arts and Activision are available through Client Link at https://secure.ms.com. If you wish to receive
this service, please contact your institutional sales representative.
Additionally, this report and its complimentary slide presentation (along with other technology overview reports) are available
at http://www.morganstanley.com/techresearch
Special thanks to Benjamin Dorr for his significant contribution to this report.
Research assistance provided by Brian Fitzgerald 212 761-4276 / brian.fitzgerald@morganstanley.com, Ramji Srinivasan 212
761-6281 / ramji.srinivasan@morganstanley.com, Orion Loundon and Cody Audette.
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 3
Summary and Investment Conclusion
We recently initiated coverage of the US Interactive
Entertainment industry with an Attractive view and
Overweight ratings on the stocks of Electronic Arts and
Activision. With a new hardware product cycle about to
start, the stocks are already beginning to discount the upcoming
trough in the cycle, and we believe that a number
of secular changes should help to smooth out the near and
longer-term cyclicality of this business. We believe the
long-term view of the sector is compelling, and think that
the secular outlook for the business looks strong, as Interactive
Entertainment continues to expand its share of consumers’
time and spending. We believe that content still
remains king, and that companies best positioned to leverage
compelling content and succeed in an increasingly
competitive world include both software publishers and
Internet content aggregators.
Interactive Entertainment is one of only two segments
of US consumer media (the other is the Internet) with a
significant acceleration in annual spending, rising from
a roughly 5-6% CAGR during 1998–2003 to 9-10% expected
through 2008, according to estimates by Veronis
Suhler Stevenson. The research source suggests that other
segments may maintain low single digit growth rates, or
even declines, through 2008. The one exception is the
Internet, which we, along with Veronis Suhler Stevenson,
believe could grow well in excess of 11% through 2008.
Strong macro indicators, at least in the US and Europe,
suggest increased time spent on all forms of gaming —
from traditional console video games, to online Tetris
tournaments, to online role-playing games such as World
of Warcraft, to competitive fantasy sports leagues, to even
weekly poker nights at a neighbor’s house. As a result, we
believe the Interactive Entertainment industry should continue
to increase as a percentage of the overall entertainment
industry, which is itself gaining greater shares of
consumers’ time and spending.
Secular changes should help dampen the cyclicality of
the business, creating better returns for both publishers
and investors over the long-term. Stocks in the industry
have been challenging for investors because of the significant
volatility induced by the console cycles, which have
averaged 5-6 years in the past. Looking forward, we see a
number of incremental revenue growth opportunities that
should help to dampen this cyclicality over the next 3-10
years, thanks to the proliferation of handheld and mobile
devices as well as a secular shift to online-enabled gameplay,
including subscription-based online gaming models
and opportunities surrounding online micro-transactions
driven by interactive content and continued global broadband
penetration. Additionally, highly relevant in-game
advertising opportunities, the expansion of games into
more diverse and mature demographics and in-game music
opportunities should also provide incremental revenue
streams towards the back half of the upcoming cycle. Importantly,
we note that these opportunities were either nonexistent
or not material in previous console cycles.
Summary
• Our view on the Interactive Entertainment (IE) industry
is Attractive. We are Overweight ERTS and ATVI,
the leading software publishers in the industry, given
our belief that the companies should benefit from strong
secular trends, as well as continue to refine their operating
structures and benefit from scale.
• Content remains king – IE publishers should be well
positioned to benefit from product cycles driven by next
generation platforms.
• The Interactive Entertainment medium continues to
gain share of both consumer time and spending – one of
only two segments of consumer media, including Internet,
that is growing.
• We estimate the industry’s 5-year trough-to-peak
revenue CAGR will be 10% globally, as the next console
cycles get underway, and that the industry leaders
will grow faster than the overall market, with the potential
for upside to our assumptions.
• Secular changes should mitigate some cyclicality of
business; mobile devices (handhelds & phones) in the
near-term, online console gaming & in game advertising
in the medium-term and an online distribution model for
software in the longer-term.
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 4
Many of the leading publishers should be set to reap rewards
from online investment, having used the success of
the last cycle to begin transitioning. Furthermore, while it
is unlikely to gain much acceptance in the next hardware
cycle, online distribution of full games could prove to be
quite profitable in the 5 to 10 year timeframe owing to
lower cost outlays associated with the reduction of physical
distribution and packaging.
We believe the industry’s 5-year trough-to-peak revenue
CAGR will be 10% globally, as the next console
cycles get underway, and that the industry leaders
(ERTS, ATVI) will grow faster than the overall market,
with the potential for upside to our assumptions. Near
term, we believe that next-generation consoles, which
should be available from Microsoft and Sony in late 2005
and mid 2006, respectively, should lead to an overall expansion
of the business, despite rising costs — as entertainment
quality increases, markets should expand.
Longer-term, we anticipate that the Interactive Entertainment
industry leaders should benefit from some of the
same trends that are benefiting the Internet leaders — Web
applications, networked/distributed computing, and pervasiveness
of online media.
Leading hardware manufacturers and software publishers
have refined their operating structures. Although
the industry is still relatively young, it has already
contended with operational challenges faced by more traditional
companies in the software and online space including
media, entertainment and global consumer electronics.
Now these publishers should benefit from their own success
as we see new talent influxes, both for experienced
management as well as for new creative talent, with the
advent of gaming design and development programs at
universities. In addition, greater management experience
with intellectual property (IP) licensing should enable a
more level playing field between IP holders and software
publishers/developers.
Exhibit 1
The Interactive Entertainment Industry: Key Players
(Units in Millions)
Current Generation Global Life-to-Date
Consoles Installed Base (1) Market Share
Sony PlayStation 2 87 66%
Microsoft Xbox 24 18
Nintendo GameCube 19 15
US Top 6 Current Generation C2004E US C2004E US
Software Publishers Units Sold Market Share
Electronic Arts 34 22%
Take 2 Interactive 16 11
Activision 13 8
Microsoft 9 6
THQ 9 6
Sony 8 6
E = Morgan Stanley Research estimates
Source: NPD, Morgan Stanley Research.
(1) Data through March 2005. Based on manufacturer company shipments.
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 5
What Sets Our Opinion Apart From Others?
We take a long-term view on the space and believe that
secular growth trends as well as new revenue opportunities
should have a significant impact on the Interactive Entertainment
company business models in the next-console
generation.
We have a global perspective. While the traditional Interactive
Entertainment markets for console and PC games
become relatively more mature in the US and Japan, we
believe that the industry will continue to expand globally at
very high rates of growth, driven by strength in Europe and
in emerging markets, including Asia.
Detailed financial models. We leverage our Internet and
PC Software coverage experience for relevant perspectives
on Internet and online-based models, PC software-based
models, and most importantly insight into Microsoft. We
believe that Microsoft could win the next generation of
console wars in the US and Europe given its previous console
experience and first-mover advantage this time around,
and point to a recent comment by Bill Gates that sums up
Microsoft’s position on the new console initiative as “one
of the most ambitious things the company has ever done.”
Additionally, we have spent a significant amount of time
trying to better understand the underlying cost structure
and economics of the business model, and feel that these
insights help us gauge long-term profitability with a higher
degree of confidence.
With a new hardware product cycle about to start, we believe
that the relative valuations for the stocks are already
somewhat discounting prospects of lower near-term
growth, while also not factoring in the longer-term growth
potential of the industry. We caution, however, that the
near-term trading patterns could still prove rocky.
Where Could We Be Wrong?
Creating compelling content can be costly and risky.
Interactive Entertainment is a hits-driven business. In order
to overcome financial choppiness, publishers must
have a stable of titles, consisting of either new creations or
franchises, in order to support development over the lifecycle
of a console (and through transition periods between
consoles). In addition, creating new, fresh, and exciting
content for an increasingly mainstream audience could
prove difficult and very costly over the longer-term.
The industry may become more cyclical and seasonal
than we expect. This could drive short-term trading irregularities
that are contrary to our longer-term positive
view on the sector. Furthermore, we are approaching the
end of the current cycle, where revenue and earnings
growth have historically reached trough levels, and where
volatility of product and company cycles are at a peak.
Retail prices could experience long-term stagnation or
price erosion. Since premium titles drive pricing power to
a large extent, pricing power is dependent on strong content,
as well as intense competition (as demonstrated last
holiday season with Electronic Arts’ Madden versus 2K
Sports’s NFL2K5). There is no guarantee that any of the
leaders will be able to raise prices into the next-generation.
Production costs could rise faster than we expect and
hinder margin expansion. Despite the increasing level of
sophistication for development tools and additional sources
of industry talent domestically and globally, we believe
that the overall costs of game development could hinder
margin expansion, even for a company with as much leverage
as ERTS.
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 6
Electronic Arts and Activision: Overweight
Industry leaders Electronic Arts and Activision should
post long-term revenue growth and margin expansion
that exceed industry averages, suggesting to us potential
above-average returns for shareholders over time.
We initiated coverage of Electronic Arts (ERTS, $59)
on May 13 with an Overweight rating. We continue to
believe that now is the time to own ERTS, ahead of significant
positive catalysts in the coming cycle. We favor
shares of ERTS as a core large-cap, long-term holding for
investors seeking significant exposure to the strong secular
growth opportunities for content-related companies in the
industry. We continue to believe that there may be some
choppy near-term trading in the stocks of the software publishers,
as we are on the cusp of a new console hardware
cycle, but we see a very attractive long-term investment
proposition based on the following:
• Best positioned for the secular shifts taking shape.
Electronic Arts is the largest Interactive Entertainment
software publisher and developer in terms of revenue,
with roughly 21% market share and 18% unit share in
C2004, according to NPD. With its significant scale
and ability to drive long-term revenue growth, as well
as to negotiate the best possible available licensed IP
deals, Electronic Arts should continue to increase
long-term profitability and free cash flow. We estimate
ERTS should be able to expand margins to 28%
from 25% currently, driving long-term (5-year) EPS
growth of 15%.
• Incremental revenue opportunities over the long
term. We see a number of incremental high-margin
revenue opportunities that the company could use to
help smooth out the significant volatility in revenue
and profits that characterizes the hardware-driven
business cycle in the industry. These include new
platform expansion (such as the Nintendo DS and
Sony PSP), mobile, online gaming / content and ingame
advertising.
• Strong online presence on the Internet and gaining
momentum on the console. Currently, EA is the fifth
largest US Web property in terms of total monthly
minutes (behind AOL, Yahoo! Sites, MSN and eBay).
• Strong showing for ERTS at E3. The 2005 Electronic
Entertainment Expo (E3) (May 16-May 19) was the
most anticipated event in Interactive Gaming in at least
five years. We were impressed with Microsoft’s Xbox
360, which should have at least limited backwards compatibility
and will roll out globally in CQ4:05. Microsoft
announced that there will be roughly 25-40 launch
titles, and there are already roughly 160 titles under development.
We believe that ERTS is well positioned
for the 360’s holiday debut, with six titles at launch and
25 total in development for Xbox 360.
• Attractive Valuation. With ERTS, we believe that
there is long-term valuation upside if the company
executes, although the execution risks are key to monitor.
Specifically, our 10-year DCF valuation is $67
(assuming a 10.0% discount rate and a 4.5% terminal
growth rate), while our discounted-future-price-toearnings
valuation suggests a $42- $71 valuation (assuming
a 10-15% discount rate, a 20-25x P/E and
$2.43-3.28 C2007E EPS), and our discounted firm
value-to-revenue suggests a $45- $78 valuation (assuming
revenue of $4,493- $5,166 in C2007E a 3.0-
5.0x FV / revenue multiple, and a 10- 15% discount
rate). Additionally, at 30.6x F2007E P/E, ERTS is
trading at a discount to its average two-year forward
P/E of 36.6x for C2000-C2002. The C2000-C2002
range is a significant period because it was the time of
the last console releases (PS2, Xbox, GameCube).
• Stock repurchase plan likely a positive near-term
catalyst for ERTS. Per the most recent 10K filing,
management intends to complete the remaining $709
million of its $750 million share repurchase program
by September 30, 2005. The opportunistic buy back
of shares should help support the stock through any
negative impediments over the next several months
leading up to the seasonally strong holiday quarter.
• Strong international presence — ERTS generates
nearly half of its revenue from abroad and has broader
geographic publishing coverage and size than the other
third-party software content developers. Global, renewable
franchises tend to have higher revenue
growth and more scale when spread across the company’s
fixed-cost base.
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 7
For a more detailed analysis and a discussion of risks,
please see Electronic Arts: Secular Outlook Should Favor
ERTS Content Leadership, May 13, 2005.
We initiated coverage of Activision (ATVI, $18) on May
13 with an Overweight rating. Activision, which is less
than half the size of Entertainment Arts in terms of revenue,
should have greater opportunities to expand market share
and operating margin, if the company executes. We project
Activision’s operating margin will rise from the current
13% to the mid 20% range by 2014, which corresponds
to the current margins of ERTS. In our view, over
the past console cycle Activision has demonstrated similarities
to ERTS by virtue of its solid execution, quality
franchise titles, developer talent and a relative increase in
owned-IP. If the market embraces this observation,
ATVI’s multiple should expand to better resemble that of
ERTS’.
We underscore that this is a long-term call, and in the nearterm,
the stock may be volatile given the timing relative to
the end of the current console hardware cycle and continued
seasonal weaknesses expected in CQ2:05. Nevertheless,
we see a very attractive long-term investment proposition
based on the following:
1. Activision is entering the sweet spot of its business
model, with revenue growth driven by its broad portfolio,
strong catalog titles, and new franchise growth.
The company has successfully expanded its operating
margins from 6% in F2001A to 13% in F2005A, on
the strength of its success in building its worldwide
franchises, with the benefits of scale of over $1.4B in
revenue, and strong growth in internally developed IP,
namely its Call of Duty franchise.
2. Significant room to expand market share in a highly
fragmented market. We expect ATVI to increase organic
software sales in a relatively flat US software
market in C2005E based on the strength of its catalogue
franchise sales, as well as the release of a strong
upcoming title lineup. We believe both ATVI and
ERTS should also benefit this holiday season from the
absence of major releases from competitors, like Halo
2 and GTA: San Andreas.
3. Margin expansion potential. ATVI should continue
to experience significant organic margin expansion as
it begins to reap the benefits of increased scale, a more
beneficial mix of owned versus licensed IP and continued
aggressive price leadership on AAA titles.
High-margin revenue opportunities like new platform
expansion (such as the Nintendo DS and Sony PSP),
mobile gaming, in-game advertising and online gaming
and content should push margins to the mid 20%
range by F2014E.
4. The company remains focused on building its content
franchise strategy through expansion of its IP
franchises, development resources, and global distribution
capabilities. We anticipate that ATVI will continue
to leverage its strong balance sheet, consisting of
$841MM in cash, and continue to focus on execution
to help realize this strategy. On June 16th, Activision
announced the appointment of Michael Griffith as
President and CEO of the Activision Publishing unit.
We believe this management change is a positive for
the company; Griffith, with 24 years of experience at
Procter & Gamble, brings consumer-facing management
strength and brand-building talent to Activision,
desirable qualities for a company focused on growing
and expanding its share of fresh brands and content.
• Attractive Valuation. With ATVI, we believe that
there is long-term valuation upside if the company
executes, specifically when considering our 10-year
DCF ($25, with a 10.5% discount rate and a 4.5% terminal
growth rate, and assuming a 10-year revenue
and EBITDA CAGR of 10%, and operating EPS
CAGR of 15%.), discounted firm value-to-revenue
($29-49 on $1,897-2,087MM in C2007E revenue, a
10-15% discount rate, and a 3.5-4.5x multiple) and
discounted price-to-earnings ($31-54, based on $1.05-
1.52 in C2007E EPS, a 10-15% discount rate, and a
35-40x P/E multiple) valuation analyses.
For a more detailed analysis and discussion of risks, please
see Activision: Opportunity to Expand Market Share and
Margins, May 13, 2005.
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 8
Guiding Principles on Interactive Entertainment that Should Resonate Throughout this Report…
• Content is King -- The most advanced hardware technology will not necessarily capture the highest market share, because
content is king and marketing/distribution matters
• Hardware Manufacturers Must Befriend Software Developers -- Hardware manufacturers can help start virtuous cycles
by creating economically favorable business models for third-party software publishers
• Next Generation Games are Very Realistic -- Hardware capability has increased to the point where a full range of realistic
game-play is possible and the expansion of genres should foster variety and inclusiveness
• Gaming Isn't Just for the Young Male Demographic -- Interactive Entertainment is an activity that is not necessarily
youth / male-dominated; gamers are staying with games as they mature, expanding the entire demographic
• Lessons from P&G -- Marketing (and distribution) matters as much as product development for both the younger demographics
as well as for mainstream users
• Broadband Inflection Point Should Help Gaming Too -- Broadband adoption improves the quality and quantity of Internet
usage, boosting the potential for online gaming
• Online Gaming Development is in the Early Innings -- Online console gaming should benefit all titles across the spectrum
through network effects, though franchise or serial software titles may be further driven by “must-upgrade-to-play” requirements
online
• A Sony vs. Microsoft Battle Should be Good for Consumers and Software Developers -- A competitive hardware environment
should benefit independent software publishers by potentially providing more favorable royalty terms and addressing
different demographic profiles
• Operating Margins May Rise for Software Developers -- Long-term (5-10+ years), online distribution models and ingame
advertising could materially increase operating margins for independent software publishers
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 9
Interactive Entertainment Global Market Sizing
The global interactive entertainment industry has many
components…
• Video game console and handheld hardware
• Video game console and handheld software
• PC game software
• Online game fees/micro-transactions/advertising
• Downloadable mobile games
The console and handheld hardware market is the largest
component, with an estimated $14.9B market size as of
C2004E, according to our estimates. Software revenue,
excluding PC software, up 8% year-over-year in C2004
across all regions; more specifically revenue was up 8%
Y/Y in US, Japan decreased by 4% Y/Y in Yen terms,
and Europe increased 18% Y/Y in Euro terms. Please
see page 18 for a detailed historical breakdown and future
estimates of the global industry.
Exhibit 2
The Interactive Entertainment Industry: Key Players
(Units in Millions)
Current Generation Global Life-to-Date
Consoles Installed Base (1) Market Share
Sony PlayStation 2 87 66%
Microsoft Xbox 24 18
Nintendo GameCube 19 15
US Top 6 Current Generation C2004E US C2004E US
Software Publishers Units Sold Market Share
Electronic Arts 34 22%
Take 2 Interactive 16 11
Activision 13 8
Microsoft 9 6
THQ 9 6
Sony 8 6
Source: Company estimates based on units shipped, Morgan Stanley Research.
Note that there is a difference between units shipped by the manufacturer and
consoles sold as reported by NPD. (1) Data through March 2005.
Summary
• The Global IE market is more than mainstream, generating
approximately $31B in revenue in C2004E,
greater than global box-office revenue, of roughly
$21B. The installed base of the current generation of
consoles is 130MM as of CQ1:05. The US Interactive
Entertainment hardware and software market represents
nearly 9% of the $113.5B that includes all US consumer
electronics spending, according to the Consumer
Electronics Association.
• The current gaming cycle, for most metrics, has already
hit record levels. Hardware sales and tie ratios (software
units per console sold) are well ahead of the comparable
point in the last cycle, driving both strong revenue
growth and improved profitability for publishers.
• Sony continues to dominate console hardware with
about 66%-68% global unit share (there is a difference
between units shipped and sold). Microsoft has established
a strong integrated online console platform with
the Xbox and Xbox Live helping to drive growth in the
US and Europe in the back-half of the cycle.
• Nintendo continues to be a dominant player in the
handheld video game market, although it faces competition
from other portable devices, such as Sony’s PSP
and, to a lesser extent, from mobile games.
• Electronic Arts remains the leading global independent
third-party software publisher on the console and the
PC, as well as on its online platform.
• Online casual gaming and persistent-state worlds (also
known as Massively Multiplayer Online Role-Playing
Games (MMOGs or MMORPGs) have emerged as opportunities
and representative models for expanding
into markets such as China.
• Mobile gaming is currently in a relatively nascent state,
though we believe the growth inherent in mobile applications
could provide substantial incremental upside to
software publishers longer-term.
In the next generation, we see potential for: 1) retail
price appreciation of software; 2) mainstream nextgeneration
hardware adoption; 3) significant ramping of
the online subscriber base; 4) the advent of material contributions
from mobile gaming and 5) extension of next
cycle versus the previous cycles.
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 10
US is Largest Market, Followed by Europe
Breaking it down geographically, we estimate the overall
C2004E Interactive Entertainment market at $31B (up 1%
Y/Y) in revenue, based on current exchange rates
• US market was $9.8B (down 2% Y/Y) including US
hardware, console software and PC software only
• European market was $9.7B (up 3% Y/Y in Euro
terms) including Europe hardware, console software
and PC software only
• Japan market was $4.4B (down 3% Y/Y) including
Japan hardware and software only
According to IDC and PwC estimates, the Asia/Pacific PC
software market in C2004E is roughly $1.5B (up 3% Y/Y),
global online subscriptions, ads & fees is $2.1B (up 43%
Y/Y), global mobile subscriptions & fees is $1.3B (up 77%
Y/Y) and the Interactive Entertainment industry in the rest
of the world is roughly $2.0B.
In total, Global Software accounts for 48% of revenue
while hardware sales account for 20% in C2004E
Breaking it down by product group and looking at the US
market specifically, total Interactive Entertainment revenue
in C2004E was $9.8B (down 2% Y/Y), based on NPD data
• Console hardware revenue only of $1.6B (down 27%
Y/Y on reduced pricing)
• Handheld hardware revenue only of $0.8B (up 11%
Y/Y)
• Console software only revenue of $5.2B (up 7% Y/Y)
• Handheld software sales of 1.0B (up 11% Y/Y)
• PC game sales of $1.1B (down 8% Y/Y)
Pure online gaming fees and mobile game downloads in
the US contribute another $0.7B and $0.3B, respectively.
Note that we do not include the cost of PC graphics/
multimedia cards and peripherals or gaming-oriented
PCs in our market sizing. To cite one example, multimedia
semiconductor designer NVIDIA averaged $250-
$300MM in revenue from Xbox GPU’s during 2001-2004,
while the company averaged roughly $1B in annual desktop
GPU revenue (a portion of which is focused on hightech
gaming cards) over that same time period. We also do
not factor in online gambling or online fantasy sports, two
markets that may converge with online gaming in the future.
Product adoption has accelerated in the current cycle
Breaking it down by cycle in the US, we believe the current
128-bit generation (e.g., Sony PlayStation 2, Microsoft
Xbox, Nintendo GameCube, excluding Sega Dreamcast)
consoles generated life-to-date hardware/software revenue
in the US of $25.2B as of end C2004. Compare this to the
same period in the 32/64-bit generation (e.g., Sony Play-
Station, Nintendo N64, Sega Saturn), when consoles generated
life-to-date revenue of $14.4B at the end of C1999E.
The C2004E market size represents 75% growth vs. the
comparable period in the last cycle. The 32/64-bit generation
has never achieved a comparable market size to the
128-bit generation. While adoption has accelerated during
this cycle, one cannot deny the overall market growth in
hardware and software adoption, especially without even
considering the further mainstreaming of the handheld.
European market, while large, is fragmented
Language, retail channel and cultural differences make it
difficult to determine accurate weekly or monthly market
sizing. GfK / Chart Track does, however, provide us with
the opportunity to step back and evaluate this important
region – albeit for only 10-11 major countries – on an annual
basis. For detailed market share data on publishers,
please see the Interactive Entertainment Key Players and
Market Share section.
Installed base for current generation hardware consoles
in Europe is 42MM, versus 27MM for AP / Japan
and 62MM for the Americas, according to company
shipment data. Thus Europe is the second most
important region in terms of size, and in terms of growth
potential, Europe might rank as the most important market.
Note, since the PS2 is 75% of the market at $2.6B in
sales, we cite that console’s data as the key platform indicator.
As shown in Exhibit 3, PS2 penetration rates are still low
in several major European countries. We note that ATVI
has stated plans to expand into some of these same countries
(Austria and Portugal, for instance).
Interactive Entertainment – June 21, 2005
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Page 11
Exhibit 3
Europe – C2004E PS2 Penetration Rates, Household
per Country
26
16
12 11
9 9 9 8
26
0
5
10
15
20
25
30%
Spain
UK
Fr ance
Austria
Italy
Poland
Belgium
Netherlands
Portugal
E = Morgan Stanley Research estimates
Source: GfK / Chart Track, Morgan Stanley Research.
Since the average penetration rate across this sample is
15.3%, there is clearly room for growth in countries that
lie below this benchmark. Also note, Xbox penetration
rates are even lower than the PS2’s – we think it is highly
likely that, for instance, MSFT will improve on the current
7.2% UK Xbox penetration rate by the end of the
life of the Xbox 360.
European console software market in C2004 ($4.6B)
was close to the size of the US market ($5.2B). What
we find even more interesting is the fact that in C2004,
GTA: San Andreas was the top PS2 title in nine of the 11
countries covered by GfK / Chart Track and in C2003,
either FIFA 2004 or Pro Evolution Soccer 3 was the top
title in 8 of 11 countries. The implication is that, even in
a fragmented market, it is possible for a publisher to produce
content that is compelling across the entire region.
The Pro Evolution Soccer franchise, published by Konami,
also suggests that EA’s dominance can be shaken
(Pro Evolution Soccer 4 outsold FIFA 2004 €91MM to
€88MM, respectively, on the PS2 in C2004).
On a country size basis, again for the PS2, the clear market
leader is the UK at 38% or nearly €1B in annual
revenue, followed by a somewhat distant France and
Germany (see Exhibit 4). The fragmented nature of the
markets in the country may give an indication of why
some companies, like ATVI, distribute hardware and
software in the region. It is equally important to note
that, as a publisher gains scale in the region, it may need
to rely less on distributors, which can take a 15% margin,
and sell directly at a higher overall margin.
Another current and potentially future advantage to
American sellers is advantageous currency exchange
rates. When one considers that Exhibit 5 shows ASP’s
for all titles, not just AAA titles, European ASP’s should
be considered relatively high, especially for companies
with lower operating cost structures due to first-party
manufacturing, developing and distribution networks on
the continent.
Exhibit 4
Europe – C2004E PS2 Software Sales per Country
France, 16%
UK, 38%
Ireland, 3%
Portugal, 1%
Sweden, 2%
Austria, 2%
Belgium, 2%
Netherlands,
3%
Italy, 9%
Spain, 9%
France, 16%
E = Morgan Stanley Research estimates
Source: GfK / Chart Track, Morgan Stanley Research
Exhibit 5
Europe – C2004E PS2 ASP’s per Country
58
55
48
45
51 53 54 54
61
45
51
0
10
20
30
40
50
60
70$
Austri a
Belgium
France
Germany
Ireland
Italy
Netherlands
Portugal
Spai n
Sweden
UK
E = Morgan Stanley Research estimates
Source: GfK / Chart Track, Morgan Stanley Research.
Note: Average C2004 $ / € exchange rate = 1.244 per Factset.
Interactive Entertainment – June 21, 2005
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Page 12
European GameBoy Advance (GBA) software market
in C2004 was €555MM with Y/Y revenue growth of
22% and 38% in C2004 and C2003, respectively. The
introduction of the GameBoy Advance SP in C2002 and
the Pokémon craze (Pokémon titles were the top sellers in
11 out 11 countries in C2003 and 10 out of 11 in C2004).
Results to date indicate Nintendo has dominant hardware
and software franchises. We look for C2005 to represent
the beginning of a paradigm shift in this market. Not
only is there a strong new handheld in Sony’s PSP, but
also third-party software manufacturers, notably EA, are
now entering the handheld markets.
Interactive Entertainment – June 21, 2005
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Page 13
All in, industry data points are imprecise…
The size of a hits-driven industry does not necessarily
follow conventional wisdom or historical trends. One
cannot model the Interactive Entertainment industry in the
same way that one models technology companies and
technology adoptions. Far too much is at play on the topline
to think about only secular trends; macro media consumption
trends must merge with the right content produced
in the right way, in our view. Consider what we see
as a strong software market in C2004E with a number of
blockbuster titles such as Halo 2 and Grand Theft Auto:
San Andreas driving console software sales and mainstream
hardware adoption and PC titles such as Doom3 and
Half-Life 2 buoying the PC market. We use this as an example
that the market does not grow at a predictable time
unless the content is there to influence consumer behavior.
A heavily marketed, blockbuster film released on July 4th
will more than likely do well, but it won’t hit record levels
unless the content is also compelling — compelling
enough to drive incremental traffic. Hence, a relative peak
could come in C2008E or C2009E or C2010E or at some
other point depending on the interplay between adoption
and content, but we have built our model with a reasonable
expectation of execution on the content side given the industry’s
ability to continue to drive demographic and geographic
expansion through strong content choices (See our
Market Growth Driver #1 section on page 24).
Historical comparability is difficult because of foreign
exchange rates. We have used (where available) shipments
and ASP in local currencies and adjusted figures to
the current spot exchange rate. As such, historical and
projected market sizes based upon future iterations of this
model may change depending on the strength of the US
dollar relative to the euro and the yen.
Industry ASP data is not sufficient to discuss percompany
trends. Because of widespread pricing variations
per company and per title, separating the model only
by market share even on a per-segment basis would not
provide clarity as to the strength of one company’s top-line
vis-à-vis another.
We see parallels with the early days of the Internet, circa
1995, across a number of categories
The Interactive Entertainment industry is in a state of flux
in a number of its high-growth segments, including online
gaming, handheld/mobile gaming and in-game advertising,
while the biggest and most mature segment, console gaming,
may see significant business model changes. Some of
the major issues that could affect the top-line but on which
we lack visibility are:
• Overall hardware convergence. Without sufficient
visibility into the 5+ year changes to the Interactive
Entertainment industry caused by convergence
of media-focused PCs and consoles,
gaming handhelds and other handheld devices, as
well as Web applications and distributed computing,
we have built our model conservatively
around the existing business model and foreseeable
trends.
• Emerging markets. While industry data is fairly
robust from the largest markets, including the US,
Western Europe, and Japan, we acknowledge that
there are some limitations on understanding the
global market in Latin America, Africa, Eastern
Europe, and Asia/Pacific, including Australia.
• Hardware transition. While we expect to see
the next-generation Microsoft console at the end
of C2005E and the other consoles likely in midto-
late-C2006E, changes to that timing would influence
our assumptions with regard to adoption
and consumer purchasing behavior.
Interactive Entertainment – June 21, 2005
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Page 14
What Is Interactive Entertainment?
We divide the Interactive Entertainment industry into
three segments: hardware, software, and online.
• Hardware consists of video game consoles such as
Sony’s PlayStation and PlayStation 2, Nintendo’s N64
and GameCube, and Microsoft’s Xbox, and video
game handheld devices such as Nintendo’s Game Boy
Advance and DS, Nokia’s N-Gage, and Sony’s PSP.
The range of hardware used to play games is expanding,
with a niche, but growing market for mobile
phone gaming. We note that many gamers use PCs as
their hardware of choice, given the ability to upgrade
devices with the latest hardware technology.
• Software for video game consoles, handheld devices,
and the PC can be developed either by “firstparty”
publishers — hardware manufacturers like
Sony, Nintendo, and Microsoft — or by independent,
“third-party” publishers like Electronic Arts, Activision,
Take 2, Konami, Capcom, and Namco. These
third-party publishers are also usually responsible for
manufacturing, marketing, and distribution costs; IP
licensing may be borne by either the publisher or developer
depending on the arrangement. Software developers
are the programmers or studio responsible for
the game content. For instance, Activision is the developer
of Shrek 2 and id Software as the developer of
Doom3.
• Online gaming can take place either on the console/
PC or on the web. In a hybrid model, a consumer
accesses online competition through the console
or PC and the online component represents an extension
of the game software. Software can provide an
access point to the game itself, most recognizably in
the form of a persistent-state world or Massively Multiplayer
Online Role-Playing Game (MMOG or
MMORPG). Sometimes players download small applications
or use browsers to access online games like
checkers or chess on EA’s pogo.com.
• Handheld refers to interactive game play on mobile
hardware devices whose primary functionality
is game play. The Game Boy, Game Boy Color,
Game Boy Advance, Nintendo DS and Sony PSP are
handheld devices. Mobile, meanwhile, refers to gaming
on cellular devices. It is important to note that,
with the cell phone continuing to evolve as a small
personal computer, we may see convergence of these
two platforms, as seen with the Nokia N-Gage.
• Hardware cycles are the periods between console
introductions with advanced levels of innovation.
For example, the 32-bit/64-bit cycle began with the release
of the Sony PlayStation and the Sega Saturn in
1995; Sega released its Dreamcast and Sony released
its PlayStation 2 in 1999 and 2000, respectively, starting
a new hardware cycle. A new hardware cycle will
begin with the eventual release of next-generation Microsoft,
Sony, and Nintendo consoles in 2005 and
2006.
• Software publishers are third-party independent
software publishers that market and distribute
games designed by either their own development
studios or external development studios. For example,
in 2004 Activision published Shrek 2 developed
by in-house studio Luxoflux; it also published Doom3
developed by external studio id Software. In addition
to development or development acquisition costs, publishers
are also usually responsible for manufacturing,
marketing, and distribution costs; IP licensing may be
borne by either publisher or developer depending on
the arrangement.
• When we speak of software developers, we generally
refer to the programmers or studio responsible
for the game content. As a matter of simplicity
and keeping with the prior example, we generally refer
to Activision as the developer of Shrek 2 and id Software
as the developer of Doom3. The major costs
borne by developers are salaries for the designers,
programmers, artists, and animators on the development
team.
Interactive Entertainment – June 21, 2005
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Page 15
A number of guiding assumptions affect our models for
the different segments of the industry
While we highlight our major growth drivers (Online
Gaming, Geographic & Demographic Expansion, Hardware
Competition) in the next three sections of the report,
each of these growth drivers have specific implications for
how we model the segments of Interactive Entertainment.
Console hardware. In the US, we estimate the installed
base of 128-bit generation consoles to grow to a level 25%
higher than the installed base of 32/64-bit consoles, from
roughly 50MM to 62MM. Given obvious limits on household
penetration and the potential for handhelds to become
a significant part of the gaming environment, we believe
that the market will expand but the growth will decelerate
to the mid-teens. In Europe, we estimate that there is a
significant opportunity to increase market penetration, as
macroeconomic conditions in Eastern and Southern Europe,
as well as online gaming, could help to accelerate adoption
of the console. In Japan, the last cycle realized market
penetration contraction, but we believe that a flat market
environment with regard to penetration is likely conservative.
We do believe that adoption will occur as rapidly as
Japan and in the US to a lesser extent in the next cycle,
with a slight acceleration in Europe due to more unified
launches and more attractive pricing.
Handheld hardware. We do not know who might have
the inside edge in the Nintendo DS vs. Sony PSP contest.
We doubt very much that this is a zero-sum game, however.
Both companies have managed to raise the discussion level
and increase “mind share” for handhelds. As consoles
have advanced, game content has become more immersive
and more mature; this content was far more relevant to an
older audience. With the DS and the PSP, we believe we
have reached the first inflection point, perhaps the level
reached by the first PlayStation, where older gamers adopt
portable game content at a higher rate, thus expanding a
market typically reserved for children. Note that the first
Game Boy did have tremendous success among adults with
the game of Tetris. Specifically, we have modeled a penetration
increase of 22% in the US for all handhelds combined
in C2006E over all handhelds combined in C2004E,
relative to the total hardware installed based, an estimate
we see as conservative given the number of Game Boy and
Game Boy Color handhelds sold over the last 15 years. In
Europe, we are more aggressive with the belief that handheld
penetration growth could grow roughly 40%+ over
the next several years depending on competition from mobile
platforms and other devices.
Console software. We have modeled console software
sales based on expected tie ratios and consumer demand.
Despite an expanding user base with more mainstream
tendencies, we believe the nature of online gaming should
offset expected tie ratio dilution. As such, we see a market
with increased penetration and similar tie ratios through
the first part of the cycle. Typically, as installed bases increase
and less die-hard users enter the picture, tie ratio
growth tends to slow. We believe that the most important
impact of online gaming should be to push software sales
through any typical slowdown or transition period (see
page 32), and online console gaming should have reached
a relative saturation point in the next cycle where this is the
case. The tie ratio growth, in other words, should continue
past the first five years of the cycle. As such, we believe
tie ratios, especially on the most successful platforms,
should reach record levels in the US and Europe, with
Europe approaching US levels of adoption.
Handheld software. We believe handheld software tie
ratios should improve in this cycle as well, as an older
demographic with deeper pocketbooks and greater focus
by frontline publishers/developers should lead to higher
adoption of stronger software titles. The handheld software
market should grow far more quickly than the handheld
hardware market buoyed by both the installed base
increase and the higher level of engagement.
PC entertainment software. We believe traditional PC
software is the most challenged segment (without taking
into account the impact of convergence) and the only segment
that we have modeled as consistently declining
across the forecast period. Recent success of Doom3, The
Sims 2 and Half-Life 2 aside, it has become clear to us that
PC software is increasingly a niche market, encroached
upon by serious online gaming that has stolen dollars and
media time share of the PC’s most die-hard users. Similarly,
PC entertainment software has been encroached upon
by consoles that provide increasingly similar technology
(e.g., hard drives, networking, etc.) and more palatable
user experiences (e.g., easier to use, multiplayer ready,
placement in the living room, etc.). Obviously, there will
be winners here and companies that take advantage of the
core user base, the high penetration rates, and low development
costs. However, we believe the investment story
for these companies will more than likely be execution,
rather than top-line growth and margin expansion.
Interactive Entertainment – June 21, 2005
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Page 16
Online gaming. We model the online gaming market as
five separate businesses: 1) console subscriptions & related
micro-transactions, 2) downloadable content, 3) casual
gaming subscriptions, 4) in-game advertising, and 5) serious
online game subscriptions. We think each of these
markets is capable of significant growth. Console subscriptions,
we believe, should become a more significant
part of the equation, as either Microsoft gains share in the
console market or Sony asserts itself with a more unified
strategy in the next hardware cycle. Overall, we believe
that online gaming usage is dependent on broadband user
penetration’s overlap with an increasingly mainstream console
user base. Some markets with high broadband penetration
are not traditionally console users, and the Japan
market has entered a more mature stage, perhaps preferring
a different online gaming experience. Hence, penetration
in US and Europe is more important for the console segment.
Additional content monetization such as expansion
packs and tournaments are likely to be a function of overall
online console penetration as well as the type of adopted
business model.
Casual gaming subscriptions, we believe, should grow with
general trends toward more premium content on the Web,
growth in overall Internet users (as users have typically
been drawn to games and community) and growth in
broadband as the user experience improves. In-game advertising,
we believe, is a wild card that could become
more pervasive in an online environment. In an online
environment, in-game advertising could move past the
monetization of casual game traffic and small product
placement deals to larger real-time impression-based deals
and sponsorships. Depending on acceptance, advertising
could be a significant source of revenue or a pittance.
What we describe as traditional or serious online gaming
subscriptions, we believe, should continue to grow, but the
majority of the revenue may originate from growth in
Asian markets including China, Taiwan, and Korea, with
growth heavily dependent on China.
Another form of casual online gaming focuses on betting
and / or gambling. Although we are not covering online
gambling in this report, we quickly highlight the recent
explosive growth seen by online poker and other related
betting sites on the Internet.
Online poker succeeds beyond traditional brick and mortar
casino poker for several reasons. For one, poker tables
take up comparatively large areas of space on a casino
floor and, given the “rake” fee structure, they do not generate
a proportionate level of revenue for the casino. The
online setting is more user-friendly -- software provides
tips to novice players, as well as reminders to users of the
proper time to bet. Consistent with the low overhead associated
with the online poker model, websites can allow
computer-controlled ‘bots’ to run games continuously, all
the while generating a steady stream of revenue for the
online casino.
Piggybacking on the success of televised World Series of
Poker Texas Hold ‘Em tournaments, online poker websites
like PartyPoker.net and PokerStars.com continue to see
increased traffic. According to PokerPulse.com, a site that
tracks traffic and wages across a wide range of online
poker sites, over 1.8MM users wagered real money (as
opposed to virtual play chips) during May 2005. Poker-
Pulse.com monitors 225 of the 304 known online poker
networks and estimates that players wager roughly
$200MM in ring-poker games every day.
However, the online poker craze faces some potential risks.
Questionable legality in many countries, especially the US,
as well as lack of regulation gives online poker an uncertain
future. Anecdotal evidence of unfair card dealing and
improper computer influenced betting has sparked a growing
backlash against several casinos, and it is widely
known that multiple players can collude online to influence
outcomes.
Mobile gaming. Mobile gaming consists of subscriptions
and/or one-time charges for games downloaded to mobile
handsets; the segment could stand by itself or be folded
into handheld gaming depending on how the industry
evolves. That said, we believe that the segment should
continue to benefit from mobile phone penetration, increasing
network speeds, growing sophistication of wireless
handsets and greater comfort with downloadable content
in any form including games, ring tones and images.
Again, Europe and Asia may continue to lead the development
of these services, given early deployment of
higher-speed networks, as well as the cultural acceptance
of mobile phone and wireless services.
We believe mobile gaming will be a substantial contributor
to casual gaming, given the small form factor of the phone
and the relatively short time-span mobile gamers spend
playing on their phones. Mobile gaming may also play a
role in networked gaming, as discussed earlier, where eiInteractive
Entertainment – June 21, 2005
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Page 17
ther two mobile phone users play the same game, or a mobile
user plays a phone-version of a console / PC game.
We forecast revenue in this segment as the product of
wireless gaming subscribers multiplied by an average
monthly fee. In the next 2-5 years, we estimate that
Europe and Asia will continue to contribute the bulk of the
subscribers in revenue, but that US revenue and gaming
subscribers could start playing catch-up in the coming
years.
Interactive Entertainment – June 21, 2005
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Page 18
Exhibit 6
Global Interactive Entertainment Market – C1999E-C2011E
(US$ in Millions)
C1999E C2000E C2001E C2002E C2003E C2004E C2005E C2006E C2007E C2008E C2009E C2010E C2011E
Global Interactive Entertainment Market $22,507 $22,347 $26,319 $29,212 $29,534 $30,942 $36,010 $34,766 $38,935 $42,373 $44,604 $47,764 $55,045
Y/Y Growth -- (1%) 18% 11% 1% 5% 16% (3%) 12% 9% 5% 7% 15%
US Interactive Entertainment Market (10) $7,407 $7,217 $9,735 $10,463 $9,980 $9,815 $10,139 $10,388 $12,160 $12,033 $11,732 $10,453 $10,093
Y/Y Growth -- (3%) 35% 7% (5%) (2%) 3% 2% 17% (1%) (2%) (11%) (3%)
Global Console / Handheld Hardware $4,986 $4,755 $8,433 $8,866 $7,398 $6,227 $5,626 $8,356 $9,225 $7,853 $6,008 $4,856 $5,341
Y/Y Growth -- (5%) 77% 5% (17%) (16%) (10%) 49% 10% (15%) (23%) (19%) 10%
% of Total 22 21 32 30 25 20 16 24 24 19 13 10 10
Units (MM) 38 31 43 45 41 44 39 44 46 44 37 31 34
ASP $132 $155 $196 $198 $179 $142 $144 $191 $201 $177 $160 $157 $159
US (1) $1,927 $1,642 $3,675 $3,534 $2,960 $2,447 $2,498 $3,401 $4,111 $3,421 $2,813 $2,120 $2,241
Y/Y Growth -- (15%) 124% (4%) (16%) (17%) 2% 36% 21% (17%) (18%) (25%) 6%
% of Total 9 7 14 12 10 8 7 10 11 8 6 4 4
Europe (2) $2,125 $1,534 $2,701 $3,552 $3,162 $2,499 $1,506 $2,650 $3,372 $3,274 $2,439 $1,905 $2,025
Y/Y Growth -- (28%) 76% 32% (11%) (21%) (40%) 76% 27% (3%) (26%) (22%) 6%
% of Total 9 7 10 12 11 8 4 8 9 8 5 4 4
Japan (3) $934 $1,579 $2,056 $1,779 $1,276 $1,281 $1,623 $2,305 $1,742 $1,158 $756 $832 $1,075
Y/Y Growth -- 69% 30% (13%) (28%) 0% 27% 42% (24%) (34%) (35%) 10% 29%
% of Total 4 7 8 6 4 4 5 7 4 3 2 2 2
Global Console / Handheld Software $11,108 $10,964 $10,998 $12,791 $13,788 $14,941 $19,232 $13,858 $14,924 $16,514 $16,218 $14,821 $14,362
Y/Y Growth -- (1%) 0% 16% 8% 8% 29% (28%) 8% 11% (2%) (9%) (3%)
% of Total 49 49 42 44 47 48 53 40 38 39 36 31 26
US (1) $4,185 $4,147 $4,564 $5,508 $5,802 $6,246 $6,416 $5,900 $7,032 $7,641 $7,960 $7,386 $6,916
Y/Y Growth -- (1%) 10% 21% 5% 8% 3% (8%) 19% 9% 4% (7%) (6%)
% of Total 19 19 17 19 20 20 18 17 18 18 18 15 13
Europe (4) $2,667 $3,008 $3,350 $3,972 $4,661 $5,510 $5,377 $5,192 $5,230 $6,188 $6,134 $5,824 $5,428
Y/Y Growth -- 13% 11% 19% 17% 18% (2%) (3%) 1% 18% (1%) (5%) (7%)
% of Total 12 13 13 14 16 18 15 15 13 15 14 12 10
Japan (3) $4,256 $3,809 $3,085 $3,312 $3,325 $3,185 $7,439 $2,766 $2,663 $2,685 $2,124 $1,611 $2,018
Y/Y Growth -- (11%) (19%) 7% 0% (4%) 134% (63%) (4%) 1% (21%) (24%) 25%
% of Total 19 17 12 11 11 10 21 8 7 6 5 3 4
Global PC Software $5,089 $5,203 $5,143 $4,708 $4,324 $4,355 $4,288 $3,859 $3,527 $3,353 $3,250 $3,161 $3,113
Y/Y Growth -- 2% (1%) (8%) (8%) 1% (2%) (10%) (9%) (5%) (3%) (3%) (2%)
% of Total 23 23 20 16 15 14 12 11 9 8 7 7 6
US (5) $1,294 $1,428 $1,496 $1,421 $1,218 $1,123 $1,225 $1,086 $1,017 $971 $959 $948 $936
Y/Y Growth -- 10% 5% (5%) (14%) (8%) 9% (11%) (6%) (5%) (1%) (1%) (1%)
% of Total 6 6 6 5 4 4 3 3 3 2 2 2 2
Europe (4) $1,443 $1,540 $1,610 $1,559 $1,634 $1,712 $1,729 $1,531 $1,360 $1,290 $1,233 $1,190 $1,176
Y/Y Growth -- 7% 5% (3%) 5% 5% 1% (11%) (11%) (5%) (4%) (3%) (1%)
% of Total 6 7 6 5 6 6 5 4 3 3 3 2 2
Asia / Pacific (6) $2,352 $2,236 $2,037 $1,728 $1,472 $1,520 $1,334 $1,242 $1,150 $1,093 $1,058 $1,024 $1,001
Y/Y Growth -- (5%) (9%) (15%) (15%) 3% (12%) (7%) (7%) (5%) (3%) (3%) (2%)
% of Total 10 10 8 6 5 5 4 4 3 3 2 2 2
Global Online Subscriptions, Ads & Fees (7) -- $135 $393 $884 $1,498 $2,146 $2,793 $3,512 $4,504 $6,055 $8,271 $11,412 $15,773
Y/Y Growth -- -- 191% 125% 69% 43% 30% 26% 28% 34% 37% 38% 38%
% of Total -- 1 1 3 5 7 8 10 12 14 19 24 29
Global Mobile Subscriptions & Fees (8) -- -- $8 $357 $733 $1,301 $1,842 $2,574 $3,547 $4,590 $5,766 $7,149 $8,628
Y/Y Growth -- -- -- 4,363% 105% 77% 42% 40% 38% 29% 26% 24% 21%
% of Total -- -- 0 1 2 4 5 7 9 11 13 15 16
Other / Rest of World (9) $1,324 $1,289 $1,344 $1,606 $1,793 $1,972 $2,229 $2,608 $3,207 $4,009 $5,092 $6,365 $7,828
Y/Y Growth -- (3%) 4% 19% 12% 10% 13% 17% 23% 25% 27% 25% 23%
% of Total 6 6 5 5 6 6 6 8 8 9 11 13 14
(1) Based on NPD point-of-sale data through C2004E and Morgan Stanley Research estimates thereafter.
(2) Based on Morgan Stanley Research estimates for C1999-2001E and C2004E forward. Based on Chart Track/Gfk point-of-sale data for C2002-2003E.
(3) Based on Media Create for C1999-2004E and Morgan Stanley Research estimates thereafter.
(4) Based on Chart Track/Gfk point-of-sale data for C1999-2004E and Morgan Stanley Research estimates thereafter.
(5) Based on Morgan Stanley estimates for C1999E and C2004E forward. Based on NPD point-of-sale data C2000-C2003E.
(6) Based on PricewaterhouseCoopers estimates for C1999-2003E and Morgan Stanley Research estimates thereafter.
(7) Based on PricewaterhouseCoopers estimates for C2000-2003E and Morgan Stanley Research estimates thereafter.
(8) Based on PricewaterhouseCoopers estimates for C2001-2003E and Morgan Stanley Research estimates thereafter.
(9) Based on PricewaterhouseCoopers and Morgan Stanley Research estimates.
(10) Hardware and Software-based revenue only
E = Morgan Stanley Research estimates
Source: Morgan Stanley Research.
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 19
Exhibit 7
Global Interactive Hardware Unit Sales – C1999E-C2011E
(units in thousands)
C1999E C2000E C2001E C2002E C2003E C2004E C2005E C2006E C2007E C2008E C2009E C2010E C2011E
Consoles
PlayStation 7 ,717 3 ,643 5 7,325 4 ,159 2 ,419 1 ,555 8 74 1 25 50 - - - -
PlayStation 2 - 2 ,906 2 1,359 1 8,483 1 6,207 1 4,197 1 0,403 4 ,450 2 ,050 1 ,150 4 50 1 10 -
PlayStation 3 - - - - - - - 5 ,753 9 ,450 1 1,200 9 ,975 7 ,929 5 ,797
Xbox - - 1 ,422 5 ,420 5 ,407 6 ,311 4 ,569 9 86 4 65 1 15 25 - -
Xbox 360 - - - - - - 1 ,680 7 ,110 1 0,025 1 0,660 9 ,535 7 ,541 5 ,720
Nintendo GameCube - - 2 ,188 4 ,672 5 ,643 4 ,119 2 ,814 1 ,750 6 75 3 00 1 10 25 -
Nintendo Revolution - - - - - - - 3 ,600 7 ,400 7 ,650 6 ,400 4 ,550 3 ,250
Handhelds
GameBoy Advanced - - 1 3,952 1 4,132 1 5,436 1 4,371 4 ,859 2 ,440 1 ,340 8 15 2 50 - -
Nintendo DS - - - - - 2 ,679 7 ,452 9 ,035 7 ,325 6 ,200 5 ,200 3 ,075 1 ,500
Sony PSP - - - - - 5 10 6 ,506 8 ,385 7 ,225 6 ,200 5 ,500 3 ,475 1 ,700
E = NPD Data, Morgan Stanley Research estimates
Source: NPD, Morgan Stanley Research.
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 20
Exhibit 8
US Hardware Market Comparison – 32/64-bit Cycle vs. 128-bit Cycle (excl. Sega Dreamcast)
(US$ and Units in Millions)
$279
$986
$1,500 $1,511
$1,083
$333 $603
$2,147
$1,580
$764
$2,888
$2,578
0
500
1,000
1,500
2,000
2,500
$3,000
Year 1:
C1995E
C2000E
Year 2:
C1996E
C2001E
Year 3:
C1997E
C2002E
Year 4:
C1998E
C2003E
Year 5:
C1999E
C2004E
Year 6:
C2000E
C2005E
Revenue
(4.00)
1.00
6.00
11.00
16.00
Units
32/64-bit Cycle Dollars 128-bit Cycle Dollars
32/64-bit Cycle Units 128-bit Cycle Units
$314 $299 $207 $290 $153 $206 $133 $167 $112 $144 $164 $103
ASPs shown at
base in red.
Source: NPD, Morgan Stanley Research. 32/64-bit cycle includes Sony PlayStation, Nintendo N64, and Sega Saturn. 128-bit cycle includes Sony PlayStation 2, Microsoft
Xbox, and Nintendo GameCube. E = Morgan Stanley Research estimates
Exhibit 9
US Software Market Comparison – 32/64-bit Cycle vs. 128-bit Cycle (excl. Sega Dreamcast)
(US$ and Units in Millions)
$897
$2,155
$3,197 $3,255
$1,834 $1,275
$3,981
$4,625 $5,141
$163 $127
0
1,000
2,000
3,000
4,000
5,000
$6,000
Year 1:
C1995E
C2000E
Year 2:
C1996E
C2001E
Year 3:
C1997E
C2002E
Year 4:
C1998E
C2003E
Year 5:
C1999E
C2004E
Year 6:
C2000E
C2005E
Revenue
0
50
100
150
200
Units
32/64-bit Cycle Dollars 128-bit Cycle Dollars
32/64-bit Cycle Units 128-bit Cycle Units
$54 $49 $53 $48 $47 $42 $40 $35 $36 $34 $43 $32
ASPs shown at
base in red.
Source: NPD, Morgan Stanley Research. 32/64-bit cycle includes Sony PlayStation, Nintendo N64, and Sega Saturn. 128-bit cycle includes Sony PlayStation 2, Microsoft
Xbox, and Nintendo GameCube E = Morgan Stanley Research estimates
Exhibit 10
US Tie Ratio Comparison – 32/64-bit Cycle vs. 128-bit Cycle (excl. Sega Dreamcast)
3.56 4.28
5.43
6.50 6.64
4.08
5.62
7.19
8.73
11.10
3.40
2.33
0
2
4
6
8
10
12
Year 1:
C1995E
C2000E
Year 2:
C1996E
C2001E
Year 3:
C1997E
C2002E
Year 4:
C1998E
C2003E
Year 5:
C1999E
C2004E
Year 6:
C2000E
C2005E
Tie Ratio
32/64-bit Cycle Tie Ratio
128-bit Cycle Tie Ratio
Source: NPD, Morgan Stanley Research. 32/64-bit cycle includes Sony PlayStation, Nintendo N64, and Sega Saturn. 128-bit cycle includes Sony PlayStation 2, Microsoft
Xbox, and Nintendo GameCube. E = Morgan Stanley Research estimates
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 21
Exhibit 11
Europe Hardware Market Comparison – 32/64-bit Cycle vs. 128-bit Cycle (excl. Sega Dreamcast)
(US$ and Units in Millions)
$330
$624
$1,868 $1,726
$1,270
$441 $516
$2,036
$3,018
$2,516
$2,037
$1,021
0
500
1,000
1,500
2,000
2,500
3,000
$3,500
Year 1:
C1995E
C2000E
Year 2:
C1996E
C2001E
Year 3:
C1997E
C2002E
Year 4:
C1998E
C2003E
Year 5:
C1999E
C2004E
Year 6:
C2000E
C2005E
Revenue
0
2
4
6
8
10
12
Units
32/64-bit Cycle Dollars 128-bit Cycle Dollars
32/64-bit Cycle Units 128-bit Cycle Units
$413 $441 $250 $339 $199 $358 $182 $269 $155 $222 $138 $172
ASPs shown at
base in red.
Source: Chart Track/GfK, Morgan Stanley Research. 32/64-bit cycle includes Sony PlayStation, Nintendo N64, and Sega Saturn. 128-bit cycle includes Sony Play-
Station 2, Microsoft Xbox, and Nintendo GameCube. E = Morgan Stanley Research estimates
Exhibit 12
Europe Software Market Comparison – 32/64-bit Cycle vs. 128-bit Cycle (excl. Sega Dreamcast)
(US$ and Units in Millions)
$404
$2,005
$3,064
$3,849
$2,601
$1,906
$2,878
$3,784 $4,147 $3,991
$134 $82
0
1,000
2,000
3,000
4,000
5,000
$6,000
Year 1:
C1995E
C2000E
Year 2:
C1996E
C2001E
Year 3:
C1997E
C2002E
Year 4:
C1998E
C2003E
Year 5:
C1999E
C2004E
Year 6:
C2000E
C2005E
Revenue
0
25
50
75
100
Units
32/64-bit Cycle Dollars 128-bit Cycle Dollars
32/64-bit Cycle Units 128-bit Cycle Units
$67 $62 $73 $77 $63 $66 $55 $56 $49 $49 $44 $43
ASPs shown at
base in red.
Source: Chart Track/GfK, Morgan Stanley Research. 32/64-bit cycle includes Sony PlayStation, Nintendo N64, and Sega Saturn. 128-bit cycle includes Sony Play-
Station 2, Microsoft Xbox, and Nintendo GameCube. E = Morgan Stanley Research estimates
Exhibit 13
Europe Tie Ratio Comparison – 32/64-bit Cycle vs. 128-bit Cycle (excl. Sega Dreamcast)
2.30 3.10
4.30
5.70
6.80
3.72 4.50
5.52
6.53
7.91
2.50
1.32
0 2 4 6 8
10
12
Year 1:
C1995E
C2000E
Year 2:
C1996E
C2001E
Year 3:
C1997E
C2002E
Year 4:
C1998E
C2003E
Year 5:
C1999E
C2004E
Year 6:
C2000E
C2005E
Tie Ratio
32/64-bit Cycle Tie Ratio
128-bit Cycle Tie Ratio
Source: Chart Track/GfK, Morgan Stanley Research. 32/64-bit cycle includes Sony PlayStation, Nintendo N64, and Sega Saturn. 128-bit cycle includes Sony Play-
Station 2, Microsoft Xbox, and Nintendo GameCube. E = Morgan Stanley Research estimates
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 22
Exhibit 14
US Hardware Market Comparison – 128-bit Cycle (excl. Sega Dreamcast) vs. Next Gen Cycle
(US$ and Units in Millions)
$333
$2,578
$2,888
$2,147
$1,802
$495 $745
$1,923
$3,144
$2,735
$2,363
$1,513
0
1,000
2,000
3,000
$4,000
Year 1:
C2000E
C2005E
Year 2:
C2001E
C2006E
Year 3:
C2002E
C2007E
Year 4:
C2003E
C2008E
Year 5:
C2004E
C2009E
Year 6:
C2005E
C2010E
Revenue
0
4
8
12
16
20
Units
128-bit Cycle Dollars Next Gen Cycle Dollars
128-bit Cycle Units Next Gen Cycle Units
$299 $300 $290 $271 $206 $228 $167 $187 $143 $169 $103 $144
ASPs shown at
base in red.
Source: NPD, Morgan Stanley Research. 128-bit Cycle (excl. Sega Dreamcast) includes Sony PlayStation, Nintendo N64, and Sega Saturn. 128-bit cycle includes Sony
PlayStation 2, Microsoft Xbox, and Nintendo GameCube. E = Morgan Stanley Research estimates
Exhibit 15
US Software Market Comparison – 128-bit Cycle (excl. Sega Dreamcast) vs. Next Gen Cycle
(US$ and Units in Millions)
$1,834
$3,981
$4,625
$5,669
$4,928
$1,407
$3,738
$5,637
$6,470 $6,395
$127 $215
0
1,000
2,000
3,000
4,000
5,000
6,000
$7,000
Year 1:
C2000E
C2005E
Year 2:
C2001E
C2006E
Year 3:
C2002E
C2007E
Year 4:
C2003E
C2008E
Year 5:
C2004E
C2009E
Year 6:
C2005E
C2010E
Revenue
0
50
100
150
200
Units
128-bit Cycle Dollars Next Gen Cycle Dollars
128-bit Cycle Units Next Gen Cycle Units
$49 $50 $48 $49 $42 $47 $35 $41 $33 $38 $31 $35
ASPs shown at
base in red.
Source: NPD, Morgan Stanley Research. 128-bit Cycle (excl. Sega Dreamcast) includes Sony PlayStation, Nintendo N64, and Sega Saturn. 128-bit cycle includes Sony
PlayStation 2, Microsoft Xbox, and Nintendo GameCube. E = Morgan Stanley Research estimates
Exhibit 16
US Tie Ratio Comparison – 128-bit Cycle (excl. Sega Dreamcast) vs. Next Gen Cycle
4.08
5.62
7.19
8.87
10.55
4.07
5.63
7.23
8.78
10.25
2.33 2.60
0 2 4 6 8
10
12
14
Year 1:
C2000E
C2005E
Year 2:
C2001E
C2006E
Year 3:
C2002E
C2007E
Year 4:
C2003E
C2008E
Year 5:
C2004E
C2009E
Year 6:
C2005E
C2010E
Tie Ratio
128-bit Cycle Tie Ratio
Next Gen Cycle Tie Ratio
Source: NPD, Morgan Stanley Research. 128-bit Cycle (excl. Sega Dreamcast) includes Sony PlayStation, Nintendo N64, and Sega Saturn. 128-bit cycle includes Sony
PlayStation 2, Microsoft Xbox, and Nintendo GameCube. E = Morgan Stanley Research estimates
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 23
Exhibit 17
Europe Hardware Market Comparison – 128-bit Cycle (excl. Sega Dreamcast) vs. Next Gen Cycle
(US$ and Units in Millions)
$441
$2,036
$3,018
$2,516
$2,037
$1,021
$1,365
$2,360 $2,588
$1,965
$1,406
$958
0
500
1,000
1,500
2,000
2,500
3,000
$3,500
Year 1:
C2000E
C2006E
Year 2:
C2001E
C2007E
Year 3:
C2002E
C2008E
Year 4:
C2003E
C2009E
Year 5:
C2004E
C2010E
Year 6:
C2005E
C2011E
Revenue
0
2
4
6
8
10
12
Units
128-bit Cycle Dollars Next Gen Cycle Dollars
128-bit Cycle Units Next Gen Cycle Units
$441 $385 $339 $323 $358 $260 $269 $238 $222 $206 $172 $187
ASPs shown at
base in red.
Source: Chart Track/GfK, Morgan Stanley Research. 128-bit Cycle (excl. Sega Dreamcast) includes Sony PlayStation, Nintendo N64, and Sega Saturn. 128-bit cycle
includes Sony PlayStation 2, Microsoft Xbox, and Nintendo GameCube. E = Morgan Stanley Research estimates
Exhibit 18
Europe Software Market Comparison – 128-bit Cycle (excl. Sega Dreamcast) vs. Next Gen Cycle
(US$ and Units in Millions)
$1,906
$2,878
$3,784 $4,147 $3,991
$2,478
$4,377
$4,909 $4,880
$4,310
$82
$598
0
1,000
2,000
3,000
4,000
5,000
$6,000
Year 1:
C2000E
C2006E
Year 2:
C2001E
C2007E
Year 3:
C2002E
C2008E
Year 4:
C2003E
C2009E
Year 5:
C2004E
C2010E
Year 6:
C2005E
C2011E
Revenue
0
25
50
75
100
125
Units
128-bit Cycle Dollars Next Gen Cycle Dollars
128-bit Cycle Units Next Gen Cycle Units
$62 $65 $77 $62 $66 $55 $56 $51 $49 $47 $43 $43
ASPs shown at
base in red.
Source: Chart Track/GfK, Morgan Stanley Research. 128-bit Cycle (excl. Sega Dreamcast) includes Sony PlayStation, Nintendo N64, and Sega Saturn. 128-bit cycle
includes Sony PlayStation 2, Microsoft Xbox, and Nintendo GameCube. E = Morgan Stanley Research estimates
Exhibit 19
Europe Tie Ratio Comparison – 128-bit Cycle (excl. Sega Dreamcast) vs. Next Gen Cycle
3.72 4.50
5.52
6.53
7.91
4.53
6.21
7.78
9.21
10.52
1.32
2.57
0
2
4
6
8
10
12
Year 1:
C2000E
C2006E
Year 2:
C2001E
C2007E
Year 3:
C2002E
C2008E
Year 4:
C2003E
C2009E
Year 5:
C2004E
C2010E
Year 6:
C2005E
C2011E
Tie Ratio
128-bit Cycle Tie Ratio
Next Gen Cycle Tie Ratio
Source: Chart Track/GfK, Morgan Stanley Research. 128-bit Cycle (excl. Sega Dreamcast) includes Sony PlayStation, Nintendo N64, and Sega Saturn. 128-bit cycle
includes Sony PlayStation 2, Microsoft Xbox, and Nintendo GameCube. E = Morgan Stanley Research estimates
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 24
Market Growth Driver #1: Gaining Consumer Dollars and Share of Time
The ability for people to interact expands in a number of
different ways once the Internet moves further into the living
room. We believe Interactive Entertainment is one of
the most logical extensions. In our experience, we have
seen groups in their mid-twenties gathering around a TV
and, instead of putting in a movie, picking up a wireless
keyboard, accessing the Media Center PC and searching for
content on the Web. The ability to share, communicate, and
play with anyone and everyone cannot be underestimated,
in our view. Additionally, we believe that many underlying
trends in media usage support this thesis.
The Internet and video gaming should drive consumer
media spending growth
The Internet and video games have realized 30.7% and
5.6% (see Exhibit 20) compound consumer spending
growth rates from 1998 to 2003. This compares to the
growth of total consumer spending on all media increasing
at a roughly 8% CAGR over this same period. The growth
across all media was largely a result of substantial growth in
the Internet, cable & satellite TV and video games (excluding
the effect of the slight decline in the industry in 2000, a
year that preceded the last significant console launch).
In 2003, spending on video game software grew at the slowest
rate in several years (since 2000), according to data from
Veronis Suhler Stevenson. The year had a tough year-overyear
comparison, and also suffered from the lack of new
hardware rollouts, few large titles and continued PC software
declines. New titles and price reductions drove software
sales to some extent. Similarly, console sales were
also uneventful given the lack of any new hardware releases.
Spending on the Internet increased nearly 15% in 2003 to
over $23B, given the increase in number of users and usage
driven by broadband adoption. On the traditional media
side, cable & satellite television delivered a roughly 7%
spending increase in 2003.
Slight deceleration in consumer spending
Although spending on Internet access and content will
likely continue in the low double digits, we believe it will
likely decelerate somewhat in 2004 through 2008 as market
penetration continues to reach a point that is closer to saturation
levels. Computer and Internet household growth has
already begun to slow since manufacturers have effectively
reached their target market with less frequent upgrades.
Additionally, slower growth in dial-up spending will likely
continue to offset gains in cable modem and DSL access
spending.
Veronis Suhler Stevenson estimates a roughly 5% and 6.5-
7% increase in video game and cable & satellite TV services
spending, respectively, in 2004. Spending on video
games should continue at just under a 10% CAGR through
2008 to reach roughly $11.5 billion in 2008, versus a forecasted
CAGR of 6% for Cable & Satellite TV over the same
period. Growth in video games will likely be driven by
increased unit sales, which in turn is driven by increased
adoption of the systems, as well as by higher price points
for next generation premium content. Spending on overall
media will increase at a slower, 7% CAGR pace.
Summary
• Gaming continues to grow share of consumer time
and dollars in comparison to other offline media, such as
recorded music, broadcast TV and books.
• Media should grow at a 7% and 2% CAGR (2003-
2008E) in terms of consumer dollar and time share, respectively,
and video games should grow roughly 10%
and 7%, respectively, over the same period, according to
Veronis Suhler Stevenson
• Visually compelling, user-controlled, and massively
diverse content are hallmarks of video games and the
Internet, the two main drivers of media growth over the
last 5-10 years.
• We forecast this trend to continue, with the Internet
and video gaming continuing to significantly outpace
growth in overall media time and dollar spending.
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 25
Exhibit 20
Consumer Spending Per Year on Consumer Media - US
Cable &
Recorded % Consumer % News- % Consumer % Box % Satellite % Video % Consumer % %
Music Chg. Magazines Chg. papers Chg. Books Chg. Office Chg. TV Chg. Games Chg. Internet Chg. TOTAL* Chg.
1997 12,237 --- 9 ,334 --- 10,066 --- 1 6,021 --- 6,366 --- 30,670 --- 4,425 --- 5,506 --- 110,376 ---
1998 13,711 12.0% 9 ,923 6.3% 10,692 6.2% 1 6,916 5.6% 6 ,949 9.2% 33,534 9.3% 5,515 24.6% 6,149 11.7% 121,955 10.5%
1999 14,585 6.4% 9 ,937 0.1% 10,900 1.9% 1 8,088 6.9% 7 ,448 7.2% 36,795 9.7% 6,102 10.6% 9,396 52.8% 133,020 9.1%
2000 14,327 -1.8% 9 ,975 0.4% 10,975 0.7% 1 8,012 -0.4% 7 ,661 2.9% 39,302 6.8% 6,058 -0.7% 11,613 23.6% 139,308 4.7%
2001 13,746 -4.1% 9 ,966 -0.1% 11,214 2.2% 1 7,924 -0.5% 8 ,413 9.8% 43,028 9.5% 6,382 5.3% 16,361 40.9% 151,811 9.0%
2002 12,616 -8.2% 1 0,079 1.1% 11,482 2.4% 1 8,849 5.2% 9 ,520 13.2% 47,716 10.9% 7,124 11.6% 20,409 24.7% 167,518 10.3%
2003 11,854 -6.0% 1 0,034 -0.4% 11,689 1.8% 1 9,529 3.6% 9 ,489 -0.3% 51,099 7.1% 7,247 1.7% 23,445 14.9% 178,397 6.5%
2004E 11,715 -1.2% 1 0,075 0.4% 11,730 0.4% 1 9,877 1.8% 1 0,124 6.7% 54,594 6.8% 7,625 5.2% 26,320 12.3% 191,346 7.3%
2005E 11,493 -1.9% 1 0,121 0.5% 11,982 2.1% 2 0,346 2.4% 1 0,512 3.8% 58,145 6.5% 8,272 8.5% 29,247 11.1% 204,183 6.7%
2006E 11,428 -0.6% 1 0,189 0.7% 12,176 1.6% 2 0,833 2.4% 1 1,154 6.1% 61,800 6.3% 9,213 11.4% 32,052 9.6% 218,027 6.8%
2007E 11,306 -1.1% 1 0,256 0.7% 12,418 2.0% 2 1,120 1.4% 1 1,684 4.8% 65,638 6.2% 9,941 7.9% 35,494 10.7% 232,752 6.8%
2008E 11,341 0.3% 1 0,313 0.6% 12,700 2.3% 2 1,507 1.8% 1 2,452 6.6% 69,662 6.1% 11,473 15.4% 39,430 11.1% 248,660 6.8%
Compound Annual Growth
1998-2003 -2.9% 0.2% 1.8% 2.9% 6.4% 8.8% 5.6% 30.7% 7.9%
2003-2008E -0.9% 0.6% 1.7% 1.9% 5.6% 6.4% 9.6% 11.0% 6.9%
Sources and Estimates (E): Veronis Suhler Stevenson 2004 Communications Industry Forecast & Report
E = Veronis Suhler Stevenson estimates
(a) Total Spending is also inclusive of other categories not listed including Basic and Premium Cable, Home Video, ITV and Satellite Radio
Interactive Entertainment and the Internet are two media
that have consistently increased their share of consumers’
time…and we see no end in sight
While consumers spent more dollars on media in 2003, they
have also spent more time with the respective media. For
over 25 years, consumers have continually increased their
media usage due primarily to major technology innovations
and new media choices (first radio, then TV, then cable,
then satellite broadcasting, videogames, etc.), not to mention
the undying human quest for knowledge and entertainment.
In 2003, overall media usage increased on a Y/Y basis, up
1.6% Y/Y to 3,663 hours per-person per-year, according to
Veronis Suhler Stevenson estimates (see Exhibit 21). This
equates to roughly 10 hours per person or over 70 hours per
week — a number generally accepted by several sources
studying media usage. Growth in overall media usage increased
at an approximate 2.0% CAGR from 1998-2003, or
roughly an hour more of media use per day since 1998.
The major driver of overall media growth in 2003, and over
the past five years, is from only a handful of media that includes
the Internet, video games, and cable & satellite.
Continuing an over six-year trend, Internet usage grew the
fastest of all categories, up 11.6% to 176 hours per person
in 2003, and also grew faster than all other segments in the
1998-2003 periods, increasing over 35%. Time spent with
video games was stronger than most other consumer mediums,
increasing at a 9%+ CAGR over the 1998 to 2003
timeframe, growing far faster than recorded music, broadcast
TV, magazines, books, newspapers, box office and
even cable & satellite TV.
To a media consumer, these higher-growth forms serve up
very compelling content in a visually stimulating manner,
while also providing for day-to-day choice and flexibility —
whether it is the billions of pages available on the Internet,
thousands of online and offline video games to choose from,
or hundreds of cable channels to select at the click of a remote
control button. While these media have driven overall
media usage, they have also taken share from other forms of
entertainment that Americans have traditionally spent their
spare time on, including reading magazines, books, and
newspapers, as well as going out to the theatre to watch a
movie.
Multitasking across various media may help to explain another
partial driver of increases in media usage. A simultaneous
media usage (SIMM) study by BIG research concluded
that over 70% of consumers, at one time or another,
use media simultaneously. Similarly, a Middletown Media
Study of users found that approximately 24% of all home
media were consumed while using other media. These studies
have concluded that multitasking is most prevalent in
certain combinations of media that involve fewer visual
stimuli and require less overall focus, such as surfing the
Internet, listening to music, watching TV or reading. Research
suggests a high correlation of media multitasking
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 26
between reading and the use of music (especially radio), as
well as Internet use while watching TV or listening to music.
There is generally less media multitasking while reading
and surfing the Internet.
These studies also found that consumers are spending much
less time multitasking while playing video games that generally
involve more visual stimuli and focused attention.
The good and bad of this is that while individuals are more
focused on the games, there are other media that have a
slight advantage in terms of total time being spent. As a
result, we believe that some of the media usage data of mediums
that compete with video games may be somewhat
overstated (and less directly comparable) relative to video
game usage data.
Looked at another way, some of the usage that is being attributed
to the Internet may be a little misleading, as the
information surfed online may belong to a traditional media
company or outlet. In a similar fashion, some of the time
that individuals spend online playing games from online
sites (such as ea.com/pogo.com, Yahoo! Games and MSN
Games), may, in fact, be time that should be allocated to the
video game medium. For purposes of this analysis, we will
not attempt to break out this data within the Veronis Suhler
Stevenson numbers.
Video games and the Internet should capture an increasing
share of consumers’ time
We concur with Veronis Suhler Stevenson estimates that
video games and the Internet will continue to grow their
overall share of consumers’ time — compared to other wellknown
mediums that are actually losing share of consumers’
time, including recorded music, broadcast TV, magazines,
books, and newspapers. Veronis Suhler Stevenson
estimates that the average consumer’s time spent using media
will grow at a roughly 2.1% CAGR in 2003-2008E to
4,059 hours in 2008. The forecast for video games and the
Internet is a 7% and 6% CAGR, respectively, though our
usage estimates suggest that Internet growth may actually
be 10-15% per year. Time spent with recorded music,
magazines, books and newspapers should continue to decline
from 2004 to 2008.
Exhibit 21
Hours per Person per Year Using Consumer Media - US
Cable &
Recorded % Broadcast % Mag- % % News- % Box % Satellite % Video % % TOTAL %
Music Chg. TV Chg. azines Chg. Books Chg. papers Chg. Office Chg. TV Chg. Games Chg. Internet Chg. (a) Chg.
1998 2 75 4.3% 881 -4.5% 134 -1.2% 118 1.1% 186 -0.1% 13 5.3% 670 7.2% 45 30.9% 39 112.4% 3 ,322 0.8%
1999 2 81 1.9% 867 -1.6% 134 0.2% 119 0.9% 183 -1.6% 13 -2.4% 720 7.6% 53 17.5% 64 65.3% 3 ,421 3.0%
2000 2 58 -7.9% 866 -0.2% 135 0.8% 109 -8.4% 180 -1.1% 12 -3.9% 769 6.8% 59 12.5% 107 67.9% 3 ,492 2.1%
2001 2 29 -11.4% 833 -3.8% 127 -6.0% 106 -2.2% 177 -1.9% 13 3.2% 843 9.6% 60 1.5% 139 29.4% 3 ,540 1.4%
2002 2 00 -12.6% 787 -5.6% 125 -2.0% 109 2.2% 175 -1.1% 14 8.6% 918 8.9% 64 6.8% 158 13.8% 3 ,606 1.9%
2003 1 84 -8.1% 769 -2.2% 121 -2.7% 108 -0.7% 171 -2.1% 13 -5.0% 975 6.3% 69 8.1% 176 11.6% 3 ,663 1.6%
2004E 1 80 -1.8% 782 1.7% 118 -2.5% 107 -0.9% 169 -1.3% 13 1.8% 1,010 3.6% 71 3.0% 189 7.3% 3 ,757 2.6%
2005E 1 76 -2.5% 785 0.4% 116 -2.4% 106 -0.5% 168 -0.7% 13 0.2% 1,042 3.1% 75 4.9% 200 5.8% 3 ,809 1.4%
2006E 1 74 -1.0% 790 0.7% 113 -2.0% 106 -0.7% 165 -1.6% 13 1.4% 1,068 2.5% 81 7.5% 213 6.2% 3 ,890 2.1%
2007E 1 70 -2.5% 794 0.5% 111 -1.6% 105 -0.7% 165 -0.4% 13 0.9% 1,093 2.4% 86 6.7% 225 5.7% 3 ,949 1.5%
2008E 1 67 -1.6% 800 0.8% 110 -1.3% 104 -0.8% 164 -0.4% 14 1.7% 1,131 3.5% 98 13.5% 236 5.2% 4 ,059 2.8%
Compound Annual Growth
1998-2003 -7.8% -2.7% -2.0% -1.7% -1.6% 0.0% 7.8% 9.1% 35.4% 2.0%
2003-2008E -1.9% 0.8% -2.0% -0.7% -0.9% 1.2% 3.0% 7.0% 6.0% 2.1%
Sources and Estimates (E): Veronis Suhler Stevenson 2004 Communications Industry Forecast & Report
E = Veronis Suhler Stevenson estimates
(a) Total Hours per Person per Year is also inclusive of other categories not listed including Home Video, ITV and Satellite Radio
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 27
Market Growth Driver #2: Hardware Competition and Convergence
Following this year’s E3, the next generation console war
is now shaping up
We believe that the biggest benefactors will be the consumers,
given the great choices that will be available, and
software publishers, given the competitive royalty terms
and potential for strong installed base numbers.
Each hardware company seems to be taking a different
strategy to capture market share in a rapidly evolving market.
In our view, Sony has been the most focused on the
hardware side of the equation, Microsoft the most focused
on the software side and online and Nintendo the most
focused on differentiating the user experience. Below is a
summary of our key takeaways from the E3.
We believe Microsoft could “win” the next console cycle
Microsoft also enjoys first-mover advantage, momentum
and developer support, even from Japan. We like the 360’s
positioning as a one-box solution for the home entertainment
center – games, online, music, videos, pictures – with
wireless PC connection ability, VOIP, a removable hard
drive and text messaging capabilities. In this sense, Microsoft’s
demographic targeting to the MTV generation has
loftier aims than mere buzz creation. Microsoft is focused
on the online community, in general, and a wired demographic,
in particular; note that children under 17 spend
more time online than with any other media outlet, according
to a Veronis / Yahoo! study.
Microsoft committed to a seamless transition from Xbox
Live to the new system, with two tiers of service, Xbox
Live Silver and Xbox Live Gold. Xbox Live Silver will be
a free service, offering free weekend live play, while Gold
will be a for-pay subscription service. Gamertags, gamer
cards and video chat and messaging should help to drive
online gaming as a social, as opposed to a solitary, experience
– an effect that could enhance the gaming experience
and lead to higher console and software sales as players
seek to “stay current” with the latest franchise releases.
And free online weekends, via Xbox Live Silver, will help
drive marginal users to the platform. As we have stated
throughout this report, we think online gaming will be
mainstream by the end of the next console cycle, and we
think Microsoft will continue to be the leader in this area.
Contrast MSFT, which already has roughly 2MM Xbox
Live subscribers, to rival Sony, which did not even mention
online gaming during its presentations at the E3.
Summary
• Hardware competition and convergence should help
1) quickly propel the market into improving the overall
user experience and 2) drive market growth, in our view.
• We believe Microsoft could potentially “win” the
next console cycle, at least in the US and Europe, given
its: 1) Likely first-mover advantage in the upcoming
next-generation console cycle; recent success as a highquality
console manufacturer and game developer; 3)
experience as a dominant worldwide software developer;
and 4) achievement in online gaming to date
• At the recent E3, Microsoft’s Xbox 360 positioning
looked solid as a one box-solution for the home entertainment
center – games, online, music, videos…and its
demographic targeting to the MTV generation may also
drive strong adoption rates.
• Still, two of the world’s strongest hardware and software
companies (MSFT and Sony) are racing to win a
new, converged living room featuring awesome gaming
and music, DVD’s, online communication, HDTV…and
Sony’s quality of graphics will further drive console
adoption and gaming quality.
• On the content side, the competitive push from Sony
and MSFT, plus innovations from industry giant EA and
a host of strong, well-equipped smaller players, from
ATVI to THQ to Take 2, could lead to IE user experience
improvements at the same speed at which we are
seeing user experience improvements in the Internet
space.
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 28
Exhibit 22
Image, Xbox 360 Console and Controller
Source, Company website: Morgan Stanley Research
Ultimately, however, the gaming experience will remain
driven primarily by quality content. To this end, “nextgeneration”
graphics on the Xbox were very strong, though
not quite as robust as on the Sony PS3. We also note that
Microsoft showed real-time playable games, as opposed to
just lead-in animated footage, during the company’s demos.
Backward compatibility with Xbox titles is another positive
for Microsoft, as this will enable the company to
somewhat extend the current cycle and to also maintain the
goodwill that the company has generated with consumers
thus far. Furthermore, Microsoft announced that a line-up
of 25-40 games are set for the 360’s launch, while another
160 games are currently under development for use on the
platform. One such game will be Square Enix’s Final
Fantasy XI, which will be available online on Xbox Live
and could serve as a tipping point for Japan, which has not
yet warmed up to the Xbox.
Despite these strengths, however, Microsoft has a lot of
ground to make recover: the company is at a 4:1 global
installed base disadvantage (based on manufacturer shipment
data) to Sony’s PS2. In other words, Microsoft needs
to be aggressive and, indeed, Microsoft has demonstrated
its eagerness to win the next generation console battle.
Microsoft is going to be the first out of the gate with a
global Holiday 2005 launch of the 360; the company’s
competitors could lag a half-year behind, not including
time delays due to expected staggered, regional launches.
We expect the Xbox 360 to launch at $299 around November
of 2005, with a potential $360 package including accessories.
Bill Gates has said the Xbox 360 launch is one
of the “most ambitious” endeavors that the company has
undertaken, and the company is committed to turning its
next console into a profit-maker. It is also highly likely
that the Halo 3 release will be timed to compete with the
launch of the PS3 – can Sony return fire?
Sony makes its living in consumer electronics and is certainly
throwing its heft, as well as considerable experience,
behind its PS3
Sony’s console, we thought, produced the most visually
compelling graphics (at this early stage). The PS3 will
also be backward compatible with the vast library of titles
that are compatible with the PS1, PS2 and PSP. In terms
of marketing, Sony has an intrinsic advantage over Microsoft
in Japan given its Japanese roots. Unless the Xbox
360 gains traction in the country, Japanese software publishers
could continue to partner with Sony and extend
Sony’s dominance in Japan. Sony also hopes to fight the
Xbox on the home entertainment front. The company
stated that the PS3 should not be thought of in terms of a
gaming machine but rather as a “computer that’s meant for
entertainment.”
Backing up its claim, Sony confirmed that the PlayStation
3 will use Blu-ray discs as its media format. The discs can
hold up to six times as much data as current-generation
DVDs. The PlayStation 3 will also sport some hefty multimedia
features, such as video chat, Internet access, digital
photo viewing, and digital audio and video. In addition,
the PS3 will have the capability to support seven Bluetooth
controllers, which can be used for up to a day before recharging
is required.
Exhibit 23
Image, PS3 Console
Source: Company website, Morgan Stanley Research
While the PS3 was certainly impressive, we did not hear
any discussion on online gaming. When it comes to connecting
the living room, we liked the 360’s Windows-like
feel a bit more. Due to a (possibly staggered) Spring 2006
launch, Sony will lose the first mover advantage it has
capitalized on so greatly in the last few cycles. We also
believe the PS3 to launch in the range of $299-$399 in late
Spring of 2006, though this is likely only in Japan, and
appears to be somewhat aggressive at this stage. We beInteractive
Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 29
lieve the full launch will likely be holiday 2006, including
North America and Europe. We believe Sony’s huge installed
base advantage to date will be challenged with the
entry of an aggressive Microsoft, who we expect to level
the playing field in the next generation. On the other hand,
one of the fundamental themes of our industry thesis is that
the industry is large and diverse enough to support multiple
winners, which we think Microsoft and Sony can both be.
The question then arises, can Nintendo also win?
Nintendo’s ability to compete is difficult to determine
based on our current information
At the E3, Nintendo did not demo any software content for
its next generation console, the Revolution, leaving us to
wonder if the upcoming generation will mark another cycle
where Nintendo does not reach significantly beyond its
entrenched user base. As a plus, the Revolution will be
backward compatible with Nintendo games of all generations
via the internet, and will feature wireless controllers
and a wi-fi connection. But, in perhaps a manner that is
telling of the company’s history and focus, Nintendo’s
biggest announcement at the E3 may have been the introduction
of the Micro, the company’s latest handheld. The
Micro is a slimmed-down version of the GBA and is slated
for a Fall 2005 launch.
Exhibit 24
Image, Nintendo Revolution Console
Source: Gamespy.com, Morgan Stanley Research
At the E3, next-generation software content was strong, if
not amazing, even at this early stage in the game
Electronic Arts will have 6 games available at the launch
of the 360 – Need for Speed Most Wanted, The Godfather,
FIFA Soccer 06, NBA Live 06, Tiger Woods PGA Tour 06,
Madden NFL 06. EA has 25 games in total in development
for the 360. The company is successfully focusing
on making games “emotionally believable”. Activision,
meanwhile, will have 4 games available at the launch of
the Xbox 360 – Call of Duty 2, Quake 4, Tony Hawk’s
American Wasteland, and Gun. This is an impressive lineup,
especially if Neversoft’s Gun gains the traction that the
company expects. We also note that all four of these titles
originate from owned IP, which supports the thesis that
Activision can significantly expand its operating margin in
the next cycle. Based on the quality of the content as well
as on the overall enthusiasm for the next generation titles,
we believe the above premium titles will launch at a $60
price point.
Pure horsepower matters less than other differentiators
for the next cycle
Over the next cycle, we agree with Nintendo that pure
horsepower from a graphics perspective is far less important
than it has been in prior hardware introductions. Additionally
we believe that certain other historical market
share drivers persist, namely the importance of an existing
installed base, the importance of recognizable and exclusive
content, backwards compatibility and marketing
credibility. The issue, as we see it, is that while Sony is
clearly far and away the winner in this cycle, its leadership
in these three legacy drivers is being challenged. Nevertheless,
we see three other market share drivers rising in
importance, namely, the strength of the online platform/
content, development costs for third-parties and overall
integration with other devices. Overall, we like Microsoft’s
efforts here.
In general, we believe a centralized online console model
works better than enabling third-party publishers to have
disparate systems and disparate user experiences. We
don’t think this is inherent advocacy of a closed or proprietary
system, but rather the belief that acceptance of a standard
architecture allows for a range of implementation, in
the same way that we accept TCP/IP or HTML as a standard
architecture. In order to have a strong online platform,
we believe that seven things should be in place:
1) The online platform should provide an easy-to-use,
seamless experience like a traditional consumer
electronics device
2) The online platform should be integrated with
other online services and devices
3) The online platform should provide an easy-to-use
payment system using unified billing or micropayments
or some combination thereof
Interactive Entertainment – June 21, 2005
Please see analyst certification and other important disclosures starting on page 165.
Page 30
4) The online platform should have a large, active
user base (both a cause and a result of a strong
service)
5) The user base should be broadband-enabled
6) The online platform should provide an open environment
and open APIs for third-parties; and
7) The online platform should have exciting, exclusive
content from either first or third-parties
In Exhibit 25, we detail our take on the competitive position
of Sony, Microsoft and Nintendo. While we know
that Sony is working on a new implementation of its online
strategy for the PlayStation 3, we observe that Sony is well
behind the curve in creating something exciting and different,
and again note that Sony did not even discuss online
gaming at this year’s E3. Sony’s focus on a narrowband,
mass-market consumer seems backwards looking and
overly defensive to us. Compared to Nintendo’s focus on
new interface experiences, as well as Microsoft’s focus on
driving advanced online features into the mainstream, it
appears Sony may be missing a market opportunity in the
US market. We build upon a point that we made our The
China Internet Report in April 2004: While broadband
penetration can drive adoption of online gaming, online
gaming can also drive adoption of broadband. And the
same could hold true for gaming and HDTV technology,
home audio, wireless/Bluetooth technology, media center
PCs, etc.
Exhibit 25
Online Console Gaming Current Competitive Landscape
Sony Microsoft Nintendo
Seamless
Experience
Integration /
Convergence
Payment
System
Large User
Base
Broadband
Usage
Open
System
Exclusive
Content
Legend:
Strong
Weak
Source: Morgan Stanley Research.
Creating a thriving third-party development environment is
also important for each hardware manufacturer and important
for the industry as a whole, we believe, as awesome
content can drive above-ave