Troy Wolverton

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Electronic Arts Lands Body Blow

Troy Wolverton

When it comes to their fight over the sports portion of the video game market, Electronic Arts has given Take-Two Interactive (TTWO Quote - Cramer on TTWO - Stock Picks) part two of a one-two punch.

On Monday, EA announced that it has signed a 15-year deal with ESPN to publish titles using the sports media company's brand, programming and personalities. The deal follows a similar long-term, exclusive pact with the National Football League that EA signed last month.

With the latest agreement, which takes effect in 2006, EA will displace Take-Two as ESPN's partner -- and effectively knock out its smaller rival from the sports market, analysts say.

"The moral of the story is don't [mess] with EA," said one hedge fund manager, who asked not to be named.

Shares of EA were recently up $2.34, or 3.9%, to $62.18. Take-Two was down $1.20, or 3.4%, to $33.64.

Take-Two had the right idea to take on EA in the sports game market, but the way it went about it -- by getting into a price war -- was a strategic blunder, added the fund manager, who doesn't have a position in either stock.

"Basically what they did was woke a sleeping giant," the fund manager said. "It's great if you make a big hit. But if the big kid on the block is going to come in and basically destroy you, it hurts your business."

In a statement, Take-Two said that it thinks it can continue to compete with EA, even without the ESPN or NFL licenses.

"The ESPN license was principally a branding tool and as such does not have a meaningful impact on game play," Take-Two said. "We spent a great deal of time evaluating the potential of working with ESPN longer term. In the end we believe we can continue to publish great sports games by focusing our dollars and creativity on enhancing the gamers' experience."

Take-Two teamed up with Sega, which held the ESPN license, to co-publish a series of ESPN-branded sports titles this year. The companies cut into EA's formerly dominating position in the sports game market by emphasizing the quality of the games -- and their cut-rate prices. Take-Two set a retail price for the ESPN games of about $20 a title -- or less than half the price of EA's comparable games.

In terms of gaining market share, the strategy worked. Take-Two sold more than 2 million copies of its ESPN NFL 2005 title alone, even though it was competing against EA's flagship sports title, Madden NFL 2005. The previous year, all the Madden competitors together sold fewer than 1 million copies.

Although the strategy brought extra revenue to Take-Two, it meant little on the company's bottom line, because the company was basically selling them at cost. But many analysts had expected the company to raise prices this year, now that it had gotten gamers to try out its sports titles.

The sports game strategy was part of a larger effort by Take-Two to broaden its lineup of titles. Although the company's Grand Theft Auto franchise is a blockbuster, and it has a couple of minor hits in its Manhunt and Max Payne franchises, Take-Two has had little success diversifying beyond such adult-themed, violent games.

But by attempting to horn in on the sports game market, Take-Two was cutting into one of EA's most important businesses. Madden, for instance, has consistently been one of the company's top five titles. Overall, the company gets about 45% of its revenue from its sports titles, according to Lehman Brothers' Israel Hernandez.

EA's immediate reaction to the threat from Take-Two was to offer promotions on its sports titles and to cut its own prices. But its latest moves have been much more strategic.

The deal with the NFL gives EA the exclusive right to develop and market games titles on the league's players and teams for console, PC and handheld gaming systems. The deal with ESPN gives EA similar rights for its content. The deals essentially mean that after 2006, Take-Two won't be able to offer an NFL football game, or to use the ESPN moniker on any of its sports games.

EA has not disclosed how much it paid for either deal, and following the agreement with the NFL, some analysts worried that the company might have overpaid.

But taken together, the deals likely mean that EA will be able to raise its prices in the next couple of years without fear of competition.

"While EA will likely see some price pressure in 2005, the EA sports flank, we believe, is now secure as it enters the next console cycle," said Hernandez, in a note on Tuesday. (Lehman Brothers has not done recent investment banking business for either Take-Two or EA.)