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1 Page 84 Exhibit 120 Third-Party Gross Margin Sensitivity Relative to Hardware Royalties and Manufacturing Costs (US$) Manufacturing Cost Royalty Cost $3.00 $4.00 $5.00 $6.00 $7.00 $8.00 $9.00 $ % 88% 85% 83% 80% 78% 75% Exclusive 3rd-Party Current Generation Console Title Non-Exclusive 3rd-Party Current Generation Console Title 3rd-Party Cartridge Economics Source: Morgan Stanley Research. The other universal component of cost of revenue is packaging costs for boxes and shipping/distribution that generally runs between $ , perhaps slightly more for special edition packaging. Therefore, for a third-party publisher, the cost of revenue before IP licensing would run typically in the $ range, or 23-34% of wholesale revenue per unit. The final component of cost of revenue would be the IP license, if necessary, that publishers consider a type of marketing. Examples of IP licenses include movies, sports leagues, or books. Licenses are significant cost burdens, but the publisher hopefully benefits from cross-marketing opportunities and an existing potential audience. Consider Activision and its Spider-Man 2 (2004) title. By launching the title on the same day as the film, it benefits from the same marketing buzz that generated $40MM in gross box office revenues in one day. Or consider Rare and the James Bond license for GoldenEye 007 (1997). What could have been a great standalone first-person shooter based on game-play, becomes immediately recognizable and emotion-inducing by introducing popular likenesses. Compare this to Rare s sequel without the license, Perfect Dark, a successful game rated just as highly as Goldeneye 007, but lacking mainstream brand awareness. In these relationships, the IP owner typically gets some percentage of sales, with multi-year advances / guarantees based on the number of titles and expected unit sellthrough. These advances are usually pegged to a certain date and guaranteed regardless of success, creating significant risk for the publisher. Some of these licenses may have caps on total payout, while other licenses have downward sliding percentages as unit volume increases. Licensing arrangements with film studios do not usually differ in structure from those struck with professional sports leagues or professional players associations. In general, we estimate that for modestly large titles (>1MM across all SKUs), IP licenses should run about 5-7% while blockbuster titles (>5MM across all SKUs) may run upwards of 12-15%. Therefore, a number of licenses are struck in the $1-5MM range, and a special few hit the $20-30MM range. We have heard that extremely sought-after long-term licenses have been known to reach the $50MM range. Therefore, the typical gross margin for a game could be anywhere between 51-77% if a game hits its target sales figures to justify the license guarantees. We note that EA and Activision, two license-heavy publishers, have averaged gross margins of 59% and 38%, respectively, since 12/01, suggesting a wide variability in these costs and a wide variability in the relative success of IP licenses. Operating expenses typically consist of marketing costs for each title on the publishing side, and salaries for the program and design team on the development side. We believe that a company such as EA pushes advances to its independent studio developers through the product development line and royalty earn-outs through the cost of goods sold line once the game is shipped. Other companies are more aggressive about their development costs, choosing to capitalize on them from the outset and amortize them over the useful selling life. IP Licensing and Margins While IP licensing takes a big cut into margins with variable costs, it also carries the potential to generate higher sales and thereby offset fixed costs such as development and marketing. Goldeneye and Perfect Dark are good examples. In Exhibit 121, we introduce an analysis developed along with Keith Boesky of Boesky & Company that describes the way a licensee is paid for game sales. In general, licensors receive increasing percentage points or simply points for the amount of sales generated by a title. Smaller licenses (think Rugrats) have less leverage and receive a smaller percentage of profits, both because the risk for the developer is higher and also because there is less potential for cross-marketing opportunities to drive sales of the game. Blockbuster film or book licenses (such as Spider- Man or Harry Potter or The Lord of the Rings) receive a much higher percentage.

2 Page 85 Exhibit 121 IP Licensing Cost Analysis Blockbuster Film / Media Typical Film / Media Sales Range Licensing Revenue Sensitivity / Implied Licensing Sales Range Licensing Revenue Sensitivity / Implied Licensing Low High Rate $5,000 $10,000 $50,000 $100,000 Low High Rate $5,000 $10,000 $50,000 $100,000 $0 $500 8% $40 $40 $40 $40 $0 $1,000 5% $50 $50 $50 $ , ,001 2, ,001 1, ,001 3, ,251 1, ,001 4, ,501 1, ,001 5, ,751 2, ,001 and higher ,500 9,500 2,001 and higher ,440 8,640 17,640 Total IP Licensing $755 $1,655 $8,855 $17,855 $350 $850 $4,850 $9,850 Licensing as % of Sales 15% 17% 18% 18% 7% 9% 10% 10% Licensing per Implied Unit (1) $5 $6 $6 $6 $2 $3 $3 $3 (1) Assumes $35 wholesale ASP. Source: Keith Boesky, Boesky & Company, Morgan Stanley Research. We have shown a wide range of game sales, but that range stretches much further, as there are titles that sell upwards of 10MM copies and titles that sell 10,000. At that level, the huge relative fixed costs of development are not the only downward pressure on margins it is also the cost of guaranteed royalties that are negotiated on a per-title basis. It is similar to guaranteed traffic payments by Google to Ask Jeeves, for example. In our next several exhibits, we trace the theoretical margins of a blockbuster media title (from the point of view of the traditional media, not the game) and a typical media title, from both a first and thirdparty perspective. Note that we have taken a very conservative perspective with regard to development costs at $10MM across all the scenarios. We believe this represents the spending level for some of the largest games such as Madden NFL. We note that EA has been spending between $2-4MM in LTM R&D per NTM SKU during this cycle. In other words, if you consider the R&D spent over the last twelve months and divide that by the number of SKUs coming out over the next twelve months, the company is spending about $2-4MM annually on those products. Only recently has that number increased to the $5-6MM range in anticipation for the next cycle something that happened in with the PS2, Xbox and GameCube as well, suggesting once again that the next cycle should begin in late Note also that the EA figures correspond to SKUs not titles, and typically EA talks about the number of units sold per title when discussing its platinum titles. This is an important distinction for investors to make when looking at our margin analysis, because for one SKU to sell 10MM copies is rare think Grand Theft Auto 3 or Super Mario Bros. 3. We have not taken into account the differences between using external developers in a co-publishing relationship, and we have taken a flat $2MM in G&A costs which could be higher or lower depending on the size of the company and the number of other titles/skus shipped by the company. As one can see, a game with an IP license is strongly hits driven, given the increase in variable costs associated with the title. Once you reach 1MM units sold at this cost structure, the titles are profitable even with blockbuster license fees and with hardware royalties. At 2MM units, operating margins range from 20-60%, getting each title squarely into the operating margin range that we feel should be a target when dealing with a 50-80% gross margin. Note also that this is for console only. PC margins will be higher, but sell many fewer copies. Handheld margins will be lower and usually sell fewer copies as well. However, given the low margins across most of this industry (excluding EA, which has seen significant success using the franchise strategy during this cycle), this analysis also speaks to both the variability of development and marketing costs (especially for games with multi-year development) as well as to how many poorly performing titles many of the software companies put out. In general, blockbuster licenses tend to sell more than typical film licenses. Games that have sold more tend to cost more to develop, and the marketing engine behind them is that much more robust. Consider the 5MM copies sold of Halo 2 thus far and the marketing behind it as well as the multi-year development process. Sometimes the long development cycle itself builds the buzz around a game, as 2004 holiday games were at one time considered to be poised for 2003 release. Even with this in mind, we believe this structure provides investors with a way of measuring the impact of a game title as well as shows the potential for this industry.

3 Page 86 Exhibit 122 First-Party Software Publisher Blockbuster IP License Margin Sensitivity IP Licensing Royalties (2) Variable % 3,005 6,155 12,455 18,755 25,055 31,355 62,855 Total Cost of Goods Sold $4,005 $8,055 $15,955 $23,655 $31,155 $38,455 $74,955 Gross Profit $13,495 $26,945 $54,045 $81,345 $108,845 $136,545 $275,045 % Gross Margin 77% 77% 77% 77% 78% 78% 79% Implied Operating Income ($1,305) $10,045 $32,945 $56,745 $81,445 $107,045 $231,545 % Implied Operating Margin (7%) 29% 47% 54% 58% 61% 66% (1) Volume discounting assumed. (2) Based on a blockbuster film license using analysis developed by Keith Boesky. Exhibit 123 Third-Party Software Publisher Blockbuster IP License Margin Sensitivity Hardware Royalties (1) Variable $ ,500 8,750 17,000 25,000 32,500 39,500 69,500 IP Licensing Royalties (3) Variable % 3,005 6,155 12,455 18,755 25,055 31,355 62,855 Total Cost of Goods Sold $8,505 $16,805 $32,955 $48,655 $63,655 $77,955 $144,455 Gross Profit $8,995 $18,195 $37,045 $56,345 $76,345 $97,045 $205,545 % Gross Margin 51% 52% 53% 54% 55% 55% 59% Implied Operating Income ($5,805) $1,295 $15,945 $31,745 $48,945 $67,545 $162,045 % Implied Operating Margin (33%) 4% 23% 30% 35% 39% 46% (1) Volume discounting assumed, but hardware royalties will be negotated on a per-title basis. (2) Volume discounting assumed, but manufacturing costs will be negotated on a per-title basis. (3) Based on a blockbuster film license using analysis developed by Keith Boesky.

4 Page 87 Exhibit 124 First-Party Software Publisher Typical IP License Margin Sensitivity IP Licensing Royalties (2) Variable % 1,600 3,350 6,850 10,350 13,850 17,350 34,850 Total Cost of Goods Sold $2,600 $5,250 $10,350 $15,250 $19,950 $24,450 $46,950 Gross Profit $14,900 $29,750 $59,650 $89,750 $120,050 $150,550 $303,050 % Gross Margin 85% 85% 85% 85% 86% 86% 87% Implied Operating Income $100 $12,850 $38,550 $65,150 $92,650 $121,050 $259,550 % Implied Operating Margin 1% 37% 55% 62% 66% 69% 74% (1) Volume discounting assumed. (2) Based on a typical film license using analysis developed by Keith Boesky. Exhibit 125 Third-Party Software Publisher Typical IP License Margin Sensitivity Hardware Royalties (1) Variable $ ,500 8,750 17,000 25,000 32,500 39,500 69,500 IP Licensing Royalties (3) Variable % 1,600 3,350 6,850 10,350 13,850 17,350 34,850 Total Cost of Goods Sold $7,100 $14,000 $27,350 $40,250 $52,450 $63,950 $116,450 Gross Profit $10,400 $21,000 $42,650 $64,750 $87,550 $111,050 $233,550 % Gross Margin 59% 60% 61% 62% 63% 63% 67% Implied Operating Income ($4,400) $4,100 $21,550 $40,150 $60,150 $81,550 $190,050 % Implied Operating Margin (25%) 12% 31% 38% 43% 47% 54% (1) Volume discounting assumed, but hardware royalties will be negotated on a per-title basis. (2) Volume discounting assumed, but manufacturing costs will be negotated on a per-title basis. (3) Based on a typical film license using analysis developed by Keith Boesky..

5 Page 88 Exhibit 126 First-Party Software Publisher Wholly Owned IP Margin Sensitivity Total Cost of Goods Sold $1,000 $1,900 $3,500 $4,900 $6,100 $7,100 $12,100 Gross Profit $16,500 $33,100 $66,500 $100,100 $133,900 $167,900 $337,900 % Gross Margin 94% 95% 95% 95% 96% 96% 97% Implied Operating Income $1,700 $16,200 $45,400 $75,500 $106,500 $138,400 $294,400 % Implied Operating Margin 10% 46% 65% 72% 76% 79% 84% (1) Volume discounting assumed. Exhibit 127 Third-Party Software Publisher Wholly Owned IP Margin Sensitivity Hardware Royalties (1) Variable $ ,500 8,750 17,000 25,000 32,500 39,500 69,500 Total Cost of Goods Sold $5,500 $10,650 $20,500 $29,900 $38,600 $46,600 $81,600 Gross Profit $12,000 $24,350 $49,500 $75,100 $101,400 $128,400 $268,400 % Gross Margin 69% 70% 71% 72% 72% 73% 77% Implied Operating Income ($2,800) $7,450 $28,400 $50,500 $74,000 $98,900 $224,900 % Implied Operating Margin (16%) 21% 41% 48% 53% 57% 64% (1) Volume discounting assumed, but hardware royalties will be negotated on a per-title basis. (2) Volume discounting assumed, but manufacturing costs will be negotated on a per-title basis.

6 Page 89 Revenue Quality and the Industry Leaders With cost structures in mind, we can start to judge the revenue streams and franchises of the industry leaders, by factoring in the different theoretical margin influences on each of their titles. We base our analysis on C2004E data for the US, Europe and Japan, and we evaluate the different traits of each of the major software publishers. We also consider what franchises have the most power and what we see as having the most differentiated potential in an online setting. First, however, there are a number of other issues that one must consider when judging the relative quality of a revenue stream including: Multiple licensors. Sports games have to pay different license fees to the league, to use the names of the teams and leagues, as well as the players association, to use the names and likenesses of the players. For players outside the players association, separate licensing arrangements can be struck or not. That s one reason why the shooting guard on the Chicago Bulls in the 90 s was never Michael Jordan but rather Roster Guard in EA s NBA Live. External studios. The use of external studios can be a positive or negative depending on the size of the title and who owns the IP. In general, using an external studio for development should be no more expensive than developing a game oneself and might be cheaper, unless that studio owns the IP and the arrangement is mostly focused on distribution. In this situation, the revenue share can surpass that of an IP license. Compare it to a third-party seller relationship on Amazon.com; Amazon.com does less work, gets less margin, but still makes money it might not otherwise have. Multi-game deals. Increasingly, we have seen companies buy the rights to a series of titles such as EA and Harry Potter or Activision and the DreamWorks Animation titles. This can change the dynamics of not only the points but also the payment of guaranteed royalties. First- or third-party? First-parties have a great deal more flexibility when it comes to developing a game but lose power vis-à-vis third-parties when they lack significant market share. Platform. We expect the PC market to contract and the console market to expand over the next several years, in spite of large titles such as The Sims 2, Doom 3 and Half-Life 2. However, at the same time, PC revenues tend to generate higher gross margin. The handheld, too, has significant growth prospects ahead of it, but the market has typically been saddled with lower gross margins offset slightly by lower development costs. As gross margin expands with new platforms, handheld publishers could have faster operating margin expansion than console publishers. We have developed a matrix within Morgan Stanley Research to consider the simple aspects of internal vs. external development and internal vs. external intellectual property. We have looked at the US console market only, and we have not made any distinction between kinds of intellectual property, multiple licensors or expected cost. Instead, it should provide some insight into the strategies of each publisher that can be useful when thinking about the development resources each has in comparison or how each company might be affected by larger trends within the industry, such as a move to a studio model like that of the film industry or a bigger move to consolidation / roll-up.