L O S A N G E L E S S A N F R A N C I S C O N E W Y O R K B O S T O N S E A T T L E M I N N E A P O L I S M I L W A U K E E.

Transcription

1 L O S A N G E L E S S A N F R A N C I S C O N E W Y O R K B O S T O N S E A T T L E M I N N E A P O L I S M I L W A U K E E Equity Research Entertainment: Software June 14, 2013 Michael Pachter (213) michael.pachter@wedbush.com Nick McKay (213) nick.mckay@wedbush.com E Review We attended the E3 Expo this week in Los Angeles, CA, and met with a number of companies presenting products at the show, including Activision Blizzard, DeNA, Electronic Arts, GameStop, Microsoft, Nintendo, PlayJam (Game Stick), Sony, Turtle Beach, Ubisoft and UNU. The show was once again very large, with the Los Angeles Convention Center hosting over 45,000 attendees and 200 exhibitors from over 100 countries. E3 was once again the centerpiece of the video game world, and we applaud the ESA for putting together another highly enjoyable and memorable conference. Two new consoles are slated to launch later this year, along with a slew of high-profile current-gen and next-gen software releases expected to positively impact the share prices of our covered publishers through the remainder of the calendar year. The PS4 is expected to be a holiday release (likely before Black Friday) with a price point of $399, and no new restrictions around used gaming or transfer fees. In addition, it will not require an Internet connection for gameplay. The Xbox One will debut at $499, requires a daily connection to the Internet and leaves used gaming and transfer fee decisions up to the individual publishers. We continue to believe that all of the publishers will enable used gaming, fearing a potential backlash from core gamers. There were a number of compelling software titles on display at E3. The software highlights of the show from our covered publishers included Activision Blizzard s Call of Duty: Ghosts and Destiny, EA s Battlefield 4, Titanfall, and its sports games, Nintendo s 3DS releases (including The Legend of Zelda: A Link Between Worlds, Pokémon X and Y, and Mario and Luigi Dream Team) and Wii U releases (Donkey Kong Country: Tropical Freeze, Mario Kart 8, Pikmin 3, Super Mario 3D World, and Super Smash Bros.), and Ubisoft s Assassin s Creed IV: Black Flag, The Crew, Tom Clancy s The Division, and Watch Dogs. Take-Two did not meet with investors at E3 this year due to its convertible debt redemption and new offering, and chose to pass up exhibiting its games at the show in favor of apparently more efficient marketing opportunities. Retailer GameStop met with investors during the show and had a positive E3 from excitement about the launches of the two new nextgen consoles, in spite of no price cuts yet for the current-gen consoles. It also benefitted from a compelling price point for PS4 and no new restrictions on used gaming for PS4. A strong slate of games should jumpstart GameStop comps through Entertainment: Software We believe Sony won the first skirmish in the next-gen console battle with its solid performance at E3. At its press conference, Sony announced that the PS4 will have no new restrictions on used gaming, unlike the Xbox One, which essentially leaves the decision up to the individual publishers. Although we continue to believe that all of the publishers will enable trade-ins and used gaming on the Xbox One due to fears of a potential backlash, Microsoft angered a number of gamers by giving publishers this option in the first place. In addition, Sony appears to have ruled out unpopular transfer fees, while Microsoft has not, again leaving it up to the publishers. Finally, PS4 does not require an Internet connection for gameplay, whereas Xbox One allows offline gaming for up to 24 hours before an Internet connection must be re-established. Xbox One s higher price point and Microsoft s approaches to used gaming and always on will likely cost Xbox One some market share in the first year or so of the cycle. PS4 will be the clear beneficiary, and we believe that Sony s consumerfriendly approach to next-gen gaming made it the clear winner of this year s E3. We attended a slew of events and hosted a number of investor meetings throughout the week. On Monday, we attended Microsoft s Xbox E Media Briefing, The Download: EA's 2013 Press Conference, the Ubisoft E Media Briefing, and the Sony PlayStation E Press Conference. On Tuesday, we attended Ubisoft s Analysts & Investors Meeting with Top Management and Nintendo s Business Partner Presentation. We also hosted investor meetings with members of the DeNA and GameStop management teams. On Wednesday, we attended EA s Analyst Breakfast and the Nintendo E3 Analyst Briefing. We also hosted investor meetings with members of the Microsoft and EA management teams. Wedbush Securities does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please see page 7 of this report for analyst certification and important disclosure information.

2 SUMMARY OF KEY EVENTS DeNA DeNA Investor Meeting Hosted by Wedbush Securities on Tuesday Company attendees were Shintaro Asako, CFO of DeNA West, and Mark Johnson, Director of IR. Management began the meeting with a brief overview of DeNA s history, driven in large part by the evolution of mobile phones in Japan and in the West. DeNA is currently focused on its mobile social game platform Mobage, social games, e-commerce, and other Web services for mobile devices and PCs. Although the company has historically been well-known for its games in Japan, it has expanded to the West. After a game s launch, it benefits from cross-promotion and consistent fine-tuning, with events introduced to drive revenue growth. Its games, many of which are based on well-known IP, have become strong revenue generators in the US. In March, it was the second-highest grossing mobile developer on the iphone, behind only EA, and the top grossing developer in the Google Play store. We note that it was ranked well ahead of Zynga in both categories. We believe this reflects DeNA s strong IP and historical expertise on mobile, as opposed to Zynga s historical expertise on the desktop, among other factors. Electronic Arts The Download: EA's 2013 Press Conference on Monday The presentation centered around the company s eleven new games for the PS4 and Xbox One. It began with a clever trailer and gameplay for new reveal Plants vs. Zombies: Garden Warfare (Xbox One, 360, PC) due in spring It then announced Peggle 2, although gameplay was not shown. Titanfall (Xbox One, 360, PC) due in spring 2014 followed next, with the company discussing the ability to control pilots (individual soldiers) and titans (mechs, which are large walking war robots). The company then turned its focus to its two new engines, EA Sports Ignite and Frostbite 3, which will be used for many of its next-gen games, including new reveal Star Wars: Battlefront (Xbox One, PS4). It showed a teaser trailer for the Star Wars game, although no release details were disclosed. An overview of the Need for Speed: Rivals game (Xbox One, PS4, 360, PS3, PC) and the Need for Speed movie followed. Dragon Age: Inquisition (Xbox One, PS4, 360, PS3, PC) will be released in fall The attention then turned to EA Sports. We viewed the presentation for NBA Live 14 (Xbox One, PS4) due in the December quarter as rather disappointing, as the game s differentiating feature is expected to be dribbling, and very little gameplay was shown. Although we do not expect another cancellation, the limited amount of in-game footage could imply a delay or disappointment. FIFA 14 (numerous platforms) and Madden NFL 25 (Xbox One, PS4, 360, PS3) were shown next, with more of the former on display. We thought that EA Sports UFC (Xbox One, PS4) due in spring 2014, which features full body deformation, looked impressive, and it should be a strong seller upon its release. The Battlefield 4 (Xbox One, PS4, 360, PS3, PC) gameplay was very strong, and we believe that the tablet-enabled Commander Mode should enhance the experience. The presentation ended with a Mirror s Edge 2 (Xbox One, PS4, PC) reveal and trailer, although no release date was provided. We believe EA had a solid, if unspectacular, E3 presentation. Although there were a number of reveals, a combination of limited footage and unclear release dates for some make it difficult to quantify the impact of the games on financial results over the next year or so. In addition, we believe that the presentations for Madden and NBA would have been enhanced by more footage (for the latter, in particular). Battlefield 4 was highly impressive, but it must overcome stiff competition for wallet share from Activision Blizzard s Call of Duty: Ghosts, Take-Two s Grand Theft Auto V, and the next gen console launches. EA s Analyst Breakfast on Wednesday Early in the presentation, management reviewed the overall growth of the video game industry, which is being driven in large part by PC digital and mobile. The industry has gone from roughly $25 billion in sales in 2005 to roughly $60 billion in 2013, with digital increasing as a percentage of total sales from 20% to 70% over that time period. The focus then shifted to EA s four strategies for making games, the first being the connected multi-platform development model centered around the console, mobile, and PC. The EA development model includes 300 million registered users, over 2.5 billion game sessions per month, over 2 billion online-enabled game installs, and 5 game-enabled devices per consumer. The second strategy is a portfolio of proven brands and new IP. The third strategy is new engine technology, including EA Sports Ignite and Frostbite 3. Finally, the company plans to extend the experience with digital services, which drive engagement. The presentation ended with a discussion of EA s FY:14 guidance, with revenue growth driven by Battlefield 4 and digital. Gross margin will continue to expand from digital, which, when combined with better cost control, should lead to earnings expansion. Some of highlights of the Q&A session that followed included a discussion of used games (EA has a gamer-first mentality), digital growth in FY:14, next-gen game pricing (expected to stay at $60), and thoughts on the new consoles (Sony was applauded for its strong presentation and pricing, with Xbox One complimented for its killer capabilities). Management sees the biggest risk to FY:14 revenue guidance being the reception for its games (sports mentioned specifically as we approach the end of the current gen), and not the new consoles. The company expects current-gen game sales to significantly exceed next-gen sales for the time being, likely due to much larger installed bases. The strengths of the next-gen consoles expected to drive adoption are speed (8x faster), 60 frames per second gaming, 1080p, larger and more dynamic worlds, social integration, and Kinect, among other factors. In addition, the architectures of the next-gen consoles are more similar than in past cycles, lowering porting difficulty and costs. Free-toplay (including for sports) and PC gaming (likely through Origin) are seen as areas of potential growth for the company. Overall, we believe management did a good job of charting EA s growth strategy and explaining the positive impact the next-gen consoles are expected to have on the company and the industry. Entertainment: Software 2

3 EA Investor Meeting Hosted by Wedbush Securities on Wednesday Management is confident that the company can achieve its 20% operating margin target over time through a combination of revenue growth, gross margin expansion (via mix shift to digital), and lower marketing expense as a percentage of revenue (Executive Chairman Larry Probst is committed to getting marketing back to historical levels of under 15%). It thinks that the next-gen consoles are similar enough to be indifferent about pricing or the winner of the cycle. Management is confident that the company has game quality under control, but has taken steps to streamline the release slate and hold people more accountable. It is very confident in the long sales tail for the current gen and in EA s ability to continue to make money as the next gen ramps. It disclosed that PopCap is unlikely to earn more than $100 million of the earnout of up to $550 million. GameStop GameStop Investor Meeting Hosted by Wedbush Securities on Tuesday Company attendees included J. Paul Raines, CEO, Tony Bartel, President, and Mike Mauler, Executive Vice President, GameStop International. There were many topics of discussion during the Q&A session, a few of which we have highlighted below. The session began with a discussion of used gaming on the next-gen consoles. Although PS4 appears to have no restrictions on used gaming, Xbox One has essentially left the decision up to the publishers. Management mentioned that it has good relationships with the publishers, and that it is in the publishers best interests to allow used gaming due to the $1 billion in trade-in credits generated in GameStop stores every year. In addition, the PowerUp Rewards community has an installed base of 24 million consoles, which we estimate represents $1.8 billion of currency available for trades for the new consoles assuming a $75 per console trade credit. In fact, many publishers now work with GameStop around credit-driven promotions for top games in order to maximize new software sales. Management believes the lack of backwards compatibility for the next-gen consoles will drive sales as users will feel more compelled to trade in older content, allowing more affordable next-gen purchases. When asked about day one digital availability on the Xbox One, management pointed out that DLC was already a $600 million business for the company. In addition, downloads will likely continue to take a long time, with the purchased download worthless from a trade-in perspective. The next-gen launches should be a boon for used sales, as the previous cycle created a 72% CAGR for used over a four-year period once the PS3 had been released. GameStop has improved the publisher perception of used through better communication, and claims that transactions on new and used games overlap on only 13% of titles, with only 4% of used sales for games that have been released in the last 90 days. Towards the end of the presentation, management discussed its capital allocation strategy, including a strong dividend and an aversion to taking on debt except for large acquisitions, and its international strength. Microsoft Microsoft s Xbox E Media Briefing on Monday The early items discussed in the presentation were the current-gen Xbox 360 and Xbox Live Gold. The current-gen console will get a new form factor that is smaller and sleeker; however, a release date for the new model was not given, and a price cut was not announced. We continue to expect a price cut of at least $50 before the holidays, with a software bundle likely. Management disclosed that beginning on July 1, new and existing Xbox Live Gold members will receive two free game downloads per month. The downloads appear to be for high-quality, but older catalog content, with Microsoft s Halo 3 and Ubisoft s Assassin s Creed II disclosed specifically. Management then announced an Xbox 360 version of Wargaming.net s World of Tanks that will be a free download for Gold members. Other Xbox 360 games discussed included Namco Bandai s Dark Souls II (360, PS3, PC) due in March 2014, Press Play s Max: The Curse of Brotherhood (360), Take-Two s Grand Theft Auto V (360, PS3) due on September 17, Ubisoft s Tom Clancy s Splinter Cell: Blacklist (360, PS3, Wii U, PC) due on August 20, and Warner Bros. Batman: Arkham Origins (360, PS3, Wii U, PC) due on October 25. A key element of the Xbox One discussion that followed was the large number of exclusives for the new console. First-party exclusives included Forza Motorsport 5, Killer Instinct, and Ryse: Son of Rome from Crytek, each available at launch, Below, Crimson Dragon, D4, Dead Rising 3 from Capcom, Halo due in 2014, Quantum Break due in 2014, Sunset Overdrive from Insomniac Games, and an unnamed title from Microsoft s Black Tusk Studios. The company also announced non-exclusives Minecraft and Project Spark. The presentation began with Konami s Metal Gear Solid V: The Phantom Pain (Xbox One, PS4, Xbox 360, PS3) due in 2014, and ended with a very impressive exclusive for Microsoft consoles (and PC as well), EA s Titanfall (Xbox One, 360, PC) from Respawn Entertainment, which is due in spring A high-profile non-exclusive on display was EA s Battlefield 4 (Xbox One, PS4, 360, PS3, PC), which will feature DLC called Second Assault that will be available first on Xbox One. CD Projekt RED s The Witcher 3: Wild Hunt (Xbox One, PS4, PC) was also shown. Microsoft s E3 presentation was less focused on the auxiliary features of the Xbox One than the May unveiling had been. Xbox One will feature a deeper SmartGlass, Upload Studio (to edit and share gameplay clips), and Twitch integration (also for sharing gameplay clips). In addition, Xbox Live will move to real money from points, will feature SmartMatch, and will no longer be limited to 100 friends. In addition, anyone in a user s house can enjoy that particular user s benefits even if he is not logged in. The Xbox One will be available in November in 21 markets at price points of $499 in the US, 499 in Europe, and 429 in the UK, with gamers encouraged to reserve a Day One Edition. The U.S. price point is $100 above the PS4 s $399 and our earlier expectation. In our Microsoft Investor Meeting on Wednesday, management disclosed its confidence in the higher-than-expected price point and in its ability to convince consumers of the strong value proposition that the new console represents despite a negative response from many gamers. Entertainment: Software 3

4 Despite our reservations about the Xbox One s $499 price point, we were impressed with the Microsoft presentation due in large part to the number of software exclusives that the console will offer. In our view, the Xbox One s release slate thus far should hold greater appeal among hardcore gamers than the PS4 s, which includes more indie titles. However, we believe Microsoft must do a better job of explaining to core gamers why the Xbox One is worth $100 more than its rival, as many remain unconvinced of the value of Kinect and Skype, among other auxiliary features. We continue to believe that both the Xbox One and PS4 will be in high demand upon their respective launches, with GameStop expected to sell out of its allocation of both consoles for the first few months at least. The lack of an Xbox 360 price cut and the higher-than-expected price point for the Xbox One negatively impacted GameStop shares on Monday; however, the share price has since bounced back due to a more appetizing price for the PS4 and Sony s disclosure that the PS4 will have no restrictions on used gaming, among other factors. Microsoft Investor Meeting Hosted by Wedbush Securities on Wednesday Microsoft remains confident in the Xbox One s $499 price point ($100 above PS4 s) despite a negative response from many gamers, as well as in its ability to convince consumers of the strong value proposition that the new console represents. It also feels good about its ability to properly manage the retail rollout. Management was non-committal about digital pricing, but implied that it is likely to be similar to physical pricing. It described GameStop as a valuable partner, and sounded committed to a trade and exchange relationship. There was no discussion of rentals on Xbox One (previously described as unavailable on the day of launch), and we continue to believe that a final long-term decision has not been made. Microsoft is very confident in the Xbox One s game slate, which includes many first-party titles as well as a number of third-party exclusives. It sees the new console as having strong staying power, with publisher support expected for several years. It remains non-committal on IPTV, but suggested it could be a possibility. It also disclosed that a number of new details about Xbox One would emerge over the coming months. Nintendo Nintendo s Business Partner E3 on Tuesday As expected, games for the 3DS and Wii U were the focus of Tuesday s Nintendo Direct and the Business Partner Presentation. Firstparty 3DS releases are expected to include The Legend of Zelda: A Link Between Worlds (November), Mario & Luigi Dream Team (August 11), Pokémon X and Y (October 12), Super Smash Bros. (2014), and Yoshi s New Island (2014). First-party Wii U releases are expected to include Donkey Kong Country: Tropical Freeze (November), The Legend of Zelda: The Wind Waker HD (October), Mario Kart 8 (spring 2014), Pikmin 3 (August 4), Super Mario 3D World (December), Super Smash Bros. (2014), Wii Fit U (December), and Wii Party U (October). Overall, we thought that the first-party Wii U release slate was strong, although the company has shown a propensity in the past to delay titles unexpectedly in order to improve game quality. In addition, many of the Wii U exclusives are scheduled for release in 2014, after the launches of PS4 and Xbox One. Third-party support for the Wii U was rather weak, with only five publishers discussed (Activision Blizzard, Disney, SEGA, Ubisoft, and Warner Bros.). Notable omissions included EA, which recently disclosed it has no Wii U games in development, and Take-Two, among others. The relative dearth of AAA content for the Wii U in its first full year of release is a key reason we believe Nintendo will lose share to Microsoft and Sony in the next generation. Nintendo E3 Analyst Briefing on Wednesday The presentation began with an overview of Nintendo s E3 strategy this year. Management then displayed a number of slides detailing 3DS software market share gains in 2013 in different parts of the world versus the other key hardware devices (including consoles). Although the gains were attributed to better 3DS software releases, management did not mention that the share gains are also due to slowing current-gen software sales ahead of the next-gen launches later this year. Nintendo then went through its first- and third-party release slates for 3DS, and discussed how it plans to improve StreetPass in the US. For Wii U, management attributed the console s struggles to a slow release pace. It expects the pace of releases to pick up in the second half of the calendar year and The presentation ended with a discussion of Nintendo s strength in the handheld market, despite the rise of smartphones, as well as a previously-disclosed generational management change. Please note that we have listed many of the 3DS and Wii U software releases above in our discussion of Nintendo s Business Partner Presentation. In the Q&A session, management discussed that it would be able to get third-party publishers interested in the Wii U again, once more software becomes available and the console s momentum improves. Management then disclosed that it needs to do a better job of explaining the benefits of asymmetric gameplay on the Wii U. Free-to-play gaming remains an option, but not for key franchises that consumers are willing to pay full retail for. If Wii U continues to struggle this holiday season, the company could increase marketing spending and take some unspecified risks. Finally, management admitted that game delays have hurt the Wii U s performance, but that it remains committed to high-quality standards. In addition, delays should become more infrequent as developers become more comfortable with the hardware and can better assess when games will be completed. Sony Sony PlayStation E Press Conference on Monday The presentation began with a discussion of the PS Vita handheld, which has over 125 games so far, with nearly 60% of purchases made from the PSN store. Management then reviewed the upcoming PS3 releases, including first-party titles Beyond: Two Souls due on October 8, Gran Turismo 6 due in Q4, The Last of Us due on June 14, Puppeteer due on September 10, and Rain due in the fall. Warner Bros. Batman: Arkham Origins (360, PS3, Wii U, PC) will be released on October 25, with a $299 Grand Theft Auto V hardware bundle expected as well. The highlight of the presentation was the PS4. Sony finally unveiled a form factor for the new console, which we thought looked quite similar to Xbox One. PS4 will include music content (Music Unlimited available on day 1) and video content (Video Unlimited also Entertainment: Software 4

5 available on day 1) from the other divisions of Sony. In addition, Sony Pictures has a new original programming plan for PS4 and PlayStation Network. New services will include Flixster, Redbox Instant by Verizon, and pay-per-view. Cloud-based gaming from Sony s Gaikai will begin in 2014, with PS4, PS3, and then PS Vita getting access to PS3 games. There are over 140 games in development for the PS4, including 100 expected to be released in the first year. Of those, there are over 30 first-party titles in development, with 20 due in the first year, 12 of which will be new IP. First-party exclusives include Driveclub, Killzone: Shadow Fall, and Knack, all available at launch, as well as The Dark Sorcerer, infamous: Second Son due in Q1:14, and The Order. There will be a number of console debuts from independent third-party publishers, including Don t Starve, Galak-Z, Mercenary Kings, Octodad: Dadliest Catch, Outlast, Ray s the Dead, Secret Ponchos, Transistor, and The Witness. Other third-party titles include Activision Blizzard s Diablo III (PS4, 360, PS3, PC), Bethesda Softworks The Elder Scrolls Online (Xbox One, PS4, PC) due in spring 2014, Square Enix s Final Fantasy XV (Xbox One, PS4) and Kingdom Hearts III (Xbox One, PS4), Take-Two s NBA 2K14 (Xbox One, PS4, 360, PS3, PC) due on October 1, Ubisoft s Assassin s Creed IV: Black Flag (Xbox One, PS4, 360, PS3, Wii U, PC) and Watch Dogs (Xbox One, PS4, 360, PS3, Wii U, PC), the latter of which will have an extra hour of gameplay and an exclusive outfit on the PS4, and Warner Bros. Mad Max (Xbox One, PS4, 360, PS3, PC) due in The Sony presentation also included the world gameplay premier for Activision Blizzard s Destiny (Xbox One, PS4, 360, PS3) due in 2014, and the announcement that Sony has reached a longterm partnership with Activision Blizzard and developer Bungie. The most important announcements from Sony regarding the PS4 related to pricing, used gaming, and always connected concerns. The PS4 will debut at $399, a full $100 below the Xbox One s $499. We note that the Xbox 360 has won the current-gen console cycle due in part to a more affordable initial price point for its most popular console of $399, which was $200 below PS3 s initial $599 price tag. We believe the tables have turned for the next-gen console cycle, with Sony likely to gain some market share back from Microsoft due to $100 of savings provided to the consumer. Microsoft feels confident in its ability to prove the value proposition that the Xbox One represents through the integration of features such as Kinect and Skype; however, we believe many gamers will remain unconvinced, as they would prefer that the extra $100 goes to purchasing key games, as opposed to voice controls or HD conversations. Sony helped itself further through its treatment of used gaming. PS4 will have no new restrictions on used gaming, unlike the Xbox One, which essentially leaves the decision up to the individual publishers. Although we continue to believe that the publishers will all enable trade-ins and used gaming on the Xbox One due to fears of a potential backlash, Microsoft undoubtedly angered a percentage of gamers by giving publishers this option in the first place. In addition, Sony appears to have ruled out unpopular transfer fees, while Microsoft has not, again leaving it up to the publishers. Finally, PS4 does not require an internet connection for gameplay, whereas Xbox One allows offline gaming for up to 24 hours before an internet connection must be re-established for authentication purposes. We believe that both next-gen consoles will be very popular with core gamers at launch, likely resulting in sellouts at GameStop for the first few months of release. However, Xbox One s higher price point and Microsoft s approaches to used gaming and always on will likely cost Xbox One some market share in the first year or so of the cycle. PS4 will be the clear beneficiary, and we believe that Sony s refreshing approach to next-gen gaming made it the clear winner of this year s E3. Sony did not provide an updated release date for the PS4, after previously announcing that it would be launched during the 2013 holiday season. We continue to expect a release date before Black Friday. Take Two On Monday, Take-Two canceled all of its E3 events, driving speculation that it would force the early conversion of its 2014 notes and possibly enter into a replacement financing. On Wednesday morning, Take-Two announced that it had distributed a notice of redemption to holders of its 4.375% convertible senior notes due in 2014, with the redemption scheduled to occur on August 29, The move was expected, as the company could force conversion if shares traded above roughly $16.01 for 20 or more trading days in a 30 consecutive trading day period (Tuesday was the 20th day). The company will settle any notes surrendered for conversion at a cash amount equal to $1, per $1,000 principal amount of converted notes, up to a total of $166.0 million, with any excess above the cash maximum settled with shares. In conjunction with the redemption of the 2014 convertible notes, Take-Two offered $250 million of 1.00% convertible senior notes that mature on July 1, The initial conversion rate of per $1,000 principal amount represents a conversion price of approximately $21.52 (a premium of approximately 39% to the closing price on June 13, 2013 of $15.50). The proceeds will be used to redeem all of the outstanding 4.375% convertible notes, and for general corporate purposes, which may include acquisitions, strategic investments, refinancing of debt, or the purchase of the company s stock. The closing of the notes offering is expected to occur on June 18, Ubisoft Ubisoft E Media Briefing on Monday The presentation began with an overview of current-gen games, including Rayman Legends (360, PS3, Wii U, Vita) due on September 3, Rocksmith 2014 Edition (360, PS3, PC) due on October 22, South Park: The Stick of Truth (360, PS3, PC) due at the holidays, and Tom Clancy's Splinter Cell: Blacklist (360, PS3, Wii U, PC) due on August 20. It also announced a free-to-play game for the PC, The Mighty Quest for Epic Loot. Its next-gen presentation had two notable reveals, The Crew (Xbox One, PS4, PC) due in early 2014, and Tom Clancy s The Division (Xbox One, PS4) due in The Crew allows the gamer to infiltrate a criminal car crew and take over the US city-by-city. It features tablet integration for car customization, as well as an online persistent world that allows the gamer to play solo or co-op. The Division is an MMO tactical shooter that requires the gamer to combat a disease spread on Black Friday that has Entertainment: Software 5

6 crippled the U.S. It also features tablet integration for drone control. We thought that Assassin s Creed IV: Black Flag (Xbox One, PS4, 360, PS3, Wii U, PC) looked good, but it will be difficult to comp the success of its predecessor, which has sold-in over 12.5 million units. It also showed additional gameplay for Watch Dogs (Xbox One, PS4, 360, PS3, Wii U, PC). It is clear that the company has high expectations for the game, although the unique premise (essentially the ability to control an entire city, Chicago, through a mobile phone) could make it a risky bet. Ubisoft also disclosed two new Trials games, Trials Fusion (next gen) and Trials Frontier (mobile). We believe Ubisoft had a strong presentation overall, with a good mix of established franchises and fresh IP that we expect to appeal to core gamers. Ubisoft s Analysts & Investors Meeting with Top Management on Tuesday The presentation began with a discussion of why management believes the next-generation consoles from Microsoft and Sony will reignite interest in video games and sales for the publishers. In addition to the unprecedented length of the current generation cycle, the next-gen consoles are also expected to benefit from new business models and their presentation as entertainment hubs. They will also feature improved graphics, AI, animation, and online and social integration. The five breakthroughs of the next-gen consoles will be systemic gameplay, co-op and social integration, low barriers to entry (integration with tablets and other devices, free betas, and asynchrone), user-generated content, and improved analytics. Next-gen games, and Ubisoft in particular, will benefit from open-world gaming, which will drive gaming hours. Management expects at least twice as many games for the next-gen consoles in the launch window as there were for the current-gen consoles. In addition, the consoles will act as a Trojan horse that hooks gamers through multiple uses in addition to gaming (Netflix for example). The consoles will have a simpler processor that should allow more units to be shipped at lower costs. Ubisoft management would not be surprised by a subsidized Xbox One, given Microsoft s recent test of a subsidized Xbox 360. Ubisoft currently has five major titles in its FY:14 guidance, including one unannounced IP, compared to just three in FY:13. Overall, we believe management did a solid job of explaining the strong next-gen growth opportunity for Ubisoft and the industry, on the whole. CONCLUSION The console war is officially underway, with Sony and Microsoft attempting to outshine one another at E3. Sony won the first skirmish, capitalizing on Microsoft s relatively high $499 launch price and differentiating itself by assuring gamers that used games would have no transfer restrictions and that the PS4 will not be required to be connected to the Internet. In our view, Microsoft s always connected requirement is not intended to be an onerous DRM requirement; rather, we think that the company believes that instant access to games is necessary, and in order to deliver instant access, it has chosen to require gamers to download games (either directly or by copying DVDs) to their Xbox One hard drives. This requirement creates a piracy problem should a DVD be copied to more than one Xbox One; Microsoft s solution appears to be the requirement that all of its next- generation consoles must log on to the Internet at least once per day in order to verify that a DVD has been copied to only one hard drive at a time. Unfortunately, the always connected requirement triggered a gamer backlash, beginning at the Xbox One reveal event on May 21, and continuing throughout E3. While Microsoft has endeavored to explain itself, it has as yet to satisfy gamers that it is not up to something sinister, and the level of mistrust remains quite high, in our opinion. We firmly believe that Microsoft has good intentions, but its communication so far has been somewhat deficient. Compounding matters is the company s decision to include Kinect in every box, and to charge consumers for the camera/microphone array combination. While we think that IPTV connectivity and Skype are killer apps, once again, Microsoft failed to convince its core audience that they really need Kinect for a quality experience. We think that the company ultimately will get its message across, but during E3, the focus was on the $100 price differential between the consoles, and not on the incremental hardware offering. We remain convinced that the price of Microsoft s console will be subsidized either by an Internet service provider (ISP) or by a cable or satellite television multi-system operator (MSO). In our view, ISPs will be motivated to market broadband services that routinely cost $50 or more per month, while MSOs will be motivated to sell cable TV services via the Internet that not only allows them to market beyond their currently limited geography, but allows them to attract new customers. We expect subsidies similar to those offered by mobile carriers eager to sign customers up to expensive data service plans, and we think that subsidies for the Xbox One could drive the effective price down to $199 for many consumers. As far as the publishers, we were genuinely impressed by several games at the show. We thought that Activision s booth was striking, with only four games featured: Diablo III, Call of Duty Ghosts, Destiny and Skylanders Swap Force. Two of the games were shown behind closed doors, with impressive next generation graphics from Call of Duty and an exhilarating multiplayer experience that felt like a first-person shooter MMO from Destiny. We were similarly impressed by the multiplayer features of EA s Battlefield 4, which appears to us to be poised to capture share of the shooter market this holiday. Our favorite game of the show was EA/Respawn s Titanfall, a first-person shooter set in the future with mechanical titans used by players to conduct battle. While the game is an Xbox exclusive (appearing both on Xbox One and the Xbox 360), we expect it to sell very well. Ubisoft had a number of impressive games at the show, with Watch Dogs, Assassin s Creed Black Flag and Tom Clancy s The Division standing out. Entertainment: Software 6

7 Covered Companies Mentioned in this Report (priced as of close June 13, 2013) COMPANY TICKER RATING PRICE PRICE TARGET ACTIVISION BLIZZARD ATVI OUTPERFORM $14.51 $22 ELECTRONIC ARTS EA OUTPERFORM $21.49 $26 GAMESTOP GME OUTPERFORM $37.53 $49 MAJESCO ENTERTAINMENT COOL NEUTRAL $0.59 $1 NINTENDO 7974.JP NEUTRAL 9,370 10,000 TAKE TWO INTERACTIVE TTWO OUTPERFORM $15.50 $19 UBISOFT ENTERTAINMENT UBI.FP OUTPERFORM Analyst Certification I, Michael Pachter, Nick McKay, certify that the views expressed in this report accurately reflect my personal opinion and that I have not and will not, directly or indirectly, receive compensation or other payments in connection with my specific recommendations or views contained in this report. Disclosure information regarding historical ratings and price targets is available at Investment Rating System: Outperform: Expect the total return of the stock to outperform relative to the median total return of the analyst s (or the analyst s team) coverage universe over the next 6-12 months. Neutral: Expect the total return of the stock to perform in-line with the median total return of the analyst s (or the analyst s team) coverage universe over the next 6-12 months. Underperform: Expect the total return of the stock to underperform relative to the median total return of the analyst s (or the analyst s team) coverage universe over the next 6-12 months. The Investment Ratings are based on the expected performance of a stock (based on anticipated total return to price target) relative to the other stocks in the analyst s coverage universe (or the analyst s team coverage).* Rating Distribution (as of March 31, 2013) Outperform:51% Neutral: 44% Underperform: 5% Investment Banking Relationships (as of March 31, 2013) Outperform:18% Neutral: 2% Underperform: 0% The Distribution of Ratings is required by FINRA rules; however, WS stock ratings of Outperform, Neutral, and Underperform most closely conform to Buy, Hold, and Sell, respectively. Please note, however, the definitions are not the same as WS stock ratings are on a relative basis. The analysts responsible for preparing research reports do not receive compensation based on specific investment banking activity. The analysts receive compensation that is based upon various factors including WS total revenues, a portion of which are generated by WS investment banking activities. Wedbush Equity Research Disclosures as of June 14, 2013 Company Activision Blizzard 1 Electronic Arts 1 GameStop 1 Majesco Entertainment Co. 1 Nintendo 1 Take-Two Interactive Software 1 Ubisoft Entertainment Disclosure Research Disclosure Legend 1. WS makes a market in the securities of the subject company. 2. WS managed a public offering of securities within the last 12 months. 3. WS co-managed a public offering of securities within the last 12 months. 4. WS has received compensation for investment banking services within the last 12 months. 5. WS provided investment banking services within the last 12 months. 6. WS is acting as financial advisor. 7. WS expects to receive compensation for investment banking services within the next 3 months. 8. WS provided non-investment banking securities-related services within the past 12 months. 9. WS has received compensation for products and services other than investment banking services within the past 12 months. 10. The research analyst, a member of the research analyst s household, any associate of the research analyst, or any individual Entertainment: Software 7

8 directly involved in the preparation of this report has a long position in the common stocks. 11. WS or one of its affiliates beneficially own 1% or more of the common equity securities. 12. The analyst maintains Contingent Value Rights that enables him/her to receive payments of cash upon the company s meeting certain clinical and regulatory milestones. Price Charts Wedbush disclosure price charts are updated within the first fifteen days of each new calendar quarter per FINRA regulations. Price charts for companies initiated upon in the current quarter, and rating and target price changes occurring in the current quarter, will not be displayed until the following quarter. Additional information on recommended securities is available on request. * WS changed its rating system from (Strong Buy/Buy/Hold/Sell) to (Outperform/ Neutral/Underperform) on July 14, Please access the attached hyperlink for WS Coverage Universe: Applicable disclosure information is also available upon request by contacting Ellen Kang in the Research Department at (213) , by to ellen.kang@wedbush.com, or the Business Conduct Department at (213) You may also submit a written request to the following: Business Conduct Department, 1000 Wilshire Blvd., Los Angeles, CA OTHER DISCLOSURES RESEARCH DEPT. * (213) * EQUITY TRADING Los Angeles (213) / (800) * EQUITY SALES Los Angeles (800) CORPORATE HEADQUARTERS (213) The information herein is based on sources that we consider reliable, but its accuracy is not guaranteed. The information contained herein is not a representation by this corporation, nor is any recommendation made herein based on any privileged information. This information is not intended to be nor should it be relied upon as a complete record or analysis; neither is it an offer nor a solicitation of an offer to sell or buy any security mentioned herein. This firm, Wedbush Securities, its officers, employees, and members of their families, or any one or more of them, and its discretionary and advisory accounts, may have a position in any security discussed herein or in related securities and may make, from time to time, purchases or sales thereof in the open market or otherwise. The information and expressions of opinion contained herein are subject to change without further notice. The herein mentioned securities may be sold to or bought from customers on a principal basis by this firm. Additional information with respect to the information contained herein may be obtained upon request. Entertainment: Software 8

9 EQUITY RESEARCH DEPARTMENT (213) DIRECTOR OF RESEARCH Mark D. Benson (213) MANAGER, RESEARCH OPERATIONS Ellen Kang (213) RETAIL AND CONSUMER TECHNOLOGY, INTERNET, MEDIA & SOCIAL MEDIA LIFE SCIENCES Consumer Products Communications and Application Software Biotechnology/Biopharmaceuticals/BioDefense Rommel T. Dionisio (212) Shyam Patil, CFA (213) Gregory R. Wade, Ph.D. (415) Kurt M. Frederick, CFA CPA (415) David M. Nierengarten, Ph.D. (415) Communications Equipment Christopher N. Marai, Ph.D. (415) Footwear, Apparel and Accessories Rohit Chopra (212) Corinna Freedman (212) Sanjit Singh (212) Emerging Pharmaceuticals Alicia Reese (212) Ryan Flanagan (212) Liana Moussatos, Ph.D. (415) Richard Lau (415) Healthy Lifestyles Computer Services: Financial Technology Christopher N. Marai, Ph.D. (415) Kurt M. Frederick, CFA CPA (415) Gil B. Luria (213) Aaron Turner (213) Healthcare Services - Managed Care Restaurants Sarah James (213) Nick Setyan (213) Enterprise Software Daniel Patt (212) Colin Radke (213) Steve Koenig (415) Medical Devices Specialty Retail: Hardlines Entertainment: Retail Tao Levy (212) Joan L. Storms, CFA (213) Michael Pachter (213) John Garrett, CFA (213) Nick McKay (213) Medical Diagnostics and Life Sciences Tools Zarak Khurshid (415) Specialty Retail: Softlines Entertainment: Software Betty Chen (415) Michael Pachter (213) Alex Pham (415) Nick McKay (213) RETAIL/CONSUMER MARKET RESEARCH Internet and E-Commerce Michael Pachter (213) Gabriella Santaniello (213) Nick McKay (213) INDUSTRIAL GROWTH TECHNOLOGY Media James Dix, CFA (213) Clean Technology Craig Irwin (212) Movies and Entertainment Min Xu (212) Michael Pachter (213) Nick McKay (213) Environmental Services / Building Products Al Kaschalk (213) Semiconductors Betsy Van Hees (415) Industrial Biotechnology Ryan Jue, CFA (415) Liana Moussatos, Ph.D. (415) Christopher N. Marai, Ph.D. (415) Water and Renewable Energy Solutions David Rose, CFA (213) EQUITY SALES EQUITY TRADING Los Angeles (213) / (800) Los Angeles (213) / (800) San Francisco (415) San Francisco (415) New York (212) New York (212) Boston (617) Boston (617) CORPORATE HEADQUARTERS 1000 Wilshire Blvd., Los Angeles, CA Tel: (213)