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[UbiSoftologist]

Recently, the New York Post speculated that Viacom intended to capitalize on the fast-growing video game market through acquisition. Midway, EA, THQ and Atari were mentioned as possible acquisition targets. In response to this rumor, the analysts at Wedbush Morgan published a report entitled ''Lame or Game: Does Consolidation of Video Game Companies Make Sense?''. The following are excerpts from the research report:

Although we think that it is likely that Viacom will seriously consider acquisitions of U.S. video game publishers, we think that any potential acquisition will more likely be consummated in 2005 or 2006, and that discussions of consolidation at this time are premature. Our reasoning is simple: video game publishers have historically faced significant challenges in making the transition between console cycles, and the industry is at a console transition inflection point right now. We believe that a prudent company such as Viacom is likely to defer an acquisition decision until it has more visibility regarding the costs of transition between the current console cycle and the next cycle. We believe that the transition between the current generation consoles and the next generation will be quite smooth, and we believe that companies such as Electronic Arts are in a very strong position to grow revenues and earnings during the transition. However, our view is the minority view, and the vast majority of analysts and investors believe that the transition years (2005 and 2006) could result in stalled industry sales growth accompanied by increased spending on next generation console software development. Because Electronic Arts is one of only a few companies that expenses its development costs (Atari is another), it is in a position to suffer declining earnings in 2005 and 2006 should the majority view be correct. Accordingly, we believe that a prudent Viacom Board of Directors would prefer to wait until the console transition is underway to make an acquisition, as it will have significantly more information about the future costs of doing business.

Will Viacom acquire Midway?

We do not think that an acquisition of Midway Games (MWY—Hold) is likely at all. The company is majority owned by Viacom Chairman Sumner Redstone, and we do not think that Mr. Redstone purchased Midway shares at a premium in order to quickly sell the company to Viacom. Any potential acquisition would raise questions about fair dealing, and Mr. Redstone recently filed a statement with the SEC outlining Viacom’s appointment of three independent directors to advise Viacom management on potential licenses or acquisitions in the video game space. We think that Midway would be interested in licensing intellectual property from Viacom, and believe that Viacom management would represent shareholder interests if it were to encourage bids from all sources for the Nickelodeon master license.

Midway has a current market capitalization of approximately $1 billion, with approximately $140 million in cash. The company has not generated a profit over the last four years, so valuation is difficult. We think that it is likely that Midway will turn profitable in the December quarter, and think that the company is on track to generate sustainable earnings growth over the next several years. In our view, the stock is fully valued at current levels, and we do not believe that any acquirer would be willing to pay a substantial premium. Because we believe that Mr. Redstone is interested in profiting from his Midway investment, we think an acquisition at this time is unlikely.

Conclusion:

We do not expect any consolidation in the video game space in 2004. Should Viacom choose to make an acquisition, we think that the likely candidates (in order of likelihood) are THQ, Atari, Take-Two, Activision, and Electronic Arts, with an acquisition of Midway highly unlikely.