Disney's bet on games not yet paying off

Walt Disney Co. wagered that its acquisition last summer of game developer Playdom Inc. would help bring Mickey, Snow White and other familiar characters to a new generation of fans who play games on social networks. The bet has yet to pay off.

Disney's $563-million investment was a key component in a broad restructuring of its interactive group intended to put the perennially money-losing division on the road to profitability. It signaled a strategic shift away from traditional console video games, to focus on emerging opportunities online and on mobile devices.

But, so far, Disney hasn't found the magic to fix what ails its Interactive Media Group, which includes Playdom, Disney's Web properties and its games business. Losses widened to $115 million in its most recent quarter ended April 2, compared with $55 million in the same period a year earlier. Wall Street analysts pounced on the performance, saying they had expected the company to be making swifter strides in stemming the tide of red ink. Disney executives acknowledged it's "a work in progress" and that they don't expect the games division to post a profit until 2013.

"The bigger question that Disney investors are focused on is whether the company has a rational strategy in interactive gaming that can produce solid returns over the next several years," said Richard Greenfield, media analyst for BTIG. He calculated that the Burbank entertainment giant has invested at least $1 billion in interactive acquisitions during the last four years — and racked up nearly as much in operating losses over that same time: $915 million.

Disney isn't the only big media company struggling to gain a foothold in the $50-billion global games market. Viacom Inc., News Corp., Warner Bros., DreamWorks, Universal Studios and others have alternated between pouring hundreds of millions of dollars into developing games internally and simply selling licenses to outside game publishers. Earlier this year, Viacom sold Rock Band video game developer Harmonix Music Systems — which it paid $175 million to acquire in 2006 — for virtually nothing in exchange for a big tax write-off and offloading its liabilities.

Executives at Disney Interactive Media Group, led by co-presidents John Pleasants and Jimmy Pitaro, declined to comment. However, in remarks made during last week's second-quarter earnings call, Disney Chief Executive Robert A. Iger said the company is seeking to capitalize on social gaming, suggesting it is still in its "infancy."

"The opportunity for growth on the social games side — at least at this point of our entry — is probably greater than it had been when we entered the space on the console side," Iger said.

Indeed, Playdom's recently released Gardens of Time has landed among the top 20 most popular social games with about 2.5 million daily users who play time-traveling detectives in search of hidden objects needed to solve a mystery. Such games are popular among adult women.

"In a hits-driven business, they've just scored a hit," said David Stewart, Playdom's former senior director of product, who has joined San Francisco start-up Yammer.

Nonetheless, analysts point to Disney's failed attempts over the years to capitalize on the long-held promise of interactive entertainment, first by investing heavily in console games, and more recently in online social games. The interactive division, which has not reported an operating profit since 2007, has been buffeted by a combination of brutal changes in the console market, Disney's inability to internally define its priorities for the business, and the company's late arrival to the cutthroat competitive social games market, according to analysts and others familiar with the situation, who declined to be identified because they had not been authorized to speak on the matter.

As losses mount, Disney is coming under increasing pressure by investors who are impatient for the company to develop a coherent strategy to turn around the troubled unit.

"We assumed the company would be making progress towards demonstrating profitability," wrote Dave Novosel, media and technology analyst for independent researcher Gimme Credit. "At this pace, Disney could lose well over $200 million this year … so investors will need to endure more pain."

Much of the pain stems from Disney's acquisition in August of Playdom, a Bay Area company that makes games such as "Sorority Life" and "Social City" for Facebook and other online networks.

Since the transaction closed, however, Playdom's audience has fallen precipitously amid an unplanned five-month hiatus in launching new products — time Disney executives said they took to elevate the quality of the games and bolster their technical capacity. In that fallow period, the number of monthly Playdom users slipped to 20.7 million in late March from 42.3 million in early October, according to AppData.com, which measures usage of applications on Facebook.

Even though the social game arena is relatively new — barely in existence four years ago — it appears that a clear winner has already emerged. San Francisco's upstart Zynga Inc. boasts 248 million monthly players, dwarfing all others, including the No. 2 game developer, Electronic Arts Inc.'s Playfish, which has 33 million users, according to AppData.

"This space has started to mature," said Justin Smith, founder of Inside Network, the research firm that publishes AppData. "Things have gotten much more competitive over the past three years."

Playdom has issues beyond a dwindling audience. Last week, Disney paid a $3-million fine to settle charges that online virtual worlds once operated by Playdom violated federal rules designed to protect the safety and privacy of children on the Internet. Disney also paid an undisclosed sum last fall to settle a trade secret dispute with Zynga. Zynga alleged that Playdom recruited four former employees and encouraged them to steal trade secrets — including the "playbook" that contains the "secret sauce" of Zynga's successful games.

Even as the gap widens between Playdom and its dominant rival, the life cycle of social media games is getting shorter and shorter and the economics are growing more challenged. Facebook is implementing its own virtual currency as the payment mechanism on the social network — and as of July 1 will collect 30% of every transaction — a huge blow to the bottom line of game developers such as Playdom.

"I think Disney has to do a lot of work to have any chance of making back the money that they put into this," said media analyst Doug Creutz.

dawn.chmielewski@latimes.com

alex.pham@latimes.com

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