Activision, Inc. (ATVI)

Going short now that the Vivendi deal is coming through.

This merger will happen at the height of Vivendi's most popular game, World of Warcraft.

By staggering the release of WOW and its expansion packs in different areas in the world, Vivendi had created an illusion that the game was growing bigger and bigger. For example, WOW came out more than 6 months later in China than in the U.S.. As a result, as US and Europe growth was slowing down, China growth kicked in. The same thing happened with the expansion pack.

if you look closely at the numbers, Chinese average concurrent user numbers were DECLINING prior to the release of the Burning Crusade. However, the release of this expansion pack juiced the numbers again.

However, in the videogame industry, each subsequent expansion pack has a diminishing effect on the popularity of the game. This is sort of like the diminishing effect of a drug. The new expansion pack, Wrath of the Lich King, is not due out for a while. And that release will have a much smaller impact on user numbers than the Burning Crusade.

There are no more big new markets for WOW to penetrate. The juice from the first expansion pack is just about spent. It's all downhill from here.

The MMORPG market is becoming ever more competitive. Fundamentally, there isn't much barriers to entry, although switching costs can be high, depending on your time investment, and how many of your friends play the game. However, when a game starts to decline, it declines very quickly (network effect erosion). I believe this is what will happen to WOW, a year from now.

These types of games have massive operating leverage, as each incremental user is almost pure profit. Now, as this effect reverses itself, margins are going to crap.