Why Disney Shut Down LucasArts

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Apologies in advance for my lame references to Star Wars.

In a move that’s been expected for a while, Disney (NYSE: DIS) shut the doors on LucasArts on Wednesday. The video game developing arm of LucasFilm, which Disney acquired in October of last year, LucasArts has struggled mightily since 2006. Revenue for the company fell from $173 million that year to just $55 million in 2012. Disney’s decision to close up shop on LucasArts is the best decision it could have made.

The force (of the video game industry)

The move by Disney is largely indicative of the video game industry as a whole. In the last year, video game disc sales are down 23%. Electronic Arts (NASDAQ: EA) recently had its CEO resign after several financial and public image failures. Square Enix faced a similar fate with its CEO, and had to lay off a number of employees as well. Activision (NASDAQ: ATVI), too, had to lay off 40 employees earlier this week, after handing out at least 30 pink slips in February.

There’s a chance that the industry will turn around, but with the growing number of entertainment options cutting into time formerly dedicated to gaming, it could be a permanent struggle. Disney’s decision to license LucasArts’ intellectual property significantly mitigates the risk that a turnaround never happens. While the company will reduce the per-unit revenue on the LucasArts games, licensing allows the company to generate a margin near 100%.

Long long ago

Disney was a prolific game developer in the early '90s as home video game consoles boomed in popularity. There are five different Beauty & The Beast games, and three game versions of The Little Mermaid and Pocahontas.

The cause of this wide proliferation of video games was Disney’s willingness to license its popular movie characters to third-party publishers. Its biggest successes throughout the '90s and 2000s weren’t created in-house by its Disney Interactive Studios, but licensed to outside developers. Most notable among Disney’s video game successes is the Kingdom Hearts franchise developed by Square Enix, which has spawned nine follow-up efforts.

What I’m getting at is that Disney isn’t a great video game developer. It is great at teaming up with outside developers to create tremendously successful games. While the company has recently tried to keep things in-house, it has yet to prove it can repeat the successes it’s had when it relies on larger, more experienced developers.

Help me, Obi-Wan Kenobi

LucasArts found great success in the 1990s with games like The Secret of Monkey Island, Zombie’s Ate My Neighbors, Full Throttle, X-Wing, and, of course, its Star Wars games. Recently, however, the company has struggled, and its best games in the 2000s such as Knights of the Old Republic were developed by third parties.

Third parties were also responsible for LucasArts recent struggles. Most recently, Star Wars: The Old Republic, a massively multiplayer online game, came highly anticipated from Electronic Arts and BioWare, but failed to create the kind of audience expected. After losing a large portion of online subscribers, the game went free-to-play last fall in attempt to mitigate losses.

Gone are the days, however, where LucasArts can make great games in-house. Its last in house hit, Gladius, is nearly a decade old. Unfortunately, the company hasn’t really done well teaming up with third-party developers lately either.

Finding Yoda

Disney’s greatest game successes are with third-party developers; LucasArts has struggled to find success the same way, but is ever more reliant on the strategy. That’s why Disney’s takeover and studio shut down make excellent business sense.

But finding a partner to team up with may be more difficult for Disney than in the past. Activision announced in February that it’s going to start moving away from licensed games. This follows moves by Ubisoft in 2010 and THQ in 2011.

There’s no doubt that licensing fees are tremendously expensive, and Star Wars may be one of the most expensive licenses to obtain. It’s estimated EA made almost no profit on the sales of The Old Republic due to fees from LucasArts, and relied on subscription fees to make money. Things didn’t work out in EA’s favor, and the partnership is becoming increasingly unproductive.

Yet, Star Wars' huge fan base and cult following makes taking on licensing fees a risk many developers should still be willing to take. There’s been a lot of buzz surrounding Star Wars: 1313 and Star Wars: First Assault, which have now halted production. The demand for such titles is rampant, and the only way either game will get a release is through a licensing deal.

Additionally, Disney’s decision to pick up the movie series and start releasing new films in 2015 could create the catalyst needed to move games off the shelves. LucasArts most popular games of the last decade were usually tied to movie releases from the same franchise.

Despite its claim that it wants out of licensed characters, I think a deal with Activision makes the most sense. The company excels in third-person/first-person shooters (Call of Duty), which is the same kind of game First Assault was rumored to be, and 1313 appeared to integrate similar game-play. Additionally, it’s had great success with massively multiplayer online games in the past with its Warcraft and Starcraft series - another genre Star Wars lends itself to very well.

While it’s sad to see the doors close on a historic video game studio, I believe Disney is acting in the best interest for investors. It’s playing to its strengths, limiting its risk, and making the best of a struggling business.

The value of LucasFilm is in its intellectual property, and no longer its game creation. The best way to unlock that value is to license it to people that have the expertise to make a new video game a success. Even if a new game flops, Disney won’t lose much in a licensing deal. It’s not like an unsuccessful video game will hurt the movie franchise.

Adam Levy has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard and Walt Disney. The Motley Fool owns shares of Activision Blizzard and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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