A key to Activision Inc.'s role in its recent $19 billion merger with Vivendi Games was last year's hard-rockin' acquisition of a small video game company with a big product.


When Santa Monica-based Activision bought Red Octane, it got its hands on "Guitar Hero," which has become the top selling music game in the industry.


While hesitant to zero in on one strategic decision, analysts point to the Red Octane acquisition as one of the main reasons to French conglomerate Vivendi deciding to scoop up the $1.5 billion company. It was announced Dec. 2.


Activision's Chief Financial Officer Thomas Tippl agrees.


"It played a significant role," Tippl said. "When we acquired Red Octane last year, the company had sales of $13 million. Now, we are turning 'Guitar Hero' into the fastest growing brand to reach $1 billion in sales."


The merged company will combine the console-based success of Activision's product lines, which in addition to "Guitar Hero," are "Call of Duty" and "Tony Hawk," and Vivendi Games' massive online fantasy game "World of Warcraft," which has 9.3 million paying subscribers.


The two companies are merging at the top of their game.


Before the merger, Activision was expecting a 50 percent revenue growth this year to $2.3 billion, and Vivendi Games forecasting a 30 percent jump to $1.4 billion in 2007.


Bringing in the Guitar Hero franchise, which followed Activision's acquisition of Infinity Ward, the company behind war game "Call of Duty," was by far "the most impactful move, the biggest move they'd made in the past five years," said analyst Arvind Bhatia of Sterne Agee & Leach.


Paris-based Vivendi, the $29 billion entertainment and telecom conglomerate announced it will exchange its Vivendi Games and $1.7 billion in cash for a 52 percent stake in the merged company, called Activision Blizzard. The name is a blend of Vivendi Games' Blizzard Entertainment, the maker of "World of Warcraft."


It's a rare merger and acquisition deal that marries two companies that don't need to be fixed, Tippl said.


"If you look at the history of M & A; transactions, most of them fail because it's the case of a well-performing company taking over an underperforming company believing it can run it better, or two weak players coming together to scale their businesses," he said. "It's very rare that two best performing companies in the sector get together."


They pulled it off because each party has what the other doesn't, said analyst Todd Mitchell of Kaufman Bros.


"Guitar Hero has been a phenomenon where it has been successful across the portfolio, but they don't have online and mobile gaming. Vivendi Games is all about online and mobile gaming but has never been a publishing company," he said. "These guys go nicely together."


Many advantages

Several pieces of the companies' operations make Vivendi and Activision compatible.


Vivendi's previous investment in video game developer Sierra Entertainment, which has been losing money the last couple of years, stands to gain from Activision's expertise as one of the best operators of console and handheld businesses, Tippl said.


The merger also allows Activision to tap into the massively multiplayer online game, called MMOG, space, where "World of Warcraft" dominates. "We came to the conclusion a while back that we would have to spend hundreds of millions of dollars to replicate what Blizzard has built in eight years and probably not succeed," Tippl said. "Now we can benefit from Blizzard's success."


Tippl also sees the synergy of the merger playing a significant role in Activision Blizzard's music department. Doug Morris, chief executive of Vivendi's Universal Music Group, will join the merged company's board.


The success of "Guitar Hero" as well as skating game franchise "Tony Hawk," named for the skateboarding star, has been driven by soundtracks of licensed music from top bands such as the Rolling Stones, Metallica and Guns N' Roses. Activision won best soundtrack for video games at a recent MTV Video Music Awards.


Becoming a part of the same conglomerate as Universal Music Group brings more local artists to the Guitar Hero franchise, Tippl said.


Blizzard Entertainment's online expertise also helps the Guitar Hero franchise, which has a growing online music downloading business. Game players downloaded 800,000 packages of songs on 2 million units of Guitar Hero II games sold between April and September.


Some skeptics

The merger makes some skeptical of the continued success of the two brands.


"I don't see how 'Guitar Hero' can get any more popular," Mitchell said. "'World of Warcraft' is a killer MMOG, but that just means other developers are coming into the space."


Activision has never projected that its double-digit growth will continue indefinitely, Tippl said. But the video game industry is projected to grow in double digits over the next couple of years and the company, based upon its track record, will outpace that, he said.


Analyst Mike Hickey expressed concerns that Activision's licensing agreements with DreamWorks and Marvel Character Inc., which include properties such as Spiderman and X-Man, could come into jeopardy with the change of ownership of the company if the contracts included a "change of control" provision.


"Vivendi did a lot of due diligence on the matter and they're comfortable," Tipple responded. "I don't foresee this to be an issue."

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