Tim Riley, who runs the music department at video game publisher Activision Inc., never thought he would be the one to reunite the Sex Pistols, an iconic English punk rock band.

He needed a studio recording of two of the band's songs for the third edition of company's wildly popular franchise "Guitar Hero," a music game that features a miniature electric guitar as the controller.

Trouble was, the original master recordings had long been missing and the only way to get the songs "Anarchy in the U.K." and "Pretty Vacant" on the game was to re-record them.

"They hadn't recorded in 30 years, and hadn't seen each other in 10," said Riley, sitting in his recording-studio-turned-office with a door that has Ozzy Osbourne's autograph scribbled on it.

He convinced them to re-record the songs, which they did in July, and now the reunited Sex Pistols are doing tours. They will appear on "The Tonight Show with Jay Leno" this month and they plan to release a "Guitar Hero" version of their songs on iTunes.

That episode shows the important and growing role that the videogame industry is playing in the music industry.

Riley, a long-time talent scout for record labels, said he knew in 1999 when he first pitched the idea of creating an in-house music department to Activision that videogames would become a huge market for musicians.

Eight years later, the Santa Monica-based company dominates the music and dance category, after it acquired "Guitar Hero" publisher Red Octane for $100 million last year. The company has sold 5 million units of "Guitar Hero" worldwide since the acquisition, making the title the No. 1 franchise in North America to date this year, beating out annual powerhouses like "Madden Football," according to tracking service the NPD Group.

Buoyed by the title's success, Activision bypassed rival Electronic Arts Inc. to become the top independent video game publisher in North America earlier this year. Activision shares have returned 182 percent over the past five years, compared to 63 percent for Electronic Arts.

Labels tuning in

"Guitar Hero," driven by a soundtrack of licensed music from top bands like the Rolling Stones, Metallica and Guns N' Roses, would be "impossible" without the music department, said Riley.

His group finds songs for games, negotiates licensing agreements and provides the master recording to the game developers. The first was the skateboarding game "Tony Hawk" launched in 1999 with a dozen songs. The latest 11th in the Tony Hawk series featured 75 songs. The newest Guitar Hero, called "Guitar Hero III," includes more than 70 songs and 70 percent are master tracks.

This is because the music industry has come to recognize videogames as a legitimate venue for promoting albums.

Five years ago, record labels were reluctant about the idea of putting a song on a game for fear that the file would be ripped off and wind up on the Internet. Today, major record labels, including Warner Bros. Studios, Interscope, Sony and EMI, have dedicated staff for placing songs on videogames, along with those for TV and film.

Such targeted placements are filling a void.

"MTV doesn't play music videos anymore. Radio has a very fixed format and it's difficult to get spins for a new artist," Riley said. "And we have the demographic in gaming especially in 'Tony Hawk' games that everyone is trying to reach." (Most "Tony Hawk" gamers are males aged 13 to 34.)

He should know. Riley, 39, has worked the music scene as a talent scout for 15 years, working under the tutelage of industry giants such as David Geffen and Clive Calder. After working in New York City for eight years, Riley moved to L.A. during the dot-com craze in the late 1990s to head a DVD-based music magazine called 750 MPH.

"It was a crazy job offer. They gave me Aaron Spelling's old office on Wilshire. It was one of those things where you knew every day that it wasn't going to last," Riley said. It lasted a year.

He began working for Activision as a consultant licensing music for its motor sports games, before being hired full-time as the worldwide executive of music. His role in the company has grown as the role of music has in its games.

It also helps that video games have become more technologically advanced. A few years ago, music tracks had to be trimmed to fit on games. Now the games have so much processing power they can hold movie trailers and b-roll videos.

This year, Activision pioneered selling music as downloads in "Guitar Hero II," and within the first five months sold 2 million songs.

Rock Band Threat

While "Guitar Hero" turbocharged the music category in gaming, the company should be bracing for some fierce competition in the next two years, said analyst Mike Hickey of Janco Partners Inc.

Electronic Arts has partnered with MTV and Harmonics, the original developer of Guitar Hero, and will launch a similar game system called "Rock Band" in November that includes additional instruments and a microphone.

"Rock Band" will also include original music heard only on the game, thanks to Electronic Art's partnership with MTV. Activision's soundtracks are mostly licensed master recordings of existing songs including "Tony Hawk's Underground," which was honored as the best soundtrack for a video game at the MTV Video Music Awards.

With the new competition, Activision may be hard-pressed in 2008 to match its stellar performance lately. In its most recent fiscal year, it more than doubled profits to $85.8 million, and its most recent quarter it rang up earnings of $27.8 million, up from a loss in the same quarter last year. Its stock is up more than 35 percent from a year ago.

"It's a double-edge sword. Everyone's happy with the remarkable success, but with that success comes a real challenge next year on how they grow off of that," Hickey said.

Dusty Welch, head of publishing at Red Octane, said Guitar Hero's unprecedented popularity bodes well for future sales. "Guitar Hero III" will be released in November and be available across major consoles Playstation III, XBox 360 and Wii. And the new Gibson guitar more authentically shaped compared to previous versions will be wireless.

Welch said it would definitely get consumers off the couch and rocking.

"What's more fun and primal than living out the fantasy of becoming a rock star?"

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