Thanks to Grand Theft Auto, PS3 and Xbox 360 are shifting into overdrive to sell more gaming machines. Courtesy of Take-Two

By Yi-Wyn Yen

Wall Street analysts predicts Grand Theft Auto IV will easily break video game sales records this week. But one question remains: Will fans buy the game for Sony’s PlayStation 3 or Microsoft’s Xbox 360?

Both Sony (SNE) and Microsoft (MSFT) are in a heated race to win over undecided gamers who must buy one of the two consoles to play the biggest game to be released this year. The popular franchise, from Take-Two Interactive (TTWO), is expected to surpass first-week sales of $400 million, which would top Halo 3’s record of $300 million, according to Evan Wilson, an analyst with Pacific Crest Securities. “Grand Theft Auto is clearly going to be a blockbuster game,” Wilson says.

GTA IV launches Tuesday, which should result in a big boost in monthly console sales for Sony and Microsoft. Both are a distant second to market leader Nintendo with its family-friendly Wii. Nintendo, which does not offer GTA IV, sold 721,00 Wiis in the United States in March, according to market research firm NPD. The Wii sold more than the PS3 — 257,000 units — and the Xbox — 262,000 console — combined. Analysts anticipate first-week sales of about six million copies for GTA IV, which retails for $60 or $90 for a special edition.

“It’s interesting that both Sony and Microsoft are spending a lot of money to align the game with their console,” says Sam Kennedy, the editorial director for gaming publication, 1 Up Network.

Neither Microsoft nor Sony will disclose how much they have spent to promote the game, though both were quick to promote their gaming machines as the best option for GTA IV fans. The Xbox 360, with a 20 gigabyte hard drive retails for $350 while the PS3, which features Blu-ray and twice the hard drive capacity, retails for $399.

“Grand Theft Auto is a premier brand that was really established on the PlayStation platform,” says Peter Dille, senior vice president for Sony’s PlayStation Network. “Guys who love the game grew up on PlayStation. We think that they’ll vote with their wallets for the PS3.”

The GTA franchise has sold more than 65 million copies worldwide in the last 11 years. Of the previous installments, only one was made available for the Xbox platform while all the games were playable on Playstations.

A Microsoft representative says gamers will side with the Xbox because Rockstar Games, the Take-Two game studio that developed GTA IV, is making exclusive add-ons for the console.

Rockstar will release two additional game plays for those who can’t get enough of the drug trade adventures of GTA hero Niko Bellic. The first will be made availabe this fall for the Xbox. “We absolutely believe having exclusive content will boost sales,” says Xbox spokesman David Dennis. “The Grand Theft Auto franchise may have been home to the PS2, but we believe PlayStation owners will stand up and upgrade to the Xbox for [GTA IV].”

Dennis says major retailers in Europe have informed Microsoft’s sales team that GTA pre-orders favored the Xbox over PS3 by 2 to 1. He argues that this is a “strong indication” that more gamers will purchase the Xbox for the month of April.

Other Xbox perks, like Xbox Live and online rewards for top gamers, will attract console converts, he contends. “The PS2 and PS3 has an online network that’s in the low single digits. Make sure you put that number next to ours,” Dennis says. PlayStation’s online network has 3.7 million users, and Xbox Live has more than 10 million.

PlayStation’s Dille was just as quick to diss the Xbox. “Microsoft had its moment with Halo, and that moment has past,” he says. “Sure they’re touting Grand Theft Auto, but you can play it on our platform too. You want to talk about exclusive content? Sony has a very deep lineup of exclusive games like Metal Gear Solid and Grand Turismo that has the industry buzzing. The PS3 has a more exciting story going on this year.”

The two rivals can continue to throw pot shots at each other until May 15, when NPD will name a console leader for April sales in the U.S. Consumers should be happy either way. GTA IV has received fierce reviews in the gaming community. “It’s quite an amazing experience,” Kennedy says. “I can’t imagine any game being bigger this year.”

By Yi-Wyn Yen

When it comes to this spring’s crop of hostile takeovers, none has become more strange and complicated than Electronic Arts’s attempt to buy smaller, rival game publisher Take-Two for $2 billion.

On Thursday evening, Take-Two (TTWO), which makes the popular Grand Theft Auto series, will hold its annual shareholder meeting at the W Hotel in New York City. One proposal on the table: giving management 1.5 million shares of restricted stock, which would be worth tens of millions of dollars in the event of a buyout. If ZelnickMedia, the firm that has been managing Take-Two since shareholders voted out the previous executives at the last annual meeting, wins approval of that management incentive, the value of Take-Two shares will be diluted by 26 cents, putting in jeopardy EA’s (ERTS) offer of $26 a share.

In a bizarre twist, EA says that the majority of Take-Two’s current shareholders will be excluded from the meeting. Take-Two will only allows those who held the stock prior to Feb. 19 to attend the meeting, which means even those who no longer own shares in the stock can determine the fate of those who do. Analysts estimate that between 50% to 70% of Take-Two’s stock has been sold since EA went public to buy the company in an all-cash deal on Feb. 24.

“The sell-off has created a situation where former shareholders will vote on a management compensation amendment which could significantly impact new shareholders - and the new shareholders are not eligible to vote,” an EA spokesman said in a statement. “It’s like having your last employer give you a million dollar bonus that your new boss is forced to pay.”

Whatever the outcome of the shareholder meeting, EA’s deadline for Take-Two investors to accept the deal ends on Friday at midnight eastern time. EA has no immediate plans to raise its all-cash offer, which Take-Two’s management has rejected as too low. Take-Two’s chairman, Strauss Zelnick has stated that the company will not entertain buyout offers until April 30, the day after the release of Grand Theft Auto IV, which is expected to be one of the biggest hit games this year. “The EA proposal failed to value Take-Two’s extensive portfolio of top-selling brands and our extraordinary creative and human assets,” Zelnick said on last month’s earning call.

Analysts have watched the drama unfold with earnest. “I have been covering M&As for 20 years, and this is by far the weirdest thing I’ve ever seen,” says Michael Pachter, a gaming analyst with Wedbush Morgan Securities. “The timing is odd. The way the events have proceeded has been odd. The fact that so many shareholders have bailed is odd. It’s unusual how belligerent the two managements have become. Take-Two thinks it’s worth more after Grand Theft Auto comes out. EA thinks the company is worth less before it comes out. They’re both wrong. The company is worth the same. So the thinking is a bit odd too.”

Along with a possible change in investor sentiment, EA also faces anti-trust concerns. On Thursday morning, EA received its second request from the Federal Trade Commission to file more details of its proposed deal. Both EA, with its Madden Football series, and Take-Two, with its 2K Sports franchise, offer competing sports video game titles. “Worst case, a combined co. would be forced to divest certain assets/franchises, but we see even that as unlikely,” writes UBS analyst Ben Schachter in a report.

Though much uncertainty remains, many analysts believe an acquisition is at hand. “The news does little to change our view that ERTS will be able to buy TTWO in the $26-$28 range,” Schachter wrote. “We still see ERTS as the best acquirer of TTWO in terms of potential synergies and the most likely to win it, w/price remaining the only issue.”

By Yi-Wyn Yen

Electronic Arts announced Monday that chief financial officer Warren Jenson is resigning as the video game publisher presses a hostile bid to buy rival Take-Two.

Jenson, who has been the CFO since June 2002, will leave the company in September. EA did not specify a reason for Jenson’s departure and said it will name his replacement “shortly.”

Analysts say the shakeup is not surprising. Chief executive John Riccitiello has made a number of key management moves since he joined the video gaming powerhouse last April. Riccitiello’s latest came last week when he hired a new right-hand man in president and chief operating officer John Pleasant.

“Riccitiello was brought in because the stock hadn’t moved in three years,” said Michael Pachter, a gaming analyst with Wedbush Morgan. “Now it’s been four years. To help him, he’s hiring people he’s comfortable with. If you hire a new coach and the team’s not winning, the coach is going to bring in new players.”

Jenson, 50, spent three years as the CFO of Amazon (AMZN) before joining EA (ERTS), and has also held that position at Delta Airlines and NBC Universal.

The timing of Jenson’s resignation indicates that the company’s plans for a new CFO are unrelated to its $1.9 billion bid to acquire Take-Two. A source who has spoken to a high-level EA executive says that the company has already chosen a successor to Jenson.

In a note to clients, UBS analyst Ben Schachter wrote, “We envision little impact to the company’s strategy on the deal going forward. We think CEO John Riccitiello is the driving force behind this deal, though the timing here is unnerving and will likely raise questions with investors.”

Take-Two (TTWO) management has rejected EA’s offer of $26 a share is too low. EA has taken its case directly to Take-Two’s shareholders, and is giving them until April 11, one day after the annual shareholder’s meeting, to aceept the offer. Take-Two’s board has urged shareholders to hold off until it reviews the offer and informs them of its decision by March 27.

By Josh Quittner

I was playing Scrabble at Scrabulous the other day and noticed that my opponent laid down a four-letter word that happens to be a racial slur.

My friend is a very PC kind of guy; I didn’t think he was trying to insult me. I figured that, since we both routinely cheat online, the “Scrabble helper” program my buddy used must not have known that the word was offensive and simply picked it for another, legitimate meaning. Curious, I clicked on the site’s in-line dictionary to see what it meant, and found that there was no legitimate meaning. So I started looking up other racial and sexual slurs. Every one I could think of was in there and allowed.

Clearly, I had too much time on my hands. So I started typing in four-letter swear words, just for the sake of science. Every one was allowed, including the seven banned by the FCC.

I should say here that I am no prude and am a free speech absolutist. Even my children talk like truck drivers. I was mainly curious because, if these words were allowed in Scrabble, I probably know more of them than most of my opponents. All these years I was ignoring them on the false assumption that they’d never stand up to a challenge. I felt like such a fool.

Being thorough-ish, I went to Hasbro’s online Scrabble dictionary, and looked up the words. Sure enough, not a one was allowed! Had Scrabulous had been hacked by a foul-mouthed, racist, sexist prankster?

Nope. Apparently, until four years ago, those words were indeed allowed. But after an uproar at a national tournament, the National Scrabble Association expunged 170 words that were deemed offensive.

I guess the Scrabulous dudes never got the memo. The Agarwallas, two brothers living in India, had put up the unauthorized site two years ago and now have more than 700,000 users. They’ve been making over $25,000 a month and are still trying to work out some kind of deal with Hasbro and Mattel, who are asserting that their companies own the licensing rights to the game. The Agarwallas, meanwhile, are reportedly holding out for more money. Maybe if they get it, they’ll be able to afford the new dictionary.

By Yi-Wyn Yen

There’s a lot riding on video game publisher Take-Two’s launch of the highly-anticipated game, Grand Theft Auto IV.

The game is Take-Two’s bargaining chip in its efforts to block Electronic Arts’ (ERTS) hostile takeover bid. Take-Two (TTWO), which rejected EA’s $1.9 billion buyout offer last month, raised its current quarter guidance for profits on the expectation of strong sales for Grand Theft Auto, which will be released April 29.

Take-Two on Tuesday reported net revenue of $240 million for the first fiscal quarter, which beat analysts’ estimates of $211 million, according to Thomson Financial. Take-Two forecasted $450-500 million for the following quarter with the bulk of revenue coming from GTA sales. The company’s shares rose 2.65% to $25.30 in after-hour trading Tuesday.

Take-Two thinks EA is low-balling with its offer to buy the company at $26 a share. “The EA proposal failed to value Take-Two’s extensive portfolio of top-selling brands and our extraordinary creative and human assets,” said chairman Strauss Zelnick on the company’s earnings call Tuesday afternoon. “[EA] ignored the tremendous operational progress we’ve made in the past year and our solid plan going forward.”

The company notified the Securities and Exchange Commission last Friday that it would sweeten severance packages for its full-time employees if a change in ownership results in layoffs. Yahoo (YHOO) has made similar moves with its efforts to block Microsoft’s (MSFT) hostile bid. And like Yahoo, Take-Two has been slapped with a shareholder lawsuit for rejecting an unsolicited offer.

Take-Two reiterated its position that it does not plan to talk to EA until after the release of Grand Theft Auto. When pressed by UBS analyst Ben Schachter if the company plans to change its stance, Zelnick replied, “We disclosed everything. It’s all out there in the public. There’s nothing new to say.”

By Yi-Wyn Yen

When Toshiba conceded defeat in the high-definition DVD format battle by ending support for HD DVD technology, it was welcome news for Sony, which has backed Blu-ray for its PlayStation 3 system. But where does that leave Microsoft, which offers an optional HD DVD player for its Xbox 360 game console?

“I don’t think this really affects us,” John Schappert, vice president for Microsoft Xbox Live told Fortune on Wednesday. “I think people buy our machines because they want to play games. And these are the best gaming machines out there.”

While video games may be the primary focus, both Sony (SNE) and Microsoft (MSFT) have worked hard to market their gaming consoles as multimedia machines that can also play high-definition discs. Xbox Live, a community of 10 million of online gamers, allows its members to download television shows and movies in high-definition, onto the console. Sony lets gamers watch Blu-ray movies on the PS3.

Gaming analyst Michael Pachter of Wedbush Morgan says the push for Blu-Ray is helping Sony drive sales. The PS3 outsold the Xbox in January in the United States for the first time since the Sony console launched in November 2006. Sony sold 269,000 PS3s compared to 230,000 Xbox consoles, according to the NPD.

Schappert dismissed the notion that the HD DVD battle will have a significant impact on the Xbox. “Of course the Xbox can be used as a media center extender so you can watch movies and TV shows,” said Schappert. “I like all that, but the primary reason why the machine is in the house is so that you can play Call of Duty or Halo 3.”

Now Microsoft is turning to games for the masses as well as hardcore gamers. In a speech at the Game Developers Conference in San Francisco on Wednesday, Schappert said in May Microsoft will open its platform to let any developer make video games to run on the Xbox, PC, and its Zune music player.  “We think allowing anyone to make their own game will double our game library. It’s just another reason why you want to have the Xbox 360 in your living room.”

By Yi-Wyn Yen

For all the last-minute Christmas shoppers who can’t find a Wii, Nintendo (NTDOY) is offering gift certificates that guarantee you can pick one up in January. Consumers must pay the $249 for the sold-out video game console at a GameStop (GME) on Dec. 20 and 21 and will then receive an I.O.U. to pick up the Wii after the holidays.

“We expect this to be a great way to put something underneath the tree,’” Nintendo of America president Reggie Fils-Aime said during a conference call this morning. “GameStop will have many tens of thousands of rainchecks.”

Nintendo has underestimated the demand of the red-hot Wii since it launched in November 2006. The Kyoto-based company has sold more than 6 million Wiis in the U.S. since its release, and last month sold 981,000 units, more than doubling sales of the Sony (SNE) PlayStation 3 and outpacing the Microsoft (MSFT) Xbox 360 by 211,000, according to NPD Group. While Nintendo has increased production by 80 percent since the launch, Fils-Aime says they did not expect such a craze for the Wii.

“We went into the launch of the Wii with very high expectations. We had expected to be in the upper range of console launches,” Fils-Aime said. “But this is unheard of.”

Last holiday season, Nintendo faced a similar shortage problem with its handheld gaming system, Nintendo DS. Last month Nintendo sold a record 1.53 million units, and Fils-Aime says there will be enough of the portable consoles to go around this Christmas. “Any consumer who wants a DS this holiday will be able to find it,” he said.

While Nintendo’s raincheck system will appease some, thousands are still paying a premium on sites like eBay (EBAY), Amazon (AMZN) and boutique shops to get an actual Wii. Some retailers are packaging extra controllers and games to mark up the cost of the $249 console by more than $200-$300. “We are always disappointed if we see retailers pricing products above the MSRP,” Fils-Aime said. “The only way we can combat that type of activity is by not rewarding those retailers with excess supply of products.”

Nintendo says consoles will be available at six major retailers - Best Buy (BBY), Sears (SHLD), Target (TGT), Toys R US, Kmart, and Circuit City (CC) - this weekend.

By Jeffrey M. O’Brien

On one level, the proposed $18.8 billion merger of Activision (ATVI) and Vivendi’s Blizzard Entertainment (EPA:VIV) seems to make a lot of sense. Good mergers maximize revenue by combining non-overlapping products (like the Guitar Hero Franchise, Tony Hawk, and the World of Warcraft phenomenon), and maximize profits by consolidating administrative costs. But in an industry like gaming, there’s an X factor, creativity. Sure, these companies fit together nicely in terms of lineup and their combined revenues can rival the Madden-sized gaming king, EA (ERTS). But then what? Can a Santa Monica gaming publisher run by a fast-talking CEO and a division of a French media conglomerate ever come together as one cohesive unit?

To get another perspective on the deal — and just to talk about gaming in the midst of the holiday sales season — I swung by the offices of Sega of America to talk to President and COO Simon Jeffery. He says the merger caught everyone off guard. “Activision has long been looking for a way to merge, and Bobby Kotick hasn’t made any secret of his desire to build a company to challenge EA,” Jeffery says. But EA CEO “John Riccitiello was just saying there wouldn’t be any big deals in the pipeline for quite a while. I was calling around this weekend when we heard about it and everyone was taken by surprise. Even the management at EA was stunned by it.”

Whether the companies can find creative synergy is unknown — but geography won’t be a barrier. Activision and Blizzard are across town from each other, but that no longer really matters. Each has development studios all over the world. Same for Sega. And besides, Jeffery says geography just isn’t generally an issue anymore. Two-thirds of Sega’s game development happens in the U.S., but the company has outposts in Australia and Europe — and it relies on the Japanese studios for the “edgier, more creative, wacky stuff.”

As for the potential upside at a combined Activision Blizzard, Jeffery says the merger doesn’t really buy a new set of relationships, but at some point, a huge company can use its girth to bully a retailer into carrying a game. That could prove useful for the combined company when launching new titles. “Powerful retailers like Gamestop (GME) can make buying decisions that can hurt a smaller company,” he says. “But if you’re EA, you can say, ‘Ok, you don’t get Madden then.”

Will the proposed merger have any effect on the sixth-largest publisher, Sega? Jeffery says “not much.” He’s mainly focused on watching the holiday season, which he expects Nintendo to win. “We think the Wii will sell the largest volume,” he says, before correcting himself. “Actually, the DS will be the biggest platform.”

But now that Sony’s PS3 has hit the magic sub-$400 price point, it will give both Nintendo and Microsoft’s (MSFT) Xbox 360 a run. Sega is developing for all four platforms and the company is banking on two new titles, Mario & Sonic at the Olympic Games (executive produced by legendary Nintendo creative head Shigeru Miyamoto) and The Golden Compass to score big at retail. Further out, Jeffery says he has high hopes for the company’s Ironman game, tied to the May introduction of the movie, starring Robert Downey, Jr., and directed by John Favreau, both of whom are involved in development of the game.

By Yi-Wyn Yen

If you can’t track down a Nintendo Wii this holiday season, you’re not alone. Nintendo has not been able to keep up with the demand for its mega-hit console. Now thousands of desperate consumers who can’t find the Wii on store shelves have turned to web outlets like Amazon (AMZN) and eBay (EBAY), where they’re paying a premium to get one.

“We’re seeing an unprecedented demand for a console,” says Billy Pidgeon, a gaming analyst with IDC Research. “This is the killer gift this season. And if you’re lucky enough to get a Wii with Guitar Hero III, that would be the ultimate.”

• Nintendo braces for more Wii shortage

The Wii’s popularity and shortage has not only made it harder to find, but also more expensive to buy than the Xbox 360 or PlayStation 3. Since Black Friday, almost 5,000 Wiis were sold at an average price of $420.50 on eBay and some with extra games and controllers have been purchased for more than $600. On Amazon, new Wiis are starting at $490 plus shipping. The console retails for $250. Both Microsoft (MSFT) and Sony (SNE) dropped prices for their consoles to boost sales this year. Microsoft lowered its entry-level 360 by $50 to $349 while the PS3’s low-end line retails for $399.

“Price alone won’t move hardware,” says John Taylor of Arcadia Research. “This isn’t about price or what’s available, but what people are willing to play.”

The Wii’s fun factor has made it a hit among the mass market compared to its more technologically-advanced rivals. The Wii uses a controller that requires players to simulate swings and punches to play video games. “Clearly, consumers place a higher value on accessible, fun games such as Wii Sports or Carnival than on high-definition graphics and leading-edge processing power,” says Lazard Capital analyst Colin Sebastian.

Though Nintendo increased production by 80 percent since its November 2006 launch, executives warned in October to expect a holiday shortage. Last week the company sold 350,000 Wiis, which gave Nintendo its highest one-week U.S. sales total since the console was released. Nintendo of America president Reggie Fils-Aime said that the company would not be able to keep up with demand until “early next year.”

“The challenge is in demand, not supply,” Fils-Aime told Fortune in October. “We planned optimistically for the launch, but no one could have foreseen how much more popular Wii would be than any other system in memory.”

Taylor says the best way to find a Wii without paying above retail is to contact store managers at gaming shops like GameStop (GME) or box retailers like Wal-Mart (WMT) and Best Buy (BBY) early in the week. “You want to call on a Tuesday or Wednesday and find out when the new Wiis are coming in,” he says. “Usually new games arrive on the trucks Monday night or Tuesday. If you wait to the weekend, you’ll find those shelves empty.”

By Yi-Wyn Yen

All those years playing the video game Madden NFL has paid off for Electronic Arts CEO John Riccitiello. To succeed in the video game industry, Riccitiello suggests taking a playbook from the popular sports game. Learning to react quickly, trusting his team, and admitting defeat are some of the lessons he’s applying to EA’s (ERTS) new strategy.

Riccitiello is shifting the focus of the company from publishing licensed video games to making its own titles. Earlier this month EA acquired independent developers, Pandemic Studios and BioWare, for $860 million to bulk up its library of original, high-quality games.

Madden NFL’s game-play has also been valuable to surviving in the gaming business. During a recent gathering at Berkeley Haas School of Business, Riccitiello talked about four lessons he’s learned since he joined EA as President in 1997.

Embrace change even if it costs a lot. A half century ago the three major networks — ABC, CBS, and NBC — were so dominant that they resisted change. Thirty years ago the three networks had more than 90 percent of the television market. Today, the big three account for less than half. “They were extremely arrogant,” Riccitiello says. “They viewed the rise of cable as being insignificant.

Riccitiello says the $31 billion gaming industry will suffer if it doesn’t start to reevaluate its business model. Game executives at Sony (SNE), Microsoft (MSFT) and Activision (ATVI) must answer some tough questions in the coming years, like how long they can expect consumers to pay $59 for a video game. Riccitiello predicts the model will be obsolete in the next decade.

“In the next five years, we’re all going to have to deal with this. In China, they’re giving games away for free,” he says. “People who benefit from the current model will need to embrace a new revenue model, or wait for others to disrupt.” As more publishers transition to making games for online distribution, Riccitiello says he expects EA will experiment with different pricing models.

Don’t let detractors define you. Riccitiello blames the media for characterizing video games as more violent than images shown on cable TV on a typical Sunday night. He compared video clips of violent scenes from Kill Bill, CSI and 24 to games like Gears of War, Halo 3 and Grand Theft Auto. “Our industry is exceptionally well-controlled. Every game gets rated” by the Entertainment Software Review Board, he says. “The desire by the media to censor games amazes me.”

Admit your mistakes. Riccitiello concedes he failed to turn premium online-gaming service EA.com into an industry-changing product in 1999. The site launched an interactive spy thriller game in 2001 called Majestic, which featured rich, dazzling graphics that were accessed over agonizing slow dial-up modems. “It was a great idea, but it was way ahead of its time,” he says. “We spent several hundreds of millions and frankly, when it failed it took a little bit of me with it. EA’s investors weren’t going to wait five years to see it right. I had to admit my mistake and move on.”

Put your trust in visionary people. The failure of Majestic didn’t stop Riccitiello from putting faith in EA vice president Neil Young, who created the game. Shortly after, Young negotiated a deal to make the Lord of the Rings franchise, which has brought in $725 million in sales since 2004.

Riccitiello is also banking heavily on two innovators to launch big first-party games. Will Wright, the creator of Sims, is working on his highly-anticipated followup, Spore, which is expected in early 2008. And Alex Ward, a game developer who believes crashing cars can be more fun than driving fast, will release EA’s Burnout Paradise in January 2008. Says Riccitiello, “I met Alex in an English pub, and I made a judgment that he’s going to be a mega hit.”