Square Enix plans to sell its entire Western video games division to Embracer Group for $300 million. Here's why.
Today Square Enix and Embracer Group shocked the gaming world. Square Enix announced that it is selling all of its North American and European-operated game studios alongside a ton of intellectual property and franchises to Embracer Group. The deal includes Crystal Dynamics, Eidos Montreal, and mobile game studio Square Enix Montreal, as well as Square Enix of America. Major IPs like Tomb Raider, Deus Ex, Legacy of Kain, and Thief are being sold as well.
One big question is why did Square Enix sell? An even bigger question is why did they sell these companies and franchises for so little? The answer requires a more broad look at Square Enix, its trajectory, and an examination of how well these studios have performed.
First let's take a look at Square Enix.
Square Enix - Ambitious Yet Scattered
- Square Enix makes most of its money from mobile, F2P, browser
- Western games are expensive to make
- Selling studios reduces costs, narrows focus to less risky business
Square Enix is a very ambitious company. CEO Yosuke Matsuda has promised Square Enix is tackling nearly every technology known to man, from cloud to AI to blockchain and NFTs. This ambition comes at a very high operational costs and a scattered focus.
This leads to and multiple blunders, missteps, and poor management decisions, more aptly with big games from its Western studios (but Eastern games like Balan Wonderworld, Left Alive, and Babylon's Fall have also been disastrous).
Another big factor of the sale is that Square Enix doesn't make most of its money from premium games like Final Fantasy VII Remake.
The publisher's smartphone and browser game segment is actually the most lucrative part of its business. The pecking order typically goes like this:
Free to Play -> HD Games -> Subscription games
There's fluctuations of course, especially when FF14 releases a new expansion.
Many gamers think Final Fantasy XIV is Square Enix's main cash crop. This isn't true. The MMORPG is extremely important for Square Enix, but its wide variety of mobile games generate hundreds of millions of dollars every year and consistently make the bulk of its yearly revenues.
The rationale behind the sale is that instead of spending big on multiple projects in a wild, helter-skelter array, Square Enix is narrowing its focus onto specific and targeted sectors.
The publisher is attempting to lean itself and cut off expensive segments that it doesn't technically need while it focuses on digital, free-to-play, and development of more risk-averse first-party games set in beloved franchises. Oh, and let's not forget their blockchain ambitions.
Crystal Dynamics and Eidos Montreal - Low Profits, "Disappointing Sales"
- Crystal Dynamics and Eidos Montreal barely make any profit
- Both studios spend tens of millions on expenses, R&D, and development costs
- Big AAA games from both studios have missed Square Enix's expectations
- Avengers was a commercial failure and cost Square Enix $63 million
- Analysts estimate production of games from these studios resulted in a $200 million loss for Square Enix
Cost reduction was the biggest motivator for the sale. Square Enix's Western studios are extremely expensive to maintain and the production cycles require lots of investment.
The studios spent a lot of money on game development, which is rightly so, considering Crystal Dynamics and Eidos Montreal released three Tomb Raider games within a five-year period. That kind of delivery does not happen often in the games industry.
A quick look at financial data for the past three years (2019 - 2021) shows Square Enix's argument.
These studios have some pretty heavy books. Crystal Dynamics and Eidos Montreal have very small profit margins. Revenues are high, but operating income is very low. This indicates both studios are spending lots of money on production.
In the last 3 years, both studios have generated a combined $489 million in revenues, but expenses were roughly $474 million.
Why is development so expensive? There's lots of factors. Let's take a look at each company as well as their earnings.
- 272 employees
- Proprietary games engine
- Full mo-cap/cinematic studio
- 3 U.S.-based locations: San Mateo, Bellevue, Austin
- 481 employees
- 4 core creative teams
- Entire R&D studio segment
- 3 locations: Montreal, Sherbrooke, Shanghai
That leads us to our fourth and final point: Disappointing sales.
"Failed to Meet Expectations"
- Both Crystal Dynamics and Eidos Montreal delivered multiple games that failed to meet Square Enix's sales expectations
- Costs of development were likely higher due to quicker delivery
Numerous games from Crystal Dynamics and Eidos Montreal have failed to meet Square Enix's expectations. Many of these games (see above) have sold millions of copies but still didn't live up to Square Enix's lofty ambitions.
I believe there's two main simplified reasons for this:
- Quicker production cycles drove up costs, which required even more game sales to recoup game development costs to make a profit
- Mismanagement and poor decision-making
Remember that Eidos Montreal and Crystal Dynamics shipped three mainline Tomb Raider games within a five year period: Tomb Raider (2013), Rise of the Tomb Raider (2015) and Shadow of the Tomb Raider (2018).
That's on top of Avengers, which launched in 2020 to commercial failure, and Deus Ex Mankind Divided in 2016.
It's worth mentioning that Avengers was a significant bomb that spurned Square Enix. The company is expected to have lost $63 million on Avengers and the game is recognized as one of the most derivative live service titles on the market. Not much is known on exactly what went wrong during development, but Avengers was not mentioned at any point during the Embracer presentation.
Sales performance on these games wasn't actually terrible.
Avengers was measured to sell roughly 2.2 million units as of late 2020, and the modern Tomb Raider and Deus Ex games have sold a combined 50 million copies.
The Tomb Raider Trilogy has sold 38 million, and the Deus Ex duology sold over 12 million copies worldwide. Those are respectable figures that represent a powerhouse combo for any video games publisher, but again, the costs to make these games was likely very high.
Square Enix has been wanting to sell its Western games division for a while now. The studios and production lines are very expensive and each studio has delivered what Square Enix considers disappointing results. That's on top of low profit margins for each studio, which isn't something that any shareholder wants to see.
Avengers, the Tomb Raider trilogy, Thief, and the Deus Ex games just didn't deliver the kind of earnings Square Enix wanted.
Embracer Group is also offering $300 million in debt-free cash which is a significant motivator, especially considering these more recent games have led to $200 million in losses.