Sierra's Game Plan -- Software Firm Hopes Acquisition Strategy Makes It A Winner In Its Niche

Can a software company move from a small town in California to Bellevue, in the very shadow of Microsoft, and emerge among the giants in its niche of the industry?

Sierra On-Line Inc. is trying.

The company went on a corporate buying binge last year, acquiring five small software companies, and expects to continue the shopping spree this year.

Sierra's goal: Diversify beyond its traditional base of adventure and simulation games for personal computers into other game types, education software and titles that help consumers do useful home tasks.

Already, Sierra has the largest market share of the PC-game business, and it hopes to use a growing stable of education and home software titles to take its traditional game customers into other areas.

Led by its new financially oriented president, Michael Brochu, Sierra's 1995 acquisitions added about 200 employees and new product categories ranging from airline flight simulators to auto racing to software for working with food and recipes to programs for designing homes and gardens.

"This is driven by our strategy to be the premiere home entertainment, home education and home productivity provider in the world," said Brochu, who was hired in 1994 as Sierra's chief financial officer and became president and chief operating officer last October.

The goal of the company, which moved from California to Bellevue two years ago this month, is to be among the major survivors in an industry that's consolidating along the lines of movie studios, Brochu said.

Keith Benjamin, an analyst at Robertson Stephens in San Francisco, said: "My view is this business is going to evolve just like the music, movie and video businesses, and there will be only a handful of studios that survive. In my estimation, Sierra will end up as one of those major studios or as part of one of them."

"Studio" seems to be the accepted metaphor in the electronic-game business, where companies create "stars" and leverage their success by pumping out a variety of products that will be shown, played and collected.

Sierra's main competitors in the PC-game business are Broderbund and Electronic Arts. Novato, Calif.-based Broderbund, which makes PC products for homes, schools and small businesses, had sales of $171.6 million in the year ended last August. Electronic Arts of San Mateo, Calif., specializes in entertainment software not only for personal computers but also for console games such as those made by Sega and Nintendo (a much larger business). The company had sales of $493 million in its latest fiscal year.

At Sierra, Brochu declined to be specific about his acquisition plans for 1996.

"We are looking to deepen and broaden our product line, and it's all focused on the home consumer," Brochu said. Five years from now, Sierra "will be much bigger, and over half of our distribution will be products distributed and played over the Internet."

When Sierra bought SubLogic Inc. in 1995, it put itself in head-to-head competition with Microsoft in the flight-simulator game category. For more than a dozen years, Microsoft's "Flight Simulator" has been one of the best-selling entertainment software programs ever.

Microsoft is developing a Windows 95 version of "Flight Simulator," which was originally developed elsewhere (partly by SubLogic).

When it picked up SubLogic with a handful of employees last year, Sierra acquired a slow-selling product called "Flight Light," similar to a previous version of "Flight Simulator." More importantly, it acquired flight-simulation technology, which Sierra says it will develop into a series of Windows 95 products that will be what Sierra calls "the first serious alternative" to Microsoft's "Flight Simulator."

Last year's acquisitions mark a new level of maturity for Sierra, which won't say how much it paid for the companies it bought. But analysts believe each deal was done for less than four times the acquired company's annual sales, which is quite low for software acquisitions.

When it moved to Bellevue, the company was saddled with owning a large stake in a money-losing online network called ImagiNation, which had sapped profits from Sierra's popular games such as "King's Quest," a perennial best seller.

Sierra lost $8.4 million and $8.7 million, respectively, in the fiscal years ending March 1993 and 1994, even though sales grew from $49.7 million in fiscal 1993 to $62.7 million the following year.

Much of Brochu's first year on the job was spent getting the finances straightened out. He cut costs, sold the company's interest in the ImagiNation Network to AT&T and restored the company to profitability. For the year ended last March, Sierra had $11.9 million in profit on $83.4 million in sales.

"That gave Mike a chance to inventory the company's competitive strengths and figure out how to leverage them," said Scott McAdams, an analyst for Ragen MacKenzie Inc. in Seattle.

Those strengths: cash, a solid distribution network, a credible brand name in the game industry and the ability to manage the creative process of not only developing a game but also of doing it on time and within a budget.

Brochu's strategy: Use the company's cash, which totaled nearly $100 million last March 31, to find other software titles and companies that could use those strengths.

"That's what he's been doing, and he has not overpaid for anything he has bought," McAdams said. He and other analysts believe the acquisitions will start pouring profits into Sierra this year.

Brochu's first buy last year was Green Thumb Software Inc. of Boulder, Colo., which makes software for designing or remodeling homes and gardens.

Judy McNary, a co-founder of the company and its president a year ago, found Sierra's pitch hard to resist.

"We were at a point where we had a good product and good ideas for producing it, but we had to either renew our contract with our distributor, launch our own distribution operations or merge with somebody," said McNary, who still runs the company in Boulder and now has the title of "producer" at Sierra.

Selling to Sierra "gave us the chance to keep doing the core things which we liked, which was developing the product," she said.

McNary was happy to have Sierra take over many job functions that she found necessary but less than fun. "Now we can concentrate on what we like without worrying about things like manufacturing, inventory and accounting."

David McDonald, who started Arion Software Inc. in Texas in 1991, last year found himself with a popular software product for working with food, menus and recipes - but without the resources to develop the product to its potential. He sold the company to Sierra last May.

"They have taken away all the aspects of our jobs that we hated, the administrative stuff, the payroll, contracts, the kinds of things that software developers hate to do like sales and marketing," McDonald said. "Their model was to keep the entrepreneurial spirit that made us what we are. They like to keep us entrepreneurial, a separate group."

That is a critical part of Brochu's sales pitch to the small software-development companies he wants to buy.

Analyst Benjamin said, "A lot of the reason game developers come up with the best games is that they are having a good time. Sierra is a fun place." Sierra founder and chairman Ken Williams "has a history of putting games first, and he has created one of the most friendly atmospheres for game developers on the planet," Benjamin said.

McAdams estimates Sierra's sales will be $130 million in the fiscal year that will end March 31. Brochu said 60 percent of the company's business is entertainment, 30 percent education titles and 10 percent home productivity.

Partly to increase the shelf life of its products and partly to mitigate the extremely seasonal nature of games, Sierra is trying to build its educational business.

McAdams predicts Sierra will turn in profit of $15.8 million in its current fiscal year. In fiscal 1997, he estimates profit of $20.5 million on sales of $170 million. Other analysts expect Sierra's profit to continue rising about 30 percent a year for the rest of the decade.

But the consolidation of the industry may change those expectations.

"In order to end up in the top ranks, Sierra probably needs to make a reasonably large acquisition or merger," said Benjamin. "There are very few private companies left out there of any size, so (any Sierra acquisitions) would probably be in the public arena. Most of the companies that are any good have already gone public."

And that leads to the ultimate question about the future of Sierra: Will it end up being the buyer or the merchandise, the predator or the prey?

"It is hard to tell," said Benjamin. "I would not be very surprised either way."

Sierra investors have had a wild ride the past few years as the stock gradually moved from about $10 a share in mid-1994 to stabilize at about $20 last spring, then shot up to a high of $46.625 last September. The stock fell sharply last fall and has been trading between $20 and $30 since mid-December.


Sierra On-Line's recent acquisitions.

-- November 1995: Papyrus Design Group, Watertown, Mass. Produces auto-racing games. Employees: 100. Adds a popular product category and beefs up Sierra's simulations and sports offerings.

-- November 1995: SubLogic Inc., Champaign, Ill. Produces non-military flight-simulation games. Employees: 12. Adds a popular product category to sports and simulations area. Will share technology with Papyrus.

-- September 1995: Arion Software Inc., Austin, Texas. Produces cooking software. Employees: 12.

-- June 1995: Impressions Software Inc., Cambridge, Mass. Produces strategy games. Employees: 40. Adds strategy games to Sierra's traditional strong offerings in adventure, sports and simulation games.

-- May 1995: Green Thumb Software Inc., Boulder, Colo. Produces landscape-design software. Employees: 10. Green Thumb and Arion both help Sierra create a home productivity category with products expected to have longer shelf lives and less seasonal sales patterns than games.