38 Studios & Rhode Island's VC Nightmare

Afternoon Monkeys,

Any Red Sox fans here on WSO? How about MMORPG fans? Maybe there's some fans of government sponsored VC failure? Well, if you inexplicably landed in all three categories, the recent Bloomberg article by Jonathan Mahler discussing Rhode Island's ill advised foray into the world of VC via Curt Schilling's 38 Studios is probably old news. For the rest of you who may be less familiar with the story, the complete meltdown of 38 Studios and nearly $100 million of Rhode Island's money is worth a read. Also, as Mahler notes, for those of you currently at HBS, an in depth look may be more readily available than you realize:

The good news is that before the company fell apart, Schilling and some of his employees spoke extensively to a few researchers from Harvard Business School. Their case study, published in 2009, is available for only $6.95. It’s worth every penny, particularly if you are a fan of Kingsley Amis-style satire.

The story begins when Curt Schilling decided to start his own video game company after his retirement from baseball. During his playing days, when he wasn't on the mound, Schilling filled much of his time playing video games, and like every 9-13 year old boy, he dreamed of starting his own video game company. But, unlike most 9-13 year olds, Schilling had millions of dollars and a healthy dollop of notoriety thanks to a successful pitching career to help him build his dream. Using a WSO-test method of "network your ass off", Schilling started on his path to building 38 Studios:

He was soon networking with game-development executives and devouring books about leadership. “The thing that jumped out at me was, there’s a broad swath of parallels between winning a world championship and creating a company that’s best of breed,” Schilling said. In other words: He could do this!

A fine start, one packed with promise and potential. A start so fine, in fact, that "founder" just wouldn't work, nor would just any old game. The one in Schillings mind wasn't what you might guess:

He wanted to develop the most complex kind of video game possible -- a “massively multiplayer online role-playing game,” in which thousands of users interact inside an elaborately conceived and designed fantasy world. He wasn’t going to skimp on the back story, either (even though most people who play these games tend to click quickly through the text to get to the action). There would be 10,000 years’ worth of it, all dreamed up by a best-selling fantasy author, R.A. Salvatore, and a well-known comic book writer, Todd McFarlane. They would be co-founders of the company -- though Schilling preferred the title “co-visionaries.”

But no matter how many big names were on the project, or how much networking was done, there seemed to be something missing. Something important:

Schilling didn’t know the first thing about the world outside baseball. That’s not hyperbole: He once asked the president of 38 Studios if employees got weekends off. Another time he suggested that they work 14 days straight so as not to lose their momentum. (No need for travel days when you’re playing only home games!) Schilling was so clueless that he had to be told by his wife’s uncle, a retired corporate executive, not to personally guarantee the company’s lease.

So, for all you VC people out there, this sounds like the greatest bet in the world, right?!? Well, you'll be surprised to learn that there may have been some red flags for the VC community in Boston:

He tried just about every high-tech venture capital firm in Boston, not to mention the governor of Massachusetts, to no avail.

Luckily (or not), small roadblocks like these proved to be only minor setbacks for Schilling when he arrived in Rhode Island:

Schilling had persuaded the star- struck governor of Rhode Island, Don Carcieri, to issue $75 million in tax-free bonds for 38 Studios. That’s when “the Big Blowhard” -- as Boston Globe sports columnist Dan Shaughnessy once called Schilling -- officially transcended the familiar narrative of the ex-athlete as failed businessman. He wasn’t losing his own fortune on a bad investment, a failed car dealership or an ill-conceived restaurant franchise. He was fleecing taxpayers in order to realize his deluded dreams.

It probably won't surprise you that a guy who knew nothing about his undertaking, backed by a state who (somehow) knew just as little, created a recipe that would not end well:

The 38 Studios deal is now under criminal investigation, and Carcieri’s successor, Governor Lincoln Chafee, is suing Schilling for misleading the state’s economic development agency about his company’s finances.

Now, personally, I don't see anything terribly criminal here. I see some astoundingly stupid decisions by a state, and a company being built with the motivations and professional background of a 9 year old, but being a fool isn't the same as being a criminal. Mahler appears to disagree - at least somewhat - when he ends his article, but it's tough to argue with his final point:

Guess what, Curt? It turns out you’re just an ex-pitcher who has managed to inflict some pretty serious financial damage on an entire state -- and landed yourself in a whole heap of trouble along the way.
 
CRE:

I thought they just made a Skyrim/Gauntlet knockoff? http://en.wikipedia.org/wiki/Kingdoms_of_Amalur:_R...

It was alright...but not as good as Skyrim. Never heard of this MMO business with them.

/nerd

Yeah, that's the one they released via EA, and really, their only product that ever hit the market. From what I've read about the whole thing, Schilling was strictly interestd in the MMO game, and he had to be prodded into making a console game.

"My caddie's chauffeur informs me that a bank is a place where people put money that isn't properly invested."
 
mikesswimn:

Yeah, that's the one they released via EA, and really, their only product that ever hit the market. From what I've read about the whole thing, Schilling was strictly interestd in the MMO game, and he had to be prodded into making a console game.

Hah, good insight. I can't imagine why someone would start a video game studio now in general. Established, well known studios are closing their doors or getting sold off. The list big names that have disappeared or been absorbed in the past couple years is staggering.

Commercial Real Estate Developer
 

Kingdom of Amalur is an action game that play like an MMO. The overall strategy of the company was poor, MMORPGs aren't in demand as they once used to be. To put things in perspective, the Star Wars MMORPG cost somewhere between $200-$300 million and it failed to reach its goals. My guess is that even if this company's MMORPG came out, it would have flopped. The company was doomed from the beginning to even try and break into the genre.

 
Best Response

I wasn't involved in this transaction, nor had I researched it until about 5 minutes ago (I saw headlines, didn't care) but how are Rhode Island or taxpayers on the hook for this? These bonds (federally taxable) were issued via the Rhode Island EDC as a conduit (name only) and are not obligations, general, special or otherwise, of the State, do not constitute a debt of the State, are not enforceable against the State, nor shall payment thereof be enforceable out of any monies of the State.

The State pledged their moral obligation (annual appropriation) to the replenishment of the reserve fund (approx. $12 million - not the full $75 million par amount), however, that's if revenues come up short and they need to use the fund just to meet a payment, and further, only if the State actually appropriates the money to do so (they are under no actual obligation). In a default, there is no point in replenishing the reserve fund so they won't appropriate that money. The bonds are backed by revenue/payments of the Company, and then further enhanced by Assured Guaranty (the main backstop in a default).

Just wondering how taxpayers, etc are on the hook.. I must be missing something other than sensational headlines because it seems to me that AGM will be ultimately repaying bondholders... who were accredited investors only, due to the private placement nature of this transaction...

 

Just for everyone's benefit... the State would've placed their moral ob on the transaction to boost the underlying rating (which was then further enhanced by the insurance policy) which would lead to a lower borrowing cost. They do this when they feel that the project will eventually lead to jobs and a benefit to the state. And, by not "honoring" that moral obligation, could eventually lead to investor push-back in the future. However, this seems to be a pretty unique set of circumstances given the PP nature as well as the structure of the obligation (on reserve, not transaction). What ultimately hurts the State are misleading headlines such as "taxpayers on the hook" and "Rhode Island Defaults" where "journalists" don't do their proper research...

 
ChiTown82:

Just for everyone's benefit... the State would've placed their moral ob on the transaction to boost the underlying rating (which was then further enhanced by the insurance policy) which would lead to a lower borrowing cost. They do this when they feel that the project will eventually lead to jobs and a benefit to the state. And, by not "honoring" that moral obligation, could eventually lead to investor push-back in the future. However, this seems to be a pretty unique set of circumstances given the PP nature as well as the structure of the obligation (on reserve, not transaction). What ultimately hurts the State are misleading headlines such as "taxpayers on the hook" and "Rhode Island Defaults" where "journalists" don't do their proper research...

thanks for the clarification (assuming noone disagrees), didn't realize how these things are structured
 

Why would you ever trust Ketchup Sock with video games of all things? Even studios that KNOW what they're doing usually fail. I mean take Bill Roper for instance. He had decades of video game experience, formerly a Vice President at Blizzard during its most successful times, then he starts his own studio and it fails completely. So if a guy like that can fail so miserably why did people think that Ketchup Sock, with no experience or knowledge of the industry or how to run a business at all, would succeed? It's crazy.

 

@ thurnis haley: what do you think are the reasons most video game studios fail? I mean I can imagine the success is heavily dependent on the product, but are you aware of any other specific reasons.

posting 2 learn, not even sure why im curious about this.

"That dude is so haole, he don't even have any breath left."
 
FeelingMean:

@ thurnis haley: what do you think are the reasons most video game studios fail? I mean I can imagine the success is heavily dependent on the product, but are you aware of any other specific reasons.

posting 2 learn, not even sure why im curious about this.

To throw my two cents in... it probably has a lot to do with unfeasible design of a game engine, cost over-runs, getting in way over your head, costs of licensing game engines if you aren't capable of designing one yourself, lame product, cutting corners to meet deadlines that in the end destroy your product, etc, etc... read, "Masters of Doom" by David Kushner. It's a pretty cool read about Id Software (Commander Keen, Wolfenstein 3D, Doom, Quake, etc...) - how they found each other, created their game engines, licensed them, success, etc.

 

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