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Activision Blizzard: A New MMORPG and Subscription Model for Starcraft II

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May 7, 2010 | SIN Picks | Author Asif

Call of Duty Black OpsAgainst the backdrop of one of the strangest days in the market with the Dow Jones dropping nearly 1,000 points in late afternoon trading, gaming giant Activision Blizzard announced strong first quarter results. During the conference call following the release of their results the company revealed some interesting details about its pipeline for the rest of the year. I got a chance to live tweet most of the conference call but in case you missed the call, I decided to post this blog entry with some key highlights from the call just like I did last quarter with the post Thoughts on Activision Blizzard’s Q4 Results.

The Good:

  • Activision reported revenue of $1.3 billion in the first quarter and earnings of 30 cents per share, more than double the 14 cents in earnings it reported in Q1 2009. On a non-GAAP basis, which excludes revenue and expenses that have been deferred for certain games, Activision reported revenue of $714 million and earnings of 9 cents per share. Non-GAAP earnings were more than double analyst expectations of 4 cents per share.
  • Activision Blizzard increased its cash balance by $300 million and now holds $3.34 billion in cash and short-term investments on its balance sheet.
  • Under a $1 billion share buyback program launched in February, the company has already purchased 8.5 million shares for an average price of $10.84.
  • The company recently struck a 10 year deal with development studio Bungie, the developers who created Microsoft’s highly successful game Halo. Bungie has almost 200 people working on a new intellectual property for Activision.
  • Activision Blizzard announced that “hundreds of thousands” of players were trying out the beta version of their highly anticipated game Starcraft II that is slated for release on July 27, 2010. The game is already the top selling PC game on and one analyst has an optimistic sales estimate of 6 million units in the first year.
  • The company is trying a couple of different revenue models with Starcraft II. In certain western countries like the United States, the company will sell Starcraft II at a certain price ($59.99 at Amazon right now), which will include unlimited online play on their platform. Players of the original Starcraft have been playing on for free for over a decade now. In certain other countries like Russia, the company will provide two purchase options. At a higher price point of $33, players will get the game and one year of online play. At a lower price point of $16.50, players will get the game and 4 months of online play. This new subscription model should help bring a consistent stream of revenue much like the World of Warcraft franchise.
  • World of Warcraft has in excess of 11.5 million subscribers and did better than expected in the first quarter. Growth in China has been particularly good thanks to the relationship with NetEase (NTES).
  • The Blizzard Entertainment division of the company is expected to have its biggest year ever driven by the release of Starcraft II and the new expansion pack for World of Warcraft called Cataclysm. World of Warcraft already brings in more than a billion dollars in annual subscription revenue.
  • The company is working on another Massively Multiplayer Online Role Playing Game (MMORGP) confirming rumors that have been floating around for months.
  • The Call of Duty: Modern Warfare 2 expansion map pack called “Stimulus Pack” sold more than a million copies for the XBOX 360 console within 24 hours of its release towards the end of the first quarter. Activision released this map pack for the Playstation 3 earlier this week.
  • Troubled studio Infinity Ward, which created Call of Duty: Modern Warfare 2 is already working on a second map pack that will be released later this year.
  • Full year 2010 outlook remained unchanged at non-GAAP revenue of $4.4 billion and earnings of 72 cents. Earnings outlook was increased from 70 cents to 72 cents just a few days before the call.
  • Activision’s outlook for the industry calls for 5 to 8% growth in software sales through both retail and online channels. As of March 31, the installed base of console and handheld hardware increased 34% year-over-year to 227 million. Activision expects 2010 to end with a “massive installed base of 265 million units of consoles and handhelds”.

The Bad:

  • Second quarter non-GAAP revenue is expected to drop to $700 million and earnings are expected to drop to 4 cents, well below analyst expectations and below year ago levels. Analysts were expecting earnings of 9 cents on revenue of $797 million in the second quarter. Some expenses from the first quarter were delayed and hence will impact second quarter results. Most of the bigger titles like Call of Duty: Black Ops and World of Warcraft: Cataclysm are slated for release in the second half of the year.
  • Activision’s results may be negatively impacted due to currency exchange rates especially in light of the recent weakness in the Euro and the British Pound.
  • More than 35 employees have left Infinity Ward following the firing of the two Infinity Ward heads for insubordination. The fired duo turned around and struck a deal with Electronic Arts (ERTS) and have been recruiting Infinity Ward talent to join their new studio Respawn Entertainment.

Overall I continue to remain happy with the execution of this company and continue holding on to my long position in the stock.

On an unrelated note, the May investment newsletter has been delayed and should be out on Monday, May 10th.

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Blizzard’s World of Warcraft: The China Growth Story

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March 11, 2010 | SIN Picks | Author Asif

The Blizzard division of Activision Blizzard (ATVI) generated $1.2 billion in annual revenue last year without releasing a single new game in 2009. Blizzard still gets some of its revenue from legacy games like the original Starcraft that was released more than a decade ago in 1998. In fact Starcraft managed to crack the list of top 10 PC games as recently as May 2009 according to the top game industry research firm NPD Group. Starcraft has been spotted in the top 20 multiple times since the announcement of Starcraft 2 in 2007. The beta version of Starcraft 2 featured in the video below was released last month and the game is expected to ship sometime in the first half of 2010.

A majority of Blizzard’s revenue however comes from its hugely popular MMORPG World of Warcraft (WoW) that had 11.5 million subscribers as of last month and has helped Blizzard generate above average operating margins when compared to Activision as a whole. Operating margins for the Blizzard division in 2009 were over 46%. Given how important World of Warcraft numbers are to Activision, I decided to dig into the subscriber numbers and specifically look at the growth opportunity from China as I have received a couple of questions about this from SINLetter subscribers.

As you can see from the chart below, World of Warcraft experienced exponential growth from its launch in November 2004 through 2008. Only Second Life by San Francisco based Linden Labs, which unlike WoW is free to play, managed to surpass WoW’s subscription numbers. Keen followers of the Massively Multiplayer Online Gaming space noted that the 11.5 million subscribers that Activision Blizzard reported at the end of 2009 were the exact same number of subscribers reported at the end of 2008.

WoW 2007 Subscriber Chart

With WoW restored in China as of September 19, 2009 following regulatory hurdles, are subscription numbers going to start growing again or has WoW peaked until the next expansion pack Cataclysm comes along? The bigger question to ask is how many of the 11.5 million subscribers are from China and how much revenue do they generate for Activision Blizzard.

If all 11.5 million subscribers were paying $15/month or $180 annually to play WoW, Blizzard’s revenue from just this one online source would be,

$15 X 12 months X 11.5 million subscribers = $2.07 billion.

Even after averaging the monthly fee down to roughly $14 after taking into account that some subscribers pick the cheaper $13.99 plan by paying for three months at a time or the $12.99 plan by paying for 6 months upfront, the expected revenue drops to,

$14 X 12 months X 11.5 million subscribers = $1.93 billion.

This is significantly higher than the $1.2 billion in revenue the entire Blizzard division reported for 2009. So it stands to reason that a large number of these 11.5 million subscribers are Chinese subscribers that don’t shell out roughly $14/month like their North American and European counterparts do. Based on what I have read from various sources, it is possible that between 4 to 6 millions subscribers are from China and they pay 6 cents per hour to play the game. Assuming 5.5 million subscribers and adopting a conservative estimate of 10 hours played per month, annual Chinese revenue works out to,

10 hours X $0.06 X 12 months X 5.5 million subscribers = 39.6 million

Chinese revenue is probably even smaller after Activision splits the proceeds with its Chinese partner (NTES). The rest of the non-Chinese 6 million subscribers generate approximately $1 billion in revenue, putting the total WoW subscription revenue at $1.04 billion. Taking the sales of legacy titles like Diablo, Starcraft, etc., into account, we get very close to the $1.2 billion in annual revenue Blizzard reported for 2009.

There is a good chance that given the addictive nature of the game, Chinese players spend more than 10 hours/month playing the game and that the release of expansion packs (some of the old ones have not yet been approved in China) might drive additional revenue. But even if you were to double both the hours and the number of subscribers, revenue would top out at $158.4 million before Netease takes its cut.

The conclusion I came to after digging into the China factor was that the Activision Blizzard investment thesis cannot rest on expectations of growth from China. The strong pipeline of games from Blizzard for 2010 and the potential of another MMORPG are better reasons to get excited about Activision.

Related Posts:

Thoughts on Activision Blizzard’s Q4 Results

Ten Reasons I am Buying Activision Blizzard (ATVI)

Activision Blizzard: Playing Diablo’s Advocate


The Apple App Store Ecosystem and Glu Mobile – Part 2

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March 10, 2010 | SIN Picks | Author Asif

Note: This blog entry was originally published as a Special Reports update on 3/10/2010 and is now open to everyone.

Glu Mobile (GLUU) $0.98

Guitar Hero 5 Mobile by GluWith 38 games currently in the Apple app store, San Mateo, California based Glu Mobile is smack in the middle of the nearly $3 billion Apple app store ecosystem discussed in the first part of this two part article. Founded in 2001, Glu was once a successful start-up, focused on producing and publishing games for mid-range handsets that were the prevailing, dominant phone of the time. The years 2000-2001 were when cell phone usage became a widespread trend and Glu had precociously jumped on the idea that gaming would take off on this technology. Glu not only publishes original game titles but also has partnerships with SINLetter portfolio pick Activision (ATVI) and other companies like Sony (SNE), Microsoft (MSFT) and Popcap Games. For example Activision’s Guitar Hero 5 is published as Guitar Hero 5 Mobile for Blackberry, Android, Microsoft and Palm based phones by Glu. The company was brought public in early 2007 at a price of $11.50 per share with Goldman Sachs as the lead underwriter. With offices in 11 countries, Glu  has been losing money every year since 2005 and the $84 million it raised in the March 2007 IPO has dwindled to just $10.5 million in cash as of December 31, 2009.

Unfortunately, Glu has been struggling to keep up with mobile gaming trends as they have shifted to phones like the iPhone and this is reflected in the stock price, which is just under a buck as I write this article. In an attempt to reformulate their approach to gaming, Glu posted a press release on July 8, 2009 informing investors and the public that their CEO for the past six years, Greg Ballard would be leaving Glu in “pursuit of other activities.” It was only two months ago, on January 04, 2010, that Glu publicly announced their newly appointed CEO Niccolo de Masi, a man with a strong background in various mobile gaming sectors, including London Stock Exchange listed MonsterMob and Hands-On Mobile, the latter of which is one of Glu’s main competitors.

It is interesting to note that Niccolo quietly replaced David White as the CEO of Hands-On Mobile near the end of 2009, also in an attempt to recoup the company’s struggling finances for a future, heavier focus on the Facebook and iPhone gaming world. Curiously enough, Hands-On Mobile just lost one of its priced mobile licences – Activision’s Guitar Hero – to rival Glu Mobile during the summer of 2009, right before Niccolo was appointed CEO, and before Niccolo left and joined Glu. Seems like Niccolo knows something we don’t – or, at least, he carries a certain faith in these smaller companies, particularly when he’s given a non-qualified stock option to purchase 1,250,000 shares of Glu’s common stock at a strike price of $1.21.

In a recent interview with PocketGamer Glu’s new CEO announced “We’re in the middle of the storm at the moment, but over a three to five year period we expect the market to grow multiple times and see our revenues in the hundreds of millions of dollars. I’m very optimistic.” Digging under the hood, Mr. De Masi has his work cut out for him considering the fact that Glu has seen sequential revenue drop in every quarter of 2009. Full year 2009 revenue also dropped to $79.3 million when compared to $89.8 million in 2008. Q1 2010 revenue is expected to be $15 to $15.5 million when compared to Q1 2009 revenue of $20.77 million. The mid-point of Q1 2010 guidance represents a drop of 26.59% in revenue. Given that the company’s only has $10.5 million of cash on its balance sheet as of December 31, 2009 and $16.4 million in short-term debt, Glu does not have a  very long runway to get its strategy right and there is a distinct possibility that existing shareholders may face dilution if the company raises additional capital.

So why did I decide to explore the market size of the Apple (AAPL) app store ecosystem and Glu in such detail? There are some glimmers of hope for this microcap stock, which the market appears to have priced for bankruptcy. I have broken down both the bull and bear case for Glu below. A number of email exchanges with a San Francisco based institutional investor who reached out to me after reading part 1 of this article, helped crystallize some of these arguments.

The Bull Case:

1. There appears to be a huge disconnect between private market valuations of mobile gaming companies and public companies like Glu. As mentioned in part 1 of this article, San Francisco based mobile gaming start-up ngmoco managed to raise $40 million in three rounds since launching in 2008. The post-money valuation numbers are not public but it could easily be in the hundreds of millions of dollars. In contrast Glu’s market cap as of Tuesday’s close is just $29.72 million despite operating in the exact same space as companies like ngmoco.

2. The company should be given credit for bringing down its operational and development expenses in 2009 when compared to 2008. The net loss of $6.88 million in Q4 2009 is significantly lower than a loss of $37.22 million in Q4 2008, even after you take out the $22.88 million goodwill impairment charge from the Q4 2008 results.

3. The new CEO’s interests are aligned with those of shareholders as his options have a strike price of $1.21, while the stock is currently trading at 98 cents.

4. One of the VC backers of Glu, Hany Nada, acquired over 400,000 shares on the open market at a price of $1.04 less than 7 months ago.

5. Having tried out Glu games like Super K.O. Boxing 2, which received a glowing review from Jackie on AppStruck, I can personally attest to the superior graphics and mostly bug free game play of Glu games. Glu currently has 38 apps in the iTunes app store, out of which 17 are free or lite versions of paid apps.

6. The company is porting its titles to other platforms such as the release of Family Guy on the Blackberry and Glyder 2 on Palm. Glu stands to gain not only from the red hot growth of the Apple app store ecosystem but also from the increasing adoption of other smart phone platforms (Android, Palm, etc) by consumers.

7. The recent partnership with Activision should not only help Glu capitalize on well known franchises like Guitar Hero but also position it well for an acquisition.

8. When compared to peers, the stock trades at an incredibly cheap 0.37 times sales and has an EV/Revenue ratio of 0.45.

The Bear Case:

1. Despite an established presence in the mobile gaming market, Glu did not have the foresight to act swiftly when the Apple app store was launched. This lack of strategic thinking has foreshadowed Glu’s results over the last few years and the market is rightfully skeptical of a turnaround at this juncture. Even with twin tail winds of a red hot app store and smart phone adoption, revenue declined in 2009.

2. The company has yet to fully explore the use of business models like in app purchases that have been highly successful for companies like Zynga through their social media games like Farmville and Fishville.

3. The Apple app store has over 160,000 apps vying for attention and it is difficult for Glu to keep its games in the spotlight long enough to earn a good return on investment. I did not find a single Glu game amongst the top 50 paid or free games on the app store tonight. I have in the past seen a number of their games in the top 50 rankings but Glu needs to develop the staying power of apps like Doodle Jump and Pocket God. Doodle Jump was developed by two brothers out of New York and recently broke through 3 million downloads. Pocket God has built a cult following by releasing fresh updates almost every week.

4. Glu’s balance sheet is not very strong (current ratio 0.93) and the company could face liquidity concerns when the short-term debt comes due. The $10 million in cash and a revolving credit facility should however give the company some breathing room.

An investment in Glu at this point is like buying a call option that might expire worthless or generate very good returns. It is also a vote of confidence in the new CEO and his ability to either turn the company around or prime it for an acquisition. Given that his interests are aligned with ours, the open market purchase by a VC, the low valuation, the strong stable of games that are being ported to other platforms and the recent deal with Activision, I am willing to start a position in Glu for my personal portfolio. The size of the position might be a little smaller than my standard position size of 5% so that the portfolio is not adversely impacted should the investment not work out. I am also going to purchase 3,000 shares of Glu for the SINLetter Special Reports Portfolio.


Marcus Revisited: The Avatar Effect

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February 20, 2010 | SIN Picks | Author Asif

Note: This blog entry was originally published as a Special Reports update on 2/16/2010 and is now open to everyone. Marcus has risen since this update was originally published and is now trading slightly above book value.

2009 was a record year for the U.S box office with moviegoers spending more than $10 billion ($10.585 billion to be precise) despite the Great Recession. James Cameron’s epic Sci-Fi flick Avatar and 3D technology have given new life to movie theater chains and investors are looking at companies in this sector with renewed interest. It should be noted that Avatar, which was released on December 18, 2009 managed to “only” generated $283.8 million in domestic box office receipts before the end of the year and that the biggest domestic earner of 2009 was actually the sequel to the Transformers movie, Transformers: Revenge of the Fallen, that managed to pull in $402.1 million on the domestic box office and over $800 million worldwide. The lifetime gross domestic receipts for Avatar currently stand at $667.61 million, surpassing Titanic’s $600 million gross to become the biggest selling movie of all time (on an inflation adjusted basis, Gone With the Wind released in 1939 still kicks the wind out of Avatar).

In stark contrast 2009 was a terrible year for the lodging industry. Revenue Per Available Room or RevPAR in industry parlance, a key metric used to determine the financial performance of a property, fell in both 2008 and 2009 with both business and leisure travelers tightening their purse strings. The good news is that RevPAR declines have moderated in recent months and now appear to be stabilizing at a number of companies in the lodging industry including Wyndham Worldwide (WYN), Starwood Hotels (HOT) – love that symbol – and Marriott International (MAR). Both Starwood and Marriott raised their outlooks for 2010 when they reported recently reported 2009 results. Wyndham Worldwide, the parent company of chains like Ramada, Howard Johnson and Wyndham amongst many others tripled its dividend from 4 cents to 12 cents.

These two trends reminded me of Marcus, a company I last wrote about in the October 2007 edition of SINLetter. Marcus owns and operates 668 movie screens in the Midwest. The company also owns 8 upscale hotel properties including the Four Points by Sheraton in downtown Chicago and manages an additional 11 properties. Marcus could in the short-term benefit from the Avatar effect and in the long run benefit from improvement in RevPAR in its lodging division.

In the fiscal second quarter ended November 2009, revenue from theater admissions and concessions was $41.29 million, more than twice the $20.43 million in revenue generated from rooms. However the gross margins in the lodging division are much higher than margins from the theater division. Since Avatar was released in December, the company should see a boost to revenue when it reports results for its fiscal third quarter ending this month. Besides Avatar, the third quarter will also benefit from the $204 million that Sherlock Homes rung up since December, about $150 million in box office receipts from The Twilight Saga: New Moon since the close of the second quarter on November 26, 2009 and a strong showing from The Book of Eli in January.

The four key reasons I like Marcus at this point are,

  1. When compared to other movie theater companies like Regal Entertainment (RGC), Cinemark Holdings (CNK) and Carmike Cinemas (CKEC) that could benefit from Avatar and the move towards 3D, I prefer Marcus because it trades at a valuation that is comparable to its peers but at the same time its balance sheet has the least amount of leverage of the group.
  2. The company has been booking charges against an investment in Las Vegas called the Platinum Hotel & Spa that fell in value following the implosion of the real estate bubble and this has impacted reported earnings for a number of quarters. Marcus booked a $12.6 million impairment charge last quarter related to the remaining 16 owned condominium units in the Platinum Hotel & Spa. The company also took a one time $1.4 million charge last quarter related to a pension withdraw liability. This liability had to do with a multi-employer pension plan connected to Chicago projections union and the one time charge allowed Marcus to exit now and lock in their portion of the unfunded liability in this plan. The company reported a small loss in the second quarter on account of these two charges but since these charges should not weigh down earnings going forward, valuation metrics will begin to start looking attractive in the next few quarters.
  3. The company pays a dividend of 34 cents per share, which gives you a 3.1% yield while you wait for the stock to appreciate.
  4. Best of all the stock trades slightly below book value of $11.17. The good news is not just that the stock trades below book value but that the assets on its balance sheet including the theaters and especially the 8 company owned hotel properties are carried at cost and are probably worth significantly more at this point.

I will purchase 500 shares of Marcus for the SINLetter Special Reports portfolio and also for my personal portfolio after this post is published. The closing price of the day on 2/16/2010 will be used as the purchase price.

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Thoughts on Activision Blizzard’s Q4 Results

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February 12, 2010 | SIN Picks | Author Asif

Activision Blizzard (ATVI) released its fourth quarter and full year 2009 results yesterday and instead of writing a blog post about it, I figured I would try to live tweet the earnings conference call through the account and follow up with some key highlights here.

Starcraft 2 Screenshot. More screenshots here.

The Good:

  • In the words of Activision Blizzard CFO Thomas Tippl, “we generated a record $1.2 billion of operating cash flow, which is more than ten times ahead of our next best competitor.”
  • The company ended the year with $3.3 billion in cash and investments on its balance sheet with no debt, $200 million higher than the prior year end. Activision Blizzard achieved this despite buying back 115 million shares at an average price of $10.87, completing a $1.25 billion share buyback program.
  • Activision announced another $1 billion share buyback program for 2010 and will also start paying a 15 cent annual dividend. Based on yesterday’s closing price of $10.10, the yield works out to 1.48%. This compares with a dividend yield of 1.84% for the S&P 500.
  • Starcraft 2, which has been included in many most anticipated game lists by publishers like the Wall Street Journal and PC Gamer, is set to launch beta testing at the end of February and is still on schedule for the first half of 2010. I personally signed up for the beta testing program on the new platform and hope that I get picked up for it.
  • World of Warcraft (WoW) now has 11.5 million subscribers. It has been operating normally in China since its relaunch on September 19th through Netease. The expansion pack for WoW called Wrath of Lich King is awaiting approval from Chinese authorities and could lead to further growth in China when released.
  • The new World of Warcraft expansion pack Cataclysm will be released in the second half of 2010.
  • The company reported better than expected fourth quarter results when it announced non-GAAP earnings of 49 cents per share, well ahead of expectations of 44 cents.
  • During this holiday season Call of Duty: Modern Warfare 2 broke “all” video game sales records. DJ Hero also appears to have performed better than initial reports, outselling The Beatles Rockband by Electronic Arts in Q4.
  • Non-GAAP revenue of $2.5 billion was $277 million higher than expectations of $2.23 billion. What was interesting about this performance was that adjusted Q4 2009 revenue was up 7% year-over-year despite the fact that Q4 2008 had three best selling games (Guitar Hero: World Tour, Call of Duty: World at War and World of Warcraft: Wrath of the Lich King), while Q4 2009 only had Call of Duty: Modern Warfare 2 and DJ Hero that made a significant contribution to revenue.
  • Non-GAAP operating margins for 2009 were 46% and operating margins in Q4 2009 was 49%. Tax rate in Q4 was a lower than expected 28% due to international growth.

The Bad:

  • On a GAAP basis, the company reported a loss of 23 cents in Q4, which included a 19 cents write down of intangible assets. GAAP earnings for the full year 2009 were 9 cents. GAAP revenue and earnings are much lower than the non-GAAP numbers because they don’t take deferred revenue into account. However the GAAP numbers are going to make the P/E,  P/S and other valuation ratios appear sky high to some investors and stock screeners.
  • Activision is going to significantly scale back its music offerings in 2010 to less than 10 products and expects revenue in this category to drop. Most of the highly anticipated games are slated for release in the second half of the year and the Q1 pipeline looks especially light.
  • The company does not expect the next version of Call of Duty slated for release in the 2010 holiday season to generate as much revenue as the recently released Modern Warfare 2.
  • Outlook for both Q1 2010 and full year 2010 is below analyst estimates. For Q1 2010, Activision expects non-GAAP revenue of $525 million and non-GAAP earnings of 2 cents. For the full year, the company expects to report non-GAAP revenue of $4.4 billion and earnings of 70 cents.

Overall I was very pleased with the results for Q4 and the fact that Starcraft 2 is so close to being launched. Even with the 70 cents earnings outlook for 2010, I am looking at an adjusted forward P/E of 14.43 for a company with very healthy margins, strong pipeline and a very strong balance sheet. I plan on retaining our long position both in the SINLetter Model Portfolio and in my personal portfolio.

Live tweeting the call was a lot of fun and you can read the tweets in reverse chronological order from the @specialsin account here.
Related posts:

Ten Reasons I am Buying Activision Blizzard (ATVI)

Activision Blizzard: Playing Diablo’s Advocate

Project Natal: Revolutionary Technology for an Industry in Distress?