World of Warcraft’s Virtual Pets Could Raise Real Money

On the surface, a video game opening a virtual pet store doesn’t sound like something investors should care too much about. But when that game is “World of Warcraft,” the stakes change.

wow_pe_1_200.jpg
Blizzard Software

There are, at present, more than 11.5 million people playing the massively multiplayer online fantasy game from Activision-Blizzard. Put another way: the number of people paying a monthly fee to play “World of Warcraft” (aka “WoW”) exceeds the current population of Greece and the Bahamas—combined.

They’re a dedicated bunch, too—some might say obsessively so. Players are willing to spend $700 and more on eBay for an in-game item that allows their character to ride a digital translucent tiger.

Actions like that make the players easy to write off as kooks, but also underscore their dedication to the game. And that’s what makes the pet store so interesting.

With its launch, Activision-Blizzard is now tapping directly into that mania. For the first time, players will be able to buy in-game content directly from the company. Two ‘pets’ will initially be offered at $10 each. They do nothing to enhance the player’s character or offer any in-game benefits. They’re purely cosmetic.

They could also be the beginning of an additional significant source of revenue for the company.

“While it is impossible to know how popular these initial pets will be, offering digital in-game items may be the beginning of a meaningful new revenue stream for Blizzard,” says Broadpoint AmTech analyst Ben Schachter. “At $10 per pet (and assuming these are virtually all margin), the EBIT contribution could be meaningful even if just a relatively small percentage of WoW's subscribers opt to purchase in-game content.”

To be clear, the WoW pet store won’t have a noticeable impact on Activision’s earnings anytime soon, but if it catches on with players, it opens the door for other sorts of micro-transactions, which would also be pure profit plays for the company.

The developers at Blizzard, meanwhile, are on the verge of completing “Starcraft II,” which could be one of the biggest games of 2010. The team is also hard at work on “Diablo III,” which is expected in late 2011 (though subject to change) and another, undisclosed massively multiplayer online game.

wow_pet_2_200.jpg
Blizzard Software

Blizzard has yet to have a flop—and if it includes in-game downloadable content in upcoming titles (as many expect it to), that could quickly become meaningful revenue. Schachter notes that content of this sort carries EBIT margins in the 80 percent to 95 percent-plus range.

While games like “Guitar Hero” command more of the spotlight, “World of Warcraft” is the real cash machine for Activision. Revenues from the game represented 37 percent of non-GAAP revenues in the third quarter and “WoW” continues to see its subscriber levels increase, despite the fact that the game was released five years ago.

Competitors, especially Electronic Arts and Sony , have tried to launch a game that could match “WoW’s” performance or dislodge it from its dominance of the genre, but haven’t come close.

The only entity that has been able to make a dent in the game’s player base, in fact, has been the Chinese government, where bureaucratic in-fighting has temporarily resulted in a ban on the game.

Part of the key to Blizzard’s success has been a good understanding of its customer base. The developer has cancelled several titles that were far along in the development process for not living up to their high standards—and it embraces players, hosting an annual event where it gives out gift bags and hosts a free concert for attendees.

Fans appreciate the respect and, as a result, tend to welcome changes like downloadable content rather than protest them as cash grabs, as they might with other developers.

“The Blizzard consumer is unique,” says Schachter.