Corporate Profile: The profits of Tomb and gloom

NOW HERE'S a recipe for sleepless nights. Start in an industry - say computer software - where your competitors include the likes of Bill Gates's Microsoft and Sony Corporation. Bear in mind thatBritish software companies have a reputation for being innovative, creative, exciting and hopeless at making money.

Next, specialise in computer game software, on the cutting edge of geek culture, which means you hire staff who don't know what a necktie is, who live on pizza and who would blend in seamlessly at a grunge-music festival.

Then market a range of products whose functionality is incomprehensible to all but adolescent and pre-adolescent males, few of them likely to have girlfriends - consumers whose fickleness is notorious and with the attention span of a gnat.

Finally, to finance this brilliant scheme, try to raise venture capital in Britain, where venture capital doesn't even mean venture capital but management buy-outs, in a market whose investors are notoriously averse to risk, and where investors have been burnt.

Alternatively, lie down in a darkened room until the feeling passes. But wait: maybe not.

Eidos, the British computer games publisher of cyberbabe Lara Croft, heroine of the Tomb Raider series of computer games, is riding high and making money. Last October its share price was at a 13-month low of 595p. Since then the company has produced strong third-quarter numbers which show turnover in the nine months to December rose by 64 per cent up to pounds 169m, producing a profit before tax up 149 per cent to pounds 32.4m. As prospects brightened, the firm's core executives have been visiting 15 cities in seven countries, making 90 presentations to 120 institutions.

Their story seems to have convinced. Today, Eidos is flavour of the month among investment analysts who have watched the computer game business double in size in 36 months, seeing Eidos emerge as a champion performer among British software houses. The culture is as much West Coast American as British, despite the unlikely location of its offices in Wimbledon, a middle-class London suburb that could hardly be further removed from Silicon Valley's wild west frontiers of technology.

One executive's first day at work was spent in shock from his first view of the open-plan office packed with new colleagues in old clothes, unkempt and straggly-haired. "It's true some of these guys have probably not been close to a bar of soap for a while, but they're good at what they do," he says.

It was not ever thus. Four years ago, Eidos was a technology-led company attempting to cut a path in the arcane world of video compression - essentially, using software instead of expensive hardware to digitise images. When the chief executive, Charles Cornwall, arrived, the share price was roughly 30p. He liked the technology but despaired of it producing much in the way of earnings. "We needed something else," he says. The answer was computer games.

Enter Lara Croft, the game that has gone on to sell more than 15 million copies worldwide. Other games, including Doom and Quake, have sold more but few rivals appear to have such long-term potential. This seems to be down largely to the incredible response of computer gamers to the character of Lara Croft herself, an Uzi-toting cyberbabe who lives in a baronial manor house and whose exploits have captivated millions of fans.

Lara was invented by a small design house called Core Design in Derby, which Mr Cornwall promptly bought. Jeremy Heath-Smith, who founded Core Design, is now an executive director of Eidos. The highest-paid director of the company, he was paid pounds 1.8 million last year and is now working on a fourth version of the game. Mr Cornwall, 36 and South African-born, has become a multi-millionaire, his 4 per cent shareholding now worth pounds 15m, with options worth much more.

Yet the best, analysts say, may be to come, with Paramount preparing to start shooting a movie version of Lara Croft, Lord Sainsbury of Turville, the technology minister, hailing Lara Croft as an "ambassador for British scientific excellence" and Eidos using Lara's notoriety to lever itself into the first rank of computer game companies.

"Eidos is doing really well," says Jeff Kaye, editor-in-chief of CTW, the computer game industry magazine. "They've exploited Lara well, and to get away from their reputation as a one-trick pony they're developing other titles including Championship Manager, which has really blown everything else away. They've got a good team at the top and though the City has had a hard time trying to figure out how to value this kind of company, the analysts are beginning to understand them and they're pretty high on them."

Perhaps most surprising of all, Eidos has begun to disprove the rule that British innovation is incompatible with commercial success.

"We're positive," says Robert Smithson, the Goldman Sachs sector analyst. "The secular trend is very good in the long term and the stock is cheap."

The secular trend, Mr Smithson explains, is that hardware sales keep growing. Eidos does not make hardware, but every time a games platform is sold, it gains potential customers. Although Mr Smithson acknowledges the volatility of the computer game product cycle, he believes that on current trends Eidos profits and shares ought to keep growing.

Eidos makes games for two main platforms: the Sony Playstation, game console of choice among the digerati, and the ubiquitous PC, which in its latest manifestations is also capable of rendering the rich graphics that are a hallmark of Eidos's offerings.

The company's real milch cow is the Playstation, with 50 million sold world-wide. Sony controls manufacture of the cartridges used in the Playstation, but there is still plenty left over for Eidos. The gross margin on a sold game is close to 65 per cent.

The industry rumour is that Sony is about to slash the price of the console in the UK from pounds 99 to pounds 69. Sony's calculation is a classic "give away the razor, sell the blades" strategy. If the sums are right, this will be a big opportunity for Eidos. The typical Playstation customer buys eight games; trends show that some - perhaps the new Lara Croft game - will have the Eidos label. The price cut is preparation for next year's launch of the Playstation 2, a console 1,000 times more powerful than the present model.

Eidos has just won an award from Deloitte & Touche as the fastest-growing tech company in Britain. Up more than 200 per cent in six months, the shares still stand on what many regard as a relatively undemanding multiple of 14 times earnings.

Even Dresdner Kleinwort Benson, house broker to the company, wonders whether the story is "too good to be true", although it concludes that it isn't. Eidos shares reached pounds 22.20 last week and volume and the number of quality investors are up.

Cornwall says the key to the business is that it is led by content although the technology is a vital component. "We are a digital media company interested in the creation of original content more than anything else. Thanks to Lara, we have reached the critical mass to have the credibility to attract new content."

A manifestation of this has been the frantic pace at which Eidos has been buying smaller software companies around Britain and cutting deals with others, ones with innovative ideas but not necessarily the publishing skills to bring them to market. The latest deal, announced last week, was a long-term publishing agreement with Free Radical Design, based in Nottingham which started this year. The company is run by the the team who built the successful Goldeneye007 game for Nintendo. Its first product for Eidos will be released next year. David Doak, their managing director, says: "Eidos is a long-term player with an enviable track record and a clear view of where the industry is headed. Their board was refreshingly open and direct. Their passion for games clinched it."

In February, Eidos did a similar deal with Elixir Studios, a London-based games developer established last year by Demis Hassabis, who created a best-selling computer game called Theme Park when he was 16. Mr Hassabis wrote to 31 venture capital companies, but was offered meetings with only four. "As soon as they heard computer games they switched off," he says.

Mr Cornwall says the Elixir deal is the kind that will allow his company to continue to prosper in a hazardous market. "Yes, it is frustrating that venture capital is not understood in Britain but it is also an opportunity because this is a country with incredible talent. We have become the mutant child of a film studio and a record company. We have a lot of individual developer relationships through equity stakes, outright ownership or contracts."

One key to the Eidos success is the even split of its senior team between bankers and technical wizards. Mr Cornwall and his finance director Jeremy Lewis are former bankers. Company chairman Ian Livingstone and executive director Jeremy Heath-Smith are the techies. The collaboration has been manifestly fruitful, and they even appear to get along.

In a curious way, Eidos is itself becoming a venture capital house, identifying promising developers and helping them to get their products to market, often taking equity stakes. This is a unique business model, one that essentially puts Eidos in portfolio management.

The business is growing at 35 per cent annually with gross margins of 65 per cent on its products, which sell here for about pounds 49 and in America for around $49. Eidos has also discovered that sequels to its hit games sell even better than the originals. They claim second place among independent publishers of games for the Playstation, behind Electronic Arts, in the key markets of the US, UK, Germany and France. Earlier this year, in a move to position itself alongside high-multiple Internet stocks, Eidos announced a deal with Easynet Group PLC, the Internet service provider, to give its customers a free connection and interactive gaming with other enthusiasts over the Web. "The Web is going to be like the first words Adam said to Eve, `Stand back - I don't know how big this thing is going to get'," says Cornwall.

Perhaps, but Eidos has still to reach the dizzying multiples enjoyed by the American Internet stocks. Unlike many of them, it does make money. Investors hope Eidos enjoys the same success as the Garden of Eden appears to have been.

Vital Statistics

Market capitalisation pounds 360m

Price 2200

Employees 590

CEO Charles H.D. Cornwall

Finance Director Jeremy Lewis

COO Mike McGarvey

Chairman Ian Livingstone

Executive Director Jeremy Heath-Smith