This Is a Big Fucking Deal

 AL ALCORN

“I sent a memo that said, ‘I have seen the future,’ ” explains Manny Gerard, one of three members of the Office of the President at Warner Communications and the company’s self-described “filter for acquisitions.”¹ Gerard, who would soon become a vital force shaping Al Alcorn and Atari’s future, recalls thinking when he sent the note in 1976, “This is something structural. This is going to be a big business. This is a big fucking deal.”²

Warner Communications, with offices in Rockefeller Center in New York City, was a $147 million conglomerate with holdings that defined American popular culture. Warner owned a bank, a cable company, a perfume label with the designer Ralph Lauren, the New York Cosmos soccer team, and three record companies whose artists included Led Zeppelin, Linda Ronstadt, Joni Mitchell, Rod Stewart, George Benson, George Harrison, Richard Pryor, and Jefferson Airplane. Warner’s movie subsidiaries produced The Exorcist, Blazing Saddles, A Star Is Born, All the President’s Men, and Clint Eastwood’s Dirty Harry series. Warner had a publishing arm and a television subsidiary (Welcome Back, Kotter; Chico and the Man) and also owned MAD magazine, Looney Tunes, and DC Comics.³

In early 1976, Gerard had received a call from Warner’s largest shareholder, Gordon Crawford, who had bought 10 percent of Warner for Capital Group. It was no coincidence that a representative from Capital Group, the original home of venture capitalist Don Valentine’s Sequoia fund, was now calling about Atari, a company with which Valentine had been working for two years. In 1975, on the strength of the Home Pong game and Atari’s $750,000 profits, Valentine’s Sequoia Capital had invested $500,000 in Atari.⁴ Valentine had also convinced three other investors to do the same: Time Inc., Mayfield (another early Silicon Valley venture capital company), and Fidelity Investments, whose Boston representative had taken off his jacket but nothing else when the stripped-down Bushnell had sold him on Atari from the comfort of the hot tub.

Back in 1975, when Valentine had arrived at Atari to sign the paperwork for the $2 million funding deal, he brought several bottles of champagne, anticipating a celebration. But Bushnell and Keenan had decided to double Atari’s premoney valuation based on the company’s recent successes with Home Pong and other games.⁵ Valentine was unfazed. He put a copy of the revised terms into his bag and headed back up the freeway, the champagne bottles growing damp with condensation. A few days later, he announced that he and the other partners still wanted in. Corks popped.

Now, less than a year later, Valentine hoped to sell Atari to Warner Communications. A significant technical breakthrough at Atari’s research center in Grass Valley, 150 miles northeast of the Bay Area, meant that the company needed another infusion of money. Bushnell and Alcorn would visit the researchers in Grass Valley every month, but they had not moved the group, originally established as an independent research organization called Cyan Engineering, to Silicon Valley. In Grass Valley, the researchers could focus on the long term, isolated from day-to-day business concerns. It was “a very protected playground, unencumbered by the feed-me aspects” of business, according to Steve Mayer, the founder of Cyan Engineering with Larry Emmons. As Alcorn put it, “My job was to keep the other people away from these people.”⁶

Off in the still rural Grass Valley, researchers who looked more like lumberjacks than engineers found a radical way to use a cheap new microprocessor, the 6502 built by the upstart chip manufacturer MOS Technology. (MOS Technology had launched by selling chips from a hotel room that the founders had rented near a major industry conference.) Before Grass Valley’s breakthrough with the microprocessor, most video games had been built around a dedicated circuit that was wired to play one game and only that game. The Gotcha arcade console could play only Gotcha, a maze game that Alcorn had designed. The Pong console sold by Sears could play only Pong.^V

But Grass Valley’s new system, code-named “Stella,” was something different.⁷ The microprocessor inside meant that the Stella system could be programmed to play any number of games. A person who bought a Stella system could plug the box into a television and then tell the box to play different games by inserting different game cartridges.^IV This was the magic of software in action.

The Stella system, released as the VCS (Video Computer System), would go on to become one of the most successful consumer electronics products of its time, in five years selling more than 12 million units and many more cartridges.

When Warner’s Gerard wrote that he had seen the future, he was referring to Stella. “I can almost remember the words,” Gerard says of the call from the Capital Group. “ ‘Would you be interested in a very fast-growing, entertainment-based technology company?’ ” Warner had not acquired a company in four years, but Gerard said that he would indeed be interested.

As Gerard began examining Atari, he developed doubts about acquiring it. The company had “no infrastructure,” as far as he could tell, and weak financial controls. Though some divisions kept careful records, in others employees could request, authorize, prepare, and sign checks payable to themselves. Employees had also been known to receive cash advances—in anticipation of a business-related trip, for example—and then quit without returning the advance. The manufacturing line routinely had to be stopped because the plant ran out of basics such as paint, glue, and screws. The company did not require that orders be written down, which led to regular disputes with customers regarding shipping dates, order quantities, prices, and payment terms.⁸ Nearly every game was invented from scratch with designers given total control, which meant there was no mandated standardization, even on basics such as cash doors, coin counters, or locks for the coin-operated video games. Atari’s leaders saw the company as a complex, multifaceted organization with employees who were trusted and empowered to be their independent, creative best. Gerard saw a chaotic mess.

Another worry for Gerard was the Atari team itself, which he describes as “a bunch of guys getting whacked every day and chasing women.”^III On one of Gerard’s early visits to Atari, a group of engineers was thrilled to show him how they had programmed a version of Tank to run backward. They called it “Polish Tank.” Gerard thought Alcorn was “a solid guy,” the cautious sort who, upon realizing he had a great deal of paper wealth after the venture capital investment in 1975, worried that “the whole thing could still go away.”⁹ But Alcorn did not run the company.

While Alcorn was worrying about the permanence of his new fortune, Bushnell, raised in a conservative, middle-class Mormon family in a small town in Utah, had gone on a spending spree. He bought a large house and a forty-one-foot sailboat. He posed for a local paper in his hot tub with his arm draped around a beautiful young woman. “Some ladies feel uncomfortable with me and some don’t,” he told a reporter. “I find the aura of power and money is intimidating to an awful number of girls.”¹⁰ Gerard thought that Bushnell, “who has a hundred ideas a day and loves them all,” needed to learn to focus.¹¹ At times Alcorn agreed with that assessment; he carried a special pager and instructed the engineers to ring it “only in the event Nolan got into engineering.” When the pager went off, Alcorn would rush to engineering and as he put it, “follow behind Nolan to remind” the engineers that they worked for him, not Bushnell.¹²

Gerard had other reasons to think twice about acquiring Atari. The future of video games was still uncertain. Pinball machines were resurging. The video game that drew the most attention in 1976 did so for all the wrong reasons. Death Race, a driving game from a small Silicon Valley company called Exidy, awarded players points for running down stick figures that Exidy called “gremlins” and everyone else called “people.” (Upon impact, the player heard a shriek and a cross replaced the stick figure on the screen.) The National Safety Council condemned the game as “ ‘insidious,’ ‘morbid,’ ‘gross, and ‘sick, sick, sick.’ ”¹³ The New York Times and 60 Minutes ran stories on it. Bushnell fretted that the general public might not agree with him that blowing up tanks and airplanes in Atari games did not count as the same sort of “violence against people” as mowing down stick-figures.¹⁴

Despite the outcry, Gerard, who had been analyzing popular media for decades, still believed that video games would become a big business. He considered games an integral part of the human experience, with a history that stretched back to markers made of stones and bones. Atari was taking that history into the new world of silicon and television.¹⁵

He also believed Atari, for all its problems, had virtues. The company’s engineers, particularly Alcorn, Bristow, and the team in jeans and long beards who had designed Stella, were “just stunning,” he recalls, “and they were astonishingly productive.” Moreover, Atari was making money; Gerard was not sure how, given the organizational chaos, but it was.¹⁶

Gerard recommended to Steve Ross, the debonair founder and chairman of Warner Communications, that Warner acquire Atari. After Ross, whose kids had loved playing Tank at a Disneyland arcade, agreed, he wooed Bushnell and Atari’s president, Joe Keenan, regally. Ross dispatched a Warner jet to bring them to New York and a Warner limousine to convey them from Teterboro Airport to suites in the Waldorf Towers.

At dinner and in conversations at Ross’s opulent apartment the following day, Ross made his case. Warner knew how to create hits and get products to consumers; Warner’s WEA group had just shipped 1.1 million copies of the Eagles’ new Hotel California album in only three days.¹⁷ And Warner understood how to work with artists who needed to be coddled and coaxed, a particular draw for Bushnell, who considered Atari’s game designers artists. Ross also told Bushnell and Keenan that they would be happy at Warner. They could stay in California and continue to run Atari. Ross explained that he took a hands-off approach and even offered to sweeten top management’s incentive structure, which already included a rich bonus pool.¹⁸

By the time the Atari team flew back to California on another Warner jet—Ross arranged for Clint Eastwood and Eastwood’s partner, Sondra Locke, to join them—Bushnell was convinced that selling Atari to Warner was the best way to get the money to develop the Stella chip.¹⁹ None of the other companies Atari had approached about an acquisition had been interested. Valentine was pessimistic about the prospect of an IPO. And Bushnell, who owned 49 percent of Atari stock, hoped that selling the company would enable him to take a break from it.²⁰ “All I could think of was ‘I’m really tired, so can I get a rest?’ ” ²¹ Later he would say that he probably would not have sold Atari if he had just been able to take a vacation.²²

“I was in the hot tub with Nolan when he told me we had a firm offer from Warner. There was a number—and I’d get ten percent,” Alcorn says. (He likely ended up with more like 6 percent.) His annual salary was $32,000. Now the stock he had thought would be worthless when Bushnell had offered it to him four years earlier was worth $1.75 million ($7.4 million in 2016 dollars).^II

“Up to that point, I thought this was all a lark. Holy shit! My life was being changed.”²³

The negotiations between Atari and Warner, held at the law offices of McCutchen Doyle in San Francisco, took months, far longer than most Warner acquisitions. Two or three times each week, Alcorn spent several hours sitting with Bushnell and Atari’s two lawyers across the table from Manny Gerard and Warner’s eight or nine lawyers. “It was not fun,” Alcorn says. “A circus,” Gerard agrees.²⁴

The negotiations exposed Atari’s improvisational style. Alcorn’s stock grant was a handwritten note from Bushnell. The buyout of Dabney’s stake in Atari had been for cash, instead of retained earnings, and so had to be done over. Atari’s CFO quit in the middle of negotiations. At one point, the lawyer representing Bushnell’s ex-wife called Warner’s attorneys to say that Bushnell’s 1974 divorce agreement had left open the possibility that she could claim half of his stock—a move that would make her a 25 percent owner of Atari. “So in the middle of this, on top of everything else, you have to renegotiate the man’s divorce settlement!” Gerard recalls.²⁵

But the fundamental problem that stretched the negotiations from the cool San Francisco June mornings to the surprising warmth of its September afternoons was that Warner did not trust many of the people or numbers coming from Atari.^I Gerard worried that Bushnell and Keenan would quit as soon as they received money from the sale. “You are all going to become cocaine addicts and blow your brains out,” he told Alcorn. Later Gerard explained, “We weren’t prepared to let them completely have control of the asylum. We knew that if we let them all have a lot of money, we would all be dead.”²⁶

Gerard’s concerns that the Atari team would abandon the company were exaggerated but not unfounded. Bushnell wanted a break, and moreover, even he feared his own fondness of excess. In college, he had taken his job as a carnival barker not only because the pay was good but also because he figured that if he was making money, that would be one time when he could not be spending it.²⁷

The agreement that Atari and Warner signed in October 1976 reveals Gerard’s anxieties. As an incentive for the Atari team to stick around and make the company profitable, it included a rich bonus pool: if Atari’s profits reached a certain level, the top managers would split among themselves 15 percent of any profits above that level. Moreover, Atari’s senior management would receive relatively little money up front. Warner paid $28 million ($119 million in 2016 dollars) for the company, an amount that would net Bushnell roughly $10 million after taxes—the precise amount, Keenan wincingly notes, that Bushnell had once told Valentine he wanted. Of that $28 million, only $12 million was paid immediately, however, and some of that went to the venture capitalists. For the remaining $16 million, Warner issued subordinated debentures in the Atari subsidiary, not in Warner, to be paid as a fixed amount over a period of seven years.²⁸ In other words, if Atari succeeded, Bushnell, Keenan, Alcorn, and the other executives would split among themselves roughly $2.3 million for each of the next seven years. And if Atari proved wildly successful, senior management would receive significant bonuses on top of the regular payout.

But if Atari failed, the key employees would each receive only their portion of the initial $12 million payment; they would never see the remaining $16 million. Gerard says, “I told them they better believe their own BS if they took the deal.”²⁹ The Atari team took the deal.

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I. Alcorn says that a Warner attorney was fired because he was so convinced that Atari’s numbers were fraudulent that he refused to participate in negotiations.“The numbers were hard to believe. Are we the mob? The mafia? . . . [Games were] a sleazy gray business area.”

II. Bushnell’s annual salary was $75,000; Keenan’s, $40,000; Bristow’s, $32,000; and Emmons and Mayer’s, $30,000. At the time of the acquisition, Bushnell owned 49 percent of Atari, Alcorn owned 6.7 percent, and Keenan, 6.2 percent. Entities associated with Don Valentine (Sequoia Capital, Sequoia II, Capital Group, and Valentine’s personal ownership stake) collectively owned 34 percent of Atari.

III. Gerard exempted a few employees—most notably Steve Mayer and Al Alcorn—from that generalization.

IV. At about the same time the Grass Valley-based Atari research group developed the Stella system, one of the few African-American engineers in Silicon Valley at the time, Jerry Lawson, independently developed a similar microprocessor-based system, called the Channel F, for Fairchild in Mountain View. The Fairchild system did not have anywhere near the success of the Atari system.

V. The Sears console played a number of games, but they were all variations on Pong.