A talk with the new video game king

Activision's super-popular Guitar Hero III will now join forces with Vivendi's video game unit.

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(Fortune) -- The $19 billion merger announced Sunday of Activision with the gaming division of French media company Vivendi creates a company that Bobby Kotick, soon to be its CEO, says is unlike any that came before.

Activision is the fastest-growing big maker of games for consoles from Microsoft, Sony and Nintendo. Its super-popular Guitar Hero 3 may be the signature product of this holiday shopping season. Meanwhile, Blizzard Entertainment, the hottest part of Vivendi Games, operates World of Warcraft, an online interactive game, with 9 million players around the world.

"This puts under one roof the people who create the best online games and the best console games," Kotick says. I spoke to him at length Monday afternoon. "I've been petrified for about two years now," he says. He built Activision (Charts), which was founded in 1979, into a $2 billion-a-year traditional video game maker.

But even though it has been succeeding with games for the three new consoles that emerged recently - Xbox 360, Playstation3, and the Nintendo Wii - something important was going on elsewhere. "We started analyzing the online experience and realized that World of Warcraft was like nothing we'd ever seen," Kotick says. "It's not even just a business. It's a social network with this incredible entertainment component to it."

"People in our industry have tried and tried to build successful online games, with Lord of the Rings and Dungeons and Dragons and all kinds of things, but most of them failed," he continues. "We realized that to do something ourselves that would be big enough to affect our margins would cost us hundreds of millions of dollars. But even if we tried, we'd probably get it wrong."

He lists all the things a company has to master to succeed with online games: data center capabilities; managing 24-hour, 7-day-a-week customer service; handling credit and collection online; planning for peak usage; and handling security for a business that involves managing for customers a lot of real assets, like in-game gold and other property, even if they are virtual.

"We were just overwhelmed thinking about it," he says. "We have a really talented engineering group but we realized we couldn't duplicate this." For instance, World of Warcraft is huge in Korea and China. "The chances of us succeeding online in Korea and China were zero," he adds.

So Kotick approached Vivendi and after a few months of conversation this new combination emerged. The deal's terms are complex, but the resulting company will be controlled by Vivendi and its stock will be worth a total of about $19 billion. This deal shows how the game industry, already by definition all-digital, can more readily adapt to the Internet era than other parts of media. "Everything near-term will be enhanced by the Web," Kotick says. "Long-term, we'll have the opportunity to deliver games onto any display device that has a microprocessor."

Vivendi also has a substantial operation creating so-called "casual games," played by people whiling away the time or trying to relax. It's another business Activision had never developed itself. "We're starting to eat into linear media in a way we haven't before," Kotick says, casually uttering the dismissive "linear media" as if it's a term any sane person would routinely use. But with it he dispenses with TV, film, books, magazines -- much of the media industry. He talks about how families are starting to leave the dinner table not to watch TV but to play Guitar Hero or use the Nintendo Wii's amazing physical interaction capabilities. He says that increasingly people at bars and dinner parties are playing these new physical electronic games as well (he admits he can't prove how much it is happening, however).

"The physical interface is so important," he says, referring to the revolutionary way that both Guitar Hero and the Wii engage the player's bodies, as they wave things around, operate a faux guitar, dance, or engage in other silly but satisfying activities. "The guys who developed Guitar Hero really figured out how to capture the imagination of that consumer," he goes on. "But if it hadn't been for the Wii I'm not sure it would have been so obvious how important the physical interface was and what a great fun game it could be."

Now Kotick envisions leveraging Blizzard's online expertise to build, for example, a great online version of Guitar Hero. He's on the board of Yahoo (Charts, Fortune 500), and he says what he's learned there about advertising makes him want to develop in-game advertising and sponsorship, along with voice, video and text communication. "But Blizzard already has all of it," marvels Kotick. "I love the model of a retail product combined with an online product."

The newly-formed company, Kotick says, "unlocks the value of Blizzard" and other parts of Vivendi Games. "Being part of the biggest video game company in the world instead of a big French media company feels more relevant to the employees." The new company, to be called Activision Blizzard, will by a hair be larger than Electronic Arts (Charts), which has been the industry's colossus up to now. But EA doesn't have nearly as much online business as will Activision Blizzard. And the two combining companies are each growing faster than EA already. Kotick is clearly turned on by the new company's possibilities.

That's good, because he's signed a five-year contract to manage the combined entity. "Once I'm 50 I'll rethink what I'm doing," says this CEO who turns 45 in March.

I'm still getting used to the idea that this gaming company will be worth $19 billion. But for Kotick, it's just the starting point.