Electronic Arts Inc's purchase of Playfish shines a spotlight on an increasingly lucrative segment of the computer games market, one likely to see more deals.
Playfish, along with Zynga and Playdom, are three start-up companies that have been generating buzz because they make free social games and earn money by selling virtual goods to players. The popularity of these games has taken off because of online networks like Facebook and MySpace.
EA, a traditional publisher of videogames like Madden NFL, will shell out $275 million in cash for Playfish, along with other consideration that may boost the company's valuation to $400 million over time.
EA said on Monday that the deal valued Playfish at three to four times forecast fiscal 2011 revenue -- a multiple that will probably set a benchmark for Zynga, Playdom and other social game makers, should they come to market.
It's like a domino effect -- if one falls there's a chance the others could fall soon, said ThinkEquity LLC analyst Atul Bagga. I think the company that might get acquired is Playdom, and there are a host of smaller companies that could be candidates for acquisition.
Playdom Chief Executive Officer John Pleasants said in a statement: We're not interested in acquisition at this point -- we're focused on growing Playdom into a world-class gaming company.
Players of the company's games range from 13 to 80 and come from more than 150 countries, Pleasants said, so the opportunity for growth is tremendous.
Meanwhile, Bagga said Zynga has been a candidate for an IPO for some time, and there could be an IPO next year.
Zynga, maker of Zynga Poker and the FarmVille farming game, is generating revenue at an annualized rate of more than $200 million, according to two sources with knowledge of the company.
Its venture capital backers include Kleiner Perkins Caulfield & Byers, Foundry Group, Union Square Ventures, Institutional Venture Partners and Avalon Ventures.
The speculation in the industry is that Zynga is too expensive for a strategic buyer, but could raise $1 billion to $1.2 billion in an initial public offering next year, should it choose to undertake one.
Zynga Chief Executive Officer Mark Pincus told Reuters the company had no plans to go public or change ownership.
I want to build a long-term sustainable company, an Internet treasure, he said. I don't see how selling the company or taking it public would accelerate that mission now.
NO QUICK DEALS
Neither Zynga nor Playdom is under pressure to sell itself as their businesses are growing quickly, analysts say, so another social gaming deal could take time.
A good new game can add $1 million or $2 million in monthly revenue within 30 to 60 days of launch, said Jeremy Liew, managing director of venture capital firm Lightspeed Partners. These companies are growing very fast.
Playdom, which is backed by private investors, is currently generating revenue at an annualized rate of around $50 million, according to two sources familiar with the company. The company makes the Mobster series of gangster games, and it has a big presence on MySpace.
Analysts and venture capitalists cite a number of possible buyers for Playdom, but none that need to do a quick deal.
Maha Ibrahim, a general partner at Silicon Valley venture firm Canaan Partners, said Asian gaming companies Tencent Holdings Ltd (0700.HK) and Shanda Games Ltd (GAME.O) are the most likely to seek such acquisitions, but others say their expertise might not overlap.
Other potential buyers include game console makers like Nintendo Co Ltd (7974.OS) and Sony Corp (6758.T), and traditional videogame publishers like Activision Blizzard Inc (ATVI.O) or THQ Inc (THQI.O).
Investing in Web start-ups can be risky -- the Internet is littered with social networks that have fallen as quickly as they have risen, due to fickle consumers.
In the last month, Zynga has been plagued by third-party advertisers that offered players special discounts on virtual goods, only to include hidden charges or subscriptions.
Zynga, which earns up to 20 percent of revenue from such advertisers, was criticized for not moving quickly enough to resolve the problem. Facebook eventually suspended a Zynga game called FishVille because of this.
Stopping (the problem) was Priority One, Pincus told Reuters, adding that Zynga has since suspended all such offers and is developing a system to screen them in advance.
Analysts said that if Zynga smooths over the problem, there would be no long-term effects.
This 'offer' controversy is deserving of being a controversy, said Pacific Crest analyst Evan Wilson.
The problem might hurt Zynga's valuation if the company were to go public tomorrow, he added, but not over the long term.
(Reporting by David Lawsky, editing by Tiffany Wu and Lisa Von Ahn)