As new technologies emerge, they often lead to big changes in gaming. Back in 2003 to 2005, mobile games turned into a high-growth category as cell phones became more powerful. As a result, venture capital poured into many startups, and mergers and acquisitions became common.

Realizing the importance of this business, Electronic Arts (ERTS) agreed to shell out $680 million for the leader at that time in mobile gaming, Jamdat. It looked like a frothy valuation -- in light of the company's $80 million in revenues -- but the deal was prescient. EA is now the industry's global leader, with seven of the top 11 games on the iPhone/iPod Touch platforms.

Now, there's yet another fast-growing category: social gaming. Since its start three years ago, the industry is on track to generate over $2 billion by 2012, according to research by ThinkEquity Partners. And yes, VCs are investing aggressively, and the M&A action is already heating up.

What's So Special About Social Gaming?

Simply put, a social game lives on social networks. And when it comes to social networks, the big kahuna is Facebook, by far the largest platform for these offerings. In fact, social gaming is a significant part of Facebook's revenue base.

Unlike traditional video games -- which have rich graphics and sounds -- social games are much simpler and cost less to develop. For example, it may take a couple designers two or three months to launch a game. As users try things out, the designers will then make changes. So while a traditional game may take $2 million to $3 million to create, a social network game can be made for around $100,000 to $300,000.

To boost distribution, social games are generally free. However, players often need to pay real dollars to buy advantages, such as tools and weapons. These are known as virtual goods, and so far, around 3% to 5% of social gamers pay up.

True, other forms of monetization exist, like in-game ads and special offers. However, these can be distracting to the user and may often result in trouble. That is, some of the offers have been misleading.

Interestingly, the virtual-goods market is likely to see a boost because of Facebook's rollout of its currency (called Facebook Credits). However, the company says it will take a juicy 30% of the transactions that use the virtual currency.

So what makes for an attractive buyout target? Here are some running themes so far (and it's still early in the M&A game here):
  • Hot games: With thousands of games on social networks, it's extremely difficult to stand out. So if a company has large amounts of capital, like Zynga, it can be easier to buy a hot title. For example, Zynga recently purchased Serious Business to pick up Friends for Sale, which has over 6 million monthly users.
  • Engineering talent: "This is often overlooked," said Michael Moe, CEO of ThinkEquity Partners, "but it's critical to success." Because of the money sloshing around, it's tough to attract smart teams.
  • New Segments: An acquisition can provide an entry onto another platform, such as the iPhone or even the upcoming iPad.
Let the M&A Games Begin

Zynga has shown the virtues of aggressive M&A, helping to build a base of more than 230 million monthly active users on Facebook. This is up from 30 million in April 2009. With this platform, Zynga has the ability to cross-promote new titles and turboboost the business. Just look at PetVille game. Launched in December 2009, it already has 18 million users.

More important, Zynga has been effective with its monetization strategies. According to ThinkEquity, the company generated $243 million in revenues last year and is on track for $460 million in 2010. No doubt, such growth is impossible to ignore. So late last year, EA shelled out $400 million for social game operator, Playfish.

With this move, EA has essentially validated social gaming, which means other traditional game companies are likely to rush into deals. Chance are good that foreign buyers will also jump in, such as from China. It seems clear that social games are ready to move to the next level in dealmaking.

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