Late Tuesday evening it became official: Electronic Arts agreed to acquire PopCap Games, a Seattle-based maker of casual games like Plants vs. Zombies and Bejeweled. The deal is valued at upwards of $1.3 billion, including $750 million up-front ($650m in cash) and up to $550 million in multi-year earn-outs based on financial milestones. The PopCap transaction is expected to close in August. EA is investing more in digital content as customers are buying fewer games on discs to play on consoles. Video game companies are now offering users options to play free or low-priced games on mobile devices, PCs and Facebook. EA’s Chief Financial Officer Eric Brown said the deal would help EA better compete with Zynga. Zynga filed with regulators on July 1 for an initial public offering of up to $1 billion.
PopCap, which is based in Seattle, has been profitable for 10 years since its founding. It makes easy-to-play games for platforms such as Facebook, RenRen, Google Android, Apple iPhone and iPad. In 2010, PopCap generated $100 million in revenue, implying an EV/Sales multiple of 13x on last year’s revenues (assuming PopCap is debt free).
Despite the lofty valuation, I found several comments that the deal will prove inexpensive for EA. “Once Zynga comes out, this acquisition is going to look like the bargain of the century,” says for example Larry Haverty, associate portfolio manager of the Gabelli Global Multimedia Trust, which owns EA shares. “Outside of Zynga, EA is going to be the only way for investors to play the casual gaming phenomenon,” Haverty added. Zynga’s IPO plans along with the acquisition of PopCap has investors searching the landscape for other hot up-and-coming video game publishers, including CrowdStar, Wooga and Badoo, said Sterne Agee analyst Arvind Bhatia. An obvious choice in this space is G5 Entertainment, listed in Sweden. Using the same valuation criteria as for PopCap (i.e. EV/Sales on last year’s revenues), G5 Entertainment is trading at a 50% discount and actually the real valuation discount is even higher as G5 is growing by more than 100% this year. Looking at the PER on 2011 EPS, the share is trading at 11.6x. Earlier this week, G5 announced that it will open an office in California, which will certainly help to put it on the map even in the US. Do I hear “takeover target”? You bet!
Further background information:
PopCap has been around since 2000, but didn’t raise outside funding until a $22.5 million investment in 2008 led by Meritech Capital Partners. CNNMoney published an edited transcript of an interview of fortune.com with Rob Ward, the Meritech partner who led the deal and sits on the PopCap board of directors. I took the liberty to post some of the highlights:
Q: Was PopCap games headed toward an IPO?
Rob Ward: The answer is yes, it absolutely was well under way. Right after we invested, they hired Bob Chamberlain as their first real CFO, and he had been CFO of Watchguard and F5 Networks and a number of big, public Seattle-area companies. Then they added Rick Fox as audit committee chair and Steve Raymond, former CEO of Tech Data, as compensation chairman. So they had made those changes to the board, and also changed auditors to get their books in order. The plan was to file for an IPO in the second half of this year, and go out in Q4 if the SEC was willing or in Q1 of next year if they were less helpful. Then they did a market check like you always do, and found themselves in a situation where they got a compelling enough offer from the right partner.
Q: PopCap CEO Dave Roberts expressed concern that the tech valuation bubble could put Popcap in the untenable position of justifying an inflated valuation in the public markets. Legitimate worry?
RW: It’s a very fair question and one we talked about a lot at PopCap board meetings and other portfolio company board meetings. How I’d frame it is: I don’t think it’s the best thing in the world to have your IPO value get ahead of the true intrinsic value of your company. IPOs are supposed to be financing events, not the end game. The problem with having your stock go from $15 to $100 in T+1 trading days is that you’ve got to bring in new employees with option pricing way out of line from where it should be. And it’s different than what existing employees have, which can create strange issues internally. The challenge is particularly tough with digital media and consumer-branded companies, because that strong retail component often drives the post-pricing pop. Ironically a lot of companies decide to have smaller deal sizes to avoid scarcity, get a good pop and trade up. I think that if you’re a recognizable consumer brand, you need to have a larger IPO to mitigate that effect. So it was absolutely a concern, but it wasn’t the overriding reason why the sale to EA is happening.
Q: So why is it happening?
RW: PopCap went out to a small handful of folks that it made sense to do a market check with, and everyone on that list either formally or informally came back at them with an offer to buy the company. It’s not really shocking, because this is one of the last great franchise companies in the casual gaming space, with some of the best brands like Bejeweled. Until now, the company had always said no to takeover offers. Sometimes it wasn’t the right cultural fit or they didn’t think the buyer had enough appreciation for great game developers or it just wasn’t the right time for PopCap. But this was a very compelling offer. Not just from a financial standpoint, but also the way that they’ll be allowed to operate inside of EA. At the end of the day, this is a great chance to build a preeminent digital gaming company across all these different distribution platforms and geographies. PopCap is about great brands and great games, which makes them a fit with EA.
Q: Well it’s clearly a strong move into digital by EA, following the Playfish purchase.
RW: I think it’s a masterstroke by [EA CEO] John Riccitiello. How many times do you see a 1.0 company turn into a 2.0 winner? It can happen, look at Apple, but it usually ends up more like Yahoo. This puts EA at the front and center of digital gaming.
Q: This deal involves a lot of earn-outs. When biotech VCs get an earn-out, they usually expect to see around 20% of it. How do you forecast a gaming earn-out?
RW: I wish I could be that formulaic. For us it’s much more deal-by-deal. One of the things that gave us a lot of comfort here was how EA dealt with other acquisitions recently, including Playfish. That deal had similar components and not only has turned into a very nice financial returns for Playfish investors, but a lot of those senior execs are still running important parts of EA’s business. So we’re banking on seeing lots of that money.