Once You Pop...

A couple of weeks ago, I argued that the rumoured billion-dollar acquisition of PopCap by Electronic Arts would be proof of a serious price bubble in the social gaming space - and would also be an immense risk for EA itself, whose financial position is arguably unsuited to making such an enormous investment. This week, the deal is no longer just a rumour - and although it's also no longer a billion dollar deal, the $750 million price tag attached to Popcap is almost as eye-watering.

In fact, although the headline figure is $750 million, the financial reality of the deal is a bit more complex. EA has agreed to pay $650 million in cash for PopCap, which is almost half of the company's present cash reserve (although whether it'll entirely be paid for out of that reserve and not through borrowing remains to be seen). That's topped up with $100 million in EA shares - and up to $550 million attached to an earn-out clause, whose ambitious terms may never be reached by PopCap but which could, in theory, bring the total price of the deal to $1.35 billion.

Large numbers, then - almost rivalling the sum which EA paid for Bioware and Pandemic back in 2007, and topping the amount forked over for mobile gaming business Jamdat in 2005. EA is no stranger to large acquisitions, although that's not entirely as comforting as it might seem, since it's also no stranger to large acquisitions that don't quite work out - Bioware, for example, may still be going strong as the heart of EA's core games strategy, but Pandemic, acquired at the same time, shut its doors in 2009.

The purchase of PopCap, however, has a somewhat different feel to EA's former cash-flashing forays - for the simple reason that this time, EA is a somewhat different company, and there are serious question marks over just how much cash it actually has to flash. The basic problem is this - EA still has difficulty in keeping its core business above the water line, and its operating income regularly slips into the red as a consequence. In one respect, adding PopCap - a seriously profitable business - to the mix should help with that, but it also slashes the cash reserve which has cushioned EA from taking too much damage from the costs of restructuring and repositioning its business.

It might work out, of course. PopCap might stay profitable and continue to grow at an immense pace - it might even hit the huge targets it needs to pick up its extra $550 million. In that case, EA will have won more breathing room for its core business along with a serious market share expansion in social and mobile gaming. That's the positive scenario, and it's obviously the one that executives at the firm want us all to believe in.

The risks, however, are immense. PopCap isn't a young company, admittedly - it's got a solid ten year track record behind it, and a number of successful IP launches - but it's a company whose valuation is heavily based on success on platforms that aren't exactly stable. Specifically, PopCap's income relies strongly on two external companies - Facebook, and Apple - and as such it's sensitive to risks far beyond EA's control.

This is a concern which underlies my own belief (shared with many in the industry) about the social gaming valuation bubble. "The sky could fall tomorrow" is no reason not to make an investment - unless the sky has a proven track record of crashing down, in which case it's a pretty important risk factor to consider. In the cases of Facebook and Apple, neither have proven to be particularly good pillars for holding up the sky.

Facebook, for instance, pulled the rug out from underneath many social gaming firms when it severely tightened controls on sending game-related messages around the social network - eventually restricting game invitations and requests to an easily ignored box, removing them from your social feed entirely. I realised this week that I have a stack of invites to play with friends in Zynga's Empires and Allies, a game which I've actually been intending to try out - but the invites are weeks old, and I simply didn't know they were there. Obviously enough, this has hobbled the ability of social game makers to build their audiences virally, and reduced many of the smaller firms to shuffling a slowly dwindling audience of existing customers around new title launches.

Apple, too, is no stranger to business moves which leave content providers on the App Store aghast. The most high-profile case came earlier this year, when providers of subscription-based services were told that they had to offer their subscriptions as in-app purchases, and they had to be the best price on offer anywhere - you couldn't sell the same subscription for less money on your website, for instance.

In neither of these cases did the companies involved have a particularly malicious goal in mind. Facebook's move wasn't designed to damage social gaming companies, it was designed to answer mounting user criticism of network spam caused by social games. Apple's motive, meanwhile, was certainly profit-based to some extent, but forcing price parity between in-app and out-of-app purchases, as well as declining to share users' information with publishers without opt-in consent, can both be argued to be moves that protected the interests of Apple's consumers over the interests of its content providers, just as Facebook's move was.

The point is that these are not fixed platforms - they're new, emerging businesses, and the goalposts slide around the field on an alarming basis. This is true of both mobile and social gaming, and it presents a quandry for traditional publishers. These are important fields, but they're also risky - a timid toe in the water could leave you paddling in the shallows while the rest of the industry sails off into the sunset, but dive in too deep, too soon, and the current might well sweep you away entirely.

That's the risk EA has opted to take. A string of mobile and social acquisitions, now including two market leaders in the form of Jamdat and PopCap, gives the company a huge presence in this market, and huge exposure to the inherent risks. EA's hope - and it's by no means necessarily a vain hope - is that the expertise PopCap brings with it will be significant enough to ensure that it can avoid those risks and build a profitable business despite the shifting sands underfoot.

It's worth considering, however, that EA's hand may not have been entirely free in this move. CEO John Riccitiello was careful to note, in an email to staff at the company this week, that PopCap had received bids from other firms - including other game publishers. In other words, EA's choice wasn't whether to buy PopCap or not; it was either to buy PopCap, or to see the company and its IP fall into the hands of a rival.

That's not the most logical reason to make a huge acquisition, but it's a surprisingly common factor in such cases. If ambition (or greed, if you want to throw a more negative spin on it) is a core emotion that drives business decisions, then fear is the flip-side of that coin, and fear of a powerful rival gaining serious ground over your firm is a major part of that. Even if EA couldn't really afford PopCap, the thinking would go, it could afford even less to see someone else - Activision, perhaps? - pick up the firm, and with it, a major slice of casual and mobile market share.

Regardless of the motivations behind the deal, this is a major turning point for EA - more significant even than the acquisition of Bioware shortly after Riccitiello took the helm. In fact, it's by far the most significant thing Riccitiello has done at the company - and also the most risky, which to a large extent explains its significance. If this works out as planned, it will likely propel EA back to the top of the third-party publishing league tables in the near future - and create a tough balancing act between core and social gaming at the company, which we can only hope will be managed rather better than it has been at Disney. If it doesn't work out, however, then EA itself could be on the auction block before very long.