Dreams of easy money create a risk of tough acquisitions | Opinion

If anyone is keeping score of acquisition activity around the industry this year -- and I don't doubt that quite a few people are -- then Electronic Arts boosted itself to the top of the league table this week. Following on from a $1.2 billion acquisition of Codemasters, which it snatched away from former suitor Take Two with a significantly higher offer, it's now spending $2.1 billion to buy Glu Mobile in an apparent bid to bolster its smartphone efforts.

Yet for all the billions that EA is spending in the first calendar quarter of 2021 alone, it seems unlikely that it'll end the year in pole position among the big spenders. Over the past year, hardly a week has passed without news of an acquisition. A wave of consolidation is sweeping over the games business, and it's driving deals at every level of the industry -- from batches of small studio acquisitions to multi-billion dollar mega-deals that restructure the whole competitive landscape.

Earlier this month, Simon Carless wrote an excellent breakdown of some of the different types of deals that are happening and the reasons behind them, all of which is spot-on. Stepping back a bit reveals that it's not just the games industry that's being consumed by a rush of acquisition activity. It's happening in many sectors, which speaks to Simon's point about the extremely "frothy" valuations of a lot of publicly listed companies at the moment, especially those in the tech industries.

A wave of consolidation is sweeping over the games business, and it's driving deals at every level of the industry

Whether these valuations give you shades of 1999 or not -- for my part, I don't think we're quite at the Pets.com level of idiocy that eventually resulted in the dot-com crash, but we're certainly swirling around the feedback loop that'll get us there -- their financial impact on listed companies is fairly straightforward; it puts a ton of cash into their hands, and that creates a significant degree of pressure to use that cash.

Shareholders don't like seeing money sitting fallow; you can get away with a big war-chest of largely unproductive financial assets if you're Apple or Microsoft, but for most companies a lot of cash on a balance sheet looks like a sign of poor capital allocation skills on the part of management. Moreover, these companies' valuation is largely being driven by their revenue figures, not their profitability (many of them aren't profitable at all), so an acquisition is a straightforward way to juice the revenue numbers simply by bolting another company's sales onto your own.

This factor alone explains a lot of the acquisitions that have happened in the past year -- and all the ones being teed up at the moment -- but not all of them. There are other factors driving this behaviour as well, and they deserve consideration, because the reasoning behind an acquisition has a huge bearing on the ultimate success of the merged company that it creates. The scale of the M&A activity we're now seeing will leave a mark on the industry for many years to come.

The reasoning behind an acquisition has a huge bearing on the ultimate success of the merged company that it creates

Perhaps one of the most unusual things about the acquisitions we've seen in recent years is the existence of a handful of "whale sharks" in the waters; gigantic companies that are pretty much just opening their maws and hoovering up everything they see. Tencent is the most obvious of these in the gaming space, and has rapidly ended up with a share (if not complete ownership) of a lot of the most influential companies in the sector, especially those with an interest in the online space. Softbank is another firm operating at a similar level, but it appears to have largely lost interest in games in recent years in favour of large investments in Silicon Valley "unicorns."

These are companies operating on a quite different level to even the big platform holders in our industry; they're backed, whether openly or tacitly, by sovereign wealth, and their objectives with their programs of acquisition may have as much to do with prestige and empire-building as with a direct profit motive. Their very existence and the nature of their activity poses a threat to other firms. They force other companies to also think more aggressively about acquisitions, simply because if you don't buy it now, someone else might snap it up tomorrow. That fear is exacerbated by the fact that it's effectively impossible for a normal company, no matter how large, to win a bidding war against an entity whose whole attitude to the financial side of acquisitions is so different -- so it's important to buy up any asset you might want before Tencent and its ilk come sniffing.

This creates a churn in the waters which also drives a sense of competition between companies a little lower down the chain. I don't doubt that there are ways in which Glu is a good fit for EA, for example, but I'm also pretty certain that part of the motivation for this deal was that Glu was a potential acquisition target for some of EA's rivals, which saw the company's revenues -- in an area that investors are especially fond of, smartphone titles -- as a fairly cheap bolt-on to their own. Attention in this sector will naturally now turn to Zynga, which just reported exactly the kind of numbers you'd expect from a company that's trying to present itself as a tasty acquisition target: great top-line revenue figures, but clearly being generated at the expense of any profit focus.

One wonders how long any company in the $10 billion or lower market cap range can expect to stay independent

One wonders how long any company in the $10 billion or lower market cap range can reasonably expect to stay independent in such a climate -- especially with the console platform holders also warily circling each other following Microsoft's Zenimax buy-out, which has left them (and the industry at large) trying to figure out if this generation is going to devolve into an acquisitions-for-exclusives race.

At the lower end of the acquisition spectrum, most of the activity seems to be tacitly designed to do the same thing Zynga is doing; building scale in order to present a more tempting acquisition target to even bigger fish. We're seeing several attempts at cobbling together decent-sized development and publishing operations through the amalgamation of multiple studios into one decently-sized organisation with enough revenue to be worthwhile for a bigger company trying to bolster its revenues in the next few quarters. That may seem like a cynical take on the waves of small-scale acquisition activity -- and sure, there are undoubtedly some genuinely good cultural and commercial fits within all of it -- but those are the deals that would have happened anyway.

All the others are being driven by a financial reality, which is that all that money floating around at the top of the market doesn't easily trickle down to the bottom. The acquisitions by seriously rich corporations are happening in the billion-dollar ranges, not the $10 million, $50 million or $100 million ranges. The one way to actually put yourself on that radar, then, is to group up, using a brace of smaller acquisitions to turn yourself into a tasty-looking morsel for a much bigger, wealthier firm.

Nobody knows when the flood of cash pouring into the market's tech unicorns will end, but everyone knows it has to happen eventually. That creates a deadline, albeit a very uncertain one, for companies who aren't big enough to be benefit from all that easy, frothy money just yet. If you're not big enough to get startlingly rich from a high-value acquisition by the time the music stops and the market corrects, you've probably missed the boat entirely, at least for another five to ten years.

If the short-term plan works out, well, I guess a lot of people get rich. Unfortunately, for many firms it won't work out, and the desire to look bigger and get bought up at a premium -- as understandable as it may be -- is not a good long-term reason to join together the fates of two companies. For many of them, unless they can leverage their new size into a rapid upstream buyout, the risk is that the deals being done now may end up creating unstable chimera companies, sewn together from parts that don't work terribly well alongside one another. That will have severe consequences down the line for those companies and anyone who works there.

Long after the easy money stops driving these acquisitions, the industry's landscape will look very different from top to bottom in their wake -- and many of the changes will not be for the better.