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.

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

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.