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The Internet is awash with rumours that Playfish has been acquired by Electronic Arts for $250 million. That’s a steal for EA if it’s true.

When a company that is less than two years old is rumoured to have been sold for a quarter of a billion dollars, you have to sit up and take notice. When the acquiror is EA, a company which has sworn off making acquisitions and which recently argued that the target’s sector – social games – is over-hyped, you have to question the valuation.

So I questioned it. And I’ve concluded that the deal is a total steal for EA, for six reasons.

Social games are big and growing

Like any good former investment banker (I keep that one quiet these days), I look for evidence that the target market is big and growing. And there is no doubt that Playfish’s market fulfils both these criteria:

• Facebook has over 300 million registered users, and is still growing. It’s a fantastic place to launch games, as I argued recently in Develop. 
• The business model of most successful social games – virtual goods – is also gaining traction. Inside Social Games is forecasting US virtual good revenues to double to $1 billion in 2010, and virtual goods are already proven models in Asia and Europe (particularly Germany)
• The top games on Facebook now command audiences of 50 million unique users per month.

Although John Schappert, COO of EA, has recently argued that social gaming is as over-hyped as mobile was a few years ago (shortly before EA acquired Jamdat Mobile for $680 million in 2005, I note), that seems like an attempt to dampen down valuation expectations amongst VCs and social games companies rather than a statement that EA is not interested in the sector.

Playfish is an extremely successful games developer

Although Playfish has recently been overshadowed by the success of Zynga, it is a phenomenally successful games developer in its own right. Nearly every game it has ever launched has been in the Top 25 and it currently has 5 games in the top 25 including Pet Society (#4), Restaurant City (#7), Country Story (#13), Word Challenge (#20) and Who has the Biggest Brain (#21). These games are getting between 3 million and 18 million users each month, even the games that are more than a year old.

Playfish has lots of users

Valuing businesses based on multiples of unique users is dangerous: it lead to the over-hyped valuations that fuelled the dotcom bubble, for example (again I should know, having been an Internet equity analyst during those heady days).

Nevertheless, for fast-growing businesses where eyeballs are a key metric, they can be useful.

Playfish has 50 million monthly unique users. (I believe that these are de-duplicated users, but they may not be). On that basis, a valuation of $250 million values each user at $5. Do I think that each Playfish user is likely to have a Life Time Value (LTV) of $5.

Yes, I do.

Let’s take a hypothetical scenario. Across most web games, an average user plays for 6 months. For that user to be worth $5, they have to spend 83 cents a month each (Average Revenue Per User, or ARPU).

But the key statistic is ARPPU, or Average Revenue Per Paying User. If only 5% of players pay any money at all, they need to generate ARPPU of $16.67 per month, or a total of $100 over the six months.

While that seems a little on the high side, it excludes any ancillary revenue such as advertising, sponsorships or sales of iPhone versions, and for all I know, Playfish could be seeing conversion rates of much higher than 5% or durations of longer than 6 months. They can also migrate customers who are bored of one game onto another Playfish title, further extending the LTV.

Playfish is making a lot of money

The latest rumour that I’ve heard is that Playfish will make $75 million in revenue this year. That’s $1.50 per average monthly user in a year. Or thirteen cents a month. If we estimate that only 5% of users pay any money at all, those figures change to $30 a year or $2.50 a month. All of those figures seem eminently plausible.

Playfish has been profitable since it raised $17 million from Accel Partners in August 2008 (it has raised $21 million in total). I think that this is a decision made by the company: it could easily have spend the $17 million in marketing to compete head-on with Zynga, but seems to have preferred to focus on profitability rather than market share. This means that EA knows that it will be acquiring a business that can operate profitably, which should push the valuation up.

If both rumours are true (acquisition price of $250 million, revenues of $75 million), the deal will be valued at 3.3x revenues, which is not a crazy valuation for a fast growing, profitable and scaleable business.

Playfish has great management

Of the senior management team, I only know Kristian Segerstrale well, but he is very impressive. Not only did he ride the mobile wave (selling Macrospace to Sorrent to become Glu in 2004), he identified the new social gaming niche and launched a business to exploit it. I have only heard good things about Sebastien de Halleux. EA will be getting the benefit of an experienced management team that has innovated successfully (twice!) in emerging games platforms. That’s worth a lot of money in it’s own right.

Playfish has also managed to avoid the unseemly spats over IP infringement and copycatting that has plagued the rest of the sector. Zynga is embroiled in over 20 lawsuits (many of which it initiated), which can only be offputting to an investor/acquiror. So far, Playfish has distanced itself from that kind of behaviour, which is likely to help it fit with EA’s corporate style.

Playfish will turn the EA supertanker, and benefit from EA’s strength

EA is a big company that is striving to adapt to the new gaming reality (unlike Activision). But it’s hard, slow work to turn such a giant around.  This deal will give EA an added push, a bit like a powerful tugboat turning a supertanker in a narrow channel. And once EA sets off in the right direction, it will rapidly become a force to be reckoned with in the social gaming market. The combined entity will have some very powerful advantages:

• Marketing skills that will put Zynga to shame
• A marketing budget that will dwarf the rumoured $50 million that Zynga is spending this year
• Access to a vast portfolio of brands to move into the social space (although this is a double-edged sword for Playfish, as no established gaming brands have made the jump to social networks yet)

The deal could really focus EA’s efforts on this new space, and show that the company had understood how gamer’s habits are changing. It might take a while for the revenues and profits to reflect the new reality, but I think that this would be a great deal for EA.

Caveats

The rumours swirling around the blogosphere are based on one source and one tentative corroboration. They suggest that the deal was done weeks ago, and is likely to be announced imminently. SImilarly, all of the financial numbers in this post are sourced second- or third-hand. I think that the numbers are probably in the right ballpark but nothing in this post should be taken as firm facts until we get concrete announcements from EA or Playfish.

Conclusion

A fast growing market, a proven development studio, $75 million in revenues, 50 million users and a strong, experienced management team.

Put that lot together and you can see why I think that $250 million would be a steal.

Or have I fallen victim to the hype? Let me know what you think.

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