EA Bends Over for Wall Street

So in possibly related news, a few days ago EA bought Playfish for $300m, and today announced it was laying off 1500 people and killing a dozen games in development to save $100m annually.

(Longish analysis after the break.)

Let's look at this. Why did EA buy Playfish? Because EA is in what is, when you get down to it, a mature market, the packaged-goods console and PC game market. Future growth there is going to be small, or maybe even negative as digital distribution gets under way. The analysts always want to know where corporate management thinks future growth will come from, and social network games are the hot thing among commentators, VCs, and analysts at the moment. Thus EA needs to have an answer for the question "What is your social network strategy?" -- and Playfish gives them one.

I'm somewhat familiar with this field, and have some knowledge about the revenues companies like Zynga and Playdom are earning; but if you look at the top games on Facebook and Myspace, you'll see that those two companies dominate, with Playfish a distant third. And I think it's pretty obvious that a $300m valuation for Playfish is not based on current cash flow, but discounts a huge level of potential growth. Or to put it another way, the suits at EA way overpaid for the company. But they did so for a reason that makes sense to them: It gives them an answer to the analysts about where the growth is going to come from. They have their solution for the social gaming market.

This is completely of a piece with EA's previous moves in similar circumstances; they bought Jamdat for $600m in 2005; Jamdat was one of the biggest North American mobile game providers, and this let EA say it had an answer to that then-hot market. EA vastly overpaid, of course -- you don't hear them trumpeting how rapidly mobile game revenues have grown and how important they are today -- but they could hardly have paid less, given that Jamdat was already public with a high valuation. And any less impressive a move would have produced analyst skepticism.

Similarly, EA bought Mythic in 2006, for an undisclosed price (Mythic was privately and closely held), as their solution for the MMO market. And as is typical for EA takeovers of independent studios, particularly ones on the East Coast, a few years later they gutted the operation and turned it over to Bioware, another EA studio, because they were unhappy with Mythic's only-modest success with Warhammer Online. In other words, that acquisition didn't do what they hoped -- make EA a major player in the MMO space, in competition with Blizzard, Sony Online Entertainment, and NCSoft -- just as the Jamdat acquisition didn't really work, and the Playfish acquisition probably won't, either.

EA has just a terrible history of blowing moves into related markets -- starting with the acquisition of Pogo.com and the $1b loss on EA.com back in the late 90s/early 00s, a fiasco led by John Riccitiello, the very man who is now EA's CEO.

The relationship between the Playfish acquisition and the layoffs is not direct -- it's not a matter of cutting staff to pay for that acquisition. Rather, I suspect, the motivation of both moves is the same: to appeal to the analysts. Riccitiello is quoted in the Industry Gamer piece as saying "...frankly anything that doesn’t measure up to looking like it can pencil out to be in very high profit contributor and high unit seller got cut from our title slate from this point going forward." Which is completely ingenuous; he's claiming, in essence, that EA management can tell in advance whether a game will be a sales success or not, and can therefore intelligently cut the ones that won't be, and publish only those that will. This is utter nonsense; games are an entertainment medium, and the one thing we know about entertainment media is that "no one knows anything" -- that is, you never really can know what's going to hit and what isn't.

What this really portends is EA's retreat from its claim that it planned to "foster new IP" and back to its old playbook of concentrating on existing franchises and licensed crap. If you buy that the conventional market is mature and growth will come elsewhere, e.g., via Playfish, this might even make sense -- though I've argued that's a strategy unlikely to be successful for EA, given its history. Cut back in the area where growth is slow, invest in the area where it's fast.

And that, I'll bet, is the story EA is giving the analysts -- in the hope for at least a short-term stock price boost, and therefore nice paydays for EA executive with large stock option grants.

But does it make sense as a long-term business strategy? Me, I don't think the console market is going away any time soon, and by cutting (in half eventually, according to Riccitiello) the number of annual titles released, EA is essentially just sacrificing shelf-space to Activision, Ubisoft, et alia. I bet Bobby Kotick is laughing himself silly right about now.