Blowing Bubbles

Published as part of our sister-site GamesIndustry.biz's widely-read weekly newsletter, the GamesIndustry.biz Editorial, is a weekly dissection of an issue weighing on the minds of the people at the top of the games business. It appears on Eurogamer after it goes out to GI.biz newsletter subscribers.

By any standards, PopCap is a remarkable company. Of the many new games companies to emerge from the new social and mobile gaming scene, it's one of the only ones which manages to sustain a delicate and difficult balancing act - appealing to an enormous swathe of the mainstream, casual market while still commanding significant respect from core gamers.

In the past decade, the company has proved its ability not only to keenly and intelligently exploit its flagship franchise - Bejeweled - but also to generate new IP that's just as compelling as that original break-out hit, including Peggle, Plants Vs. Zombies and Zuma. Moreover, it seemingly effortlessly straddles the mobile and social gaming sectors, just as comfortable providing apps to iPhone users, coffee-break entertainment to Facebook users and downloadable titles on Steam for more dedicated gamers.

There's absolutely no question that PopCap is a great games company. However, if this week's rumours turn out to be correct, and the company sells for $1 billion, it will be the final confirmation of something that's been whispered for a while now - that social and mobile gaming, along with the "social internet" in general, has become a bubble market.

In the past year, company valuations in this sector have soared, and some truly eye-watering deals have gone through. Last October, Japanese mobile gaming giant DeNA paid out up to $400 million for iOS game developer ngmoco - another great company with fantastic products whose price tag raised plenty of eyebrows. Not to be outdone, DeNA's local rival GREE dropped over $100 million in cash on OpenFeint - creators of a social gaming platform for iPhone and Android.

In the west, EA paid $300 million for PlayFish last year, while Disney paid $760 million for Playdom, and has been aggressively restructuring its entire games business around the social gaming model - with mixed results.

Those are just samples of the deals we know about, because they were made in public. The biggest fish in the pond, Zynga, bears a price tag as high as $10 billion according to some valuations. It's not just in acquisitions that the figures are getting breath-takingly high, either - venture capitalists seem to have caught the fever too. Back in March, Finnish firm Rovio - a developer with only one hit to its name, even if that hit is the seemingly ubiquitous Angry Birds - took in $42 million in a funding round which even the investors admitted the company didn't actually need.

It's not just games, of course. In the wider world of the social internet, analysts mostly seemed to come around to the idea that we had entered a bubble market when Color Labs raised $41 million in first-round funding for an iPhone application which not only hadn't yet been written, but which nobody even seemed to be able to explain without resorting to buzzword-laden drivel. That's even before we start to consider the valuation of a company like Twitter - whose service is wonderful, but whose long-term plan for making money seems almost as confused and optimistic as the worst of the dot.com era hopefuls.

Yet even if the wider bubble in the social internet allows us to place the money flying around the social and mobile gaming sector into a logical context, it doesn't do anything to defuse the potential damage of an implosion. What happens when a bubble bursts in a market like this? That's predictable enough - purchasers are left holding an asset that's not worth what they paid for it, and potentially laden with debt which they took on to pay for that asset, while everyone else finds that funding dries up as investors take flight.

So who is exposed to this kind of risk? Electronic Arts, as mentioned, has a $300 million investment in PlayFish. It's no stranger to large acquisitions in this space - it paid out $680 million for mobile publisher JAMDAT back in 2005, although that's not a deal it may particularly want to be reminded of, given that it later had to knock around 50% off its valuation of the asset. Crucially, EA is also linked to the billion-dollar PopCap deal that's said to be on the table, although it's hard to say how credible that is. EA's financial position wouldn't allow it to make an acquisition on that scale easily - it could be done, of course, but it will be an immense risk for the company to swallow.

Disney has committed itself even more heavily to the space than EA, but its Playdom acquisition has been criticised on many fronts for under performing - and although the company has redoubled its commitment to a future in the social games space, it's yet to turn that commitment into any kind of leadership position. However, Disney actually isn't terribly exposed to a social gaming "bubble"; it may have paid above the odds for its investments, but it's an enormous company which can afford to swallow those losses, and the investment bubble shouldn't disguise the fact that social gaming itself is still a market with growing audience and revenues, one which a firm like Disney can ill-afford to ignore.

Beyond those two firms, others do have significant involvement in mobile gaming - Ubisoft, through GameLoft, being a great example - but have mostly avoided getting caught up in the bubble. Indeed, GameLoft CFO Alexandre de Rochefort was one of the main voices to warn of this emerging situation, earlier this year.

Instead, the investment has come heavily from VCs, and from Asia - and sometimes from both. Asian companies, both Chinese and Japanese, are very keen to invest in this market, and the Japanese firms in particular have been both spurred by the need to keep abreast of the smartphone growth that's displacing the huge "featurephone" market in their native territory, and emboldened by the historic strength of the Yen which allows overseas acquisitions to be made on the cheap, at least relatively speaking.

What happens to those companies when the confidence leaks out of the market and the bubble collapses? It's therein, I think, that the really interesting question about what this bubble actually means to the games industry starts to find some answers.

Nobody - be they a corporation or a private individual - wants to end up holding an asset that's worth far less than they paid for it, but that doesn't tell the entire story. As mentioned above, the ludicrous prices flying around in this sector disguise an underlying story that's arguably much more important - a story of immense growth in both audience and revenue, growth which doesn't justify those prices but which does certainly justify much of the interest being taken in this market.

For companies in Asia seeking to build their presence in the West, or for Western media firms determined to stay on top of developments in their sector, one could argue that social and mobile gaming acquisitions aren't really an "investment" in sense of asset growth. Yes, it would be lovely to buy an asset and watch its value swell on your balance sheet - but what's more important to these firms is to buy into a market, expanding their global or demographic presence and, crucially, denying their rivals an opportunity to do likewise.

Even once the bubble bursts, DeNA - to pick an example - will own a leading mobile developer with fantastic insight and experience in the western market. Whoever ends up buying PopCap will own a social gaming developer whose success is almost unrivalled and whose skills and experience can potentially unlock vast swathes of the marketplace. Their asset values may implode, and the markets aren't likely to like that very much, but the core reasons for the acquisitions will remain.

In other words, if you've got the money to buy, and if your business strategy requires or benefits from this kind of acquisition - then the bubble in the mobile and social markets only matters to you because it'll make it harder to make back the money you spend, but you're in this for the long term and the acquisition may still make sense. Where it matters more is to those companies and investors who are just hopping on the bandwagon because everyone else is doing it, throwing millions at companies with little IP to their name or incredibly risky business plans. Moreover, it definitely matters to companies who really don't have the money for this kind of investment, and will seriously suffer if its value collapses.

A bubble market is by no means a good thing, but equally, it's not a sign that everyone should cower and wait for the sky to fall. It simply means that companies need to be much more wary about their investments, and accept that the gambling stakes are much, much higher than usual. Mobile and social gaming is here to stay - but these valuations are not. If calm heads prevail, we can at least hope that none of the games business' great names get dragged down when the madness eventually ends.