At home, Peter VanRysdam rocks out to Guitar Hero on Microsoft's (MSFT) Xbox 360. But while he's on break at work, the 31-year-old marketing executive from Gainesville, Fla., gets his gaming fix from Word Challenge, a basic word puzzle game he can play against friends on Facebook. "I'm usually eating lunch at my desk and I'll open that up just for fun," says VanRysdam. Electronic Arts (ERTS) had gamers like VanRysdam in mind when on Nov. 9 it announced plans to buy Playfish, the London startup behind Word Challenge and other online games. The deal, valued at $300 million in cash and stock plus as much as $100 million for meeting undisclosed growth objectives, underscores booming demand for online social games, a business that is just two years old and already thought to be worth more than $700 million a year. Amid a slowdown in sales of traditional console games, other game publishers may follow EA's lead and try to expand in online social gaming, possibly through acquisitions. Double-Digit Revenue DropConsumers are increasingly turning away from costly, packaged games for the PC and consoles like Microsoft's Xbox and Sony's (SNE) PlayStation as they spend more time playing games on social networks and downloadable applications sold through such Web storefronts as Apple's (AAPL) App Store. "Probably two of the most impactful things that have hit our business over the last 12 to 18 months have been the emergence of Facebook and the [Apple] App Store," says Barry Cottle, general manager of EA Interactive. Playfish will join the growing digital unit of EA that also houses Pogo.com, the casual game maker it bought in 2001, as well as JAMDAT, the mobile game maker it acquired in 2005. Just how bad EA is hurting was made plain the day it announced the Playfish deal. Redwood City (Calif.)-based EA reported a net loss of $391 million in its fiscal second quarter as revenue dropped 12% to $788 million. EA also said it will eliminate 1,500 jobs, or 17% of its workforce, and drop 10 of its poor-performing games by March 2010 in an effort to cut costs. Rival publishers in video games are also making moves into online social games. In July, Ubisoft (UBIP.PA) launched Ubifriends, a portal for users to play games on Facebook. "We go where the players are," says Omar Abdelwahed, producer at Ubisoft. Activision Blizzard (ATVI) set up a Facebook page for its Guitar Hero game that has attracted more than 1 million fans. Selling Virtual Goods Is KeyWhile such efforts generate buzz, they have yet to contribute substantial profits to any traditional game publisher. "I don't know that it's going to add significant profits in the near term, but it does give a window into social gaming and how those approaches of driving adoption of games might also work for PC and console games," says Lewis Ward, research manager of gaming at IDC. Social games try to generate revenue in part by selling so-called virtual goods, such as custom avatars for their digital personas. Analysts say Playfish generates more than $75 million in revenues, mainly on virtual goods. One of its top rivals, Zynga, has revenue of more than $100 million. In the next year, the industry could be worth $2 billion, says Atul Bagga, an analyst with investment bank ThinkEquity. "We're a small, growing company compared to EA, which dominates so many hardware platforms," says Sebastien de Halleux, Playfish's co-founder and chief operating officer. "This deal is all about accelerating." Another social gaming company that may find itself in the crosshairs of an acquirer is Playdom, run by former EA chief operating officer John Pleasants. "Given the exponential growth of social gaming, I would expect the whole industry has taken note" of the trend, he says. "All gaming companies likely see the power in this model." Look for More VC InvestmentMeanwhile, San Francisco-based Zynga may be hoping for a share sale rather than a takeover. "Zynga will probably go public," says ThinkEquity's Bagga. Based on the valuation of Playfish, which claims 60,000 active users, Zynga could already be worth more than $1 billion, he says. "They are too big to get acquired." Meantime, venture capital firms are likely to take the sale of Playfish as a sign to invest more and contribute to further innovation in the space. "Online gaming startups are much more attractive to VCs than the traditional gaming model," says Ben Holmes, partner at Index Ventures, which along with Accel Partners invested in Playfish in October 2008. "The risk is lower, the budget to produce the games is in much more reasonable amounts, and you get to see early traction of a product before you have to invest more heavily."
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