In 1794 Eli Whitney invented the cotton gin. If you’re a bit rusty on the American industrial revolution, Mr. Whitney’s agricultural device mechanized the arduous process of extracting cottonseeds from the plant fibers. Its promise of timesaving was revolutionary. Its simplistic design was ingenious. The cotton gin transformed the cotton industry, helping to establish it as a commodity, enabling America to emerge as a player on the world economic scene.
So what does this have to do with video game acquisitions, and more specifically to ngmoco?
While there are conflicting implications to Mr. Whitney’s invention,(1) it illustrates the principle that timesaving devices are valuable, and one of the common reasons that companies are acquired. Fast-forward two hundred and seventeen years and we realize that the video game industry faces similar challenges to Mr. Whitney’s stubbornly embedded seeds. In order to make games more profitable, publishers need to find ways of making game development more predictable, more efficient, and less expensive. When they find entities that fulfill these needs, they snatch them up quicker than a boll weevil breeding in a cotton patch.
And this surely must have been Electronic Arts’ thinking when it purchased British developer Criterion Software Development Group Ltd. in August 2004 for $68 million dollars.
In EA’s 2005 Annual Report,(2) the Criterion assets are itemized as follows:
$ 21 Current assets
$ 1 Property and equipment, net
$ 9 Acquired in-process technology
$ 23 Goodwill
$ 21 Finite-lived intangibles
$ 3 Long-term deferred tax
$ (16) Other liabilities
$ 68 Total purchase price (MILLION)
When Criterion was acquired, and with the Xbox 360 and PS3 platforms just over the horizon, EA was anticipating a substantial rise in its next generation development costs. Criterion was a proven developer of high quality racing games, including the popular Burn Out series.(3) More importantly, they owned a robust and profitable middleware solution called RenderWare. By purchasing Criterion, EA not only acquired a seasoned team of developers and management staff but a game engine they believed was capable of putting them in a strong technical position for the upcoming hardware cycles.(4) The sweetener was Criterion’s healthy royalty stream derived from over 500 middleware licensees.(5) Quite simply, EA was in the market for a gadget to make next generation games, and Criterion had a gin they were willing to sell for $68 million. In the end, it wasn’t a bad deal for either party, even though Criterion’s technology didn’t work out quite the way EA had hoped.(6)
Activision’s motivation for buying Beenox was similarly based on utility value. This thirty-person company had a keen talent for cost effectively porting console games to the PC and Macintosh platforms.(7) While the May 2004 acquisition of Quebec based Beenox went largely unnoticed by most, Beenox had created a porting machine, so to speak, and Activision wanted it. Further, because Activision typically values its acquisition targets using the present value of the expected five-year earnings/savings,(8) it strongly suggests that the acquisition price was probably in the neighborhood of $5 million dollars.
Interestingly, in the years since, Beenox has become significantly more valuable. The studio has grown to over 350 employees, and evolved into one of Activision’s most respected console development studios. There is little doubt that Activision considers the purchase of Beenox among its best business decisions.
And this brings us back to ngmoco.
As a reminder, in November of 2010 DeNA purchased ngmoco for $403 million dollars. ngmoco had a proven ability to build and publish iPhone games, but not cost-effectively. With over $40 million dollars in venture funding, they lost money in each of the two years they were in business prior to the purchase. From a utility-purchase-perspective, such as what we’ve discussed with Criterion and Beenox, the deal doesn’t make sense because it turns out that one of the primary reasons DeNA bought ngmoco was because of ngmoco’s social networking engine.(9) But in a recent interview with DeNA’s CEO, Tomoko Namba, she acknowledged that the engine wasn’t finished when they purchased the company.(10) So it raises the question of how much value was really there. For $403 million dollars, you would expect quite a bit. For that much money, you’d expect more than a prototype.
Further, Ms. Namba stated that DeNA’s purchase decision was based ngmoco’s ability to create hit iPhone games, which begs the question: what hit games? The ones they were giving away for free or the ones they lost money selling?
Electronic Arts recently purchased Angry Birds publisher Chillingo for $20 million in cash, plus incentives and earn outs, which is approximately one-twentieth the price DeNA paid for ngmoco. Chillingo is the publisher of Rovio's Angry Birds in the same way that ngmoco is the publisher of HandCircus's Rolando. With over 75 million copies of Angry Birds sold or downloaded already,(11) some would argue that Chillingo may be more successful in "creating" hits than ngmoco. Admittedly, ngmoco has published several popular iPhone games, including Rolando, Touch Pets, and Skee-Ball, but none have been as successful as Angry Birds. Further, Chillingo appears to be on somewhat of a roll, with the release of Russian developer ZeptoLab's Cut the Rope, and other popular titles. The point is that if ngmoco's purchase is based on a proven ability to create hits, then what justifies a purchase that may be up to twenty times bigger than the publisher of the best selling iPhone game?
Further, from a pure free-to-play perspective, Tapulous, creator of the hit iPhone game Tap Tap, was recently purchased by Disney for between $20-$50 million. The research firm comScore reports that Tap Tap is installed on a whopping 32% of the iPhones in the U.S. Which free-to-play ngmoco game is as popular? Yet ngmoco was sold for four to eight times more money than Tapulous.
ngmoco was bought for almost seven times the price EA paid for Criterion. They were purchased for nearly one hundred times the price Activision paid for Beenox. The disparity leaves industry experts baffled.
Eli Whitney invented the cotton gin and transformed an industry. Criterion invented a solid, dependable next generation middleware engine that helped establish an important segment of the video game industry. Beenox invented a process that made porting console games less expensive and more predictable. ngmoco did none of these things, yet the founders and venture capitalists behind them reaped significantly larger rewards. Why?
Here’s a thought: Eli Whitney not only invented the cotton gin, but went on to create one of the most successful firearm companies of the era, providing weapons to the United States government, which for the first time ever used interchangeable parts. It was a novel idea, and while the government was satisfied with Mr. Whitney’s products, they thought he was overcharging them. Whitney’s response was to show them a new way to look at the numbers, using a cutting-edge cost- accounting methodology. Surprisingly, it satisfied everyone concerned.
Perhaps ngmoco showed DeNA some sort of new-fangled accounting scheme to justify their purchase price? Unfortunately, whatever it was is a mystery to all of us simple cotton pickers.
Dan Rogers | Copyright 2011
1 Because the gin greatly improved the painfully slow process of extracting cotton seeds, it caused a substantially higher demand for slave labor to pick the raw product and therefore may have exacerbated the South’s dependence on slavery.
2 Electronic Arts 2005 Annual Report.
3 Criterion reported in 2008 that the series had sold over 15 million units. http://www.eurogamer.net/articles/new-burnout-paradise-dlc-videos
4 Larry Probst, EA’s Chairman at the time, succinctly summarized their thinking: “Criterion offers us studio talent and a proven management team, globally recognized intellectual property and technology infrastructure that will accelerate our readiness on the next generation of consoles."
5 http://www.gamespot.com/news/6104101.html. August 4, 2004.
6 One year after the purchase, EA used Epic’s Unreal engine for its Metal of Honor PS3 game, citing that RenderWare wasn’t ready. “Electronic Arts ‘Epic Deal’” Chris Morris, CNNMoney.com http://money.cnn.com/2006/08/22/commentary/column_gaming/index.htm
7 Brian Ward, Senior Vice President of worldwide Studios, Activision; GDC Canada, 2010 interview: http://www.youtube.com/watch?v=g_v2MT-Fge4
8 Dan Winters, Activision.
9 According to Tomoko Namba, CEO of DeNA, ngmoco’s in-house engine was “essential” because it allowed the development of both iOS and Android games with one platform. http://www.insidesocialgames.com/2010/10/15/dena-global-tomoko-namba-ngmoco/
10 http://www.insidesocialgames.com/2010/10/15/dena-global-tomoko-namba-ngmoco. Tomoko Namba interview quote regarding ngmoco’s engine: “We’ve taken the prototype, and we really liked it. I think it was the single biggest reason that we acquired them.”
11 http://www.wired.com/gadgetlab/2011/01/app-stars-angry-birds/2/. Chillingo is the publisher of Angry Birds. The developer is Rovio. Rovio retained the rights to Angry Birds. While I'm not convinced that the purchase of Chillingo by EA in October 2010 was justified in itself, it still illustrates the disparity in purchase price between ngmoco and Chillingo, both iPhone publishers.