All Quiet On The Western Front: Gaming M&A May Be In A Lull As A New Generation Grows Up

When you step off the elevator into Kixeye’s new downtown San Francisco office, a guy in military fatigues has you sign an NDA. After you do (I didn’t), a receptionist with a lot of piercings takes your name, while The White Panda’s “Foolish Monsters” blares in the background. Kixeye has whale harpoons stapled to its office walls, bad oil paintings (see left), ceiling-to-floor drawings of fire-breathing dragons and jacked unicorns, a 3-D printer of questionable purpose and little desire to answer to anyone else.

All while remaining profitable, the midcore social gaming company has quintupled its headcount over the last year to more than 450 employees. The company says it has “several” times the $19 million in capital they raised stowed away in the bank.

Too expensive for acquirers and still too small and unproven for public markets, privately-held gaming companies like Kixeye are chugging along profitably and doing things their own way.

“We don’t talk about exit scenarios here. The employees are not here for that,” said Brandon Barber, who is Kixeye’s chief marketing officer. “Most people are here because they love making games and that’s what they want to do. Focusing on that stuff at this point in our trajectory is super distracting.” (If you want to know what Kixeye really thinks of everyone else in the industry, watch this video.)

Meanwhile, across the Atlantic, other privately-held gaming companies such as Finland’s Rovio and Supercell, the U.K.’s King and Germany’s Wooga are also growing profitable businesses.

Buyers Beware

That feeling is mutual on the buyers’ side too. Warner Bros said last week that it would be opening a gaming studio in San Francisco. In other words, it is choosing to build, not buy.

“Every time we looked at a company that was really interesting, we found that the price tag was more money than we thought was reasonable to pay,” said Greg Ballard, who is Warner Bros. senior vice president of digital games.

Similarly, EA is holding off after some big ticket deals in the last few years to buy Seattle’s PopCap for up to $1.3 billion.

“With regards to a large acquisition, we’re probably OK for the time being,” said Nick Earl, who oversees most of EA’s free-to-play games as a senior vice president there. “If the right deal presents itself, we would make that deal. But we’re not actively seeking it.” He said his arm of EA’s business, the All Play label, is putting more effort into a smaller number of games this year.

Likewise, Zynga’s COO David Ko emphasized a more “disciplined” approach toward acquisitions in an interview with me last month. Zynga’s shares were burned after the $180 million deal to buy Draw Something-maker OMGPOP. After some layoffs and a hard pivot to mobile platforms, Ko said the company is a lot more rigorous about what it looks for. Since OMGPOP, Zynga has only done a few talent deals with startups such as A Bit Lucky.

Basically, buyers and sellers are at odds over what these companies should be worth. Sellers want several times annualized revenues — based on the months where they have hits. Buyers have limited cash and are aware of how difficult it is to integrate acquisitions and retain talent in such a competitive market. GREE’s U.S. CEO Naoki Aoyagi told me in a panel at an event put on by investment bank Covert & Co. earlier this week that the company was much more careful about structuring retention with the $210 million deal to buy Funzio compared to the time that they spent $104 million to buy OpenFeint. He said he was much “happier” with the Funzio outcome, given that the co-founders have stayed on.

“Just a few years ago top media companies would pay high multiples for game companies on emerging platforms whose ultimate profitability was still unclear,” said Kristian Segerstrale, who just stepped down as executive vice president of EA’s digital business and came to EA through the $300 million acquisition of Playfish. “Most large media companies are still digesting past acquisitions and can simply not afford a reasonable multiple on today’s stars.”

Why Sell?

At the same time, if you can run a creative business that generates loads of cash when you have a hit, why work for anyone else?

On the back of two hit iOS games “Clash of Clans” and “Hay Day”, Finland’s Supercell is opting for a massive round of more than $100 million over acquisition conversations, sources tell me.

“There is a set of profitable, cash generating companies that feel they have a very legitimate shot at challenging the existing cadre of public game companies as the industry’s next leaders,” added Segerstrale, who didn’t comment specifically about Supercell. His early-stage firm Initial Capital is one of Supercell’s largest shareholders.

What that means is that is that the M&A market for big gaming deals might be quiet in the short-term — at least in the West. (The Japanese market is an exception with deals like GREE’s deal to buy Pokelabo, Nexon’s acquisition of Gloops and Softbank’s recent investment in Gung Ho Entertainment.)

It’s possible that the big gaming companies could start to feel comfortable with public markets in a few years, if they have a broad enough portfolio of hit franchises. Companies like San Francisco’s Kabam, Seattle’s Big Fish Games and Finland’s Rovio already regularly report basic revenue figures to generate interest — either from future public shareholders or buyers.

On top of that, it looks like this year is the first one where a single mobile game’s revenues could rival that of a traditional console blockbuster. Japan’s Gung Ho Entertainment published a financial statement a few days ago suggesting that its iOS game Puzzle & Dragons made somewhere between $62 million and 86 million, all in a single month and all from Japan. That company’s stock has surged by more than 2,000% in the last year because of that single title, and Gung Ho is now worth more than $4.8 billion, according to its market capitalization.

IPO Window Still Feels Closed

But none of these companies are going out to market now, especially considering that Zynga shares fell by almost three-quarters in the first year after the company went public.

Instead, this generation of gaming companies is biding its time, riding the wave of surging iOS and Android revenues and making sure that their businesses are more hit-proof.

“IPOs are fine, but there have also been scenarios where it was too much of a focus. Ultimately, they’ve been very destructive to companies that were doing notable and amazing things,” Barber said. “Those variables have to be weighed super carefully, so we’re not in a rush.”

King, an arcade-gaming company that started more than a decade ago, just made the leap to mobile last fall. Its game Candy Crush Saga has been competing with Supercell’s “Clash of Clans” for the top-grossing spot in the U.S. That single title blew through all of the’s company 2013 financial targets in a single month and brought them more mobile daily active users than Zynga had last quarter. They’ve quadrupled their headcount in the last two years ago, haven’t taken funding for eight and have always been profitable.

“We’re not planning to be acquired. There’s a bright future for us, whether we will do an IPO or not,” said King’s CEO Riccardo Zacconi. “We’re just working on execution.”