A lot has been and will be written about Facebook’s IPO filing but I wanted to post some thoughts on how it could affect the social game industry. Overall, I think the IPO will in the medium term have many of the same consequences that I predicted the Zynga IPO would create (my most recent post on Zynga IPO).
Valuations Will Continue to Rationalize
Facebook valuation will continue the move to rational valuations in the social gaming space. Although Facebook is likely to go public at a very aggressive valuation, the multiples will likely serve as an upper boundary for social game companies. The P-E and P-R (price to earnings and price to revenue) ratios will be the most investors or acquirers are likely to pay for social game companies (and my guess is social game companies will get a significantly lower multiple). Many are going to think that if Facebook ends up with a $100 billion valuation, how could that hurt. Where it will hurt is the social game company that is seeking a $1 billion valuation. If its revenue is not 1/100 of Facebook (about $37 million), it will be impossible to justify a higher multiple than Zuck’s team (no matter how big your next game is going to be).
Facebook May Become a Competitor
Looking at the numbers and risk factors, I now think there is a strong chance that Facebook enters the game space as a first party publisher. In the past, I had pooh-poohed the chance of Facebook becoming a gaming company as I did not feel there was an economic reason for them to. Right now they bear no development risk, get 30 percent of in app transactions, generate a high percentage of their ad revenue from game companies and serve another high percentage of ads around games. Why get into the notoriously risky and costly game business (see THQ) when they can make so much with so little risk.
First, they have to spend the up to $10 billion they raise. With all the news about federal spending and deficits, it is easy to forget how much money $10 billion actually is (or even $5 billion). For those who do not have a doctorate in mathematics, $10 billion is $100 million one hundred times. To put that into perspective, there are probably only two or three non-Asian social game companies that have $100 million in revenue. Facebook is raising the cash for a reason. Much will go to the investors and founder but the company will still have a huge cash hoard. They have shown no interest in acquiring other social networks either domestically or internationally, as they have can compete effectively without an acquisition premium. Internal development would give Facebook a way to get the games their game team keeps saying they want, new genres and HTML5 games to support its mobile initiatives.
Second, Zynga has too much leverage. A $100 billion company cannot rely on one partner for 12 percent of its revenue; it is not a smart business decision. Analysts have frequently criticized Zynga for its reliance on Facebook but it is clearly a two way street and any degradation of its relationship with Zynga would significantly impact Facebook’s numbers. Just as the market has pushed Zynga to reduce its dependence on Facebook (through mobile acquisitions, building its own portal, etc.), analysts will also push Facebook to lessen its exposure to Zynga. With $10 billion in its pocket, it would make more sense for them to create games internally instead of trading one dependency for another.
Finally, Amazon is creating a precedent of moving from a sales platform to a publisher/content creator (and in the game space, Nintendo, Sony and Microsoft have done it since day one). Amazon is wooing top authors (NY Times article on Amazon’s publishing strategy) to go directly through a flagship publishing line. If Amazon feels they can move into content creation from a distribution strategy, the team in Palo Alto is likely to see that as a sign that it can make a comparable move without alienating its social game publishers (or alienate them but not enough to lose them). It may also help that Amazon is apparently moving into social gaming itself, creating even more incentive for Facebook to invest in game development.
What The IPO Means
As I mentioned in earlier posts, I think the rationalization regarding valuations will have a great long-term impact, forcing our industry to create stronger content more efficiently. Even if Facebook enters development space itself, there should still be room for competitors. Third party games generate so much money for Facebook they are not likely to cut off or even damage significantly that revenue stream. What it probably will do is make it even more competitive to acquire and retain users. If you are creating great social games, however, people will continue to play and monetize.
