An in-depth report on Playdom's financials

What's Playdom's revenue, valuation and M&A prospects?

More money is pouring into the social gaming space. Playdom announced Thursday that it's raised $33 million from Bessemer Venture Partners and Steamboat Ventures. Late Thursday, rumors swirled that Playdom was being courted by Disney for as much as $600 million.

If you want to know more about the financials of Playdom, here's the latest report by CandleStick.

Playdom is a leader in Social-Networking Games on MySpace

With over 55 million in total users on MySpace, Playdom is one of the largest developers of social
entertainment widgets and games. The company, a pure play on the social gaming segment is poised to
grow at a CAGR of 22% from 2010 to 2013 in our estimate. The widget segment, mostly aided by new
entrants should grow at 26%.

Diversified Distribution: In addition to MySpace, Playdom also has a significant presence on Facebook.
Playdom is the third biggest application developer on Facebook with 42.5 M monthly active users.
Playdom also has a few games on other social networking platforms such as Hi5, Tagged and smart
phones like iPhone. 

Valuation: We have used two methods: a) steady-state target EV/Revenue multiple, and b) comparative EV/Revenue multiple based on a peer group to arrive at a market cap of $328 million to $377 million, and an estimated price per share of $2.04 and $2.34 for common shares.  

Investment Concerns
Facebook Relationship: Playdom‟s profitability could be affected by the extent to which Facebook
credits become mandatory and the terms that Playdom is able to extract. We note that recently, Zynga
and CrowdStar entered in to a five year deal with Facebook to implement Facebook credits.
 
Competitive Landscape: Many of Playdom‟s games are similar to that of others that exist on Facebook.
The switching costs are not high for users who want to try out or migrate to alternative game providers.
Larger competitors such as Zynga have the ability to spend over $100M a year on advertisement – which
is something smaller players such as Playdom may find hard to match.  

Leader in Social-Networking Games on MySpace
With over 55 million in total users on MySpace, Playdom is one of the largest developers of social
entertainment widgets and games. The company, a pure play on the social gaming segment is poised to
grow at a CAGR of 22% from 2010 to 2013 in our estimate. The widget segment, mostly aided by new
entrants should grow at 26%.

Diversified Distribution: In addition to MySpace, Playdom also has a significant presence on Facebook.
Playdom is the third biggest application developer on Facebook with 42.5 M monthly active users. Playdom
also has a few games on other social networking platforms such as Hi5, Tagged and smart
phones like iPhone.

Valuation: We use the following methods namely a) Multiple of EV/Revenue, b) Target EV based on steady state revenues, normalized net margins, and a growth multiple to arrive at an enterprise valuation
of $328 - $377 million for Playdom.
 
(a) Multiple of EV/Revenue:  With no publicly traded companies in the widget or SNS segment, we believe a close proxy would be the publicly-traded Internet software and services companies. We have used a media EV/Revenue multiple of 3.35x, assuming long term EBITDA maring of 30% to 35% and growth rate of 16% over the next few years. Using a multiple of 3.35 x and CY11 revenue estimate of $ 98 million, we arrive at a target enterprise value of $328 million.
 
(b) Target EV based on Steady State Revenues: Appendix A details our valuation approach and the choice of our our multiple. Assuming steady state revenues of $114 million in 2012, normalized net margins of 17.5%, a growth multiple of 25, we arrive at a target enterprise value of $377 million. 
 
Investment Concerns

Facebook Relationship: Playdom‟s profitability could be affected by the extent to which Facebook credits become mandatory and the terms that Playdom is able to extract. We note that recently, Zynga and CrowdStar entered in to a five year deal with Facebook to implement Facebook credits.  
 
We estimate that Facebook is likely to take a cut of 30% of the revenues generated by virtual good sales
using Facebook Credits. However, Facebook may agree to more favorable terms for larger players and
early adopters.
 
Competitive Landscape: Many of Playdom‟s games are similar to that of others that exist on Facebook.
The switching costs are not high for users who want to try out or migrate to alternative game providers.
Larger competitors such as Zynga have the ability to spend over $100M a year on advertisement – which
is something smaller players such as Playdom may find hard to match.  
 
We believe the large ad budget has allowed Zynga to become the largest game provider on Facebook
platform. Zynga also cross promotes its new games to its existing user base. Playdom, with a much
smaller user base, may be at a competitive disadvantage for games with similar features.Even if Playdom
is able to offer a differentiated game, it is not difficult for other vendors to issue “me-too” versions.  
 
Growth in Users May Not Correlate to Revenues: Only a small fraction (about 2 - 3%, in our estimate) of users actually makes any form of payment to Playdom. As with most social networking sites, future growth
in user base could come from emerging economies, where revenue opportunity per user is often a fraction
of what it is for the US. However, supporting such a user base continues to demand constant upgrade to the company‟s infrastructure. Accordingly, we are concerned that at some point the increased capital expenditure may not result in commensurate revenue opportunity.  

Crowded Widget Space: We expect the revenue growth of the widget space to have a CAGR of over
26% for the next several years. But the industry growth is likely to come primarily from the entry of more
developers. We note that Facebook now has over a million registered developers, up from 650k only six
months ago. We expect the vast majority of these developers to have low growth rates and compete for
the same user base.

MARKET OVERVIEW  

Over 75% of the US internet users have used a web widget, sometimes unknowingly. Such applications,
which appear on many social networking sites, allow users to integrate their social experiences with their
community of friends and acquaintances. Some of the most popular widgets include music lists, videos,
photo slide shows, post-it notes and virtual pets that can be fed or dressed. 

In some cases, widgets are created and customized on another site, such as Slide or Photobucket
(owned by MySpace). The site that creates the content generates a string of software code to be copied
and pasted onto a users‟ web page. The widget code can be installed and executed without requiring
additional compilation.

The widgets usually use DHTML, JavaScript or Adobe Flash for execution. Social network companies such as Facebook and MySpace host these applications and provide the underlying platform services through special-purpose application programming interfaces. The social networks (such as MySpace or Facebook) offer hardware and software infrastructure, as well as access to the social network's end user base. This frees up the resources of the application provider to focus only on R&D. Such application providers can range from a single programmer to large established firms such as Playdom, Zynga, Slide or RockYou.

Widgets and applications account for only 5% of the total online social network advertising spending
budget. However, increasingly widgets are a key driver of traffic and time spent on a social networking
site. Widget providers can gather a variety of information about the user based on the type and frequency
of the widget usage. This should allow a potential advertiser to tailor its message to the user. Accordingly,
we expect revenue growth for widget creators to significantly outpace that of social networking sites
(Exhibit 3). We estimate that advertisers will spend $2.43 billion in 2010, up from $2.2 billion in 2009 on
social networks, a 10% increase from 2009 levels. This growth pales in comparison to the 36% year over
year growth we expect for widgets in 2010. 

We attribute the rapid revenue growth to the explosion in the number of developers as well as increasing
revenue per application. With low barriers to entry, even part time programmers can become a developer
of an application. We note that Facebook alone has over 1 million registered developers, up from 660k
registered developers only a few months ago.

Among widget makers, Zynga‟s various widgets continue to top the popularity metrics on Facebook with
over 215 million users a month. Playdom has been steadily increasing its subscription over the last few
months and has consolidated its third position in the widget developers space (Exhibit 4).  
 
We believe that the number of monthly active users to Zynga has stagnated at around 220M users. Its
actual monthly active users declined to 215M in July 2010, from 232 million in December 2009.
During the same time frame, Playdom‟s MAU has jumped to 40M users, up from 22M in December 2009.
We believe that the widget market for SNS is still in early stages of adoption and that changes over a few
months may not necessarily portend a trend. Most users often use multiple networking sites and several
widgets on each of them.

We believe that the number of monthly active users to Zynga has stagnated at around 220M users. Its
actual monthly active users declined to 215M in July 2010, from 232 million in December 2009.
During the same time frame, Playdom‟s MAU has jumped to 40M users, up from 22M in December 2009.
We believe that the widget market for SNS is still in early stages of adoption and that changes over a few
months may not necessarily portend a trend. Most users often use multiple networking sites and several
widgets on each of them.

Various versions of widgets have been in existence since the launch of GUI (graphical user interface) in
1981. The earliest form of such an application can be traced to that by Bud Tribble and Andy Hertzfeld,
who showcased a concept called "desk ornaments" for the original Macintosh operating system. These
ornaments, later renamed accessories, wrapped small computing functions such as a calculator, notepad,
or simple games within a single application.

In 1996, Netscape offered the PowerStart widget as part of its Navigator browser. Netscape PowerStart
was a personal start page application built-in to the Netscape Navigator web browser in 1996. PowerStart
gathered various pieces of information such as e-mail, stock quotes and weather reports and displayed
them in a single page. Fotki, founded in 1998, started as a site for sharing photos. It has subsequently
added other features such as video sharing, photo printing and blogging. In October 2000, Stardock
released a new GUI engine for Windows named DesktopX, a widget that displays system information
such as CPU, memory utilization, news tickers and live updates from the web. Arlo Rose and Perry Clarke
released Konfabulator for Mac OS X as a shareware project in 2003. Konfabulator was subsequently incorporated as Pixoria, which was acquired by Yahoo! in July 2005. 

M&A and partner activities

Playdom acquired two game developers - Green Patch and Trippert Labs - immediately after raising aSeries A funding of $43 M in November 2009.
 
Green Patch, based in Palo Alto, CA, was founded by David King and Ashish Dixit. Green Patch had
many popular Facebook games such as (lil) Green Patch (a garden simulation application), (lil) Blue
Cove, (lil) Eco Racer and (lil) Farm Life, a virtual farming game which has many similarities with Zynga‟s
FarmVille and other farming games on Facebook.  
 
Even though Playdom had managed to launch several games on Facebook, it had not achieved the same
success as it had on MySpace. With nine popular gaming applications on Facebook, totaling over 8M
monthly active users, Green Patch had developed a strong player community. The acquisition of Green
Patch helped catapult Playdom to the ninth spot on Facebook in terms of monthly active users. The
acquisition of Green Patch helped Playdom increase its monthly active users from 14.7 M to 22.8M.   
Trippert Labs is a game developer for iPhone platform. The company‟s popular games include MobRacer,
The Godfather II Crime Rings, Fighter Jets, Armada and Bug Olympics. 

Playdom had entered the iPhone space in July 2009 with the launch of a mobile edition of its game Mobsters (which is popular on both MySpace and Facebook). We believe Trippert Labs brings a large
iPhone user base to Playdom. Green Patch and Trippert Labs continue to exist as studios in the company.  

Playdom acquired Facebook game developer Offbeat Creations in March 2010. Offbeat Creations has
developed popular applications such as Super Farkle, Be A tycoon, Give A Heart, Chug It! and Ad Food
Fling!. Of these, only Super Farkle had meaningful traction with 1.03 M monthly active users. Playdom  derives nearly 90% of its revenues from sale of virtual goods. Playdom entered in to a partnership with pre-paid card provider InComm to allow its users to buy virtual currency at retail outlets.

In March 2010, Playdom started accepting Facebook‟s virtual currency for its game “Tiki Resort”. The
Facebook Credit system replaced Gems in Tiki Resort.

Playdom invested $ 5 M in Argentina based MetroGames in March 2010 as a part of its plan to expand its
user base and offerings on Facebook. MetroGames is based in Buenos Aires and has 30 applications
launched on Facebook.

In April 2010, Playdom acquired Buenos Aires based social game company Three Melons which was
popular for its Facebook soccer application Bola. Three Melons, founded in 2005 with a capital of $150k,
is known for its Daiquiri technology, a game engine that makes 2D with flash appear three-dimensional.

In May 2010, ESPN entered in to a two year agreement with Playdom for building social games. The
agreement is to launch two games initially, and to expand to more later. The future games (launched as
part of this partnership) will either allow players to build their own sports franchise or create a game
similar to FarmVille.

Also in May 2010, Playdom entered in to a partnership with Moblyng for launching its games on webOS,
Symbian, Blackberry and Android. So far, Playdom had launched games only on iPhone. As a result of
this partnership, Playdom games such as Mobsters and Sorority Life should get a wider mobile audience.  
The company made three acquisitions in May 2010 – Merscom, Acclaim Games and 2Moons. All these
acquisitions were for less than a few million dollars apiece, in our estimate.

Merscom makes games for big brands such as Sea World, Purina, National Geographic and NBC
Universal. Playdom plans to leverage Merscom‟s expertise in working with brand owners. Acclaim Games
is a social game publisher known for RockFree (a guitar game similar to Guitar Hero) and its reputation in
the casual and MMORPG gaming space. Acclaim Games has more than 15 million registered users.
2Moons is the North American version of the free Asian MMORPG video game Dekaron published by
GameHi. 

In June 2010, Playdom acquired Hive7.com, a California based social gaming company. Founded in
2005, Hive7.com is a game developer on Facebook and other social networks. Hive7.com is best known
for Knighthood, a medieval theme game of combat and diplomacy and other games such as Youtopia,
Kick-Off and Sindicate.

Playdom acquired Metaplace in July 2010. Initially, Metaplace created tools that let users build their own
small virtual worlds within a larger virtual world. But Metaplace did not achieve much traction with this
approach.

Later, the company started offering social games and launched titles such as Island Life and My Vineyard
earlier this year. With this acquisition, Metaplace‟s social game engine will become a key part of
Playdom‟s unified back-end technology for a variety of games.

Financials and valuations

Playdom‟s games are free to play. Playdom derives its revenue through virtual goods, in-game
advertising and lead generation.  

Virtual Goods

Although the company is the leading player on MySpace with 55 M total users and seventh biggest
application developer on Facebook with 29 M monthly active users, only a tiny fraction, less than 1% in
our estimate, consistently make purchases of virtual goods. Playdom derives nearly 90% of its revenue
from sale of virtual goods.

Direct payments for virtual goods (using virtual currencies) account for 70% the Playdom‟s overall
revenues in 2010, up from 30% in 2008. Playdom also earns revenues through lead generation during
games, which accounts for the 20% of overall revenues.

The virtual goods are accessories for the games that can enhance a player‟s capabilities. For instance, a
tractor or high yield seeds could be a useful accessory for a farmer in (Lil) Farm Life. In Mobsters, the
accessory could be higher performance guns or hot cars. All these accessories can be purchased
through Playdom‟s virtual currency. Players can also earn points by completing missions and then use
these points to buy virtual goods such as weapon upgrades in games like Mobsters.

Each game has its own virtual currency that can be used only for that game or the social network on
which the game is played. For instance, Playdom uses hi5 coins for its game Poker Palace on hi5 social
network. In March 2010, Playdom adopted the Facebook Credit System for all virtual currency
transactions on its game Tiki Resort on Facebook. We expect virtual goods sales to dominate the
company‟s revenue mix for the foreseeable future.  
 
Lead Generation (or Offers Marketing)

Players can also earn virtual currency by signing up for offers (that are made by lead generation firms).
We estimate that Playdom gets nearly 20% of its revenues from lead generation through reputable firms
such as Netflix and has banned firms which make money through scam offers such as mobile
subscription from all its games.

In Game Ads

Majority of Playdom users never make a purchase and the company monetizes them through in game
advertisements that appear during a game session. Such ad dollars contribute in our estimate to 10% of
the company‟s 2010 revenues.

Playdom has an analytics platform for creating and improving its games. Nearly 10% of the product
development cost goes in to the original development of the game and nearly 90% of the cost is directed
towards improving the game by adding new features based on the feedback provided by the players.

M and A Transaction Analysis:
 
In this section we look at the valuation metrics of acquisitions, mergers and IPOs for comparable
companies, to provide a sense of what the market is willing to pay for these securities.