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The fad of the day is social and mobile gaming, and investors are more than a little fired up over the upcoming IPO of Zynga. While some people dread seeing notifications from games their friends are playing on platforms like Facebook, others cannot get enough of them and buy smartphones and tablets, in part on their ability to support gaming. Not wanting to get left behind, Electronic Arts (Nasdaq:ERTS) is making a major financial commitment to becoming a player in this space.

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The Latest Deal

Electronic Arts announced Tuesday night that it would acquire PopCap Games, publisher of games like Plants vs. Zombies and Bejeweled, in a cash-and-stock deal. Electronic Arts will be paying $650 million in cash and $100 million in stock up front for the privately held Seattle-based game company. But scaled earn-outs could push the total deal price north of $1.3 billion if PopCap delivers cumulative two-year operating income of over $343 million.

Any way you slice it, this is a rich valuation on the fundamentals. PopCap does boast over 150 million installed games, but it produced about $100 million in revenue last year (though reportedly with a growth rate in the vicinity of 40%). To the extent that traditional game publishers like Electronic Arts, Activision Blizzard (Nasdaq:ATVI) or Take-Two (Nasdaq:TTWO) are comparables, the 7.5 times trailing sales that Electronic Arts is paying (just based upon upfront consideration) is about triple the going rate.

Price, Value and Relative Value

It will not be altogether surprising to see Electronic Arts' deal look like a relative bargain soon. Zynga's IPO valuation is being talked about in a $15 billion to $20 billion range, while annualizing the company's last quarterly revenue result would result in a $940 million figure (and a price-sales ratio of 21 at the high end).

It will also not be surprising to hear about how this isn't a bubble, how the valuations aren't outrageous, and how those who point to those issues are hopelessly out of touch. Then again, a few investors still remember the "valuations don't matter" days of Internet and e-commerce IPOs during the tech bubble and how that all worked out. That could be especially relevant, considering that Zynga does not look as profitable as you might think it should given the advantages of its business model.

One Of Many, But Will It Work?

By no means is this Electronic Arts' only foray into social/mobile gaming. ERTS bought Chillingo in October 2010, Firemint in May of this year, and shelled out $375 million (including all incentives) for Playfish a couple of years ago. And Electronic Arts is not alone - Disney (NYSE:DIS) shelled out $763 million (again including a full earn-out) for Playdom back in 2010.

Time will tell, though, how many ultimate winners there can be in this new gaming format. MMORPGs were all the rage a few years ago, but it seems only Activision Blizzard has really made a lot of money from them, and many others have failed. To be fair, that's referring primarily to North America. Companies like Netease (Nasdaq:NTES), Shanda (Nasdaq:SNDA), Tencent (OTCBB:TCEHY) and The9 (Nasdaq:NCTY) have had a very different experience in China.

The risk, then, is that Electronic Arts has spent over $1 billion for a collection of businesses that may never be as profitable as EA's old business, may have only the thinnest of moats, and may be vulnerable to the vagaries of whether Facebook, Renren (Nasdaq:RENN), Google (Nasdaq:GOOG) and Apple (Nasdaq:AAPL) continue to allow them on their platforms.

The Bottom Line

Time will tell whether Electronic Arts has made a savvy purchase or has simply thrown away hard-earned capital on the latest gaming fad. That skepticism aside, it seems like a gamble the company has to take. Electronic Arts was once a force in PC gaming and transitioned to consoles as gamers switched from desktops to Xboxes and Playstations. Likewise, this may be the beginning of another transformation in how people wish to play games.

With about half of the PopCap purchase price contingent on performance, Electronic Arts is at least making sure that PopCap has to justify its existence to some point. What's more, the company should now be able to tie into some of the value that will be assigned to Zynga; it is only a matter of time before some analyst says "Zynga is worth X, so on that basis EA is worth Y." Electronic Arts looked like a value back in May, and while some people will probably chastise the company for overpaying and/or "wasting" money it could give back to shareholders, this acquisition may just be the sort of deal that allows EA to play in the third era of electronic gaming. (For related reading, also check out Summer's Hottest Upcoming IPOs.)

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