ZYNGA: Onoine Games Get More $$ and a New Deal Structure.

Summary: The New York Times today reported yet another investment in online games, this time with an interesting structural twist. http://www.nytimes.com/2009/12/16/technology/internet/16game.html. Digital Sky Technologies, from Russia, made yet another investment in the online world, after its $200 million investment earlier this year in Facebook.  They are leading a group that will invest $180 million in Zynga, purveyor of wildly popular Facebook games like Mafia Wars.  (Venture investors had already invested about $39 million in Zynga.)  This deal follows EA’s acquisition of Zynga’s competitor, Playfish, for $300 million.

Most interesting is the deal structure.  While it is similar to the deal cut with Facebook, it vastly differs from the usual venture investment.  DST bought common stock from employees and, in spite of the size of its investment, did not request a seat on the board.  In addition, we see the virtual micropayment model as something that could be applied in online “rental” of digital content—itself a potentially large market. Once users get accustomed to paying for virtual tools, they may be willing to pay for digital content.

The Details.

Digital Sky Technologies, a Russian investment company known for its patience with its investments, has done it again.  After stunning the world with its investment in Facebook in the middle of 2009, DST has just announced that it will lead an investment team that will invest $180 million in Zynga, a recent startup that has seen explosive revenue growth from its online games such as Farmville and Mafia Wars.  Marc Andreesen’s fund, Andreesen Horowitz, and Tiger Global are part of that team.

The Deal Itself. What struck us was the deal structure.  Normally, venture investors receive preferred stock that comes with substantial controls on the future of the company.  DST plays by different rules.  They buy commonand preferred stock.  Moreover, they are buying Zynga’s common stock from existing employees.  And, they have chosen not to take a seat on the board.

Such investors usually expect a return—either through an IPO or a sale of the company—in a relatively short period.  Evidently, DST differs;  they are said to be patient with their investments.  Given that DST does not have any limited partners with their own short-term needs for returns, it looks like a good move.

So What?

It looks like a prescient move by DST.  Zynga’s annual revenues were reported at $250 million, coming from the online game players purchasing virtual products with real money.  This model has been astoundingly successful elsewhere in the world, most notably China and other parts of Asia.  People playing these games seem willing to fork out a few bucks here and there to buy a virtual tractor or seeds for their online garden.  A few dollars here , a few dollars there and pretty soon you are talking real money.  $250 million and growing.

We also like Zynga’s space.  The model for these types of games has been around for a long time:  Think Sim City.  So also has the virtual economy, fueled by micropayments for virtual goods:  Think SecondLife.  The virtual micropayment model has proven to be a durable and sensible model in China for quite some time.

Sure, such games are subject to potentially fickle behavior of online users.  If Facebook loses its “cool” factor, the decline in online usage could hit Zynga.  No doubt user growth will taper off with Facebook (what is it now?  In excess of 360 million?) but it will take awhile for the user base to decline in any significant way.  Plus, those users might become accustomed to such micropayments, which behavior could then translate to increased revenue for digital content providers.  Hello, newspapers and magazines!

James C. Roberts III

http://www.globalcaplaw.com