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ONLINE GAMES GET MORE MONEY AND A NEW DEAL STRUCTURE

Summary: The New York Time today reported yet another investment in online
games, this time with an interesting structural twist.
http://www.nytimes.com/2009/12/16/technology/internet/16ga
me.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 common and 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.

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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 (jcrext@globalcaplaw.com) is the Managing Partner of Global
Capital Law Group and CEO of the strategic consulting firm, Global Capital Strategic
Group. He heads the international, mergers & acquisitions and transactional practices
and the industry practices concentrating on digital, media, mobile and cleantech
technologies. He is currently involved in opening the Milan office for Global Capital.
Mr. Roberts speaks English and French. He received his JD from the University of
Chicago Law School, his MA from Stanford University and his BS from the University of
California—Berkeley.
GLOBAL CAPITAL counsels domestic and international clients on legal issues inherent in
the deployment of intellectual & financial capital—a merger or acquisition, foreign
market expansion, a strategic alliance, a digital content license, a mobile deal, foreign
and domestic labor and employment policies, starting a new entity or raising capital.
Clients range from global Fortune 100 corporations such as Deutsche Bank and News
Corporation and its subsidiaries, MySpace.com and Fox Interactive Media, to start-ups.
Industries represented include digital media, Internet, software, medical and
biotechnology, nanotechnology, consulting firms, environmental technology, advertising,
museums and other cultural institutions and manufacturing.

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