M&A Alert - March 22, 2010
The9 Acquires Majority Interest in Red 5 Studios
Transaction Overview
On March 22, 2010 The9, Limited (NASDAQ: NCTY) announced that it has entered into a definitive investment agreement to invest a total amount of approximately US$20 million for a majority interest in Red 5 Studios, Inc.
Target Description
Red 5 Studios is an Irvine, California-based online game developer. The company was formed in 2005 by several former employees of Blizzard, the developer of the top-ranked massively multiplayer online role-playing game (MMORPG) Worlds of Warcraft. Red 5 received $18.5 million in venture investment from Sierra Ventures and Benchmark Capital in 2006. (The company is not listed under Sierra’s portfolio, and is listed as a “previous investment” for Benchmark). Red 5 reportedly had up to 100 employees at one point, although recent staffing was closer to 60. Roughly half the remaining team was dismissed in January 2010 when the company cut back spending, leaving only one ex-Blizzard staffer on board, Red 5 CEO Mark Kern. Kotaka in January reported on the company’s new focus on a MMORPG for the China market and cited rumors that The9 had made an investment at that time.
Buyer Description
The9, Limited (NASDAQ: NCTY) is a Shanghai-based online game developer and operator. The company mainly operates licensed MMORPGs and advanced casual games such as Soul of the Ultimate Nation, Granado Espada, EASports FIFA Online 2 and Atlantica for the mainland China market.
Until June 2009, the vast majority of the company’s revenues came from operating World oF Warcraft in China under license from Blizzard Entertainment. Worlds of Warcraft was contributing over $200 million in annual revenues in 2008, and The9 revenues dropped over 90 percent when the license was not renewed. The9 has been looking for new proparties to fill the gap for some time, most notably making an equity investment for a minority stake in G10 Entertainment, a game developer in Korea.
The9 has over 800 employees and reportedly has five of the ten fastest supercomputing clusters in China, built by Hewlett Packard for operating the online games for as many as a million concurrent users.
For the quarter ended September 30, 2009, The9 reported over US$250 million in cash on its balance sheet.
Transaction Parameters
The9 announced a majority investment of approximately $20 million, but the ownership percentage is unknown. It appears that prior investors were either diluted out or sold their shares.
Strategic Rationale
With the Worlds of Warcraft license, The9 held the proverbial golden goose. Losing that license left a massive hole in The9’s business, and the company is actively working on internal development and licensing to fill that gap.
Architect Partners Observations
This transaction is notable for the high valuation placed on a relatively small game developer with no properties in the market. And despite spending $20 million over four years, it appears that Red 5 has dropped the MMO first person shooter they’ve had in development and shifted to a new game more suitable for the China market.
At the same time, this deal demonstrates the huge potential scale and value of online games, especially in the Asia market.
And given their cash position (even post a recent share buyback), we expect The9 to continue to invest aggressively in game properties and internal development.