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In late 2009, video game company Electronic Arts (ERTS) bought the social network-based gaming company Playfish for approximately $300 million in cash and stock. EA has a lineup of hit video games like Madden NFL, Metal of Honor, and the Sims, to name a few. So why purchase Playfish, which specializes in developing games that are played only on social networking sites? For one thing, Playfish’s games have been installed more than 200 million times and played by millions of people worldwide. More important, players are using real-world currency to buy items in these games and are turning the market for virtual goods into a very big business. 

Consumers spent roughly $1 billion on virtual goods last year and we think that this market will grow exponentially over the next five years. Social networking platforms like Facebook are benefitting from this trend as games like FarmVille reap in profits from the sales of virtual tractors, cows, seeds and other items.  FarmVille, which is owned by Playfish rival Zynga, has over 82 million people playing worldwide at least once a month and on average has been selling 500,000 virtual tractors ($20 each) a day (compared to Deere & Company’s (DE) 2009 annual tractor sales of around 210,000 units). We think that Zynga, founded in 2007, may well post revenues of over $250 million in 2010. It’s no wonder Google recently invested over $100 million into the company.

The virtual goods market is also going mobile. Over 70 million Americans currently own smartphones and almost half of these users play mobile games. We believe that as time progresses many of these smartphone gamers will increase their purchases of virtual goods. Given the ease of purchasing these items while on the go, the typically small size of the transactions, and the swiftly growing number of online games available, it is likely that the mobile virtual goods market will top $160 million in 2010.

Using real-world cash to directly buy virtual goods is not the only option. Going through a “middle man” by purchasing virtual currency is gaining greater acceptance. In China, there is a roughly $2 billion virtual currency market and South Korea recently ruled that virtual currency is the equivalent of real-world money. Facebook is set to launch its Credits, which would be the primary medium for virtual goods transactions that are processed on its site. In addition, it plans to sell its credits at retail outlets throughout Asia and Australia. Establishing a uniform currency platform on the site is not the only incentive that is prompting this move, Facebook is also getting a 30% take from the sales. The continued growth of virtual goods sales from games like FarmVille and Pet Society, and the successful launch of newer entities such as Cameo Stars would then likely translate into a strong source of revenue for the social networking behemoth.

Although rumors have been circulating in regards to a potential IPO of Zynga, the company has, at this point, denied these reports. Given that there is a very grey area when it comes to virtual currency (issues of regulation, taxation, black markets, hacking, and money laundering have been on the rise) and bourgeoning virtual economies, investors may be somewhat tepid to park their funds in these companies. The purchase of Playfish by Electronic Arts and the likely move by many other video gaming companies to extend their reach into the virtual goods arena may provide a more secure entryway to building equity in this growing space. Indeed, investors may be more at ease buying shares in EA, Sony (SNE), and Activision Blizzard (ATVI) given their track records and more diversified product lineups. All told, the explosive growth of the global virtual goods marketplace over the past few years appears to indicate that this is more than just a short-lived phenomenon.