Load up your carbines. Strap on your +2 Sword of Slicing, investors.

Electronic Arts (NASDAQ:ERTS) is taking the action market by storm. The world's biggest purveyor of electronic gaming announced its biggest acquisition ever: It's picking up VG Holding. (Did I mention that this is big?)

EA made clear its desire to ante up big bucks to capture a market "where we have not historically been strong" but "exactly where we need to be made stronger." The numbers are still a bit fuzzy, ranging from $620 million up to $860 million. Between the press releases and the conference call, here's how the deal is breaking down:

The company will pay "up to $620 million in cash," plus "up to an additional $155 million in equity" as its basic purchase price to acquire VG Holding Corp from the private equity fund Elevation Partners.

EA will loan VG $35 million to tide the firm over until the deal closes in January 2008.

Finally, EA will honor the acquired firm's employees' stock options, valued at about $50 million. Put it all together and the deal is worth at most $860 million; much of the consideration will be tied to the target company meeting certain performance goals, and be parceled out over time.

Hold up a sec. Who is VG again?
Ah, yes. A subsidiary of Elevation Partners, VG houses gaming developers BioWare and Pandemic. And while we're on the subject, alert readers will recognize the name Elevation Partners, the shop that invested $325 million in Palm (NASDAQ:PALM) back in June. It's also the place where John Riccitiello worked between his last and his current EA CEO gigs.

For this reason, when describing the acquisition, EA went to great pains to describe how Riccitiello tried to distance himself from this deal, even as he shepherded it to completion. The fact that the EA CEO stands to earn as much as $4.9 million for buying BioWare/Pandemic from his previous shop will naturally raise questions of conflict of interest. But it shouldn't.

I'll bite. Why not?
Because when you crunch the numbers, there's just no room for doubt that this deal works. It's good for the target companies. It's good for EA. And it's great for EA shareholders. Here's why:

The wow factor
In investing, there are two sides to every story. One side focuses on the "wow" factor -- all the cool stuff that a business does. The other side focuses on the "why" factor: whether something makes sense economically, earns a profit, and carries the right price. EA obviously wants to wow investors, so that's the angle it played up in yesterday's post-news conference call. Management ooh-ed and ah-ed over how BioWare and Pandemic fill out its product line-up -- which most gamers will agree leans heavily toward sports games.

Already dominant in that field of play, BioWare and Pandemic give EA significant capability in role-playing games, action, and adventure, which management says makes up about 36% of the domestic gaming market. Bioware in particular has one product, Mass Effect, due to be published by Microsoft (NASDAQ:MSFT) before year-end. It's also working on a massively multiplayer online game due in a couple of years that will give EA entrance into that exploding market.

The why factor
All of that's well and good from a touchy-feely perspective, but I have to admit -- as an investor who puts my money at risk with every share I buy -- I'm more interested in the why of this deal and whether it makes sense economically.

It does.

According to the conference call, these firms will generate combined revenues in excess of $300 million per year in fiscal 2009. Even if we take the biggest estimate of the purchase price as gospel, an $860 million price tag means EA will pay about 2.9 times forward sales for these firms (not to mention EA expects adjusted gross margins to be above 65% from BioWare/Pandemic). That's not the cheapest price in the industry. Still, after reviewing the competition, the price looks good to me.

Market Cap
($ billions)

2009 Sales
(est. $ billions)

Forward P/S

Midway (NYSE:MWY)












Activision (NASDAQ:ATVI)




Electronic Arts




Foolish takeaway
Paying 2.9 times sales means that EA gets BioWare/Pandemic at a discount to EA's own price-to-sales valuation, and matches industry-No. 2 Activision's 2.9 times multiple. But with BioWare/Pandemic commanding gross margins over 65%, it unlocks high-margin value for EA's shareholders.

Bonus takeaway
Oh yes, I almost forgot: Unmentioned in the press release and most news reports, EA gave us a bonus bit of info in its conference call. "We expect to exceed our guidance range, both for our GAAP and non-GAAP results" in Q2. Now aren't you glad you read this column?

Related Foolishness:

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.