DEEP DIVE: Here’s What EA’s Lawsuit Against Zynga Really Means

The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities. 

On Friday, Electronic Arts (NASDAQ:EA) filed a federal lawsuit against Zynga (NASDAQ:ZNGA) claiming misappropriation of valuable intellectual property by Zynga.  The 50-page complaint alleges, among other things, that Zynga’s recently-launched game, The Ville, misappropriated characters, mimicked art, and copied many concepts from EA’s copyrighted and trademarked The Sims franchise, and alleges direct copying of many aspects of EA’s The Sims Social Facebook (NASDAQ:FB) game.  The complaint specifically mentions Zynga’s access to proprietary and confidential information, allegedly obtained through the hiring of key former EA executives John Schappert, Jeff Karp and Barry Cottle, although none of the three executives are named as defendants in the lawsuit, nor is any specific wrongdoing alleged by any of them.

Many specific items were allegedly copied from The Sims Social, including the exact colors for skin tones, the same ratio of home height to floor width, refrigerator dimensions, yoga mat patterns, etc. While some of the items alleged appear somewhat generic and trivial to us (“zzz” indicating sleep, for example), the sheer number of items alleged to have been copied suggests to us that EA is deadly serious about seeking injunctive relief, and potentially damages.

It is not clear to us that the mere emulation of a game concept constitutes a copyright infringement.  The concept of The Sims is life simulation, so eating, sleeping, home improvement, dating, breaking up, earning money, etc. all are ordinary activities engaged in by most people.  We believe that emulation of a life simulation game, in and of itself, would not ordinarily give rise to a successful lawsuit.  For example, EA’s own Medal of Honor franchise was emulated by Activision’s (NASDAQ:ATVI) Call of Duty franchise, and the initial developers of the latter franchise worked on the immediately past version of the former before going to work for Activision.  EA did not seek to stop Activision from emulating its World War II military shooter game, as it apparently understood that games based upon real-life events that were in the public domain were difficult to copyright and protect.  Activision’s game was sufficiently different from EA’s that a lawsuit was unlikely to prevail.  The same reasoning leads us to conclude that the mere emulation of a life simulation game would be insufficient, in and of itself, to result in successful lawsuit.

The suit alleges willful infringement of EA’s copyrights, and alleges that EA has suffered from and will continue to suffer irreparable damage unless Zynga is enjoined from continuing to infringe upon EA’s copyrights. In English, this means that EA is asking the court to force Zynga to shut down its game.  The suit also requests damages totaling all profits Zynga has earned from the game, plus attorney’s fees and other costs.  EA demanded a jury trial, suggesting that this suit may not be resolved for several years.

In our view, this is a close call.  Many of EA’s allegations have a ring of truth, while others appear harmless.  We agree that the direct copying of skin tone colors, for example, is a likely copyright infringement, but think that such items are easily remedied.  On the other hand, the copying of refrigerator dimensions appears quite harmless to us.  We think that Zynga is likely to change many aspects of its game over the next several months, shifting its game presentation to make it different from the presentation in The Sims Social.  However, EA will likely allege that the damage has already been done.

We are convinced that EA will press on with this lawsuit until it receives a jury verdict, and we think that sufficient controversy over the facts exists to preclude a grant of summary judgment. It is our opinion that the two companies will remain adversaries for the next several years over this case, and we do not expect the case to be resolved for several years.  In the meantime, it is difficult to assess the likelihood that EA will receive significant damages, and equally likely to assess the likelihood that Zynga will be required to shut down its game.  This case reminds us of the “Barbie vs. Bratz” case, which has dragged on for seven years without resolution.  Copyright infringement cases are complex, and it is exceedingly difficult for plaintiffs to prove that defendants misappropriated their ides.  Even if misappropriation is proved, juries may declare “no harm, no foul”.  This case is likely to drag on for quite some time, and it is difficult to assess the impact on either EA or Zynga.  As we do not expect a resolution prior to the end of 2013, our estimates for both EA and Zynga will remain unchanged for the time being.

Michael Pachter is an analyst at Wedbush Securities.